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Vertex Pharmaceuticals (NASDAQ:VRTX ) is a leading company in the space of cystic fibrosis (CF) with its current four-drug portfolio, namely Kalydeco (ivacaftor), Orkambi (lumacaftor/ivacaftor), Symdeko (tezacaftor/ivacaftor, and ivacaftor), and Trikafta (elexacaftor/tezacaftor/ivacaftor, and ivacaftor). Collectively, the portfolio generated a total of $7.57B in revenue in 2021. However, since Trikafta’s launch in 2019, despite its eye-dazzling revenue growth, sales for the other three drugs have slid significantly due to patients shifting away from them and using Trikafta. Therefore, a key question remains that given the level of product cannibalization created by Trikafta, can VRTX’s portfolio uphold the level of revenue generation required to support VRTX’s current share price?
I present here an epidemiological-based model approach to demonstrate that the currently approved CFTR modulators portfolio alone has an intrinsic value of $297 per share for VRTX. Considering further potential upside from its pipeline developments, I believe VRTX to be a strong long position. The article will first go into the epidemiological-model to assess VRTX's existing products portfolio -- essentially the currently approved products: Kalydeco, Orkambi, Symdeko, and Trikafta -- and provide an DCF analysis to calculate their intrinsic value. Since these four drugs are all of VRTX's currently approved products, the DCF model can be taken essentially as a whole-company valuation model. After that, I will also touch on other aspects of the stock to make a more well-rounded analysis, including VRTX's other important assets that are currently in clinical trials and not yet approved (referred to as "pipeline" or "clinical development assets"), latest earnings readout, and potential risks. These parts will be less quantitative but more qualitative in nature as I think their impact are less quantifiable.
Before diving into the specifics of the model, some general idea of the CF space would be helpful to interpret the model. CF is caused by mutations in the CFTR gene that leads to either dysfunctional CFTR proteins or CFTR proteins unable to reach the cell membrane. VRTX’s portfolio products, known as CFTR modulators, are small-molecule drugs that help restore the function of these pathological CFTR proteins. Also, all of the CFTR modulators are approved for use to treat a common mutation called F508del that accounts for 87% of all cases. Amongst them, the newly launched Trikfta showed transformational data over the other three drugs. Previously, CFTR modulators improved the endpoints versus placebo by a few single digit percentages, but with Trikafta the improvements are boosted to mid-teen percentages. Trikafta is now approved to be used in CF patients aged 6 years and older with at least one F508del mutation. The other three drugs are also approved for the treatment of F508del, heterozygous or homozygous, along with other rarer mutations, but just show much less impressive efficacy.
Now, diving into the model. I have to lay out three very important assumptions that should be always kept in mind when looking at the model, before I explain the specific parameters. These assumptions will be backed up by some analysis of the CF competitive landscape.
First, the model neglects the potential future competitor AbbVie’s three drug combination (ABBV-3067/ABBV-2222/ABBV-119) to treat CF that’s currently in Ph2 trial. The main rationale is that ABBV3067 and ABBV-2222 are a failed combination with disappointing results from Galapagos, AbbVie’s long-time CF partner, and are adopted by AbbVie following its acquisition of Galapagos. Given the low acquisition price, I can see that the bet makes sense that you either make it or break it, in terms of getting into a virtually monopolistic CF market, where a future lower-price, me-too drug could enjoy a decent share. However, I am just not sure that tweaking a failed old combination could turn it to a panacea that matches the efficacy demonstrated by Trikafta. Also, the trial is comparing against a placebo, rather than head-to-head against Trikafta/other CFTR modulators, so the interpretations of the data could be inconclusive unless the result is good to a point beyond argument. In addition, the combo is in Ph2 right now with a primary completion date in September this year. If you add on one year for Ph3 trial (which is very short in my opinion, but not impossible given that Trikafta’s pivotal trials also took only less than a year) and another half to a full year for regulatory review, the combo could be approved in late 2024 to early 2025. However, at that time, the comparator for AbbVie ’s triple combo may no longer be Trikafta, but VRTX’s new triple combo, which could generate an even better data package based on the available Ph2 data. Therefore, in my opinion, AbbVie's threat is very low given the reasons listed above, unless it turns out to be such a panacea. Anyways, AbbVie’s trial (NCT04853368) is set to release top-line data in this quarter (Q1, 2022) and provide us with more clarity at that time.
Second, the model ignores the new CF triple combination (VX-121/tezacaftor/VX-561) under development by VRTX itself. This new triple combination is already in Ph3 trials, with primary completion dates in the second half of next year. Counting in the regulatory review period, the new combo could be approved in H2 2024. The main rationale here is that we’re assessing whether VRTX’s legacy CF portfolio could support its current share price level. If the triple combo is even more efficacious and better tolerated than Trikafta, then the outlook for VRTX can only be better; if it’s not, well, Trikafta still holds its position and the new triple combo may have to find its place somewhere else in the treatment landscape, but at least this wouldn’t hurt VRTX’s revenue stream and make it look worse.
