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Author: UCalgaryGeer Two stars, 250 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 24974  
Subject: BioTech Shootout - Round II - AMGN (very long) Date: 4/22/2000 2:00 AM
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Round II

If you remember the earliest postings in this series, this is a series of postings intended to illustrate my thought processes as I sort out a series of leading biotech companies for my personal portfolio. The 'playoffs' have completed their first round, and where once there were 16, now there are eight. The first posts are located here: (Introduction) (AMGN, GENZ, IMNX, HGSI) (MLNM, MYGN, DNA, BCHE) (CRA, QLTI, MEDI, PEB) (CHIR, INCY, AFFX, BGEN)

For the semi-finals, I'm going to look at the companies four at a time and in much more detail, one of the reasons that this post has been so long in the making. ('Life' is the other - the last month of the school year was hell; I've still got one exam left.) The first four were to be Amgen, Genzyme General, Millennium Pharmaceutical and Immunex. (The next four were to be Incyte Pharmaceutical, Affymetrix, Medimmune and PE Celera Genomics.) The top two companies from each pool will make it into the 'final'. However, I've noticed that, thanks to the broad survey that my initial series comprises, the companies that I'm listing fall into two basic business models - genomics-based and traditional biopharmaceuticals.
Traditional biopharmeceuticals can be more readily weighed by such old-fashioned measures as pipeline, profit, and the like, so it does seem to make life a wee bit simpler at this point if I 'shuffle' the semifinals, so that Medimmune and Millennium switch places. This sort of illustrates that perhaps my original methodology of just grabbing the best companies and comparing them was not a particularly great one, and that in the future, more generic industry-related research may well be a good foundation. Lesson learned.
When I had narrowed this list down to eight, I made a watch portfolio on Yahoo! (sorry, TMF, but they can do Canadian stocks, so I learned their portfolio thingy instead of yours). In the six weeks since, this watch portfolio (which began as $1000 (or so) virtual investments in all eight of these, plus QLT PhotoTheraputics (which I'm looking at for my RRSP and not for this - see my conclusion to the QLT/Celera debate) and the Biotech HOLDR, in other words, a $10,000 mock portfolio, is down by 46.8%. Leading the way are, of course, the genomics-heavy stocks, Affymetrix, Incyte, Celera and Milennium -- all down around 65-75%(!) The 'best performer' of the eight is Amgen, down a scant 18%. Jeez. (Mind you, the stock I was thinking about selling to buy a biotech with, Network Appliance, is down 52% in the same period…)

Division I: Amgen - AMGN (1) vs. MedImmune - MEDI (5) vs. Immunex - IMNX (8) vs. Genzyme General - GENZ (16)

Amgen - AMGN (1)
The Company: Amgen is the biggest of the big boys in biotech. Sporting $60 billion in market cap or so, and one of the few biotech companies old enough for me to reasonably go on a date with (i.e. founded in 1980), the company is clearly the leader on the block. So, what does Amgen get for this? Aside from status and superior name recognition, being big means being broadly held (including both the S&P 500 and the Nasdaq 100) and, probably most importantly, having a kick-ass research budget.
Amgen is based in Thousand Oaks, CA (near LA), and has 7% insider and 62% institutional shares. That is a low insider number for biotech, but Amgen is so huge and old that it's not unreasonable at all.

