A stock that became very high-profile over the past year, AbbVie (ABBV), made a seemingly minor announcement before the open on Thursday about a Phase 2 study:
AbbVie will not seek accelerated approval for Rova-T in third-line relapsed/refractory small cell lung cancer (SCLC) Rova-T demonstrated single agent responses in advanced SCLC patients Ongoing Phase 3 studies, MERU and TAHOE, will continue to investigate Rova-T in first- and second-line SCLC.
ABBV is a large company. Consensus is for $32 B and almost $35 B in revenues this year and next, rising to $40 B in 2021 (E*Trade data).
How could not seeking accelerated approval – a nonexistent regulatory pathway not that many years ago – based on an open label mid-stage study trigger a loss of as much as $20 B in market cap intra-day? Suddenly, ABBV has gone from bull market star to another falling star.
Are even large, strong, mega-cap, dividend-paying/dividend-increasing pharmaceutical companies such as ABBV so fragile that one weak result in a mid-stage trial can begin to do them in?
Especially when the same compound, an antibody, is in two Phase 3 pivotal trials for earlier use in the same disease, and in other diseases.
But the stock valuation may be that rich that the “spell” can break, and suddenly, we can see cinders on what looked like the belle of the ball (Cinderella transformed).
The background of the Rova-T deal
The price did raise eyebrows when ABBV announced it in 2016:
AbbVie to Expand Oncology Presence Through Acquisition of Stemcentrx and its Novel, Late-Stage Rova-T Compound for Small Cell Lung Cancer
Rovalpituzumab tesirine (Rova-T) is a biomarker-specific antibody drug conjugate targeting cancer stem cell protein DLL3 Compelling data on Rova-T was presented at the European Society of Medical Oncology demonstrating overall response rates of 44 percent in DLL-expressing small cell lung cancer (SCLC) patients who have previously failed one or more standard therapies Rova-T represents a multi-billion dollar peak revenue opportunity with expected commercialization in 2018… Expands AbbVie’s oncology pipeline with four additional early-stage clinical compounds in solid tumor indications and a significant portfolio of pre-clinical assets Transaction valued at approximately $5.8 billion, with additional milestones payable upon successful completion of pre-determined clinical and regulatory achievements.
$5.8 B based on a single Phase 1/2 study?
Did legal at ABBV really sign off on this? Look at these words just from ABBV’s introductory summary points:
“Compelling data” “multi-billion dollar… revenue opportunity” “expected commercialization in 2018” “significant portfolio of pre-clinical assets”
Was the data presented at ASCO really “compelling,” or merely interesting and hypothesis-generating? And so on.
Will lawyers be parsing that press release given Thursday’s price action in ABBV?
Well, we’ll see. (I’m sitting tight with ABBV.)
One blog commented on the deal this way (emphases added):
Biotech Dumb Money Looks Smart in $6 Billion Stemcentrx Sale
… The head-turning price tag reflects intense demand for new cancer drugs, but AbbVie is also taking a big risk…
Stemcentrx was founded on the theory that certain cancers have stem cells that drive them to spread. It built a slick manufacturing center and a huge colony of more than 18,000 mice. The setup allowed them to try and launch a large number of drugs against different cancers. So far, it has reported results for only one drug, to treat small-cell lung cancer, but has several others in early testing.
Clearly, with the sale, Stemcentrx has decided it’s not going to try to be the next Amgen or Genentech on its own. That could be seen as an astute move by Peter Thiel… and other investors [who] will net several billion dollars in profit, but are letting AbbVie now take on most of the risk, since drugs generally fail in costly human trials.
Yep, they got it right. An astute move by an astute investor. A lot of mice and one “positive” very early clinical trial later, and ABBV shareholders, which include me, are having a very bad day.
Thoughts on ABBV and biotech (NASDAQ:IBB) based on the latest news, the deal, and the stock’s reaction
First, I’m comfortable saying that Rova-T looks to be dead, or at least doing a Rip Van Winkle (a long rest period) for 3rd line SCLC. That’s because Rova-T is not merely an antibody, but an antibody conjugated with a toxic drug, and these ADC’s are more toxic to the patient than antibodies alone, usually substantially so. Thus, to be clinically useful, an ADC has to offer a real step-up in efficacy.
However, if ABBV thought enough of the science and the data it had on hand to put Rova-T into Phase 3 for both front-line and second-line therapy, I cannot comment on its prospects in these settings. So, could this be a severe case of “shoot first, ask questions later?” Sure. Plus, Stemcentrx has other assets that might pay off, and Rova-T has other indications for which it might work.
However, I take a different message from this. It’s that many stocks have gotten risky simply based on valuation, and that includes ABBV.
On Jan. 29, a time when I was beginning to worry publicly about the general stock market (SPY), I wrote a piece on ABBV:
AbbVie: Too Darn Hot?
