Gilead Sciences, Inc. (NASDAQ:GILD) investors need not worry about its patent lawsuit against Merck & Co., Inc. (NYSE:MRK)
after all. On Thursday, a federal jury decided Gilead would have to pay
$200 million to Merck for infringing two of its patents related to the
biotech’s mega-blockbuster hepatitis C franchise consisting of two
drugs, Sovaldi and Harvoni. The penalty payment is a far cry from what
Merck had been demanding and incapable of impacting Gilead’s huge cash
pile in a big way.
In a separate court hearing, the jury will now determine the amount Gilead owes on sofosbuvir sales starting January 1 of this year. Note that while the biotech giant expects sales from its HCV franchise to decline this year forward, it is still expected to rake in over $17 billion in 2016, $14 billion in 2017, $11 billion in 2018 and $10 billion in 2019. In a March 22 research report, Merrill Lynch had estimated a 10% royalty from past, current and future US sales of both Sovaldi and Harvoni to exceed $50 billion. However, if the jury continues to apply the same arithmetic as that used in Thursday’s decision for future payment calculations, the eventual financial impact on Gilead will be insignificant. The biotech giant had nearly $26 billion in cash at the end of 2015, out of which 40% exists onshore.
“Assuming the same arithmetic applied by the jury in estimating the damages obligation is then applied to our expected future US sales of Sovaldi and Sovaldi-containing combinations, the value effect per share based on the NPV of these future royalties would be $0.44/share (4% royalties; including the $200mm upfront payment, the combined effect is $0.59/share),” Mr. Porges estimated. He maintained an Outperform rating on the company’s stock and a 12-month price target of $127 apiece, representing an upside of nearly 40% over the stock's last close of $91.32. He said the stock was expected to trade much higher than it was in the last few days following last Tuesday’s ruling.
Gilead plans to appeal if the judge upholds the jury’s decision which can leave the final outcome of the patent trial potentially years away. Credit Suisse analysts have said in a prior research report that the appeal process can take up to 1.5-2 years. Gilead said in a statement, “We do not believe Merck is entitled to any amount of damages. We continue to believe the Merck patents are invalid.” The biotech claims Merck “assumed none of the risk” in the discovery of sofosbuvir, nor did it contribute to manufacturing the drugs.
Merck, on the other hand, lauded the verdict in a statement, “We are pleased that the jury recognized that patent protections are essential to the development of new medical treatments. The compounds and methods at issue in this case facilitated significant advances in the treatment of patients with HCV infection, and achieving these advancements required many years of research and significant investment by Merck and its partners.”
The bigger threat to Gilead's stock from Merck is the latter’s newly approved HCV drug, Zepatier. Cleared in the US this January, the drug is the third next-gen HCV treatment to make it to market after Gilead’s sofosbuvir-based drugs and AbbVie’s Viekira Pak. Zepatier is priced more than 30% less than all these drugs, making it a more attractive option for both state and private payers. Gilead has been attempting to diversify into the lucrative cancer market to make up for lost HCV sales. However, its only commercial cancer product, Zydelig, was recently associated with serious adverse reactions including death, while its cancer pipeline is still unimpressive and risky. It is for these reasons that Credit Suisse analysts believe Gilead’s stock performance this year will be guided more by steps it takes to drive growth, particularly quality and price of its acquisitions, rather than its patent suit with Merck.
The Lawsuit
On Tuesday, the same jury in San Jose, California, had upheld the validity of the two patents held by Merck and partner Ionis Pharmaceuticals Inc which covered the use of some compounds capable of treating HCV. Merck claimed it had registered the patents back in 2002, and Gilead infringed upon them with its sofosbuvir-containing medicines, Sovaldi and Harvoni. The pharma giant demanded a 10% royalty on all past and future US sales of these drugs, a demand called “outrageous” by Gilead when it filed a suit against Merck in 2013.
Gilead claimed Sovaldi was based on work started
by scientists at Pharmasset Inc as far back as 2001. The company
acquired Pharmasset for $11 billion in 2011 and launched Sovaldi in
December 2013 as an essential cure for the debilitating liver disease in
as little as 12 weeks’ treatment time. The drug was followed a year
later with its advanced combination therapy, Harvoni. The drug lowered
treatment time to as low as 8 weeks for many HCV patients. The two drugs
rose to become some of the fastest-growing medicines in no time and
pulled in more than $20 billion in US sales over the past two years.
