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Pharmaceuticals
Contemplating paradigm shift:
Thoughts after results
Kenji Masuzoe, CMA
Research Analyst
(+81) 3 5156 6764
kenji.masuzoe@db.com
Osamu Iwata
Research Associate
(+81) 03 5156-6319
osamu.iwata@db.com
The end of the pure pharma business model?
Following FY3/08 results announcements, we revised our forecasts for sector
firms and extended our outlooks to FY3/13. We revised our target prices based on
our new forecasts, and changed our rating on one firm, but our investment opinion
is basically unchanged for both the pharma sector at large and individual firms.
That said, with patent risk becoming more of a reality, we believe it is time to
rethink the current pure pharma business model.
Deutsche Securities Inc.
All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from
local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies.
Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should
be aware that the firm may have a conflict of interest that could affect the objectivity of this report.
Investors should consider this report as only a single factor in making their investment decision.
Independent, third-party research (IR) on certain companies covered by DBSI's research is available to customers of
DBSI in the United States at no cost. Customers can access this IR at http://gm.db.com, or call 1-877-208-6300 to
request that a copy of the IR be sent to them.
DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1
Industry Analysis
Top picks
Shionogi (4507.T),¥2,140 Buy
Mitsubishi Tanabe Pharma (4508.T),¥1,375 Buy
Ono Pharmaceutical (4528.OS),¥5,900 Buy
Kissei Pharmaceutical (4547.T),¥2,300 Buy
Companies featured
Takeda Pharmaceutical (4502.T),¥5,830 Hold
2008A 2009E 2010E
EPS (¥) 400 248 421
P/E (x) 18.1 23.5 13.8
EV/EBITDA (x) 10.5 9.3 5.1
Astellas Pharma (4503.T),¥4,390 Hold
2008A 2009E 2010E
EPS (¥) 342 330 326
P/E (x) 14.7 13.3 13.5
EV/EBITDA (x) 6.5 5.6 5.2
Shionogi (4507.T),¥2,140 Buy
2008A 2009E 2010E
EPS (¥) 71 90 132
P/E (x) 27.5 23.8 16.2
EV/EBITDA (x) 12.0 11.2 7.6
Mitsubishi Tanabe Pharma (4508.T),¥1,375 Buy
2008A 2009E 2010E
EPS (¥) 57 72 80
P/E (x) 23.4 19.1 17.3
EV/EBITDA (x) 6.5 5.9 5.6
Chugai Pharmaceutical (4519.T),¥1,650 Hold
2007A 2008E 2009E
EPS (¥) 72 47 53
P/E (x) 32.9 34.9 31.0
EV/EBITDA (x) 14.7 13.8 11.1
Eisai (4523.T),¥3,790 Hold
2008A 2009E 2010E
EPS (¥) -57 187 234
P/E (x) – 20.3 16.2
EV/EBITDA (x) 33.3 8.6 7.6
Ono Pharmaceutical (4528.OS),¥5,900 Buy
2008A 2009E 2010E
EPS (¥) 290 276 283
P/E (x) 20.5 21.4 20.8
EV/EBITDA (x) 10.3 10.6 9.7
Taisho Pharmaceutical (4535.T),¥1,895 Hold
2008A 2009E 2010E
EPS (¥) 78 76 79
P/E (x) 28.6 25.0 24.0
EV/EBITDA (x) 11.5 9.3 8.7
Kissei Pharmaceutical (4547.T),¥2,300 Buy
2008A 2009E 2010E
EPS (¥) 38 54 63
P/E (x) 58.1 42.5 36.7
EV/EBITDA (x) 12.5 11.0 10.2
Daiichi Sankyo (4568.T),¥2,835 Hold
2008A 2009E 2010E
EPS (¥) 133 117 138
P/E (x) 25.2 24.2 20.5
EV/EBITDA (x) 9.6 8.5 7.4
Global Markets Research Company
Our May 30 memos and reflections
We published a series of reports on May 30. We revised our forecasts following
FY3/08 results, added forecasts for FY3/13 (FY12/12 in Chugai Pharmaceutical’s
case) to factor in likely impacts from drugs in Phase 3. We then reviewed our
target prices based on our new forecasts. In this report, we explore each firm’s
sales by product and development pipeline. We begin with our thoughts on the
likelihood of a paradigm shift to take the industry away from the pure-play pharma
business model, given downtrends for valuations for the pharmaceutical sector
around the world.
