Elan Corp, plc (ADR) (ELN)

[written 6 Apr 07]

Élan (ELN) is a biotech company based in Ireland, and constitutes a poster child for the vagaries of speculation. At the beginning of the decade, the company had a marketcap around $20B and shares traded as high as $61 in June 2001…but then a grievous accounting scandal broke, and within 16 months, the stock was down below $2 amid strong doubts the company could recover. However, they hired a CEO from the USA, G. Kelly Martin, and he focused on moving Tysabri—a humanized monoclonal antibody that proved efficacious in the treatment of multiple sclerosis (MS) and Crohn’s disease (CD)—to market.

Élan had entered into partnership with Biogen Idec (BIIB) in 2000—BIIB is responsible for manufacturing and distribution in Europe; ELN is responsible for distribution in the USA; revs are split 50-50 up to $700MM and 65-35 in favor of BIIB thereafter unless ELN elect to make a milestone payment of $75MM, which buys them a 50-50 split up to $1.1B, after which it is 65-35 in favor of BIIB unless ELN elect to make a second milestone payment of $50MM, which buys them a 50-50 split on all revenue thereafter. After the FDA approved Tysabri for MS in late 2004, the stock reached $27. But then in February 2007, two cases of a rare and often lethal brain disease known as progressive multifocal leukoencephalopathy (PML) were found in patients given Tysabri in combination with Avonex (BIIB’s interferon beta-1a MS drug). The companies withdrew Tysabri from the market and began a safety evaluation. This review uncovered a third case of PML, in a Crohn’s disease patient taking Tysabri in conjunction with immunosuppressant agents who had died in December 2003 from what was thought at that time to be a brain tumor, but the diagnosis was subsequently re-evaluated as having been PML. This time, the stock only fell to $3, but the collapse took a lot less time (two months).

Fast forward to June 2006: satisfied with the safety review, the FDA and EMEA (European Medicines Agency) both approved the return of Tysabri to the market. The stock bounces around in the $17-to-$19 range. But enthusiasm for ELN on The Street is low. Analysts worry that there will be more PML cases. They worry that MS patients and doctors will worry about PML and won’t use/prescribe Tysabri. They worry that Biogen Idec salesmen won’t push Tysabri in Europe now that it can no longer be used in conjunction with BIIB’s old MS drug, Avonex (for whom the salesmen might be better compensated as Biogen does not have to share Avonex revenues with Élan). They might worry that folks would remember when they recommended ELN at $60 in 2001 or at $27 in 2005, except no one ever seems to track what analysts on The Street said in the past so that most likely is not a concern. Whatever, no one seems to like ELN and the stock is languishing here back down around $13.50 (marketcap of $6B).

But we like ELN here.

First of all, we are reasonably reassured that the folks at Élan have a handle on the PML issue and that the safety guidelines they have come up are likely to avert any more cases. Of course, some risk from that quarter remains—and there is always the chance that some new complication will arise, perhaps a problem that only becomes evident after some years have passed—but based on what is known now, we believe that MS patients will embrace a drug that reduces relapses 67% of the time and slows progression of the disease 42% of the time (both numbers twice as good as anything else out there).

Now from a valuation point of view, biotech companies with their first $1B blockbuster potential drug and the earning growth to match—e.g., CELG today and AMGN, BGEN, DNA in the past—typically command multiples of 15x to 20x revenues depending on how The Street regards their pipeline. (Mature healthy pharmas have marketcaps more typically in the 4x to 6x revs range.) The potential MS market for Tysabri is 500,000+ patients in the USA and Europe. To reach revenues of $1B, Tysaberi needs about 7% of the potential market—35,000 patients—currently they have just a few thousand and expect to exceed 15,000 this year. Here is how we see Tysabri sales unfolding over the next few years (barring any more catastrophes, of course; typical annual cost of treatement is $28,500):

Year End—# of Patients
2007—17,544
2008—35,088
2009—63,158
2010—101,053

So, we forsee Tysabri becoming a $1B product on an annualized basis by the end of 2008. Because ELN only get about half this revenue, it takes them until sometime in 2010 to get to $1B themselves. By the end of 2010, they will be taking in $1.4B on an annualized basis (presuming they elect to pay the milestone payments to BIIB in 2008 and 2009, as we expect). At a P/S ratio of 17.5x sales, ELN shares ought to be fetching around $58/share by then. Discount that price 25% per annum to reflect the various risk factors and we figure a fair price for ELN here is around $20 ($24.50 by the end of the year if they hit our target of 17,500 Tysabri users by then).

Therefore, presuming Tysabri meets expectations—and presuming the pipeline looks good—the stock appears to be somewhat undervalued here. So…what else they got?

What they got is the world’s leading candidate Alzheimer’s disease (AD) treatment.

Élan already back in 2002 were testing the first (and up to now, still the only) AD drug—AN 1792, a synthetic form of the beta amyloid peptide—that succeeded in reducing beta amyloid plaque in patients’ brains! Unfortunately, the stimulation of the patients’ immune system AN 1792 induced in order to mobilize the body’s defenses against the plaque also apparently engendered encephalitis, so the Phase II test was halted. Well, actually, they continued the study but switched everyone over to placebos; the results indicating the efficacy of AN 1792 were reported in 2004 based in part on autopsy reports.

But that was then, and now Élan have a new AD treatment in Phase II testing: AAB-001. Unlike AN 1792, AAB-001 is not designed to stimulate the body’s immune system to fight the beta amyloid peptide, but rather provides antibodies itself. According to Élan’s website, “Animal studies have shown that this approach is equally effective in clearing beta amyloid from the brain as traditional active immunization methods” such as AN-1792…but absent what we know know to be the risky tactic of stimulating the patient’s immune response to beta amyloid.

Now it is only Phase II, and their last AD Phase II ended badly, and even if the these results show both efficacy and safety, it’s a long way from there through Phase III to approval…and while AN 1792 is still the only treatment proven to reduce brain plaque in humans, other companies are not standing still and that distinction won’t last indefinitely: competition is coming. But…having said all that…AAB-001 is right now the best hope there is for AD and if it lives up to its promise, the potential annual market could be anywhere from $2MM to $10MM+…anywhere from blockbuster to humongous and beyond.

So ELN is not a one-trick pony. Aside from Tysabri and AAB-001, they have some other stuff under development…and they actually have some real products and real revenues (unlike Dendreon, our other biotech investment): $560MM worth or revenue in 2006 with no help whatsoever from Tysabri. Not enough to generate black ink, but it ain’t hay. For more details, check out their website.

Bottom line: a $6B company that should be worth $9B here, likely will be worth $20B in 21 months or so, and has a reasonable shot at a $40B+ valuation in the next five years or so.