Business Model: Amgen is generally called a biopharmeceutical -- they research drugs, test them, make them and sell them. The basic advantage of this business model is that you get to keep all the cash from the drugs, rather than relying on royalty or equipment sales. The downside is that you are dependent on your pipeline alone to make you money. As a result, I'd think that a good pipeline and healthy R&D spending is the desired situation.
Amgen currently has two main drugs, Epogen and Neupogen. Saying that these are 'main' drugs is a bit of an understatement; for 1999, these two drugs combined for 99.3% of Amgen's sales. The only other drug of note, Infergen, constitutes pretty much all of the rest of the sales.
Epogen is a synthetic version of erythropoietin, a hormone produced by healthy kidneys that stimulates red blood cell growth. Without this hormone, anemia results. Damaged kidneys in what is called end-stage renal disease (ESRD) are typically treated with dialysis or transplants -- transplants restore kidney function, where dialysis simply performs the functions of the kidneys (except produce erythropoietin). Even when transplants are performed, patients are usually on dialysis for six months to a year waiting to get a kidney for the transplant. (I'll take a moment here to point out that it's not too late to sign your organ donor card and tell your friends and family about your decision.) About 300,000 Americans have ESRD, Amgen currently claims 150,000-200,000 patients for Epogen (the first is from an Epogen FAQ, the second from the '98 annual report), a strong market penetration. The kidney disease market is a slow-growing one, growing about 7% per year. Epogen produced about 58% of Amgen's total 1999 sales. Sales grew 27.5% for 1999 vs. 1998, higher than the 5 year compound growth rate of 19.6%. Epogen has four years of patent protection left, with the patents running out in 2004.
Neupogen is somewhat similar to Epogen in some ways. It is a granulocyte colony-stimulating factor, which means it also stimulates the bone marrow to produce cells -- in this case, white blood cells called neutrophils. These cells fight infection, and are depleted in patients undergoing chemotherapy. Neupogen is approved for 'certain types of cancer', most notably breast cancer (180,000 new cases per year -- most are treated primarily through surgery). Neupogen produced 41% of Amgen's 1999 sales, growing by 12.5% over 1998, higher than the four-year compound growth rate of 11.0%. Neupogen's patents start running out in 2008, and it is under application for treatment of the same white cell depletion in HIV-infected patients; similar applications have been approved in Canada and Australia.
Infergen is an interferon, a type of protein that fights viral infections. Infergen's specific target is Hepatitis-C, which afflicts 3.9 million Americans, with 30,000 new cases per year. Sales were $26 million in 1999, up 62.5% from 1998. While this is a high growth rate, I don't think it's sustainable, since the drug was fairly recently introduced. As a side note, the Infergen and Neupogen web sites are amazingly well done. Very slick marketing here.

Future Prospects: Amgen's pipeline is very good for a biopharm; they have a clinical index of 4.9 (according to Idorius in the Biotech Numbers Game post). But what are these future prospects? The furthest along is Stemgen (application filed), a blood growth factor that works along Neupogen in preparing patients for a particular type of transplantation. It strikes me as a smallish market, but if you sell Neupogen, you can sell it's companion product very easily.
Recently filed for approval was NESP, aka novel erythropoiesis stimulating protein. Basically, it's a longer lasting variant of Epogen, and is an attempt to stretch the Epogen work into the future. Half of me says that NESP is better and will supplant Epogen, but the other half says that Epogen is typically administered during dialysis, so as long as it will last for the period between dialysis treatments, a longer-lasting version is really not all that useful, and as soon as a generic comes out for 1/3 the price, NESP will be forgotten. This is a hard call, and is where more knowledge of the industry would make me happy.
Also apparently filed for approval is Kineret, the new name of IL-1ra, or Interleukin 1 receptor antagonist. Kineret blocks the harmful effects of IL-1, which is central in rheumatoid arthritis. Rheumatoid arthritis is widespread -- affecting 2 million Americans -- and both chronic and progressive. This is, in my opinion, a potential blockbuster. I have an aunt with severe arthritis, and she has gone through every treatment in the book already. The one caveat is that two out of three listings have Kineret in phase II/III (including one of two notes on Amgen's site. They need to update their pipeline page.)
In phase III trials, we have a few encouraging drugs, starting with Abarelix (in collaboration with Praecis Pharmaceutical.) Abarelix is designed to reduce testosterone (and estrogen) levels. Why is this good? Well, other than hindering an appreciation of art film, testosterone can worsen certain forms of prostate cancer -- one of the most common cancers. It's also being studied (in phase I/II) for endometriosis, a gynecological condition. Also in phase III is SD/01, which sounds like a long-lasting version of Neupogen. Since Neupogen is injected directly into chemotherapy patients, a longer-lasting version is desirable. However, just like NESP, SD/01 is a cannabalistic product -- I can't forsee a whole lot of market expansion from this product.
The exciting Phase II product is Leptin, which isn't talked about in a great deal of detail, but promises to help battle obesity. It is currently in the middle of the pack in a several-horse race, with the leader apparently Ergoset from Ergo Sciences (entering type III -- but apparently showing no difference from placebo in a 9/99 result), a product from SuperGen (RF1051 in a slight lead), and an appetite suppressant from Pfizer in type II. The loser is Redux from AHP, the fen in the lethal fen-phen cocktail. The winner of the race could have one of the biggest blockbusters ever. Zowie.
Other phase II products are Calcimimetics (which deal with parathyroid hormone oversecretion, which is also associated with dialysis) and sTNF-RI (another rheumatoid arthritis product). There are a handful of products in phase I or I/II that treat Lou Gerhig's and Parkinson's diseases, prevent the loss of bone mass due to osteoporosis or cancer, and reduce gastrointestinal mucus lining damage from cancer treatment. Overall, a good bunch of phase Is, with a wide range of severe ailments, but I'm not going to put much stock in them. Or buy much stock because of them.

