AZ to acquire BMS' diabetes business (Expanded Report) – December 20, 2013

AZ and BMS announced early Thursday that AZ will acquire BMS’ share of the two companies’ global diabetes alliance for $2.7 billion, plus up to $1.4 billion in potential milestone payments and future royalties. This means that AZ will hold the full, worldwide rights to the DPP-4 inhibitor Onglyza (saxagliptin) franchise (~$700 million in 2012 sales), the EU-approved SGLT-2 inhibitor Forxiga (dapagliflozin; no 2012 sales recorded), the GLP-1 agonist exenatide franchise (Byetta and Bydureon; ~$225 million in 2012 sales), and the insulin adjunct Symlin (pramlintide; $36 million in 2012 sales). AZ will also own, of course, the rights to the line extensions for these franchises that are in development, including the dual-chambered Bydureon pen (eliminating the need for manual reconstitution, which is a bit of a hassle) and, excitingly, fixed-dose combinations such as “saxa/dapa” and Xigduo (dapagliflozin/metformin). AZ management noted during its presentation that “saxa/dapa” in particular is a major product of interest for the company. The two companies did not have many early-stage pipeline candidates, but AZ will obtain full rights to the once-monthly Bydureon, which was a very hot drug back in the Amylin days, and the leptin analogue metreleptin, which recently received a positive FDA Advisory Committee vote for general lipodystrophy. BMS and AZ’s deal will be subject to local regulations, and is expected to be finalized and approved by 1Q14.

This move, while theoretically not very surprising given that BMS and AZ each have different views on the future of the diabetes care arena as of early November when BMS announced it would not continue with diabetes discovery, was actually pretty astounding to us. First, a major company likes BMS bids up Amylin to $7.0 billion, and then creatively finds a partner to pay for half of it. Next, it puts together its marketing organizations. Then, it announces that it cannot any longer devote resources to early-stage diabetes compounds and still feel like it is a good steward of BMS funds; basically, the uncertainty related to FDA is too much to handle, combined with payer constraints. Then, it sells the whole lot, which can’t be at a profit according to our back of the envelope math. This seems like a lot of resources to have spent on diabetes, at a loss – we would love to know what the board of directors said.

By contrast, AZ continues to list diabetes as one of its major three areas of priority. We believe AZ’s strong primary care focus and significant presence in emerging markets will serve it well; as a reminder, the incidence of diabetes is growing most rapidly in emerging markets – fully half of the 11 million newly diagnosed people with diabetes in the last year globally, for example, were from the Middle East. BMS’ “evolution”, on the other hand, has involved a pivot away from diabetes, toward narrower specialty areas such as immuno-oncology and virology. During its call, BMS conveyed a relatively gloomy outlook of the diabetes care market, which has seen significant increases in competition and challenging pricing and reimbursement pressures, prompting slower uptake of new products, according to management. Ultimately, we do agree that AZ might be the better fit for the formerly shared diabetes portfolio and we hope CEO Pascal Soriot can make this deal one of his smartest at AZ.

During AZ’s presentation, management appeared excited about the possibilities that full ownership of the diabetes portfolio could provide. For example, Mr. Soriot stated that the additional control will enable faster decision making, enhance operational effectiveness, and improve efficiency. Mr. Soriot is known to be a real powerhouse who seems to have a soft spot for diabetes (for example, he spoke on a panel at this year’s Cleveland Clinic’s Medical Innovation Summit, which was focused on diabetes and obesity), and we are eager to see how he and the rest of the AZ team will move the diabetes portfolio further without the noise of a joint venture. We hope that AZ’s new ability to make direct decisions and call all the shots will result in strong support for new diabetes drug discovery, and an emphasis on meeting particular areas of unmet need (such the developing world and drug options for type 1 diabetes).  Specifically, we hope to see more on Bydureon once-monthly; this went a bit under the radar at BMS, but the adherence benefits alone of this potential compound render it quite exciting.