Lastly, VRTX also has collaborations with CRISPR Therapeutics (CRSP) and Moderna (MRNA) to develop additional treatments that could address CF in the future. However, these drugs are in the "Research" phase, meaning that they have not yet even started in-human trials. Therefore, they will have at least another 7-10 years before they reach the market, and any judgement call to be made at this point would be my random guesswork given the little evidence they have generated. As a result, I left out their potential in the future to make the model as objective as it could be, rather than incorporating any of my guessing.
With these two overarching assumptions in mind, we can now look at the specific parameters that go in the model. Information regarding CF population size and CFTR modulator use in the U.S. can be found in the “2020 Patient Registry Annual Data Report” (Abbreviated as “The 2020 Report” below) from CF Foundation’s patient registry website . 2020 is therefore taken as the base year, and the revenue forecast starts in 2021 and extends to 2026 to reflect a forecasting period of 5 years (2022-2026). Next, I will explain the assumptions down below one by one.
Keeps the 2-6 yrs old F508del homozygous pts share
Keeps G551D 6yr+; II-III 2yr+; II-III additional 2yr+; and F508del 1-2yr+ pts share
Keep 10% of its peak historical share (26% in 2018), which is 2.6%
Where eligible, Trikafta would be strongly preferred over others
Also, for Orkambi and Kalydeco, I am assuming the shares decrease by 1% per year until they reach the target shares, whereas for Symdeko, I am assuming a 4-yr fading period, from 7.4% in 2020 to 2.6% in 2023 with shares for 2021-2022 calculated by linear interpolation.
2. US Revenue as % of total revenue: now, here’s the place to remember that all the above epidemiological modeling is for the U.S. and the U.S. only, since the patient registry is only for the U.S. However, VRTX sells these drugs in multiple countries. Therefore, an assumption about the US revenue as % of VRTX’s total revenue is needed, and the number used here is calculated as the historical mean of this statistic from 2015-2020;
3. Revenue Normalizer (2021): this is the one parameter that’s magically correcting the whole model. Basically, the 2021 full-year result in the latest Q4 earnings call for VRTX shows that the full-year revenues for the CFTR modulators sum up to $7.57B. However, you can see that my model generates a revenue of $10.2B already in 2021. As a result, there must be some assumptions that is wrong in the process (I suspect it most likely to be the price since the WAC report was only for the state of Vermont and could dramatically skew the calculation upwards). Nonetheless, there is literally no way for me to figure out which specific assumptions went wrong and by how much given that only publicly disclosed resources are available. Therefore, I am using this revenue normalizer to match the revenue of my forecast revenue in 2021 to align with the 2021 full-year revenue result. This normalizer is carried forward in each year of the future forecast to correct the results.
You may agree or disagree with me on some specifics of the assumption parameters, but I figure it would be worth taking a look at what the model is telling us regarding the future potential of VRTX’s current portfolio.
Image created by author using data from The 2020 Report, IQVIA report, and other available public information
According to the model, by 2026, the portfolio could generate a revenue of roughly $9.4B, with the majority, or 82.9%, of all the treated patients using Trikafta. Also, as you probably already guessed from the assumptions entered into the model, Trikafta leads to significant cannibalization over the other products of VRTX, and later year growth in revenue is largely driven by patient number growth, price rise, and penetrance increase. To me, this is quite reasonable (given that I developed the model after all!). But if you were to disagree, adjusting the parameters and rebuilding the model wouldn’t be too much of a trouble.
Now that we have the revenue forecast for VRTX’s current portfolio, a super-simplified DCF model is built to calculate the intrinsic value of these revenue streams. 2021 is taken as the base year, and quick assumptions are to be given below:
6% (slightly higher than historical risk premium) is chosen to be conservative
Average effective Interest rate, 2015-2020
Market Value of equity used
Book Value of debt used
All currency in USD millions
Image created by author using data from Capital IQ
With these assumptions, the DCF model generates a price of $297/share for VRTX’s current CF portfolio (common shares outstanding = 254.3M). Some of the specific assumptions, especially the reconciliation from EBIAT to FCF, may seem less solid to you, but I would argue that their impact is quite minor given that they are so much smaller than EBIT. Also, I am trying to be conservative as well in making these assumptions so that the FCF may be higher than what I show here. Again, fine-tuning the model is always a choice if you strongly disagree with me.
Finally, it’s always good practice to do sensitivity analysis as a sanity check on the most important assumptions, and I am showing them here.