Maintaining Marketweight sector rating
We see a mix of negatives and positives, with exposure to patent expiration,
reforms to the healthcare system, and tremendous rises for R&D spending on one
hand, and new drug stories, aggressive shareholder returns, and prospects for
industry realignment on the other. We believe major players’ exposure to the
expiration of their US patents is having a significant effect, lowering valuations for
the sector at large. At the same time, we expect impacts from higher interest
rates, higher commodity prices, and turbulence in equity markets.
Spotlight on Shionogi, Mitsubishi Tanabe, Ono, and Kissei
We recommend investment in domestic firms with prospects for growth over the
next five years, rather than giant megafirms staring at patent expiration. (continued
on pg. 2)
Valuation & Risks
Our target prices are based on our FY3/13 EPS forecasts and a P/E of 17x, the
average of the last three months. Upside risks relative to our Marketweight sector
opinion include waning concerns about healthcare reform in Japan and the US,
growth in the relative appeal of the sector for its defensive characteristics should
stock markets fall sharply, and significant yen weakening. Downside risks include
faster healthcare reforms than our forecasts anticipate, and a shift from a jittery
market to a bullish one, which could send investors out of pharma and into other
sectors. Company-specific risks include changes in new drug pipelines (fasterthan-
anticipated progress, delays, and failures), lower sales of existing products
because of the emergence of side-effects, and trends in M&A
Spotlight on Shionogi, Mitsubishi Tanabe, Ono, and Kissei
We recommend investment in domestic firms with prospects for growth over the next five
years, rather than giant megafirms staring at patent expiration. We have a Buy rating on four
stocks: Shionogi, anticipating growth for Crestor sales and stronger royalty income, lower
costs, and impacts from an anti-obesity drug; Mitsubishi Tanabe Pharma, where we expect
solid figures and steady earnings after excluding goodwill amortization; Ono Pharmaceutical,
which we believe is poised to rebound with five new drugs and proactive shareholder
returns; and Kissei Pharmaceutical, which is poised to enjoy growth for Urief in the US and
Japan. Considering the likelihood of realignment within the industry, we believe valuations for
appealing for Shionogi, Ono, and Kissei.
Table of Contents
Thoughts ........................................................................................4
Is the end near for the “Pure pharma” business model? .........................................................4
Possible paradigm shift—From “Pure pharma” to “hybrid” models .......................................6
Possible paradigm shift: From “mergers” to “demergers” .....................................................7
Conclusion: Investment opinions could begin considering paradigm shifts .............................7
Sector view: Maintaining Marketweight.......................................8
Sector view: Marketweight.......................................................................................................8
Share price trends .....................................................................................................................9
Global comparisons.................................................................................................................10
Negative factors ...........................................................................12
Domestic healthcare reforms..................................................................................................12
FY3/09 drug price revisions .....................................................................................................12
US healthcare reforms ............................................................................................................15
Patent risk...............................................................................................................................16
Patent expiration and earnings declines..................................................................................17
Forex ......................................................................................................................................18
Positive factors ............................................................................19
New drug stories.....................................................................................................................19
Expectations for industry realignment.....................................................................................20
Aggressive shareholder returns ..............................................................................................22
Investment ratings on stocks under coverage ............................28
Target prices and ratings .........................................................................................................28
Target price basis ....................................................................................................................29
Buy ratings ..............................................................................................................................29
Hold ratings .............................................................................................................................30
Valuation.................................................................................................................................32
Event calendar .............................................................................34
Key events of 1H FY3/08.........................................................................................................34
Chugai Pharmaceutical 1H results...........................................................................................36
Management presentations ....................................................................................................36
Overseas scientific meetings..................................................................................................37
2Q results of overseas (US/EU) pharmaceutical companies...................................................37
Deutsche Securities Japan Pharmaceutical Conference 2008................................................38
Company trends...........................................................................41
Takeda Pharmaceutical (4502) .....................................................42
Revisions following results announcement.............................................................................42
Astellas Pharma (4503) ................................................................52
Revisions following results announcement.............................................................................52
Shionogi (4507) ............................................................................60
Revisions following results announcement.............................................................................60
Mitsubishi Tanabe Pharma(4508) ................................................66
Revisions following results announcement.............................................................................66
Chugai Pharmaceutical (4519) .....................................................74
Added forecasts following results announcement..................................................................74
Eisai (4523) ...................................................................................80
Revisions following results announcement.............................................................................80
Ono Pharmaceutical (4528) ..........................................................88
Revisions following results announcement.............................................................................88
Daiichi Sankyo (4568)...................................................................94
Revisions following results annoucement ..............................................................................94
Taisho Pharmaceutical (4535) .................................................... 102
Revisions following results announcement...........................................................................102
Kissei Pharmaceutical (4547) ..................................................... 108
Revisions following results annoucement ............................................................................108
Thoughts
Is the end near for the “Pure pharma” business model?
