Profits in the pipeline

Shares in German biotech MorphoSys firm could double as the royalties start to roll in, says Mike Tubbs.


Shares in this German biotech firm could double as the royalties start to roll in.

MorphoSys (Frankfurt: MOR)is a German biotech firm specialising in antibody drugs those that stimulate the body's immune system. It has one of the largest libraries of human antibodies in the world, which makes it a very valuable partner for any pharma company seeking an antibody to treat a particular disease. Hence it has partnerships with most big pharma companies together with several smaller biotechs.

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The firm has only one drug on the market so far, so its main potential is in the royalty income that will flow from sales of further late-stage partnered drugs as these complete Phase III trials and are approved. This pipeline includes drugs to treat cancer, rheumatoid arthritis, diabetes, psoriasis, Alzheimer's, haemophilia and many others.

For now, MorphoSys earns revenue from partners for R&D funding (where partners pay it to carry out development work), licence fees (one-off payments when a deal is signed to use one of its antibodies in a new drug) and milestone payments (where specific goals are met in developing a drug). These earnings have enabled it to amass €450m in cash, giving it a range of options including acquisitions and R&D on unpartnered drugs.

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Exciting prospects

MorphoSys has one of the broadest pipelines in the biotech industry, with more than 100 distinct drugs in R&D and 76 clinical trials in progress. The quality of its pipeline is emphasised by thecompanies partnering 71of these clinical trials: they include Bayer, Boehringer Ingelheim, GlaxoSmithKline (GSK), Johnson & Johnson (J&J), Novartis, Pfizer and Roche. Importantly, 50 of the partnered clinical trials are late stage, with 17 in Phase III and 32 in Phase II. Four interesting examples of late-stage pipeline drugs are Guselkumab with J&J, Gantenerumab with Roche, Utomilumab with Pfizer and Ianalumab with Novartis. These drugs all end in "mab" since they are based on MorphoSys's monoclonal antibodies antibodies that bind to a specific cell or protein and serve as a flag for the immune system to attack it.

Guselkumab was approved by the US Food and Drug Administration (FDA) in 2017 and is sold as Tremfya by J&J for plaque psoriasis. Analysts estimate peak annual sales will be over $1bn. MorphoSys's royalty is likely to be mid-single figures or a peak of over $50m per year. Guselkumab is also in Phase III trials for other forms of plaque psoriasis and for psoriatic arthritis and in Phase II testing for Crohn's disease. Gantenerumab is partnered with Roche and five Phase III trials are in progress for mild Alzheimer's. Success with FDA approval on this would give Roche and MorphoSys a super-blockbuster drug. Utomilumab with Pfizer is in Phase II testing for breast cancer, acute myeloid leukaemia and, in combination with other Pfizer drugs, for advanced malignancies and solid tumours. Ianalumab with Novartis is in five Phase II trials for rheumatoid arthritis, pulmonary fibrosis and other conditions.

Work in progress

As well as these late-stage partnered drugs, MorphoSys has several proprietary pipeline drugs. MOR208 is a currently unpartnered drug that is in Phase III trials for lymphoma and Phase II for leukaemia. Success with these should lead to partnering at an attractive royalty rate. (Drugs partnered after late-stage clinical trials attract higher licence fees and royalty percentages than drugs partnered at earlier stages to reflect the fact that Morphosys has borne more cost and risk.)

There are also three already-partnered proprietary drugs in Phase II for multiple myeloma (I-Mab Biopharma), atopic dermatitis (Novartis) and rheumatoid arthritis (GSK). Double-digit royalty rates have been agreed with GSK and probably apply to the others. As Phase II/III drugs are approved, the firm is likely to become highly profitable.

I hold shares in MorphoSys and have done for many years.

The odds look good for MorphoSys

MorphoSys (Frankfurt: MOR)
Share price€81.5Cash€450.5m
Market cap€2.5bnDividendn/a
Recent results2017 reported2018 guidanceChange (%)
EBIT (loss)(€67.6m)(€55-65m)-18.6%/-3.8%

MorphoSys's medium-term and long-term success will rely on royalty streams from market sales by its partners of approved drugs. Its current value is therefore the royalty stream from its one approved drug (Tremfya, J&J) plus the value of its cash pile and the value of its pipeline drugs in clinical trials. Industry-standard probabilities for approval ofpipeline drugs in Phase III are 50% with 15% for Phase II, and 10% for Phase I. There are currently two partnered drugs in Phase III, 12 in Phase II and 12 in Phase 1 with one proprietary drug in Phase III and 3 in Phase II. Most of the pipeline drugs arebeing tested against two-to-five different diseases, so there are effectively 32 drugs in Phase II, 3 in Phase III and 16 in Phase 1. Applying the standard probabilities gives the expectation of one-to-two approved drugs from the three in Phase III and five from the 32 in Phase II and one or two from Phase I a total of between seven and nine.

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However, MorphoSys has a much better than industry average record ofsuccessfully moving drugs through phases so it is reasonable to expect between nine and 11 of the pipeline drugs to be approved. If we add the drug already approved, that makes around 11 reaching the market. Aroyalty rate of 5% on average (not peak) sales of €750m per drug, with ahigher 10% rate for one drug (a proprietary one), gives royalty income from clinical-stage drugs building up to about €450m per year. That means after tax earnings per share (EPS) of €10.2 as these royalties come through.

Regeneron, a US biotech also developing antibody drugs, is on a price-earnings ratio of 19, so the €10.20 EPS for MorphoSys plus cash implies a share price of €208. That ascribes novalue to the preclinical pipeline. Should just onepartnered drug become a super-blockbuster (revenue of more than $5bn) eg, a treatment for Alzheimer's, rheumatoid arthritis or breast cancer the royalties could reach €700m and the share price €300. MorphoSys's shares are up five times since May 2012, but in my view they have much further to go as its royalty income grows.



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