Royalty Pharma (RPRX) is a very interesting and successful public offering, with shares having seen spectacular returns on their first few days of trading. The reason for the move higher is easily understood – an interesting business model which is very profitable and benefits from growing revenues.
I like the business. Although the significant move higher has killed the appeal for now, the business is interesting enough to keep a watch going forward.
An Interesting Biotech Play
Royalty Pharma has a mission to accelerate innovation in life sciences through collaboration with innovators in an effort to make the R&D ecosystem more productive.
The company collaborates with academia and not-for-profit organizations to acquire royalties from innovators. Collaborations include universities and research hospitals. The other side of the business is collaboration with actual commercial companies where the company co-invests in clinical trials and equity of such companies.
Founded in 1996, the company claims to have been a pioneer of the royalty market, claiming to be the largest buyer of pharmaceutical royalties. Between 1996 and 2019, the company deployed $18 billion to acquire biopharmaceutical royalties, which the company estimates is half of all royalty transactions over the same period of time.
Currently, the company has 45 marketed therapies in its portfolio and 3 development stage candidates. Of these 45 therapies, about half (22 therapies) generated end-market sales of more than a billion, with seven generating over $3 billion in annual sales. Of course, the company only generates a smaller percentage of these sales in royalties.
The overall biopharmaceutical market is growing at a decent clip amidst aging of the demographic population and innovation in the medical industry. Royalties are set to grow at a quicker pace as costs and complexity of drug development keeps increasing as drug creation involves more parties today as has been the case in the past.
The company has key partnerships with big names including Vertex (NASDAQ:VRTX), Biogen (NASDAQ:BIIB), AbbVie (NYSE:ABBV), Johnson & Johnson (NYSE:JNJ), Gilead (NASDAQ:GILD), Pfizer (NYSE:PFE), and others. On average, royalties come in at low or mid-single digits compared to end sales, yet given the large portfolio, the company has quite a large portfolio and revenue base.
IPO & Valuation Talks
Royalty Pharma initially aimed to sell 70 million shares in a range between $25 and $28 per share, as solid demand resulted in shares being priced at the high end of the range. Note that 60 million shares were offered by the company, with the remaining shares sold by selling shareholders. The company raised $1.68 billion in gross proceeds in the process.
With a total share count of 595 million shares, the company supported a huge $16.7 billion market value at $28 per share, although this valuation has jumped to $29.2 billion at $49 per share currently. Note that this company even excludes a net debt load of around $5.9 billion ahead of the public offering, seen at $4.4 billion after including the offering proceeds. Hence, the entire company is valued at $21 billion at the offer price and nearly $34 billion at $49 per share.
The company generated total revenues of $1.81 billion in 2019, up a percent from the year before as revenues have pretty much been flattish in recent years. The company reported operating earnings of $2.62 billion. The fact that this profit number is larger than the revenue base suggests that something odd is going on, in this case a $1.02 billion provision for changes related to royalty payments, adding to profits. If that number is excluded, EBIT came in at $1.60 billion, with adjusted EBITDA seen at $2.0 billion.
This suggests that leverage is no real issue, with leverage pegged at 2.2 times EBITDA. Based on EBIT of $1.60 billion, assuming a 4% cost of debt on pro-forma net debt of $4.4 billion, and assuming a 15% tax rate, we can construct a pro-forma P&L of $1.21 billion. Based on a total share count of 595 million shares, I see pro-forma earnings per share just above $2 per share.
At the offer price of $28, shares trade at just 14 times earnings, hence the reason why shares have seen probably a big jump in their price as other investors feel this multiple is compelling as well.
Furthermore, the company has seen great momentum in the first quarter with total revenues up 15% to $501 million, for a run rate of $2.0 billion. Reported earnings fell sharply as a result of high provisions for changes in expected cash flows from royalty assets, as this is a volatile P&L item. Given the stable cash flow generation and reasonable leverage ratios, the company is anticipated to pay out dividends of $0.60 per share per annum going forward.
With sales currently trending at a rate roughly 10% higher than the 2019 numbers, earnings power should improve towards $2.25 per share, for a 21-22 times earnings multiple at $49 per share.
Royalty Pharma is quite an interesting business. I like the business model, growth, leadership position, modest leverage ratio and the compelling valuation at the offer price. Trading just shy of $50 now, pro-forma earnings multiples have expanded to 21-22 times earnings, a full multiple despite the 10% topline sales growth.
While the company has great diversified operations on paper, the company relies on just 5 product candidates for little half over revenues, although that concentration risk seems manageable. Other risks include, of course, the risks of making wrong acquisitions related to future royalty streams, and the fact that capital allocation is essentially controlled by a unique management contract.
Nonetheless, I find the business and its business model quite unique and interesting. A big move higher on the opening days has reduced most of the appeal, with shares essentially having seen a boost from a valuation at around 12 times pro-forma earnings at $28 per share, to 21-22 times currently at nearly $50 per share.
Right here, right now, I am not initiating a position, yet I find the business and valuation reasonable enough to keep the shares on my watch list from hereon. For now, I am planning to keep a close eye on the future developments, both on the business and share price front going forward.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.