1. What’s happening, exactly? AZ will acquire BMS’ half of the companies’ shared diabetes portfolio, as well as two US manufacturing facilities, for an up-front cash payment of $2.7 billion. This is to be financed from existing cash resources and credit facilities. BMS will be entitled to potential future regulatory, launch, and sales-based milestone payments of up to $1.625 billion, bringing the potential total to over $4.3 billion. BMS will also be entitled to a pre-determined percentage of royalties from 2014-2025: we explain the rather complex royalty system in more detail below. Details of the transaction can be found on the BMS site. The deal is expected to close in most geographies in 1Q14, and management did not seem worried that local regulatory authorities would oppose the transaction.

• The transaction includes the potential for substantial future milestone payments from AZ to BMS, including up to $800 million in approval milestones, up to $600 million in sales milestones, and fixed asset payments. The major approval milestone ($600 million) is for the FDA approval of the SGLT-2 inhibitor Forxiga (dapagliflozin), which is expected in 2014; the recent second FDA Advisory Committee convened for dapagliflozin voted 13-1 in favor of approval (read our report for more details), so we agree that US approval is likely this time around. A $100 million milestone is due if Forxiga is approved in Japan (where a decision is expected in 2014), and another $100 million is contingent upon the ex-US approval of a saxagliptin/dapagliflozin fixed-dose combination (the press release guides for a decision in 2016).
  
  • On the SGLT-2 competitive front, we do believe there will be a much more crowded market soon; as we understand it, BI/Lilly’s SGLT-1 submission of empagliflozin was apparently so successful that it an EMDAC advisory committee meeting will not even be required. 
• AZ will pay BMS $150 million for each of the following four sales-based milestones: (i) When cumulative US diabetes care sales reach $8.5 billion; (ii) When cumulative US diabetes care sales reach $10.5 billion; (iii) When cumulative ex-US diabetes care sales reach $6.0 billion; and (iv) When cumulative ex-US diabetes care sales reach $8.0 billion. These milestones, which rely on cumulative totals from 2015 through 2019, will be payable in 2020. If we understand the terms of this part of the agreement correctly, AZ will need to achieve average annual sales rate of $1.7 billion in the US and $1.2 billion outside the US for BMS to earn the first round of milestones, and AZ would need to achieve average annual sales of $2.1 billion in the US and $1.6 billion ex-US for BMS to earn the second round (full $600 million). Although BMS/AZ’s 2012 worldwide diabetes portfolio sales were slightly shy of $1.0 billion, and although significant growth will be needed to hit these milestones, we believe these numbers are achievable. That said, the milestones are a fair way off. We were a bit disappointed that there didn’t appear to be milestones related to, for example, hot drugs like fixed dose combinations or once-weekly Bydureon.  
• Approximately 4,000 BMS diabetes care employees will be transferred to AZ. AZ CEO Pascal Soriot charmingly welcomed these employees in his presentation (and before that, on Twitter), and we believe that integrating the teams will not be particularly difficult given that BMS and AZ’s diabetes employees were already cooperating closely and, in some cases, like marketing, were already integrated. That said, frequent reorganizations of the diabetes sales force and the acquisition of Amylin have slowed the uptake of some of BMS/AZ’s products (notably Bydureon), and this is yet another. While this new transfer itself certainly doesn’t help in this regard, we believe that AZ’s sole leadership will allow the sales force to really dig in and focus on effectively marketing the portfolio. We also hope they will work on compelling pipeline products like once-monthly Bydureon but of course they will likely need to see more sales traction first.
• The published transaction overview also includes a payment of $225 million to be made when “certain assets related to the Mt. Vernon [manufacturing] facility and [BMS’] business in China” are transferred. In addition to the Mt. Vernon plant, a facility in West Chester, Ohio is included in the agreement.
• BMS will continue to co-fund certain pre-specified ongoing clinical trials for the diabetes portfolio; the most notable trials include the EXSCEL and DECLARE-TIMI 58 cardiovascular outcomes trials for Bydureon and Forxiga, respectively. The former trial has a planned enrollment of 9,500 patients with an estimated primary completion date in 2017, and the latter has a planned enrollment of over 17,000 patients and an estimated completion date in 2019. These two trials alone will result in a sustained substantial cost for BMS to bear. However, AZ will be solely responsible for funding future clinical trials for the portfolio. BMS announced several weeks ago that it was dropping out of early-stage diabetes discovery; we wouldn’t anticipate that AZ would be taking on any more major trials in the near term and would instead hope that R&D funds (which we assume there are sum, from this $1.7 billion business) would be directed toward advancing toward later-stage products on the GLP-1 front.
• The terms of the agreement also include the provision of sales royalties to BMS from 2014 through 2025. We found the terms of the royalty payments to be surprisingly complex. The exact percentages change from year to year, and vary for Amylin and non-Amylin products. See the table below for the detailed scheme (note: Amylin ex-US sales are not subject to royalties). We were surprised that the two companies decided to disclose the royalty scheme is such great detail. It seems that for the first year, BMS will net nearly as much from sales royalties as it did with half ownership for some products, such as dapa; with other products, such as Onglyza, given that sales already exceed $500 million, the royalties actually seem on the very low side but increase over time. Onglyza royalties, for example, start at only 3%, which sounds very low; they peak at 25% in 2020, which is higher than we would have imagined they go. After 2020, they start to move down but hover in the double digits, even after DPP-4 inhibitors will likely go generic. The royalties make, of course, the relatively low sales price, sans royalties, more understandable – in short, the deal probably isn’t as cheap as it might’ve originally seemed. On the Amylin front, the royalties are a bit easier to understand; they seem to be highest when GLP-1 revenues are likely to be peaking.

