There have been several healthcare spinoffs recently that have enjoyed much fanfare and success. These are the Abbott Labs (ABT) and Abbvie (ABBV), Elan (ELN) and Prothena (PRTA) and the Covidien (COV) and Mallinkrodt (MNK), to be specific. But the latest spinoff announced, Theravance Biopharma, is smaller than the other healthcare spins and has remained largely unnoticed by the investment community. Historically, after a spin, the parent and spun company have higher probabilities of being bought out relative to the rest of the market. This happened with ELN, whereas the ABBV/ABT and PFE/ZTS spins were of such a size that no other company would bother a takeover of them. Because Theravance(NYSE:THRX) has a market cap of around $4B, as well as significant ties to GlaxoSmithKline (NYSE:GSK), I feel that Theravance will be targeted for a buyout soon after it is split in two.
Theravance is a biopharmaceutical research company with both approved and pipeline drugs. On April 25th of this year Theravance announced that it was going to spin off its drug research unit under the name Theravance Biopharma. From the language used in the 10-12b, it looks as though THRX is planning to complete the spin before Q1 2014, however the company has given itself leeway to delay or cancel the spin. I'm generally not one for healthcare stocks, and do not profess any special knowledge of drug companies, but a corporate restructuring could squeeze out some value that the market will notice.
Theravance Biopharma:
Theravance Biopharma will hold the rights to VIBATIV, a treatment for serious bacterial skin infections that has won FDA approval. VIBATIV is scheduled for sale in Europe by Clinigen Group plc, and in the Middle East by Hikma Pharmaceuticals. Theravance Biopharma will receive royalty payments on 20-30% of VIBATIV's net sales for at least 15 years, and will hold about a dozen VIBATIV patents. This spin will have $300M cash backing and a 2% equity interest in Theravance.
Moreover, Theravance Biopharma will start off with a bunch of Phase I and Phase II drugs in the pipeline. Long-Acting Muscarinic Antagonist (LAMA)-TD-4208 is currently in Phase 2b study with completion anticipated before January 2014. TD-1792, a treatment for hospital-acquired pneumonia, is about to begin Phase II studies in Russia. Theravance Biopharma will also receive economic interests in UMEC/VI/FF and the MABA programs from a previous partnership between Theravance and GSK. Theravance Biopharma is partnering with Alfa Wassermann società per azioni (S.p.A.) on a Phase II trial for Velusetrag, with potential royalties of up to 20% of future sales. Theravance Biopharma is also working with Merck (NYSE:MRK) on preclinical research programs initiated with Theravance, but with all proceeds assigned to Theravance Biopharma.
Now, assuming for argument's sake that each and every one of the Phase II and Phase I drugs are worthless, a conservative valuation for Theravance Biopharma can be based off of VIBATIV's commercialization, Theravance Biopharma's stake in Theravance, and the MABA program partnership with GSK.
The commercialization for VIBATIV should net Theravance about $50M per year for at least 15 years. Assuming a healthy 15% discount on the cash flows, 0% growth in royalties, and a market penetration of only about $500M in sales per year, that would equate to ~$336M in today's cash. Theravance's Biopharma's equity 2% stake in Theravance at current prices would equate to $80M in value. Since Elan recently bought 21% of Theravance's RELVAR ELLIPTA/BREO ELLIPTA, ANORO ELLIPTA, MABA and vilanterol monotherapy programs for $1 Billion, it can be assumed that the public market would value the relatively new MABA programs attributable to Theravance Biopharma for at least $100M. This results in a valuation floor of at least $516M, which along with the $300M cash infusion, totals to $816M.
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Theravance:
Theravance itself will retain full interests in RELVAR, ELLIPTA/BREO, ELLIPTA, ANORO ELLIPTA and vilanterol monotherapy programs, which are all partnered with GSK.