Since the 1990s, drug makers around the world—not only in Japan—have focused their
resources on their pharmaceutical operations. A number of major, blockbuster drugs were
launched in a number of areas—cardiovascular and gastrointestinal products, treatments for
diabetes, depression, and so on—at roughly the same time. This and more efficient
management resulted in significant contributions to earnings at pharma giants, and the stock
market began to pay higher share prices for increased corporate value.
That said, share prices began weakening—despite relatively firm earnings—from 2003 for
major drugmakers in the US and Europe, and from 2007 for Japan’s larger pharma firms.
Where overseas pharmaceutical stocks were trading at P/Es around 20x in 2003, valuations
declined to around 15x in 2007, continuing on to 12x–13x currently. Some firms have seen
their multiples slip below 10x, with some major companies now trading on P/Es of 8x–9x. In
Japan, drugmakers enjoyed P/Es of 26x in 2000 or so, but this weakened to around 21x in
2006 (after deducting for daiko henjo and other extraordinary items). In 2007, share prices
began to decline further.
We attribute much of the share price weakness to worries over exposure to the expiration of
patents. This is particularly an issue with, for instance, a firm that develops a drug that
becomes a blockbuster in the US, the world’s largest market for pharmaceuticals. A
blockbuster will typically bring substantial positive earnings impact, and a rise for the maker’s
share price. Right now, however, the other side of the coin is a factor—the negative earnings
impact likely once the blockbuster’s patent protection expires, and concerns about the firm’s
near-term earnings prospects. From the mid-1990s through the early 2000s, there were
essentially no multibillion dollar products (drugs with sales of $1bn or more), but the
presence of potential multibillion dollar products in firms’ development pipelines boosted
corporate value. Now, patents for multibillion dollar products are expiring, and new drug
candidates in companies’ pipelines only offset potential negatives from patent expiration.
With no additional candidates for growth in the development pipeline, the market has
reversed itself, and lower share prices are a reflection of declining corporate value.
No firm is safe from patent risk. It is, in essence, a time bomb that cannot be deactivated
once the timer starts ticking. After a given period of time has elapsed, it is a near certainty
that the expiration of a drug’s patent will result in lower sales. If this time bomb is inevitable,
is it possible to boost corporate value under the “Pure pharma” business model? To offset
patent risk, firms using the “Pure pharma” model can win extensions for their patents
(although these will eventually expire as well), or continue developing new blockbuster
products for the rest of time. With this line of thinking, the acquisition of a new blockbuster
would offset the negative impacts of the expiration of a single drug in a firm’s portfolio. The
catch is that the patent for this new blockbuster will also eventually expire.
Consider the case of Takeda Pharmaceutical’s PPI Prevacid and diabetes treatment Actos. In
FY3/08, US sales totaled $2,252mn for Prevacid and $2,786mn for Actos, based on figures
for TAP Pharmaceuticals. Their US patents, and exclusive sales rights, expire in November
2009 (Prevacid) and July 2011 (Actos; taking an extension for a pediatric indication into
account). In April 2008, Takeda bought Millennium Pharmaceuticals. Over the medium- to
longer term, the move will strengthen Takeda’s oncology franchise. Over the nearer term, it
gives Takeda cancer treatment Velcade, which could become a major product. If,
hypothetically, Velcade becomes a blockbuster and generates sales of $1bn or more, once
the Actos patent expires, investment opinions for Takeda would need to take risk associated
with the expiration of Velcade’s patent (in 2017) into account.
Earnings outlooks for the next five years have put patent risk in the spotlight at Takeda,
Astellas Pharma, and Eisai. The three have enjoyed substantial earnings contributions from
their various blockbusters for the last 10 years or so, and they continue to do so today, but
over the next few years the US patents for these products will expire. Daiichi Sankyo’s US
patent for hyperlipidemia treatment pravastatin (Mevalotin in Japan, Pravachol in the US)
expired in April 2006, ending the drug’s exclusivity in the market and opening the door for
generic versions. As a result, export sales fell sharply, to ¥17.5bn in FY3/07 from ¥64.5bn in
FY3/06. (We believe this was one factor spurring the merger that led to the creation of Daiichi
Sankyo in September 2005.) Negative impacts associated with the expiration of the Pravachol
patent have run their course and new drug stories have emerged, so the share price has
settled down. Now, however, a major consideration in investment outlooks for the firm is
patent risk for its current top-selling product, antihypertensive olmesartan (Olmetec in Japan,
Benicar overseas; FY3/08 sales of $769mn). Shionogi is in a similar position with its statin
Crestor. Sales are robust—$2,796mn in FY3/08, including figures from AstraZeneca—but
before too long investment opinions may need to anticipate potential impacts from the
expiration of Crestor’s patent in 2016.