PGR/WACC sensitivity table on share price:
Image created by author using data from Capital IQ
EBIT Margin/WACC sensitivity table on share price:
Image created by author using data from Capital IQ
From this table, we can tell that EBIT Margin does have a visible influence on the share price. Although 55% may seem a bit too high to some people given that it is much higher than historical average, but I would argue that the product mix for VRTX is changing, especially after the launch of Trikafta. Increased operating expense is not required to support the revenue generation of Trikafta, since most of the R&D, which accounts for a large portion of the operating expense, is already finished here. Therefore, moving forward, I would expect an EBIT Margin somewhere in the range of 50-55%, give or take.
PGR/WACC sensitivity table for Terminal Value/EBIT(2026) multiple:
Image created by author using data from Capital IQ
Looking at this, a 13.78X TV/EBIT (2026) multiple is very reasonable to me given that the 2021 Total Enterprise Value/EBIT fluctuates between a range of 16-22.
For a fuller picture of the stock, it is worth a dive into VRTX's other assets that are in clinical development but not approved yet. I will only dive into the assets that are in Phase 2 or later, for the reason that Phase 1 and earlier assets are just way too early to for me give any meaningful analysis at this point. Also, since the CF landscape has been addressed in the "Model Assumptions", I will not re-address VRTX's collaboration assets with MRNA and CRSPR in this section.
That leaves on the table CTX001 for the treatment of Sickle Cell Disease (SCD) and Beta Thalassemia (TDT), VX147 for APOL-1 mediated Kidney Disease, and VX548 for pain.
To start off, I believe CTX001 should be the one to focus on the most. Topline data for CTX001 Ph3 trial is set to be released in the first quarter of this year, and in my opinion, this would be more important than following AbbVie’s movement in CF. Based on the epidemiology that VRTX provided, a total of 95,000 patients in SCD and TDT would be eligible for the gene therapy, and the current data on CTX001 looks quite good, basically a functional cure for SCD and TDT. However, how many patients out of the 95K will actually be on the treatment is a big question mark. For some context, Bluebird Bio (BLUE) has a similar gene therapy named Zynteglo for the treatment of TDT that serves essentially as a functional cure, and it could be a good analog for CTX001. The drug was approved in the EU in 2020, but then withdrawn in Germany due to its high list price of $1.8M per patient. In other words, it treated no patients due to its high cost in EU. It is unclear how much CRSPR and VRTX are going to charge for CTX001, but I suspect it has to be in the millions. Considering the resistance Zynteglo has met, the outlook for CTX001 is probably not something like 40-50% of the addressable population. Nevertheless, a twist to the story is that a patient on Zynteglo developed leukemia in the trial, and the trial was suspended by FDA for this reason. That leaves CTX001 the chance to be the first-in-class gene therapy for SCD and TDT. The first mover advantage and price-setting strategy could be leveraged to gain a better share in SCD/TDT, where the standard of care is multiple blood transfusions per year that are both costly and inconvenient.
Anyways, the revenue opportunity that CTX001 brings may be less exciting compared to CFTR modulators, but were it to succeed, it would prove the management’s ability to make deals that help VRTX expand into spaces beyond CF and diversify its revenue stream. With ~$7.5B cash free in hand to make transactions, such success is desperately needed by the management to signal to the investors that they are capable of making more of these transactions, which would convert VRTX from a CF-only mid-sized biotech to a larger, more diversified biopharmaceutical company.
Apart from CTX001, VX147 has positive data readout back in December 2021. Again, APOL-1 mediated kidney disease is an area with no satisfactory treatment just like SCD and TDT. Therefore, if VX147 could hold up its efficacy in Phase 3 trials just like it did in the first data readout for these 13 patients, there could be a high hope of approval. According to VRTX's data, there are <10,000 patients with APOL-1 mediated kidney disease who are eligible for the treatment. Price tag is unknown at this point, but probably much lower than CTX001, which may result in better adoption amongst the patients. Again, this is another area where VRTX is trying to break through and diversify the revenue.
The Phase 2 for VX548 has no data readout at this point, but is expected to have it in Q1 2022 as well. The success of the trial could pave the road for the establishment of Phase 3 pivotal trial, which could enable approval for VX548 if successful. Pain is definitely a large market with no satisfactory treatment (opioids apparently isn't a good option), so if VRTX could break into it, the promise is huge.
To summarize the pipeline development, VRTX is really trying hard to expand outside of CF, heavily focusing on SCD/TDT, APOL-1 kidney disease, and pain. Also, a common theme behind these developments is that, just as the management pointed out in their strategy, they're really trying to first crack the underlying biology of the disease and then develop a targeted therapy that could work well, which sort of explain how they gained a virtual monopoly in CF. Such a strategy could help the firm establish better disease understanding and therefore more effective products in the development processes.