Table 1: Royalties due by AZ to BMS for net sales

2. What products are included in the BMS/AZ diabetes alliance? This alliance, which started in 2007, includes the DPP-4 inhibitor Onglyza (saxagliptin) franchise (~$700 million in 2012 sales), the GLP-1 exenatide franchise (Byetta and Bydureon total ~$225 million in 2012 sales), Symlin (the insulin adjunct, pramlintide; $36 million in 2012 sales), and the EU approved SGLT-2 inhibitor Forxiga (dapagliflozin - no 2012 sales). On its conference call this morning, the AZ slide deck forecast 2012-2018 CAGRs as 10% for DPP-4 inhibitors, 19% for GLP-1, and 93% for SGLT inhibitors (presumably from a low base). Together, the products represented about $1.0 billion in sales for BMS last year and about $430 million in revenue for AZ.

• In addition to the alliance products currently on the market, AZ will own the companies’ pipeline products in diabetes. The pipeline currently includes the leptin analogue metreleptin (which recently received a positive FDA Advisory Committee vote for general lipodystrophy) and a once-monthly GLP-1 agonist candidate (phase 2). BMS/AZ has refrained from discussing the once-monthly suspension formulation since BMS’ 4Q12 update when it stated that it remains “interested” in the product but is “still working on the technical aspect of it.” More details on the development of these candidates can be found in our BMS/AZ 3Q13 full report.
• Additionally, BMS/AZ had been working improved delivery methods and formulations of its exenatide franchise. BMS/AZ were developing a Bydureon dual-chambered pen, as Bydureon currently requires reconstitution prior to injection. In the past, BMS/AZ had guided for regulatory submission of the dual-chamber pen in 3Q13 and a launch in 2014. The two companies were also developing once-weekly (advanced to phase 3 in 4Q12) and once-monthly exenatide suspension formulations that do not require reconstitution. 

