Is Biocon undervalued?

Even as analysts continue to be conservative on Biocon, a lot has changed. Over a period, it has built a portfolio of prescription drugs worth Rs 400 crore annually in India, comprising products for specialised therapy such as cancer, auto-immunity, and nephrology. It is the country’s second-largest insulin provider, with a 15% market share after Novo Nordisk. Its tie-up with Mylan opens up another $55 billion market. Biocon will supply drugs, receive upfront payment, and share profits. So far, Mylan has paid $38 million as upfront payment. This year, Biocon pipped Dr. Reddy’s to launch the biosimilar of Herceptin—Roche did not renew Herceptin’s patent in India when it sensed Biocon would launch its clone. The biosimilar is priced 25% lower than Herceptin, effective marketing of which could further establish Biocon as India’s biggest biologics company. Says Abhijeet Barve, Biocon’s R&D head, “This far, our strategy has been to not dilute [intellectual property] and stretch the [investment] dollar further.”

Shaw and her team are now aiming for $1 billion in revenue by 2018, which factors in launching generic drugs in the U.S., an easy growth path that Biocon has shied away from so far. Getting approvals for generics in the U.S. is easy and Biocon has several complex products to offer. According to its recent presentation too, 2009 to 2014 has been its investment phase with focus on R&D and partnerships. “In the past five years, several pieces of the Biocon story are falling into place,” says Shah of MP Partners. Last year, his call on Sun Pharma was providence. Sun’s market capitalisation shot up based on the moves initiated by its new chairman Israel Makov.

So, will the tide turn for Biocon? For starters, some positive news on its biologic products may help. Also, as noted, in the next one year, Biocon plans to release more data on the oral insulin product, something that hardnosed U.S. analysts have been demanding. That will help Shaw find partners to enter the regulated markets—an expensive proposition that can cost $150 million to $300 million. Once Biocon’s Malaysian factory, Asia’s biggest insulin facility, is up and running, it can also sell its generic insulin in the U.S.

Last month, while talking to All India Institute of Medical Sciences graduates, Prime Minister Narendra Modi said that Indian doctors have made a name for themselves globally, but India has lagged behind the world in medical research. He exhorted doctors to focus on creating patient case histories that could further research. Modi was sowing the seeds for changing the national narrative on science. Cue Biocon. 

Now Biocon plans to conduct several short tests to prove the efficacy of its biggest bet in the U.S.—the oral insulin product—and show data to analysts. Also, for the first time, when Biocon introduced Alzumab and the breast cancer drug in India, whose molecules Shaw picked up in Cuba, she conducted Phase III trials on 100-odd patients for each and shared the data. Kavita Thomas, who has covered Biocon for a decade at Mumbai’s brokerage First Global, says, “The onus of proof lies with Biocon if its stock has to be revalued, as historically it has spoken much ahead of its performance.” Earlier, a report, Is Biocon a con?, which Thomas worked on, suggested the company listed at high valuations because it carried the biologics stamp.

Initially, the ‘bio’ tag worked. In 2004, the world was warming up to India, followed by an IPO bull run. On listing, Biocon was valued at Rs 4,484 crore, lower than Rs 5,400 crore for Dr. Reddy’s, but more than Lupin’s Rs 3,700 crore. It was one of 56 Indian companies that enjoyed a valuation of Rs 1 billion or more ($1=Rs 43.54). But at the time, its biggest business was fermentation, a process of breaking down carbohydrates with yeast, to make statins, a class of drugs to control cholesterol. It wasn’t as high-value as making and selling conventional drugs, and much of the IPO money was to be used for building fermentation capabilities further. There was very little of biologics.

As a result, a decade later, when Lupin’s market value rose to Rs 61,000 crore and Dr. Reddy’s nearly 10 times to Rs 51,000 crore, Biocon’s only doubled. “A lot of foreign investors who bought the stock dumped it as the company’s performance never matched expectations. Some of that hangover is perhaps still there,” says Tarun Shah of Ahmedabad-based boutique investment firm MP Partners.

But there are tough moulds to break. Biologics is yet to catch on in India. Among the top pharma companies, only Hyderabad-based Dr. Reddy’s and Mumbai-based Wockhardt have in place a strategy for biosimilars. Dr. Reddy’s has invested over $200 million to research biosimilars and has several products in India and emerging markets. Wockhardt started in the late ’90s with a tie-up with German firm Rhein Biotech and has introduced several products here.

