VERNALIS: AIM-listed pharma co looking to make it big in the US
Vernalis PLC - LON:VER
I stumbled across AIM-listed Vernalis as I was researching UK small cap pharmaceutical companies with export potential.
Vernalis Revenue Streams
Vernalis derives income from two main sources: sale of pharmaceutical products and research milestone payments.
Research
Revenues derived from research activities have been between £6m to £8m annually for the last five years. Some income has come from milestone contracts (most recently £3m from Corvus in February 2017) but the bulk seems to be made from (and spent on) FTE research collaborations. These "Full Time Equivalent" contracts fix the cost of a given project, Vernalis uses the mechanism to outsource and insource specialist knowledge. According to Vernalis, the research department is financially self-sufficient and generating a small profit, though the December 2017 interim report states that in six months the department generated £3.2m in revenue while incurring £5.5m in costs.
Frovatriptan
A medication developed for the treatment of migraines, it utilises slow-release technology. The technology allows pain relief to last longer (27 hours). Not being a pharmacist, I may have missed some technical nuances here. Frovatriptan is marketed in Europe by Menarini Pharmaceuticals.
Moxatag
An antibiotic used to fight certain infections and marketed as the only "single dose daily" antibiotic. It was approved by the US Food & Drug Administration (FDA) in 2008 with a retail price of $100 (cheaper with coupons and other offers), Vernalis acquired the license in October 2015, the cost of Moxatag also increased to $165 with coupons. An alternative medication is generic amoxicillin, it is widely stocked and less than a tenth of the price of Moxatag.
Tuzistra XR
Tuzistra XR, an antihistamine and cough suppressant synthesised jointly by Vernalis and Tris Pharmaceutical, was approved by the FDA in 2015. Delivery is through oral liquid suspension (taken as a measure of syrup). Since launching in July 2015, the retail price for Tuzistra has been approximately $200 ($135 with offers). Like Moxatag, Tuzistra has cheaper and more readily available rivals: genreric promethazine at $30 and tussionex at $60. It should be noted that Spriaso LLC, the (manufacturer behind nearest competitor Tuxarin ER) was sanctioned by the FDA in December 2016 for failing to disclose age restrictions on product packaging, this matter is ongoing.
Sales Analysis
Frovatriptan
There was significant news about Frovatriptan in the recent interim announcement: a patent expiry on 31st December 2016 with sales in the six months leading to expiry having already dropped over 30%. The chart below will provide some context on Frovatriptan sales income since 2009.
Frovatriptan Sales Revenue
To discover the reasons behind the steep decline in revenue, it is necessary to untangle and understand the complexities of the license rights of Frovatriptan:
- The license is owned by Italian pharmaceutical company Menarini Pharma which markets the product in Europe
- VER owns the right to 25.25% of Frovatriptan royalties sold through the Italian company
- In 2008, VER gave up 90% of this revenue stream to Paul Capital Healthcare (PCH) in return for a cash injection of €18.7m
- In 2010 VER paid PCH £21m to terminate the arrangement. PCH also received a 2.1m share issue in VER
- Frovatriptan is protected by several patents, the most material of which expired in December 2015 with another recently expiring in December 2016
Vernalis interim and annual statements on Frovatriptan seem to be perennially suffixed by "and has led to a discount in the retail price". The discount in price will certainly be a reason for the drop in revenue but, as noted by Vernalis, volume of sales has also rapidly declined due to cheaper, generic rivals steadily gaining greater market share after the expiration of each Frovatriptan patent.
Moxatag
Having got our heads around Frovatriptan, we can go back to Moxatag and consider the license and production of the drug. Vernalis acquired the Moxatag license from Pragma Pharmaceuticals, a Vernalis statement in October 2015 reading:
“Vernalis has paid to Pragma an undisclosed up-front cash payment …. the consideration does not materially impact the Group’s cash resources.”
A few months later the immaterial consideration was revealed as £3.7m, £2.4m paid upfront (as shown on P&L of June 2016 Annual Report).
Like many pharmaceutical products there are some facts that must be understood in order to gauge the revenue attributable to licensees (as we have already discovered, there can be multiple licensees and even more contracted interests):
- Moxatag is protected by six patents. Two patents expire 8 December 2026 and another on 7 May 2027. The other patents though have much less time - these three expire 13 October 2020 (US Patent Number 6544555, 6669948 and 6723341). These three are "material patents" as they protect Moxatag's most valuable asset: three pulse slow release technology. Vernalis need look no further than Frovatriptan to see what happens to sales revenue when material patents expire.
- No income was realised from the product until after the relaunch a year later in October 2016, by the end of December 2016 it had generated £100,000. Keeping in mind patent time restrictions, Vernalis has a window of opportunity of three years to maximise sales of Moxatag. If the Board wants to ensure that atleast the £3.7m capital outlay on the acquisition is recouped in that time, Moxatag must deliver net revenue of £1.2m per year.
- To complicate matters, Moxatag sole manufacturer Suir Pharma in Ireland went into administration in May 2016. The due diligence conducted before the Moxatag acquisition would have recognised the risk of a sole manufacturer and further investigation would have raised a red flag on a Suir being forced to downsize after several years of losses and declining US sales. One must assume the Board felt the risk was acceptable. It is not beyond possibility that Vernalis finds a new manufacturer, though the task will be an unforeseen and potentially expensive cost on the P&L. Fledgling company IQ Pharmatek has taken over the Tipperary laboratory and while it has indicated it aims to continue some of the US market production, there is no specific progress on Moxatag.