3. At peak, what’s the BMS/AZ diabetes alliance franchise worth? BMS reported sales in diabetes of just a smidge under $1.0 billion in 2012 while AZ reported closer to $700 million; given the opportunity for growth, we see total peak sales much higher – well into the $3.0 - $5.0 billions of dollars range and much higher if disruptive technologies emerge from this group (better GLP-1 formulations, fixed dose combinations that AZ gets to first, fixed dose combinations that AZ gets that are superior to competitors, new diabetes drugs, etc.). 

4. What are the advantages for AZ? Company management, especially CEO Pascal Soriot, spoke at length about the reasons for the transaction during AZ’s Thursday-morning conference. Mr. Soriot outlined five principal drivers behind the deal, from AZ’s perspective:

• Diabetes is a key growth platform for AZ – a point AZ has reaffirmed in multiple quarterly presentations, including their 2Q13 update.
• AZ has a core capability in primary care promotion, as well as a strong presence in emerging and developed markets. Mr. Soriot’s presentation began by noting that an estimated two-thirds of diabetes patients are living in emerging markets, and he characterized AZ’s asymmetric excitement about the potential and unmet need in emerging markets as one of the drivers of the deal. Management noted during Q&A that AZ has an interest in bolstering its diabetes sales force in countries such as China, and will no longer be restricted by the requirement to match marketing contributions with BMS.
• AZ will now have greater control over its diabetes portfolio. The reduction in management friction and “noise” from the previous joint venture should allow for faster decision-making and greater operational effectiveness and efficiency, according to AZ. The increased flexibility should allow AZ to more effectively seize opportunities, as well as adapt to changes in the increasingly competitive diabetes market.
  
  • AZ seems particularly excited about the possibility for diabetes fixed-dose combinations (FDCs). Management characterized the “saxa/dapa” FDC (combining saxagliptin and dapagliflozin) as a key line extension for the diabetes portfolio. We see combinations of SGLT-2 inhibitors and DPP-4 inhibitors (both of which are generally once-daily tablets) as a bright rising star in the type 2 diabetes care arena. BI/Lilly have also expressed enthusiasm for their proposed FDC of the DPP-4 inhibitor Tradjenta (linagliptin) and the SGLT-2 inhibitor empagliflozin. When asked about the reimbursement challenges the company has experienced in Europe (BMS/AZ recently announced a decision to withdraw Forxiga from the German market after a failure to agree on reimbursement; read our report), management commented that it expects FDCs to be a major factor in the company’s fight to secure better reimbursement.            
• AZ can apply its lean manufacturing strategy (which focuses on reducing waste and improving efficiency in manufacturing) to the full drug production process, which has the potential to cut costs.
• The company sees diabetes as a way to rapidly return to growth, an important goal for the company given setbacks in diabetes and other areas in recent years.

5. Why did BMS agree to sell its share? Even until last year, BMS made aggressive efforts to stay competitive in the diabetes care arena, co-purchasing Amylin in a deal worth $7 billion (read our report on that deal for more details). As an aside, Amylin’s value has fallen substantially since the acquisition due to the pancreatitis scare and product delays. In recent months, BMS has embarked on an “evolution” (read: refocusing) of its priorities away from disease areas such as diabetes, towards specialty areas such as immuno-oncology. Last month, BMS announced its decision to end early-phase research in diabetes — read our report on that announcement for more details. That decision slightly softened the impact of today’s news, as in recent weeks, some analysts had speculated that BMS might consider divesting some of its diabetes alliance share.

• During the BMS call, management painted a rather gloomy picture of the diabetes market. Citing significant recent increases in competition and pricing pressures, as well as relatively slow uptake of new medicines, CEO Mr. Lamberto Andreotti stated that diabetes was not as attractive a proposition for BMS as were other areas such as immuno-oncology. He stated that the company’s view of the diabetes market had changed significantly since the company’s co-acquisition of Amylin.