Arun Chandavarkar, joint MD and CEO of Biocon, says that they are already investing a disproportionate amount of funds into biopharma research and market expansion, compared to other areas. The rest, including market leader Sun Pharmaceuticals, Lupin, and Cipla, are still cranking up their generics business. In a report, brokerage firm Edelweiss’s equity analysts Vrijesh Kasera and Raksha Thadani wrote that Biocon was at the forefront of monetising the opportunity, and supporting growth over the long run. They recommended a buy on the stock, expecting it to touch Rs 590 from Rs 477. Six months on, Biocon trades at Rs 455, after a poor show in the second quarter of FY15. For the quarter, compared to last year, its consolidated net fell 0.1% to Rs 102.05 crore on a 2.7% rise in total income to Rs 772.63 crore.

According to Biocon’s investor relations executive Saurabh Paliwal, local analysts focus more on quarterly performance and don’t go deep into what makes the company’s biologics portfolio tick. U.S. investors ask much more—from the design of clinical trials for its under-test drugs to research methodologies. “Indian analysts want to arrive at a number for everything,” he says. “Valuations are driven by what analysts see around them. If there aren’t many companies like Biocon in India, how will they appreciate what Kiran is doing?” asks Sanjiv Kaul, MD of private equity firm Chrysalis Capital and former vice president and head of corporate affairs at Ranbaxy Laboratories. He adds that analysts here are only adept at valuing a generic portfolio and its pipeline, as there is an established market and years of experience.

Also, take the long-winded process of clinical trials that every pharma company follows. It goes on for 10 years or more in case of biologics. Before a drug is approved, there are pre-clinical trials, and post approval, three more phases of trials before a product is launched. Each time, a company generates clinical data, which it shares with investors. Roche put out its Phase III clinical trial data for its Rituxan successor, even though it was apparent that a biosimilar may show up when the drug goes off patent in Europe in 2018. Biocon has done very little of all that. It has even missed several deadlines on its oral insulin. And when it withdrew from giving sales breakup for its novel products in the local market, analysts were not sure if the products were successful.

Apart from biosimilars, Biocon has an orphan drug for giloma, a rare brain cancer, in the U.S., and for pancreatic cancer in Europe. All this means it is time to overhaul the way Biocon’s biologics business is looked at, and take the risk of giving it a premium. “I see that coming already from the language potential investors are talking. They are willing to take more risks,” says Theramyt’s Rodrigues.

Biologics firms command sky-high valuation, even if they are reasonably successful. Their P/E average is 90, compared to the S&P 500 average of 19. U.S.-based Cubist Pharmaceuticals, with nearly $1 billion in revenues, trades at a P/E of over 90. A larger player, Gilead Sciences, with sales of $17 billion, trades at a multiple of 25. In other words, the market expects biologics to be a high-growth story in the foreseeable future. Global Use of Medicines 2017, an IMS Institute of Health Informatics report, pegs the market for biologics at $221 billion by 2017, to account for a fifth of the total drug market. It grew to $169 billion in 2012 from $46 billion a decade ago.

Biosimilars are the next best thing. Complex processes and slow approvals ensure there are very few biosimilars and little competition in this segment. They are also 30% and more cheaper than the originals. Thus, once a biosimilar is in the portfolio, companies get a long time to extract value from the market. The U.S., for instance, gave its first tentative approval to a biosimilar this August. Europe has just over 20 biosimilars. Orphan drugs are another lucrative catch. The U.S. Food and Drug Administration (FDA) has authorised several orphan drugs that can be introduced without elaborate, long-winded clinical trials. Mostly biologics, they are intended for critical, life-threatening situations where other drugs have failed. They can be priced at any amount, with up to 70% less investment, which makes it a low-cost-high-return sector. Alexion’s valuations come from an orphan drug.

Orphan drugs’ sales are also expected to reach $127 billion by 2018 and $176 billion by 2020. Roche’s Rituxan for blood cancer clocks over $7 billion in sales and the company has already lined up another drug. The FDA approved it last December.

Post the ’90s dotcom bust, technology startups attracted phenomenal valuations in the last one decade. So did biologics, which became the U.S. investors’ new El Dorado. A biologic is a product made in a living system such as a microorganism, plant or animal cells. Most biologics are very large, complex molecules or mixtures of molecules. It took roots a quarter century ago largely as a startup play, while Big Pharma (established generics businesses with chemically synthesised products) stayed away, too busy selling their blockbuster drugs. As the first flush of biologics notched up billions of dollars in sales, the fad caught on. Connecticut-based Alexion Pharmaceuticals, which built its business around just one biotech drug Soliris, commands a market capitalisation of $37 billion. The stock traded at $4.5 in 2004 when analysts like T. Rowe Price’s Kris Jenner bet heavily on it. Now it trades at $186. As on Dec. 31, 2013, T. Rowe Price held 9.5% of Alexion. Before Soliris, Alexion’s research was on stopping the immune system from attacking healthy tissues.

