The Sanofi Genzyme Contingent Value Rights (CVRs) represent a speculative opportunity where the odds have recently shifted in the holders’ favor. I believe that at the current price, these CVRs offer an attractive opportunity.

 

Background

In conjunction with Sanofi’s purchase of Genzyme in 2011, Sanofi issued one contingent value right for each share of Genzyme it acquired.  The CVRs helped bridge the perceived value gap between Genzyme and Sanofi, which largely centered on the future value of Lemtrada (alemtuzumab), which was being developed by Genzyme for use with recurring multiple sclerosis (MS).  Sanofi repurchased 40 million CVRs in October 2012 for $70  million ($1.75 per CVR). Sanofi repurchased an additional 10.9 million CVRs in the 2013 for $9 million  ($.82 each).  At December 31. 2013, there were 238.3 million CVRs outstanding.

 

Lemtrada was approved for use as a first line therapy in MS by the EU in September 2013, and has subsequently been approved by Canada, Australia, and Brazil. Surprisingly, in December 2013, FDA refused to approve Lemtrada for sale in the US.  Sanofi initially indicated that it would appeal the FDA’s decision, but on April 6, 2014 Sanofi announced that it would submit a revised application to the FDA.  Whether this

 

 

Lemtrada

Lemtrada is the trade name for alemtuzumab. Alemtuzumab was originally approved by the FDA for use as a second-line treatment for B-Cell leukemia and was marketed under the name Campath beginning in 2001.  Ilex Oncology, which originally developed alemtuzumab began seeking approval from the FDA for its use in MS starting in 2002.  Ilex was acquired by Genzyme in 2004.

 

Lemtrada is administered in two cycles, one year apart.  The first cycle involves five infusions over consecutive days. The second round involves three infusions. Proposed pricing is roughly $60,000 for the first round of therapy and $30,000 for the second round.

 

Multiple sclerosis is an autoimmune disease that strikes young, healthy people.   Average age at diagnosis is 37.  Women outnumber men 2 to 1. By eating away at the coating that allows nerve cells to transmit messages, multiple sclerosis leads to awkward movements, walking difficulties and mental gaps, among other problems. For some, the symptoms come and go, though each relapse leaves the person worse off. It can be fatal.  Nearly 3,000 people in the U.S. die each year from MS.  Lemtrada seems to slow or even stop the progression in those with advanced disease. In three clinical trials, patients were significantly less likely to have relapses on Lemtrada compared with Rebif , a common treatment.   (Relapses were reported in 22 to 35% of Lemtrada subjects versus 41 to 53% of the Rebif subjects.)

 

 As a result of the positive clinical trial results, Lemtrada was approved for sale in the EU in September 2013.  Surprisingly, the FDA did not follow the European’s lead, and denied approval in December 2013

 

To avoid off-label use of Campath in MS, (and to protect the much higher pricing of Lemtrada) Genzyme withdrew Campath from the market in September 2012, Genzyme continues to make Campath available to cancer patients without charge.

 

 

Milestones

The CVRs have a series of milestones, each of which result in a payment to holders.  Several of these milestones have passed without payment, so I’ll focus on the ones that remain:

 

Product Milestone 1 - $2.00

The first product milestone requires sales of $400 million.  Sales are tallied separately for the six major markets (United States, Germany, France, United Kingdom, Italy and Spain) and the rest of the world.  Only sales for the first four quarters following introduction are counted for each market. (The meter starts running only after a sales is made in a specific market.)  A sale occurred in Germany in October 2013, so for Germany, sales for the period January 1, 2014 through December 31, 2014 will count towards Milestone 1.  First sales in the other major markets have not been reported, but with the exception of the U.S., should occur in 2014.

 

There is also an outside date.  No sales occurring after December 31, 2016 will count towards Milestone 1.

 

Product Milestone 2 - $4.00

The second product milestone requires sales of $1.8 billion in four consecutive quarters.  (Technically the sales milestone payment is only $3.00, but there is also a $1 make-up payment if sales reach $1.8 billion despite the fact that the FDA didn’t approve Lemtrada prior to March 31, 2014.) 

 

The CVRs expire December 31, 2020 so this milestone would have to be met by then.