6. What’s the net impact? We are sorry to see BMS completely exit the diabetes care arena, which is in desperate need of more innovation. That being said, we are cautiously optimistic about the potential of sole AZ ownership of a major portfolio of products. Indeed, if the BMS/AZ portfolio had to be “owned” by either BMS or AZ, we’d rather AZ own it since it is a major focus there, along with cardiology/metabolic disease, cancer, and respiratory/inflammation, and is a declining focus at BMS. Sole ownership should also provide a clearer path to execution, and eliminate the noise and mess involved in joint ventures. We look forward to seeing how AZ takes advantage of its opportunities to make more direct decisions, call the shots, and make the plays. 

• We see AZ’s CEO, Mr. Pascal Soriot, as a real powerhouse. He was in a very senior role at Genentech following Roche’s $47 billion acquisition of Genentech and won strong reviews for integrating Genentech and Roche Pharma; indeed, integrating BMS and AZ may seem like a bit of a cakewalk, particularly since the two units are already working together. Soriot was presumably brought into AZ to address a range of challenges (declining businesses, generic drugs) and integration of the two units that are already working so well together is probably not a worry; indeed, for him to be able to put together the groups is probably something he sees as a major opportunity. Mr. Soriot is said to have a soft spot for diabetes and we’re thrilled he won’t have to live with the noise of the JV and execution will be really up to one company. As a reminder, at Roche Pharma, Soriot was very familiar with diabetes, having developed Roche’s GLP-1 taspoglutide all those years ago. As a reminder, taspoglutide provided superior A1c reductions compared to Byetta (a 2012 Diabetes Care study showed a reduction of -1.3% from a baseline of 8.1%) but had unacceptable GI side effects, the main reason Roche dropped the drug, as we understand it.

7. What are the biggest risks?

• Pricing pressure (DPP-4s have seen a lot of pressure recently with very sizable rebates); 
• Revenue pressure (AZ has a huge decline in revenues for major patent expirations - diabetes will be a big area of growth opportunity); 
• Product uncertainty (branded fixed dose combinations represent a big hope but they haven’t been created yet in diabetes - can they move the dial on adherence?);
• Safety uncertainty (how will Forxiga’s safety label will look in the US, particularly in terms of the potential bladder cancer signal)
• Competition (Is an insulin partner important?)
• The usual other elements of regulatory and reimbursement risk. 

8. Our questions:

• When will we actually see the Bydureon dual-chambered pen? It was good to hear commentary from AZ management that development is still underway, but we had hoped to see this product (which will greatly improve ease of administration) much earlier.
• What should we expect in the once-weekly GLP-1 competitive landscape, when Lilly/BI, Novo Nordisk, GSK, and Sanofi/Zealand have products on the market in the US (where most profitability is associated)? Hopes were initially high for Bydureon, the first once-weekly GLP-1 agonist to market, but the acquisition of Amylin and frequent sales force reorganizations has resulted in poor uptake. Will AZ be able to regain the lost momentum?
• How much integration is left? As we reported earlier this year, AstraZeneca and BMS have already merged their diabetes marketing teams and have relocated the combined sales force to a new US headquarters outside of Philadelphia. That said, there is still presumably many still to come and integration left to do. Said Soriot on Twitter earlier today: "Soriot: I extend a warm welcome to the BMS people who are due to join us. My colleagues and I look forward to working with them.”  
• How will AZ maximize marketing potential? The BMS/AZ sales force began promoting the entire diabetes portfolio in October 2012, after acquiring Byetta and Bydureon through BMS/AZ's June 2012 acquisition of Amylin; while BMS/AZ had highlighted their plan to promote all diabetes products together, AZ management had also noted that BMS/AZ may allocate single products to separate sales forces.
• How much will AZ invest in early-stage research and discovery work in diabetes? The company appears to aggressively be looking to build its pipeline, which bodes well in this regard.
• How much R&D will be done in the US vs. Cambridge, England, where worldwide HQ and R&D lives?

-- by Manu Venkat, Hannah Deming, and Kelly Close