Another consideration is that massive outlays are required to acquire the blockbuster drugs
required under the “Pure pharma” business model. New drug development requires 7–10
years from start to finish, and tens of billions of yen per drug candidate—and even then the
odds of success are low. This clearly makes the “Pure pharma” format a high-risk business
model. If a company is unable to develop its own blockbusters, it can sacrifice near-term
earnings and acquire one (or a firm that can create one). M&A work also can be seen as an
effort to scale back one group of stakeholders—employees, the engine for a firm’s longerterm
growth—for the sake of another—shareholders. Despite the long-term perspective
required for drug development, firms may restructure to enhance corporate value over the
near term.
It is estimated that less than a third of illnesses and diseases can be completely remedied
through pharmaceuticals, with HIV/AIDS, cancer, and Alzheimer’s prominent among those
that can be treated, but not eradicated. Global warming could result in increased incidence of
malaria and other diseases. In addition to avian flu, a new outbreak of which is seen by many
as inevitable, new types of influenza are likely to emerge. In short, there are a number of
areas in which medical needs have yet to be met. This makes the business of
pharmaceuticals of great significance to mankind. The “Pure pharma” business model,
however, focuses only on a single sphere of the pharma business.
A number of Big Pharma firms following the “Pure pharma” business model are aggressively
working in oncology. With greater weightings for older demographic groups, the population
for cancer patients has been rising every year. (In 2008, 565,650 people are expected to die
from cancer in the US—1,500 people a day.) Advances in diagnostics and surgical and
pharmaceutical treatments have meant steady improvement in mortality rates, but is still no
drug that can completely cure cancer. Oncology is one area with unmet medical needs, and
successful development in this sphere could mean tremendous returns. A report from
Pharmaceutical Research and Manufacturers of America (PhRMA), an industry group, says
drugs are currently in development (in clinical studies or at the NDA stage) in the US for the
treatment of 750 types of cancer. While the contribution this development is making to
mankind is laudable, it also means competition in oncology is fierce, and not all firms
conducting development will succeed. Put differently, investment risk (business risk) is high.
Under the circumstances, then, what sort of business model has the best risk/return balance?
Would it be one that turns the “Pure pharma” business model around 180 degrees, or a
hybrid of the sort we discuss below?
Another consideration is the possibility of epidemics or pandemics of heretofore unknown
viruses or bacterial infections against which today’s antibiotics are ineffective. An end to all
social interaction (and suspension of stock trading) would of course be extremely detrimental
to mankind. This sort of discussion is better suited to the national level, but the development
of new technologies—treatments, vaccines, and public sanitation measures—is extremely
critical. To contribute to mankind in this sense, we would like to see many firms (and not just
drugmakers) consider the “hybrid” model.
Possible paradigm shift—From “Pure pharma” to “hybrid”
models
With the limits of the “Pure pharma” model coming into view, we turn to “hybrid” formats
as next-generation business models. Many firms—and not just drugmakers—have
concentrated and focused their management resources, but recent share price trends
suggest this trend is approaching its limits. We believe the next-generation business model
will not be a “Pure pharma” model, nor a “pure diagnosis” model, nor will it be a “pure
medical device”, “pure nursing home”, “pure chemical”, “pure agrochemical”, “pure
food/confectionary/beverage”, or “pure cosmetics/toiletries” model. We believe it could be a
“hybrid” model that links all these aspects of the industry. We find the possibilities
suggested by, for example, Kirin Holdings’ acquisition of Kyowa Hakko Kogyo, or Fujifilm
Holdings’ successful tender offer for Toyama Chemical, of great interest.
We believe these combinations could lead to the birth of new “hybrid” business models
which would not fit neatly into any of the Tokyo Stock Exchange’s 33 industry classifications.
We are not thinking of a return to the past, when drugmakers had non-pharmaceuticals
operations, but something new, a comprehensive healthcare firm with a pharmaceutical unit,
a lifestyle-related company in the broadest sense of the term.