 

Product Milestone 3 - $4.00

Product Milestone 4 - $3.00

While these two milestones offer a sizeable potential reward, they require sales of $2.3B and $2.8B respectively.  I view the likelihood of achieving these milestones as remote, and will ignore them for valuation purposes.

 

Full details on the CVRs can be found here:

 

http://1.usa.gov/1hcRl7I

 

The market for MS drugs is estimated at $14 billion worldwide.  Approximately 60% of the market is in the United States.  This market is shared by a number of products as shown in the table below:

 

			Worldwide
		FDA	Sales
	Maker	Approval	2013	Method	Frequency
Tecfidera	Biogen	2013	876	Oral	2X Day
Aubagio	Sanofi	2012	166	Oral	1X Daily
Gilenya	Novartis	2010	1,934	Oral	Daily
Tysabri	Biogen	2006	1,527	Infusion	Monthly
Rebif	Merk	2002	1,138	Injection	3x Week
Extavia	Novartis	2009	159	Injection	Every Other Day
Copaxone	TEVA	1996	4,328	Injection	3x Week
Avonex	Biogen	1996	3,006	Injection	Weekly
Betaseron	Bayer	1993	1,401	Injection	Every Other Day
Total			14,534

 

 

The older MS drugs required frequent injections, which is undesirable for a number of reasons, including patient compliance and injection site infections. The newer generation of MS drugs, led by Gilenya in 2010, are provided in pill form, which is much easier for patients. The newer generation also has better efficacy, with roughly 50 to 60% of patients reporting no relapses when using these drugs compared to 20 to 30% of patients using the first generation products.

 

Lemtrada represents a potential third approach.  Lemtrada is administered in two cycles, one year apart.  The first cycle involves five infusions over consecutive days. The second round involves three infusions.  It is believed that after two cycles of Lemtrada, many patients will no longer have MS symptoms, and will no longer need treatment. (Note that not every treatment has the same effects on every patient, there will probably be a need for a variety of treatment options to treat this disease.)

 

The cost of MS drugs is generally in the $40,000 to $60,000 per year range. Lemtrada is priced at roughly $60,000 for the first treatment and $30,000 for the second round.  This brings the two-year cost in line with other treatment options, with the expectation that costs in subsequent years can be avoided for many patients.  The other benefits of Lemtrada are its efficacy (the clinical trials suggest significantly fewer relapses with Lemtrada) and the elimination of the need to take pills every day or injections on a frequent basis.

 

 

Why wasn’t Lemtrada Approved in the U.S.?

The FDA’s objection centered on the fact that the trial design was not double blind, because the patients and the doctors administering the drugs new which patients were getting Lemtrada, and which were getting the alternative therapy.  (The reviewers, who judged the efficacy of the treatments were blinded to which group the patients were in.) Since Lemtrada is administered via five infusions over a single week period, and the alternative therapy, Rebif, is injected three times a week, Genzyme argued that it was not feasible to design a trial that would be truly double-blind.  For ethical reasons, the control group could not simply be given a placebo.  Rebif does provide relief to many MS patients – asking subjects to participate in trial while denying them was not an option, at least according to Genzyme.

 

There were also a number of serious side effects observed in the trials – 15% to 20% experienced some thyroid issues, and another 1-2% had potentially fatal blood clotting issues.  It should be noted that serious side effects are common in all of the MS treatments, and that MS is a serious, life-threatening disease. 

 

The FDA’s decision to deny approval for Lemtrada was not well received by the MS community in the US. Seventy doctors published an ad in the Lancet calling for Lemtrada’s approval.

 

On April 6, Sanofi announced that it would re-file its application with the FDA, rather than appeal the FDA’s original decision.  I believe the appeal may offer a face saving way for the FDA to reverse its course on Lemtrada.  Sanofi can propose increased monitoring for clotting and thyroid problems and other concessions to the FDA short of running a new trial.  A new double-blind trial, even if it were feasible, would take several years.  In the interim, a number of desperate MS patients would likely seek treatment in Canada, the UK, Europe or other countries where Lemtrada has been approved.  The FDA’s position is further undermined by the fact that alemtuzumab, under the trade name Campath, has been offered legally in the U.S. for over a decade. 