On a side note, VX880 is also a very interesting asset with large potential. VX880 is a gene therapy developed as a one-time cure for Type-1 Diabetes. The Type-1 Diabetes space is, as you can imagine, very large, although crowded with all kinds of effective treatments. However, there is still unmet need for these with severe disease. Therefore, if VX880 could really offer a one-shot cure in diabetes and relieve the patients from the trouble of life-long treatment, that is for sure a medical breakthrough.
VRTX's 2021 full-year revenue of $7.57B beat the consensus estimates by $700M, and upheld a non-GAAP operating income of $4.34B. 2022 revenue guidance was also raised to $8.4-8.6B. Although the EPS for both Q4 2021 and the full year fall below the estimates, I consider that as a lesser concern given the strong growth the company has achieved.
In addition, VRTX's other financial fundamentals were also quite solid. Gross Margin increased from 35.7% in 2017 to 58.7% in 2020, but is 88.1% in 2021, potentially due to the launch of the more profitable Trikafta. EBITDA and EBIT margins also rose to the high-50s from the mid-40s for the same reason. The company also lives basically off without any debt, only with $842.7M in debt as of Q4 2021. This converts to a debt ratio of 0.06, a level way below the biotech industry average of 0.34. This means the company is well-positioned for the upcoming high-interest rate environment as it has all the resources to operate without resorting to additional debts. Apart from that, the company has also generated positive operating cash flow that is growing from $236.1M in 2016 to $3.3B in 2020. That's the reason why the company is holding ~$7.5B cash in hand, which is well sufficient to support clinical development or product life cycle management, and enables the management to be more aggressive in making more transactions that could expand the company's development pipeline and potential future business areas.
The biggest threat for VRTX in the short term is for sure AbbVie's triple combination for CF, as the disease is the foundational area for VRTX. I have addressed that and expressed my opinion of it in the "Model Assumptions" section. Competitive threat also exists for CTX001 as it races with BIIB's Zynteglo to be the first to market gene therapy for TDT and SCD. Therefore, these two near-term events should be closely followed and monitored.
In addition, uncertainty with drug development is something not to neglect. VRTX has ceased the development of VX864 and VX814, both of which were in Phase 2 trials already. Therefore, there is always the chance that any of VRTX's clinical pipeline asset doesn't make to the market. Though the likelihood for VRTX's new CF triple combo is low given their history of success in CF, the risk for CTX001 is quite high. That is not to say CTX001 will for sure fail, but this is the first time that CRISPR/Cas9 technology is being applied to actually treat human disease, and the safety issues is still a large question mark, although assessment had found no off-target effect for patients who have received CTX001 so far. Also, the study halt for Zynteglo should be taken as an alarm on whether the technology is carcinogenic or not.
In addition to the fundamentals, market risk is also something investors should bear in mind.
VRTX looks quite pricey than some comparable companies when it comes to valuation. It's LTM P/E comes at 27.2X compared to 21.8X for Biogen (BIIB), 9.6X for Regeneron (REGN), and 11.8X for Gilead Sciences (GILD). VRTX's current P/E also comes at the higher end throughout its historical P/E. On one side, the higher P/E may reflect investor's confidence in VRTX's sound leadership in the CF market, but on the other hand, it also incorporates investors' fear that VRTX may fail in expanding out of the CF market and grow to a diversified pharmaceutical company. Therefore, the outcome for CTX-001, VX147, and VX548 becomes all the more important for VRTX at this point.
Lastly, the influence from the larger market environment should not be left unconsidered. With the Fed being more and more hawkish, rate hikes are down for certain and there may also be shrinkage of the balance sheet in the near term. This pressure would for sure drag down the valuation for growth stocks. However, if you look at the sensitivity tables for the share price, you can see that you would have to pop up the WACC to 7% to yield a price that matches the current share price level. Remember, the share price calculated here is only for VRTX’s legacy CF portfolio, and there will be extra value created by VRTX’s pipeline development that further adds to the value. Therefore, I consider there to be enough of a margin of safety for the stock even under an ominous market environment like this.
In this analysis, I showed that using an epidemiological-model based approach to evaluate VRTX’s current CF portfolio we can see that the intrinsic value represents a 30% upside from the current VRTX share price. However, it is worth pointing out that this is only a valuation of the CF portfolio, and VRTX’s pipeline potential is left out. Given the additional value VRTX's clinical pipeline could potentially bring in the future, I consider the stock a long position.
This article was written by
Disclosure: I/we have a beneficial long position in the shares of VRTX either through stock ownership, options, or other derivatives. 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.
Additional disclosure: This is a mere display of my thought process and analysis process, and is not to be interpreted or used as investment advice in any sense. I also make the disclosure that I personally hold VRTX in my portfolio, but I tried my best in making my analysis approach objective.