ABBV had an amazing response to its Q4 and full-year results. The stock has now slightly more than doubled in only one year while paying 4% dividends. This article tries to show that because of its net debt and very high level of intangibles and goodwill, the stock may be fully valued at best. No matter how excellent management is (and it has performed superbly), the market had a good point when it kept the stock in the $60s. Thus, my strategy is to be a long-term holder of ABBV but not to own much at this very high valuation.
ABBV had closed above $123 when I wrote that article, having closed 2017 below $97. It is back to the $98-99 range as I write this on Thursday, early afternoon.
So, all that has happened is a dramatic round-trip.
ABBV is now more or less a 4% dividend-yielder; but it was a 4.15% yielder when I first wrote a bullish article on it in January 2017, saying in a summary bullet point:
This article goes through several key considerations in valuing ABBV and finds it interesting as a potentially undervalued stock with a seemingly secure dividend above 4%.
ABBV was around $61 then.
And, I only thought it was “potentially” undervalued. So, I was bullish due to the dividend, not because I thought there was a lot of growth ahead. With the stock now about 60% higher in 14 months, can it really be cheap?
At $123 less than two months ago, ABBV had about a $200 B market value. In addition, it had a large net debt position, perhaps $30 B, perhaps more. That gave it a valuation similar to the very largest and strongest pharma companies, basically Pfizer (PFE), Novartis (NVS), and Roche (OTCQX:RHHBY). Yet most of its profits come from one aged drug, Humira.
Most of RHHBY’s run-up was based on a deal with Amgen (AMGN) to resolve their legal issues over AMGN’s biosimilar to Humira, and positive news on ABBV’s pipeline. The three candidates with good news last year (and this year) that have excited investors are:
upadacitinib risankizumab elagolix
All these look good to me, but none have earned a dime yet. And the latter two are in-licensed, one from the private company Boehringer Ingelheim and the other from Neurocrine (NASDAQ:NBIX). Thus, both require ABBV to share revenues with these companies.
How does a rational investor assess the value of these pipeline products? How much royalty is AMGN paying ABBV to license its patents and get its biosimilar to the US market in January 2022? How will other biosims fare legally and at FDA, then in the marketplace? By then, will there be some EU-type of price controls on very expensive drugs?
Not only do we not know any answers to these, ABBV has a huge pipeline. How will the pipeline fare beyond all the drugs discussed so far? We do not know.
We also do not know how tight the Fed will get, so as usual we are not sure what hurdle rate to apply to ABBV’s hypothesized future profits.
All these comments are more or less valid for any biotech stock, even the largest ones. But, in my view, it’s not just biotechs and not just techs (NASDAQ:QQQ).
The entire stock market, including theoretically defensive pharmaceutical stocks, has been driven to a high valuation level by, I believe, the immediate and lingering effects of quantitative easing, once called money printing, as well as enthusiasm for the global economy.
Thus, all I’m willing to say is that ABBV is clearly a better buy now, below $100, than it was above $120. The news from Rova-T was disappointing, and devalues the deal, but hardly disastrous.
More important to me are the implications of repeated blow-ups lately in larger, seemingly stable stocks that appeal to income-oriented investors such as General Mills (NYSE:GIS) and Kraft Heinz (NASDAQ:KHC).
ABBV’s crash could be a warning for the SPY
Here, the core problem as I see it. Just today, the Leading Economic Index was reported out, up a strong 0.6% after two very strong preceding months. Yet, the SPY is down 1.5% as I write this, the yield curve is flattening, and the Federal Reserve recommitted to its stated, ongoing program of reverse QE. I expect that so long as the economy “behaves,” in essence, QE 3 is going to be completely negated. I expect that to put growing pressure on market liquidity. Thus, I continue to look to other precedential periods in which the Fed tightened following a prolonged, strong run in the markets. Examples include the non-recessionary bear market of 1966, the difficult year of 1994, and the non-recessionary severe sell-off of 2000-1 (followed by the recessionary period in 2001).
Thus, coming back to ABBV, I continue to enjoy holding an unusually large percentage of assets in cash. In general, I am not buying dips and am not buying this dip in ABBV. However, with the economy performing well, I am targeting the classic weak period in the markets of August-September-October to buy stock. The reasoning involves much more than seasonality. The main reason is that the banking system has $13 T of deposits, growing 4% per year, or $500 B per year. By July-September, the reverse QE program of the Fed will be at $40 B per month, or $480 B per year, ramping to $600 B per year thereafter beginning in October for as long as the Fed wants – potentially into 2021.
When the Fed is taking as much liquidity out of the system as the banking system is injecting, I want to have cash, because perhaps finally, greater values may appear in the markets than I now perceive. I remain long ABBV, am confident about its long-term prospects, but am undecided as to where it “belongs” and thus am just sitting tight and watching liquidity seemingly evaporate.
Thanks for reading and sharing any comments you wish to contribute.
Disclosure: I am/we are long ABBV,RHHBY.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Not investment advice. I am not an investment adviser.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.