The whole purchase value of £3.792m is also added to intangible assets on the balance sheet of the FY June 2016, with the accountants (PWC Reading) declaring they see no reason to reduce the book value of the asset:
"The value in use calculation for Moxatag does not indicate a need to impair the carrying value of the intangible asset at 30 June 2016."
PWC may well be privy to information not available to the public, but keeping in mind the above facts, valuing the Moxatag license at its full purchase price seems questionable. In the meantime the Board are left with a decision to make on whether now is the moment to market a product with a finite supply and no immediate new source.
Tuzistra XR
Vernalis stated in September 2015 the US cough cold market is made up of 30-35 million annual prescriptions. Fifteen months on, the half term report of FY June 2017 showed sales just shy of 12,000 prescriptions. On the one hand, this could (and arguably should) be an indictment of management for failing to implement a solid marketing strategy and overpricing the medication. On the other hand, there is plenty of room for sales growth should management adopt the right pricing strategy. When setting price, cost of production and marketing as well as the need to directly replace falling Frovatriptan revenues may be foremost in the minds of the Board. If so, that thought process needs to be counterweighted against a price the consumer is willing to pay.
There are also challenges with route to market - a minority of physicians are acquainted with the product while a fraction of pharmacies stock Tuxarin. And many of those which do, look unfavourably upon medication which burdens their patient or customer with such a significantly higher cost.
However, armed with a solid product which does not face the patent time limits of Frovatriptan or Moxatag, Vernalis can afford to lower price and gain market share in the short term (important to note Vernalis is not looking for market dominance of amoxicillin antibiotics). Once established as a recognised brand by physicians and pharmacists, management can then look to increase price of Tuzistra to that elusive point which satisfies both patient and shareholder. It seems management are beginning to address these issues with a sales team reshuffle and increased coupon discounts.
In the meantime, Vernalis is expected to make an announcement in June on Tuzistra revenue during the US cough season. This will be big news for the company and will provide foresight of the annual financial results due in autumn 2017. Until last financial year, Frovatriptan has regularly added £5m annually to the Vernalis P&L. In order to replace that income, Tuzistra must significantly increase the £2m it is on course to generate in FY June 2017. And that is before considering cost of sale implications.
The Vernalis Strategy
The long term strategy from the Board seems to be to utilise the extended-release science of Tris Pharma in developing patient-friendly medication (including future CCP-07 & 08) focusing specifically on the US market where it is gradually building an efficient sales infrastructure. Tuzistra is lined up to replace and surpass the diminishing Frovatriptan revenue and act as a launching pad for future products. This looks a strong forward thinking strategy which concentrates on the companies knowledge and takes advantage of sterling weakness. There is sound science too, dosage compliance is the single biggest hurdle to effective medication and Vernalis' products address that vital issue. Vernalis though, overvalues how much a US patient is willing or able to pay for the convenience of less frequent doses. While there is an argument for co-pay and full cover, the reality is the cost will still filter down the demand chain. It might be better for all parties if Vernalis accepts a lower margin and chases volume gain in its sales.
One other thought: there is no specific mention of Directors and Senior Manager salaries, or indeed any wages. The layering of salary information likely means the Board is conscious enough that, if in the public knowledge, this information might not be well received. It would be reasonable therefore, to deduce a significant portion of the £5.3m in “Gen & Admin Expenses” (June ’16) is made up of salaries. With 103 employees, Vernalis either pays great salaries or the Board are well remunerated. This is no moral indictment. Much like taxes, it is a fact of life PLC directors are well paid. The concern is that Vernalis is on course to make a £32m loss this financial year (having posted losses for previous four consecutive financial years totalling over £20m) and its salaries, which represent nearly 20% of the loss, are increasing.
On the horizon
In the short to medium term Vernalis may seem a value buy. Canaccord Genuity recently reiterated its Buy rating with a target of 88p while Shore Capital have also issued similar announcements (Note: Canaccord and Shore are joint brokers acting on behalf of Vernalis). The wisdom behind this may be questionable given the share price slumped 20% a few days later when interim results were announced though it does seem to have hit its support level. Significantly, there are opportunities for good news: CCP-07 and 08 could both be FDA approved by June 2017. Approval would be positive news, so to any milestone payment announcements all of which would likely result in a bounce in share price. No additional negative news from VER (June's expected Tuzistra sales update is a potential and serious banana peel) or from the market would be a relief for the share price. This may change significantly on annual report announcement day in September.
Annual report day may well mark the end of the good news for a while. Should Vernalis find a manufacturer for Moxatag, the market would initially be relieved, then likely baulk at the cost when it is later revealed, doubly so should the share pool be diluted to fund the cost. That may or may not happen by the time of the annual report release due in autumn 2017, Despite the Board's optimism and in the absence of a change in pricing strategy, there is little reason to suggest sluggish sales revenue from Moxatag and Tuzistra will be turned around, while Frovatriptan's already diminished returns will fade further. Should this trend be born out in the annual report fundamentals, would this test the share price and possibly even its current support level?
Looking beyond the autumn report and into the future, there is opportunity for Vernalis. Products are in the pipeline with CCP-07 & 08 looking for FDA approval by June 2017. If approved, the experience of a well managed Tuzistra sales team will be a crucial asset in generating significant immediate revenue at a marginal increase in expense.
Final Thoughts
Granted Vernalis spends money on research so it can bring products to the market superior to generic counterparts and thereby command a premium. Granted management strategy is not to dominate but to market products at an end user who values time/efficiency over money. Granted that a six month loss of £11.8m declared in the Dec 2016 un-audited half term report is in line with the forecast of a £33m loss for FY June 2017. And not undervaluing the science of slow-release medication. It just seems simple wisdom that medical products should be priced so as to be accessible to a larger target market.
