GILEAD SCIENCES, INC: AN UNDERVALUED ACQUISITION MACHINE?

In today’s frothy equity markets, it’s not easy to find a good deal. With many companies sporting stratospheric valuations that would make Icarus blush, the astute investor must look for value where others only see declining revenue or diminishing prospects. In recent years Gilead Sciences has seen its fortunes decline; however, new CEO Daniel O’Day has begun executing a bold turnaround plan based on acquisitions. Does Gilead’s shopping spree qualify it as a value stock that should appeal to investors? 

By The Florida Atlantic University Investors Association

(Daniel Hric, Matthew Kerr, Adam Lewis, Milan Hric & Seth Dixon)

Gilead Sciences ($GILD) is a biopharmaceutical company that focuses on the development of medicines to prevent and treat a variety of diseases, including HIV, AIDS, cancer, hepatitis, coronavirus, and liver diseases, among others. Since its incorporation in 1987, Gilead has embarked on twenty-one acquisitions. The company has been able to furiously expand its business through M&A activity- in 1999 it acquired NeXstar Pharmaceuticals which gave the company access to the international markets. In 2020, Gilead had its largest acquisition when the firm acquired Immunomedics for $21 billion. Gilead Sciences has made a variety of deals since Daniel O’Day became CEO in 2019; in 2020 alone four transactions were completed along with the Immunomedics deal-Forty Seven in April for $4.9 billion, Pionyr Immunotherapeutics in June for $275 million,  and Tizona Therapeutics in July for $300 million. Gilead, among other biopharma companies, occupies a market that has at least a trillion dollars in capital for M&A activity available to it.

In the first six months of 2021, Gilead saw a 18% increase in revenue compared to the same time period in the previous year, increasing from $10.6 billion to $12.6 billion. However most of its already marketed products did not outperform their last sales dramatically, in fact they underperformed by around 1%. The real driver of the increased sales was the introduction of a new products Trodelvy and Veklury, earning $161 million and $2.2 billion respectively. The self developed medication Veklury was the first FDA medication approved as a treatment for Covid-19, and by the end of 2020 1 in 2 patients in the US hospitalized with Covid-19 were treated with it. Without the massive sales of Veklury, which overshadowed all other offered products as a result of the pandemic, Gilead’s revenue would have actually decreased approximately 1% as compared to the same period in the last year. 

HIV and HBV treatment constitutes the majority of Gilead’s revenue, approximately 70%, and they are currently in a downtrend of 7.7%, as compared to the same period last year. If it were not for the massive sales revenue from Velklury, Gilead would likely experience a decrease of its total revenue.

This declining revenue can be attributed to the extraordinary success of Harvoni, Gilead’s Hepatitis C treatment with 94% to 99% effectiveness. After the first 2 years that Harvoni was being sold, hepatitis cases decreased by 25% in the US, dropping from 3.2 million to just 2.4 million. Although the temporary surge in revenue was extraordinary, $25 billion to $32 billion in the first two years, the shrinkage of the patient base has negatively affected long term growth as demand decreases. With the enormous revenue produced by Harvoni and declining revenue, Gilead has decided to reinvest it’s gains and expand into other sectors, notably oncology, by acquiring other healthcare research firms to support its growth.

To offset the decline in revenue Gilead aims to introduce new products in the area of oncology and HDV treatment. In early 2021 and late 2020, Gilliead acquired two companies, a German biotechnology firm MYR, and Immunomedics, for $1 billion and $20.8 billion respectively. Immunomedics has allowed Gilead to gain access to the medication Trodelvy, which has been approved by the FDA in April 2021 for use in adult patients with locally advanced or metastatic urothelial cancer (UC) and breast cancer.

After it was approved to be sold in the US in late April, Gilead recorded $89 million in sales in just 3 months. If the sales do not take an unexpected turn, Trodelvy is expected to surpass most of the other medicines in it’s portfolio with expected sales of $350 million dollars in the US alone. This projection however, takes into account only it’s current indications, specifically UC cancer and breast cancer. An important possible indication currently under testing would be for lung cancer. Lung cancer is the second most common form of cancer in the US (28% of all cancer deaths), and in March 2021 Merck withdrew its indication for lung cancer for it’s medication Keytruda. Therefore supply is low for treatments of lung cancer, and if Trodelvy would get approval for this indication, the projected sales would grow even further. Keytruda generated revenue of $3.8 billion in just the first quarter of 2021. Under the assumption that 20% of sales of Keytruda were for cases of lung cancer, an additional $760 million in revenue could be generated by Gilead if Trodelvy successfully obtains this indication and replaces Keytruda for lung cancer cases. Trodelvy, listed as Finite-lived intangible assets on Gilead’s 10-Q statement, was valued at $4.6 billion at the time of the acquisition of Immunomedics, but since it gained FDA approval in April 2021 for treatment of UC and breast cancer, it’s value has increased by more than $1 billion. As a result, Gilead’s total intangible assets have grown by $1 billion, which represents a 2.5% increase since the acquisition. This value would grow even further with new indications for Trodelvy. Additionally, with the acquisition of MYR, Gilead gained access to $15.7 billion worth of in process research and development, which would indicate that Gilead will introduce more novel agents in the future, further diversifying their portfolio of drugs.

The acquisition of MYR has gained Gilead access to Hepcludex, a medicine conditionally approved by the European Commission in July 2020 for treatment of chronic HDV. Hepcludex at this time is not approved by the FDA, nor has its safety and efficacy been established in the United States. In Gilead’s 2021 Form 10-Q for the period ended June 30th, no domestic or international sale or revenue of Hecludex is recorded. At this moment there is however a contingent consideration of $300 million representing a future potential payment upon the FDA approval of Hepcludex, raising the acquisition price of MYR to $1.3 billion. 

Measuring Gilead next to its competitors of comparable size, Gilead stands at a price to earnings ratio of 16.5 and a yield of 4.2%, which is less than the average PE ratio of 29.3, and above the average yield of 2.2% annually. Also, Gilead’s current profit margin of 39% exceeds 98% of all pharmaceutical companies. For these reasons, as well as the expected increase in revenue from the aforementioned new medications, their expansion into international markets, and their possible new indications, revenue can be reasonably expected to grow. Gilead’s cash flow has been too volatile as a result of its recent acquisitions, expiring patents on medications, and sale of new medications, therefore we will use the Discounted Dividend method to value Gilead instead of Discounted Cash Flow. It is important to note, that although cash flow has been quite volatile in the past years, at times gyrating by as much as 50%, Gilead’s dividends were steadily increasing. Only in 2020, (decrease of EPS as a result of acquisition of MYR and Immunomedics) did Gilead distribute dividends that exceeded its earnings; in all other past 4 years, including 2021, earnings per share exceeded the dividends, therefore we can assume the dividends are sustainable. Gilead’s dividends have grown on average 9% over last 4 years, using the Discounted Dividends valuation method and conservative average growth of dividend amount of 4%, Gilead is valued at a fair value of $74.94 per share, which is as of writing of this article 8% above its current market price. Therefore Gilead at this moment seems to be undervalued. 

With a low price to earnings ratio, a very high profit margin, and a generous, and growing dividend, value minded investors may find it worthwhile to bet on the company’s acquisition and expansion strategy.

Disclosure: The Sick Economist owns shares of Gilead Sciences, Inc. 

Gilead revenue and profit data cited in this post can be found here:

Gilead Sciences Inc 2021 Quarterly Report 10-Q (sec.report)