What do drugmakers, which, by concentrating their resources, can develop blockbuster
products with operating margins of 30%–40%, think of this? If they were to see the end of
the road for the pharmaceutical sector as we currently know it, we believe they would
embrace the “hybrid” concept as a way to improve corporate value. Essentially all the areas
within the scope of the broader sector serve the same stakeholders—the combination of
individuals and mankind in general. From the consumers’ perspective, corporations that work
for the consumer’s well-being are probably more important than sector classifications.
For a firm that has specialized in cardiovascular drugs, for example, a “hybrid” model could
include stents and other medical devices, and diagnostic products to approach cardiovascular
therapies from multiple, comprehensive angles.
New drug discovery and creation could conceivably be expanded to include work with
agrochemicals, which in turn could be used to benefit agriculture by combating impacts from
global warming—insect pests and the ever-worsening effects of drought. In cosmetics,
development work could target aging or skin conditions, while the boom for functional foods
could mean fusion for pharmaceuticals and the food/confectionary/beverage areas.
Seen from outside the sector, pharma’s high margins are attractive. The barriers to entering
the market for pharmaceuticals, however, particularly the prescription drug business, are
extremely high. We believe starting from scratch would be a very time-consuming endeavor,
which suggests that firms in other sectors would be more likely to approach pharma through
M&A. We note that the market average P/E is currently 17x, while some firms are trading at
multiples of 10x or so. This means that some firms could generate returns of around 10%,
even with long-term interest rates below 2%.
In one sense, “Pure pharma” itself can be a “hybrid”, pairing prescription pharmaceuticals
with OTC drugs, or brand drugs with generics. Among Japanese firms, Takeda’s OTC unit
booked ¥61.8bn in sales in FY3/08, giving it a sales weighting of 4.5%. Daiichi Sankyo’s OTC
business posted sales of ¥50.3bn for a 5.7% weighting, and Eisai’s turned in ¥20.1bn for
2.7% (Eisai has not disclosed figures for its generic products). Mitsubishi Tanabe has
announced plans to enter the generic market. We believe the time is coming when these
firms will need to look at the next step to developing “hybrid” business models.
Possible paradigm shift: From “mergers” to “demergers”
Bioventures and midsized drugmakers do not face the same massive development costs
“Pure pharma” business model firms do, nor do they maintain the same sort of distribution
networks. As such, their business models are probably not as close to their limits. One
option Big Pharma do have should they feel their model is at risk is the demerger.
For example, a major pharmaceutical company could spin off its skin cancer business, then
use the wealth of knowledge it has developed in skin to work with a cosmetics business.
Conclusion: Investment opinions could begin considering
paradigm shifts
The “Pure pharma” business model—what does it really mean? Companies that discover new
vaccines and drugs to help those with illness and to prevent others from suffering further down
the road? Or firms with little ability to create new drugs, but with pockets deep enough to
afford new drug development (to conduct large-scale clinical trials, for example) and deliver
drugs to patients around the world? We believe the model covers both types.
Companies that develop and sell pharmaceuticals are usually well known. Firms that specialize
in the discovery of new drugs, however, are making a tremendous contribution to patients—to
mankind—but they are relatively unknown, save to a few specialists and others. With the
internet and other sources, it is easier to get a handle on firms focusing on drug discovery than
it has been in the past. If a firm embraces the “Pure pharma” business model, should it focus
on distribution or discovery? We believe this will be a question of increasing significance.
Major drugmakers following the “Pure pharma” business model are repeating a cycle
alternating between work in new drug development and patent expiration. Pharmaceutical firms
pursuing a “hybrid” model—make that firms with a pharmaceutical business—have a number
of steps at which they can increase corporate value. We also believe theycould be in a better
position to mitigate business risk.
If firms embracing “hybrid” business models emerge, investment opinions based on historical
multiples would become meaningless. Similarly, with no clear sector, comparative valuations
would also be unwieldy. We believe the only answer would be valuations based on sum-of-theparts
analysis. This would mean different mindsets with regard to investment opinions, in what
would be a paradigm shift in this area as well.
In one school of thought, investment opinions weigh the big picture with regard to a firm’s
growth prospects, as well as management’s skills in terms of flexibility and decision-making.
The key, and this is the case with investment in general, is for management to have a vision
that pleases investors, and encourages investors who share management’s views to invest in
the company. In other words, shareholders can be viewed as a cheerleading squad that funds
companies that they are sympathetic to. We believe it would be extremely difficult to develop
an investment opinion for a firm too broad to be confined to a single sector, that keeps its
stakeholders’ (consumers’) well-being in mind, and that has a broad array of businesses—but
we find the thought fascinating
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