In a recent presentation, Elliot Sigal, the chief scientific officer and president of BMS, said the company’s productivity grew by 30% with only 10% more investment on research after the Biocon partnership. The latter built and staffed a state-of-the-art R&D facility in Bangalore to help BMS deliver drug discovery programmes. It is capable of optimising potential new drug leads, conducting toxicology studies, and even scaling up production, says Sigal. In other words, one of the most successful research companies in the U.S. acknowledges that Biocon has put in place several building blocks needed for a drug discovery programme. In the last five years, India’s R&D expenditure has grown to Rs 5,888 crore (FY13) from Rs 2,594 crore. If Hyderabad-based Dr. Reddy’s Laboratories, which has traditionally taken a research-based approach, spends 11% of its revenue on research, Biocon spends close to 8%.

So, you can’t really fault the promoter of Biocon for wondering why the largest biopharma company out of India and the world’s fourth-largest insulin provider is undervalued. Biocon is valued at Rs 9,300 crore, which includes a research subsidiary, Syngene, whose shares recently traded at a valuation of Rs 3,800 crore. That makes Biocon alone worth about Rs 5,500 crore or Rs 275 a share. At a price-to-earnings (P/E) multiple of 13.78, it’s substantially discounted to the industry average of 23. “They [analysts] make it sound as if my research capabilities are a drag on my bottom line,” says Shaw. Kavita Iyer Rodrigues, director and COO of Bangalore-based boutique biotech research firm Theramyt Novobiologics, however, says: “Standalone valuation of the research capabilities of Indian firms are traditionally drummed down, which makes them plum for someone to buy out.”

Now, as private equity firms return to startups, especially in Bangalore, Shaw hopes her firm’s research efforts will be revalued. In August, online retailer Flipkart raised a record $1 billion, which made it a $7 billion startup. The seven-year-old company—among India’s 50 most valuable today—is yet to make any profit. Since Citi Venture Capital and ICICI Venture Fund bought and sold into Dr. Reddy’s research arm Perlecan Pharma between 2005 and 2008, big-ticket investments in original research programmes in India have been few and far between.

It is a national holiday and a day off for Kiran Mazumdar-Shaw, 61, founder-chairperson and managing director of the $487 million (Rs 3,009 crore) pharmaceutical firm Biocon. In two days, she will be headed to Paris for the annual CPhi convention, attended by the who’s who of global pharma. Shaw travels 200 days a year. Today, on a warm October afternoon, relaxed in the balcony overlooking the swimming pool of her single-storey plantation-style bungalow Glenmore on the outskirts of Bangalore, Shaw is chatty. She has a lot to talk about—from becoming a board member at Infosys, which underwent tumultuous leadership changes, to heading the Bangalore Political Action Committee. Be it the narrow dusty roads to her bungalow or India’s IT and pharma policies, Shaw’s out to improve everything.

For starters, she wants the national narrative around science and technology to change after the Mangalyaan feat. “Indian science is undersold,” she says. A few days earlier, on September 24, India created history by placing the indigenous unmanned spacecraft, Mangalyaan, in Mars orbit in the first attempt. It was done at one-tenth of the cost ($74 million) of NASA’s mission a week before. Any conversation with Shaw, however, must include Biocon, her garage startup that took off in 1978. She says Biocon has been doing many things similar to Mangalyaan. But nobody understands its importance—analysts, regulators or the market. “Our valuation is a reflection of that.”

In recent times, Biocon has launched a novel drug—Alzumab (in 2013) for psoriasis, a chronic skin disorder with increased risk of certain cancers, cardiovascular disease, and other organ failures—and a biosimilar breast cancer drug, a clone of Roche’s Herceptin, early this year. (Roche has sued Biocon for infringement of patents.) Biocon was the second domestic company to launch a “Made-in-India” drug after Ahmedabad-based Cadila. Copies of patented biological drugs, biosimilars are tough to develop and it’s even tougher to get them approved. One approval for such a product in the U.S. could mean hundreds of millions of dollars in revenue. The U.S.’s third-largest generics company, Mylan, is conducting advanced clinical trials for Biocon’s insulin, a biosimilar of Sanofi-Aventis’s $8 billion diabetes blockbuster Lantus. The U.S. research firm Bristol-Myers Squibb (BMS), which has tied up with Biocon, is doing trials for its research drugs.