Biogen Scores Surprise Win

Biogen BIIB and partner Eisai announced that amyloid antibody BAN2401 has yielded positive data in a large Phase 2 study in Alzheimer's disease. We've raised our Biogen fair value estimate to $404 per share as we add the drug back to our valuation model and assume a higher (60%) probability of approval for both of the companies' amyloid antibody drug candidates, aducanumab and BAN2401. We continue to see Biogen's steady neurology focus and increasingly diverse portfolio and pipeline as supporting a wide economic moat.

We think this positive data supports the broader amyloid hypothesis, which has been severely tested by the failure of Eli Lilly's LLY amyloid antibody solanezumab as well as oral BACE inhibitors from Johnson & Johnson JNJ (liver toxicity), Merck MRK (interim safety analysis), and Lilly/Astra AZN (lack of efficacy). BAN2401 targets amyloid beta protofibrils (oligomers and fibrillar amyloid), which are aggregates of amyloid beta that lead to the production of plaques. Biogen's phase 3 Alzheimer's disease drug aducanumab, which is expected to produce data by early 2020, has a similar mechanism of action to BAN2401, which we think bodes well for aducanumab's efficacy. We're still cautious on Biogen/Eisai's Phase 3 BACE inhibitor elenbecestat, however, given the multiple failures in this class and the fact that elenbecestat's recent positive Phase 2 data (in June) was based on only 38 patients at the highest 50-milligram dose. That said, elenbecestat had encouraging safety data, and the 50 mg dose showed statistically significant reductions in amyloid beta in the brain as well as a trend toward slower functional decline. Data from the Phase 3 studies of elenbecestat is expected in late 2020.

BAN2401 failed to achieve significant results at 12 months earlier this year; however, at 18 months, the highest 10 mg/kg biweekly dose of BAN2401 showed a statistically significant ability to slow clinical decline, based on an Alzheimer's disease composite score, relative to placebo. Looking solely at this dosage, benefits were seen as early as six months into treatment, and brain imaging indicated reduction in brain amyloid, which fits with the drug's expected mechanism of action.

Biogen Dominates MS Treatment
Biogen's strategy has its roots in the 2003 merger of Biogen (multiple sclerosis drug Avonex) and Idec (cancer drug Rituxan). Rituxan's market penetration is already high, and patents in the United States (where Biogen derives its profit share from Roche RHHBY ) expire in 2018. However, we think a subcutaneous Rituxan as well as novel antibody Gazyva will allow for extended oncology revenue. Avonex and longer-acting Plegridy generate $2.5 billion in annual sales and remain the leading MS interferon franchise. Biogen acquired full rights to MS antibody Tysabri ($2 billion in annual sales) from partner Elan. A diagnostic test can isolate patients with the lowest progressive multifocal leukoencephalopathy risk, which allows the 50% of patients who have not been exposed to the JC virus to benefit from Tysabri's strong efficacy profile with low PML risk. That said, older products like Avonex could see pricing power and demand erode, now that a generic version of Teva's TEVA Copaxone has launched and novel high-efficacy drugs are reaching the market.

Based on oral MS drug Tecfidera's strong launch and solid safety and efficacy data, as well as the potential of BIIB098 (licensed from Alkermes) to improve GI tolerability, we expect Biogen's oral MS franchise to see steady sales around $4 billion. We think Tecfidera's pricing power and demand will remain relatively steady despite oral generics in other classes, and the Alkermes patents could extend protection from 2028 to 2033. Biogen will also see significant royalties on novel high-efficacy drug Ocrevus (approved in the U.S. in 2017 and Europe in 2018) that will help offset other pressure on its MS franchise.

Outside of MS, Biogen has strong human genetic validation for its neurology pipeline, creating potential to offset MS pressure. Spinal muscular atrophy drug Spinraza is launching and could reach $2 billion in peak sales. In addition, early data for Alzheimer's drugs aducanumab and BAN2401 could allow for multi-billion-dollar potential if approved (beginning in 2020).

Specialty Portfolio and Novel Pipeline Create Wide Moat
Biogen has achieved strong profitability on the success of three marketed products in the fields of oncology and neuroimmunology, and the introduction of Tecfidera secures the company's dominant share of the MS market. We think barriers to entry are high for potential biosimilars to Biogen's products, and Biogen has a strong research and development strategy for maintaining its leadership in MS, where pricing power is strong, patient need for novel therapies is high, and the pipeline has been particularly productive. These factors contribute to the company's wide moat. Returns on invested capital, which we think will average above 20% during our 10-year explicit forecast period, easily exceed our 7.3% estimate of Biogen's cost of capital.

Rituxan remains the standard of care in several forms of hematological cancer, and collaboration revenue received from partner Roche boosts Biogen's margins. Biogen's Avonex is the leading interferon therapy in MS because of its long-term safety record and relatively convenient once-weekly injections. Biogen's third drug, MS drug Tysabri, is achieving blockbuster sales based on outstanding efficacy despite rare but serious side effects, and we think efforts to target the drug to patients least likely to experience side effects will allow the company to see continued sales despite novel products with cleaner safety profiles. We expect combined sales of Tecfidera and BIIB098 to remain around $4 billion annually for the long run, based on convenient oral administration and relatively strong efficacy and safety profile.

With the exception of Tecfidera, all of Biogen's current blockbusters are biologics. Biosimilar competition is a looming threat, but we think the significant manufacturing and development costs that biosimilar makers are expected to incur would slow any erosion of sales of these products, limiting the number of contenders and their ability to compete on price. Data quality may also be an issue with biosimilars; the first application for an Avonex biosimilar was rejected based on insufficient efficacy, and delays and discontinuations with Rituxan biosimilars pushed the European launch to 2017. Tysabri is likely to be a lower-priority target for biosimilar entrants, given the risk monitoring and potentially serious side effects in certain patients.

Competition Lurks
Biogen's profitability depends on four key blockbusters and a high-risk but potentially high-reward pipeline. If physicians and payers fail to support Gazyva use over Rituxan despite strong superiority data in leukemia and a large lymphoma setting, Biogen and Roche could be vulnerable to competition from cheaper, biosimilar Rituxan beginning as early as 2018 in the U.S., and revenue from the Roche collaboration feeds directly to the bottom line and boosts Biogen's margins. While Plegridy is likely to help Biogen maintain its lead in the interferon market, we expect generic Copaxone to weigh on sales of injectable MS therapies. Biogen's MS portfolio has enjoyed tremendous pricing power in the U.S., and insurers could begin to find ways to put pressure on future price increases as more competitors reach the market (Avonex and Plegridy were excluded from the CVS national formulary in 2016-17). Tecfidera's U.S. sales are seeing slower growth, partly due to concerns about cases of PML and gastrointestinal issues, and other oral drugs (Celgene's ozanimod) are poised to enter the market.

Biogen's year-end 2017 cash balance ($6.7 billion) and free cash flow (around $4 billion annually) will help fund future repurchases and allow the company flexibility on the size of future acquisitions. The company's cash and investments on its balance sheet are matched by a similar amount of debt, with most maturities in the 2020s. Biogen issued $6 billion in debt in 2015 to help fund its share-repurchase program. Historically, Biogen has focused on returning excess cash to shareholders via buybacks, but its limited acquisition and collaboration record is strong, and we expect more tuck-in acquisitions going forward. Of the $15 billion in free cash flow generated over 2006-15, Biogen spent the vast majority on stock buybacks, with an average repurchase price of $87 per share over that period.