This made the damages demanded by Merck equal to at least $2 billion,
far greater than the amount jury ordered Gilead to pay on Thursday.
Gilead’s Insignificant Penalty
Leerink Partners analyst Geoffrey Porges explained the jury’s decision in a research note. The $200 million awarded to Merck was based on all sales of sofosbuvir prior to December 31, 2015. “Although the combined US revenues of Sovaldi (sofosbuvir) and Harvoni (sofosbuvir/ ledipasvir) between 2013 and 2015 were $23bn, the jury factored in Gilead’s investment, subtracting it out before assessing 4% on the remaining $5bn,” Mr. Porges wrote. He noted that the figure was still roughly triple the $73 million amount Gilead had proposed during the trial.In a separate court hearing, the jury will now determine the amount Gilead owes on sofosbuvir sales starting January 1 of this year. Note that while the biotech giant expects sales from its HCV franchise to decline this year forward, it is still expected to rake in over $17 billion in 2016, $14 billion in 2017, $11 billion in 2018 and $10 billion in 2019. In a March 22 research report, Merrill Lynch had estimated a 10% royalty from past, current and future US sales of both Sovaldi and Harvoni to exceed $50 billion. However, if the jury continues to apply the same arithmetic as that used in Thursday’s decision for future payment calculations, the eventual financial impact on Gilead will be insignificant. The biotech giant had nearly $26 billion in cash at the end of 2015, out of which 40% exists onshore.
“Assuming the same arithmetic applied by the jury in estimating the damages obligation is then applied to our expected future US sales of Sovaldi and Sovaldi-containing combinations, the value effect per share based on the NPV of these future royalties would be $0.44/share (4% royalties; including the $200mm upfront payment, the combined effect is $0.59/share),” Mr. Porges estimated. He maintained an Outperform rating on the company’s stock and a 12-month price target of $127 apiece, representing an upside of nearly 40% over the stock's last close of $91.32. He said the stock was expected to trade much higher than it was in the last few days following last Tuesday’s ruling.
Gilead plans to appeal if the judge upholds the jury’s decision which can leave the final outcome of the patent trial potentially years away. Credit Suisse analysts have said in a prior research report that the appeal process can take up to 1.5-2 years. Gilead said in a statement, “We do not believe Merck is entitled to any amount of damages. We continue to believe the Merck patents are invalid.” The biotech claims Merck “assumed none of the risk” in the discovery of sofosbuvir, nor did it contribute to manufacturing the drugs.
Merck, on the other hand, lauded the verdict in a statement, “We are pleased that the jury recognized that patent protections are essential to the development of new medical treatments. The compounds and methods at issue in this case facilitated significant advances in the treatment of patients with HCV infection, and achieving these advancements required many years of research and significant investment by Merck and its partners.”
What Really Matters For Gilead
Note that Gilead was never really at significant risk from Merck’s patent lawsuit. A large settlement, as sought by Merck, was unlikely in the first place. In fact, even with 10% royalty, the payments wouldn’t have caused much of a dent in Gilead’s cash flow. Credit Suisse had estimated a $4.5 billion payment to Merck/Ionis from Gilead by end of 2018, after modeling in 10% royalties starting the same year. The biotech’s future growth is not expected to be as reliant on the HCV franchise in the future as it currently is, anyway. Gilead derives almost 60% of its top-line from Sovaldi and Harvoni for now. Credit Suisse analysts believe the company’s newly approved TAF regimens will help drive upside in its HIV business going forward, while its HCV sales will decline but still stay sustainable.The bigger threat to Gilead's stock from Merck is the latter’s newly approved HCV drug, Zepatier. Cleared in the US this January, the drug is the third next-gen HCV treatment to make it to market after Gilead’s sofosbuvir-based drugs and AbbVie’s Viekira Pak. Zepatier is priced more than 30% less than all these drugs, making it a more attractive option for both state and private payers. Gilead has been attempting to diversify into the lucrative cancer market to make up for lost HCV sales. However, its only commercial cancer product, Zydelig, was recently associated with serious adverse reactions including death, while its cancer pipeline is still unimpressive and risky. It is for these reasons that Credit Suisse analysts believe Gilead’s stock performance this year will be guided more by steps it takes to drive growth, particularly quality and price of its acquisitions, rather than its patent suit with Merck.
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