Financials: Amgen's strength is in their R&D budget, which is what is building this pipeline. They spend a huge amount of cash on their pipeline, and this is, theoretically, what gives them their sustainable advantage. So, what are Amgen's financials? What do they look like? What are the key measures? I used the 1999 annual report for these questions. (As far as I know, Amgen's earnings are due out any day now…)
I'll start out with the income statement ratios. Amgen posted a gross margin of 88.0% and a net margin of 32.3% for 1999, both up slightly from 1998. This is what a profit machine looks like. As far as it's spending, 24.6% of it's income was spent on R&D (good), 19.6% on SG&A (not so good…). Both categories rose compared to 1998, and were down compared to 1997 values. And, unpleasantly, SG&A is growing faster than R&D - up 3.3% vs. 0.9% on the 1999-98 comparison. This is not a good trend, but it's not a huge amount.
Looking at the balance sheet now, return on equity was 36.3%, return on assets was 26.9%; both very nice numbers, and both better than a year ago. Long term debt is only 7.4% of equity, down from 1998. The flow ratio was 0.88, up from 1998's 0.67 based on increased inventory and decreased accounts payable. Still, 0.88 is nothing to whine about.
Finally, looking at cash flow, free cash flow was up massively, resulting in a Cash King Margin shooting up from 18.1% in 1998 to 26.0% in 1999. A profit machine. Overall, I'm very impressed with Amgen's financials.

Valuation: The first word on valuation is that a company like Amgen is sketchy in terms of valuation methods - it's income is not easily predictable, and neither is it's growth. Keep this in mind. I recently (okay, two days ago) bought and re-read Buffettology (Mary Buffett and David Clark), which is an interesting book with a few chapters covering various valuation methods.
One is based on the projection of future per-share equity value. Basically, the idea is that you use the company's return on equity and dividend payout rates to predict future rates of equity growth. You then use these future equity and earnings values to predict the value of the company, based on the historic P/E ratios. As an example, using Amgen, it's recent ROE of 36.3% and no dividend payout:

Future Equity (per-share)
Year Equity Earnings Dividend Retained
1999 $2.80 $2.8*.363=$1.02 $1.02*0=$0 $1.02-0=$1.02
2000 $2.80+$1.02=$3.82
Lather, rinse, repeat for 10 years. The next step is to use these forecast 2010 per-share equity and earnings values and combine them with historic P/E ratios. Looking at the last 8 years or so for Amgen, the high P/E is 120, low is 10, which creates an average of 65. I also added a 'trend' value, basically based on eyeballing the P/E ratio for what a truer average is - I used 30. Forecast 2010 earnings times P/E equals forecast 2010 price. I also found the compound annual return rate based on a 2000 buying price of $54/share, and the theoretical 'buy' price, based on earning a 15% return for 10 years. The results:

P/E ratio 2010 Price Forecast CAGR 'Buy' price
High - 120 $3,669 52.5% $906.93
Avg - 65 $1,947 43.4% $491.26
Trend - 30 $917 32.7% $226.73
Low - 10 $305 18.9% $75.58
So far, so great. A table-pounding buy, or something like that. But, there's more than one way to skin a fish, so let's look at a second way to handle this particular halibut. Earnings have historically grown at Amgen at a rate of around 20%; by forecasting this growth for earnings based on present earnings, we can find future earnings, and then use the P/E split method described above. I used three earnings growth levels - a high value of 20% (past 5 years' rate), a low of 17.1% (analyst predicted rate), and a middle value of 18.5%. I'll just report the middle value to reduce the amount of data overload. (Yeah, I know. A 2400 word plus report, and I'm worried about overload.)
P/E ratio		2010 Price	Forecast CAGR		'Buy' price
High - 120 $666 28.6% $164.27
Avg - 65 $380 20.9% $89.20
Trend - 30 $166 11.9% $41.17
Low - 10 $55 0.3% $13.72
Not nearly as nice. But this still indicates a 'fair' value, rather than an overpriced one. The final word on valuation will likely depend on the other companies I'm looking at.

Other Stuff: Amgen is currently locked in a fever-pitch court battle with Transkaryotic Therapies (TKT), a pipsqueak biotech company that has produced Epogen using a different technology than Amgen. TKT uses a technique called gene-activation technology, in which the compound is produced by human cells that have had the dormant erythropoietin gene 'switched on', rather than Amgen's recombinant DNA technology, in which the compound is produced by the erythropoietin gene removed from human cells, cloned, and inserted into hamster ovary cells in a bioreactor.
The issue in court is whether TKT's method of production is covered by Amgen's five patents on Epogen. If it is, then Amgen shareholders can breathe easy. If it isn't, then Amgen's biggest product will be open to competition from TKT, and that means that Amgen won't be able to make the kind of cash that they currently do. As a side note, the rumor is that TKT is beginning tests on a gene-activation version of Neupogen. Talk about patents envy. Presumably, if the patents on Epogen permit TKT to make their version, then the same would likely apply to Neupogen. My take on the whole thing is that I barely understand the fundamentals of biotechnology, barely understand a few basic concepts of law and patents, and the only thing I know about biotechnology patent law is that I don't know jack.

The Final Analysis: Jeez. Did I ever write a lot. And learn a lot. The final word on Amgen is that it has attractive financials. Reasonable valuation. A decent pipeline, highlighted by Kineret on the arthritis front, and with future potential in Leptin for obesity. The downsides are the TKT court battle, which highlight's Amgen's dependence on only two products, including Epogen with only four years of full patent protection. Amgen's a very nice company.

Points To Ponder:
1). Will NESP be widely-prescribed, even in the face of generic Epogen?
2). How likely is Leptin to reach market? First? Best?
3). What are the prospects for the phase I drugs?
4). Who's gonna win the court battle?

Web Links: Useful Amgen links include:
Company home page -
Yahoo! finance profile -
Rule Breaker Port Buy Report -
TMF probably also wants a link to their research report -
Biotech Numbers Game post -
Amgen as a Rule Maker (vs. biopharms) -
Some top posts from the Amgen board - (overall analysis) (Amgen vs. TKT) (Amgen vs. TKT) (Amgen vs. TKT) (Amgen vs. TKT - update)
Yahoo! news release about kidney disease -
Kidney disease -
National Cancer Institute -
Recombinant Capital (competitor and industry information) -
Buy Buffettology -
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