Wednesday, June 8, 2016

Gilead: Ninety-Nine Problems But Merck Ain't One

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Gilead's got 99 problems but Merck ain't one...

The HCV patent war with Merck (NYSE:MRK) has taken a toll on Gilead (NASDAQ:GILD). The potential pay outs for patent infringement and constant negative publicity helped create an overhang for the stock. The Merck drama might have come to an end after a judge ruled Gilead did not have to pay damages for infringing upon Merck's HCV patents:

U.S. District Judge Beth Labson Freeman said Gilead proved that in the process of applying for its patents, Merck deceptively used confidential information from Pharmasset, Inc., a company Gilead bought in 2011.

Freeman also said Merck cannot enforce the patents because Merck's own lawyer gave inconsistent and untruthful testimony during the trial. "Merck's acts are even more egregious because the main perpetrator of its misconduct was its attorney," she said.

The judge accused Merck of lying under oath and other unethical practices. Merck vowed to fight the ruling, but it could be difficult if courts deem the circumstances under which it acquired information on Gilead's patent infringement were dubious.

The Situation

Merck previously claimed that Pharmasset used its patents published in 2002 to develop sofosbuvir. Gilead acquired Pharmasset in 2013 and later used sofosbuvir in its HCV regimens for Sovaldi and Harvoni. Gilead's launch of Sovaldi has been one of the biggest drug launches in history. Sovaldi/Harvoni not only garnered more than $30 billion in revenue, they cut into Merck's HCV sales as well. In 2012, Merck's HCV drugs, Victrelis and PegIntron, generated combined sales of $1.2 billion. They fell to an estimated $200 million shortly after Gilead's HCV drugs hit the market.

Merck was originally awarded a $200 million upfront payment and potential future royalties from Gilead in the dispute. Gilead generates over $10 billion in annual cash flow so the upfront payment would have been a drop in the bucket. I was more concerned about the impact on the company's operating margins from the potential royalties. It appears to be a moot point now.

Gilead's disappointing Q1 results were partly due to having to reserve for the $200 million potential payment to Merck. Judge Freeman's ruling will likely remove the "Merck overhang" from the stock.

Ninety-Nine Problems

Despite the favorable Merck ruling, the company still faces a bevy of problems. Gilead and the pharmaceutical industry have been under assault for price-gouging since Q3 2015. GILD diverged to the downside on fears that it would get lumped in with Turing and Valeant (NYSE:VRX) and become victim to onerous healthcare regulations. Furthermore, the disparity in the company's HCV prices in the U.S. and emerging countries like Egypt created natural fodder for politicians.

Q1 results were disastrous as HCV revenue fell 12% Q/Q due to mandatory roll backs of prices in Japan and discounting in the U.S. to beat back challenges from Merck and AbbVie (NYSE:ABBV). A saving grace was that only about half of VA sales were recorded in the quarter. The company should get the fully benefit of VA sales in Q2, just as Japan - the company's second largest region for HCV revenue - feels the full brunt of 30% price reductions.

State regulators in Massachusetts, Vermont and California (amongst others) are smarting from rising healthcare costs and their impact on state budgets. Backed into a corner, they have appealed directly to Gilead and to Congress to help find ways to cut prices for Harvoni. Add in the fact that the company's single-tablet HIV treatments (Stribild and Complera) are expected to cannibalize Atripla and Truvada, and Gilead's problems appear to be never-ending. Some of these issues are priced into the stock and some are not. That's where the "art of the deal" comes in.

GILD is off over 20% over the past year, yet 7% off its 52-week low. I anticipate the company to deliver solid earnings in Q2, but its guidance will likely be weak. I also expect limited upside from here. Nonetheless, every dark cloud has a silver lining. GILD's got 99 problems but Merck ain't one.

Disclosure: I am/we are short GILD.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.


Source: Gilead: Ninety-Nine Problems But Merck Ain't One

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