 

A possible compromise would be to approve Lemtrada as a second-line treatment for MS with additional monitoring.  This would address the FDA’s issues with toxicity, while making the product available to people who have tried other treatments without success.

 

The Bull Case

The market for MS treatment is large, as mentioned above, approximately $14.5 billion.  Approximately 60% of the market is in the U.S., leaving a $5.8 billion opportunity in the rest of the world.  Lemtrada would need to capture approximately 5% of the dollars spent outside the U.S. to achieve the first milestone.  Rather than focus on dollars, I believe it is better to look at the number of patients needed to make the milestone.  Assuming $60,000 revenue per patient (only the first treatment is likely to fall within the four quarter window for milestone purposes), 5,000 patients would be required to meat the first milestone.  The MS patient 

populations of the five “major markets” (other than the U.S.) plus Canada and Australia are as follows:

 

 

	Population	MS Rate	Potential	Percent	Patients
	'000s	/ 1000	Patients	Treated	Treating
France	65,700	107	70,000	70%	49,000
Germany	82,000	159	130,000	70%	91,000
Italy	57,600	122	70,000	65%	45,500
Spain	39,400	114	45,000	55%	24,750
UK	58,600	171	100,000	50%	50,000
	303,300		415,000		260,250
Canada	35,100	142	50,000	55%	27,500
Australia	23,300	107	25,000	55%	13,750
	361,700		490,000		301,500

 

To achieve the first milestone, Sanofi must treat fewer than 2% of the patients in these markets during the four-quarter window. The likely target populations are the 60% of patients still receiving injections and the 40 to 50% of patients who have switched to oral medications, but who are still suffering relapses. 

 

If the FDA approves Lemtrada, the first milestone is almost certain to be met.  The U.S. has an additional 400,000 people diagnosed with MS.

 

The second sales milestone is almost certain not to be met if the FDA doesn’t approve Lemtrada.  Whether it could be met with the addition of American patients is questionable.   Tecfidera, which was introduced in April 2013, achieved sales of nearly $900 million in the US alone in its first nine months on the market.  (Tecfidera was approved for sale in the EU in February 2014.)  Gilenya, the most established oral treatment for MS had sales of over $1.9 billion in 2013.  On the other hand, Sanofi’s Aubagio achieved sales of less than $200 million in its first full year on the market.

 

While I think there is a chance that Milestone 2 would be met, a conservative way to look at the CVRs is to assume no value other than the payoff from the first milestone.  Assuming that the payment would be made in early 2017, the payoff matrix at a price per CVR of $.53 assuming various probabilities that the FDA approves and that the Non-US sales alone would meet the $300 million hurdle is as follows:

 

 

 

Non-US Exceeds		Value					IRR
$300M	30%	20%	10%		30%		20%		10%
50%	$1.30	$1.20	$1.10		34.9%		31.3%		27.6%
40%	$1.16	$1.04	$0.92		29.8%		25.2%		20.2%
30%	$1.02	$0.88	$0.74		24.4%		18.4%		11.8%
20%	$0.88	$0.72	$0.56		18.4%		10.8%		1.9%

 

 

Risks

Needless to say, these are options and could wind up being worthless. (Sanofi has the right to buy in the CVRs at a price equal to trailing VWAP anytime after the third anniversary of the launch of Lemtrada if the 45-day trailing VWAP is below $.50 and Lemtrada sales are less than $1 billion.

 

While Sanofi is obligated to use its best efforts to market Lemtrada, there could be point where the potential payment to the CVR holders exceeds the incremental benefit to Sanofi of exceeding a milestone.

 

The CVRs are a bet on a single product.  While it has been tested extensively, Lemtrada faces the usual risks related to a powerful new drug.

 

Sanofi posts sales of Lemtrada quarterly.  The next posting is due by May 20^th.  I expect minimal sales on this release. Sales results should be more informative later this year.

 

Progress in approvals, pricing and adoption of Lemtrada from the various countries where it has been approved should surface over the next six to nine months,

 

Resubmission of the Lemtrada approval to the FDA may clarify Sanofi’s strategy for approval.