It's well known that the market can give a conglomerate discount to companies with multiple divisions and complicated business relationships. Splitting a company's mature products from its longer-term research pipeline decreases operational costs for the mature products while increasing the amount of attention and fundraising capabilities for the pipeline. Because GSK has been a partner with Theravance for every project that will remain with the parent post-spin, it's possible that GSK will just want to take over Theravance after the spin.
Why would GSK attempt a buyout, and not buyout all of Theravance now? First, a regulatory decision for Theravance's Anoro drug is due on December 18th 2013, which will be a large factor in Theravance's valuation. Since GSK has continued to increase the number of shares it owns, GSK is most likely waiting until Anoro is approved before proceeding on determining a buyout price. Piper Jaffray alluded to this possibility in a memo several months back, with a target buyout price of $51. I'm guessing that GSK is holding back because it wants to pay the least amount of money possible for a portfolio of drugs that are currently sellable to consumers. GSK is currently hurting on the drug markets, with very little annualized growth in earnings, book value, and sales over the past five years. GSK is also issuing dividends that are taking up a larger and larger percent of earnings each year. GSK also does not have any new drugs that have been developed in-house lately. Thus, GSK is a bit strapped for cash and future earnings, so it will need to buy new drugs for its portfolio. This puts Theravance in a convenient position. GSK's biggest product currently is Advair (20% of GSK's sales, or around $8 Billion per year), which has dominated the asthma and COPD treatment markets. But Advair has recently come off patent, and there is competition from similar products by AstraZeneca and Pfizer, along with new drug developments from Pfizer, Novartis, and Forest Laboratories in the pipeline. While Advair has been difficult for generics to replicate so far, sales for Advair are dropping and GSK needs a successor quickly in order to stave off competition. Theravance arguably has a better drug called BREO in its portfolio that is only taken once daily. BREO can succeed Advair and allow GSK to stay ahead of the competition for asthma and COPD treatments. So ideally the catalyst of Theravance's buyout price will be if Anoro is approved. Assuming approval on Dec. 18th, (which should increase the value of THRX beyond what its current price assumes, along with my current valuation of THRX) GSK will have interests in another drug with patent protection for the asthma and COPD markets, and it will most likely move to keep all future profits for itself. If Anoro turns out to be worthless, GSK can lower its buyout price for Theravance and get BREO. The last thing GSK needs right now is a cash-draining pipeline that GSK did not have much interest in the first place, hence the creation of Theravance Biopharma. If GSK had attempted to buy out Theravance before the spin-off, it would undervalue Theravance Biopharma's pipeline and increase its own future R&D costs in an nonstrategic manner, with added risk of Anoro possibly failing approval only a few months later. This would be a lose-lose situation for both investors and GSK.
The other reason that GSK is biding its time is that GSK will most likely be the only company bidding for Theravance, since GSK already owns over 26% of Theravance's equity. Although another major company could step in for a takeover, the purchase would require a significant premium to justify GSK releasing its interest in all of THRX's projects. Because the market has known about GSK's position for years, I don't see how GSK could buy out THRX from current shareholders without a large premium from current prices. However, if Theravance's drugs are appealing to competitors, GSK does not own enough of Theravance to block another takeover if it initially cuts a raw deal.
Result:
I estimate the total market value of both Theravance and Theravance Biopharma within the next twelve months to be at least $6.1 Billion, which is a 50% premium to THRX's current price. After Theravance spins off its drug pipeline, the parent will probably sell itself to GSK for at least a 30% premium within 2 years, assuming that the healthcare sector and macro environment continue to be stable enough for takeovers. Also, if GSK and other institutions immediately sell their stakes in Theravance Biopharma out of disinterest, individual investors can pick up shares for cheap. Theravance Biopharma will most likely attract enough interest by institutions and other drug companies to warrant a decent market capitalization soon after the spin, thereby resulting in a nice profit for those investors who might not want to stick around long enough to see the pipeline to completion. A small position in THRX for around $33-$36 per share would make a good medium-term investment, based on an increased likelihood of a buyout and an extra bit of value created by the spin.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in THRX over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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