Royalty Pharma Earns Its Profits The Slow Way

Paying cash up front to scientists, hospitals, biotechs and pharmas in exchange for their royalty stakes in successful drugs has proven profitable for Royalty Pharma. The firm has begun applying its long-term strategy to late-stage clinical candidates in addition to marketed products.

Buying up royalty streams on marketed drugs isn’t the sexiest part of the pharmaceutical industry, but Royalty Pharma has made it one of the most profitable endeavors in the business. The firm owns rights to more than three dozen revenue streams worth about $8 billion, collected over a series of deals spread out over its 17-year history. And its dealmaking process has recently taken a more creative turn and shown more appetite for risk, including deals for royalties on late-stage pipeline products awaiting approval and even an attempted hostile takeover.

Many marketed drugs have a royalty tail that extends past their current owners, through the biotechs that funded their early-stage trials, all the way back to their inventors and the universities or hospitals where they worked. For Royalty Pharma, each owner represents a possible target for a deal. The basic strategy is fairly simple: the New York-based firm pays cash now for royalties generated later, and assumes commercial risk at a discount price. It doesn’t develop drugs on its own, nor does it influence how their primary owners market them.

It’s a growing sector of the drug business, thanks to the immediate cash needs of pharmas and biotechs as they look for sources of capital to invest in new projects. Others have gotten into the act – Cowen & Co. launched HealthCare Royalty Partners in 2007, and OrbiMed Advisors’ newest $600 million fund is dedicated to royalty investments, to name two – but Royalty Pharma is the largest specialist in the field.

Most of its deals are what Executive Vice President of Investments George Lloyd calls “plain vanilla” purchases of royalties from pharmas, biotechs or universities passively collecting their money over time. Many are willing to forgo a full payout in favor of a lump sum, often to finance newer programs. Royalty Pharma has accumulated about 40 of them; it initially focused on buying from hospitals and academic institutions, but has increasingly worked with pharmas and biotechs over the years.

Though the firm keeps a fairly low profile, some of its drugs are well-known blockbusters. Eight of its portfolio drugs generated more than $1 billion in sales during 2012, including AbbVie Inc.’s Humira (adalimumab) and Johnson & Johnson’s Remicade (infliximab) for autoimmune disorders, Pfizer Inc.’s Lyrica (pregabalin) for neuropathic pain, and Gilead Sciences Inc.’s antiretroviral combinations that feature emtricitabine for HIV infections.

Even if the royalty streams represent a small percentage of those drugs’ total sales, they add up to a large sum. Privately-held Royalty Pharma doesn’t discuss all of its financials, but Executive Vice President and Head of Research & Investments Jim Reddoch said the profitable firm forecasts revenue of $1.5 billion this year, balanced by very low operating expenses. The firm is structured as a partnership for tax purposes, and as a self-replenishing evergreen fund that further supports its investments with low-interest debt, as many private equity firms do.

A New Aim For Late-Stage Clinical Products

During such profitable times, Royalty Pharma has made some of its largest investments. In May 2012, it made the biggest royalty acquisition of all time, a $761 million buyout of inventors’ rights to Biogen Inc.’s Tecfidera (dimethyl fumarate), previously known as BG-12. Biogen obtained the drug when it bought Fumapharm AG in a 2006 deal that included substantial sales milestones (Also see "Biogen Idec Will Move MS Therapy Into Phase III After Fumapharm Buy" - Pink Sheet, 31 May, 2006.). Some estimates suggest that the recently-introduced Tecfidera’s sales could reach $3 billion at peak; that would generate total royalties of up to 10% annually, according to a schedule in Biogen’s most recent annual report.

Tecfidera also represented something relatively new for Royalty Pharma: a deal for what was then a clinical-stage candidate’s royalties, rather than a commercial product’s. All but three of Royalty Pharma’s 27 disclosed holdings have been accepted by regulators, but Lloyd said the firm has slowly dipped its toe into the higher-risk field of candidates seeking approval.

The firm is even willing to acquire whole companies in the right situation. Most notably, it attempted a hostile takeover of Elan Corp. PLC this summer but was ultimately outbid by Perrigo Co. PLC (Also see "Elan’s Saga Comes To A Close With Perrigo’s $8.6 Billion Bid" - Pink Sheet, 5 Aug, 2013.). In February, Elan had sold its half of the rights to Biogen’s multiple sclerosis drug Tysabri (natalizumab) (Also see "Elan Prepares For A Buying Spree Now That Biogen Has Taken Over Tysabri" - Pink Sheet, 6 Feb, 2013.). Its late-stage Alzheimer’s candidate also failed last year, leaving it with little besides cash and royalties (Also see "Bapineuzumab Failure Raises More Doubts About Beta Amyloid Approach In Alzheimer’s" - Pink Sheet, 23 Jul, 2012.)

“Elan was a classic case of a biotech company [whose] drug development pipeline later failed,” Lloyd explained, pointing to its inability to generate a successor to Tysabri. Although Royalty Pharma didn’t land Elan in the end, Reddoch said the firm is still interested. “We believe [Tysabri offers] a large royalty that doesn’t fit into [Perrigo’s strategy], and we’re hopeful that it will come back on the market someday,” he said.

“Stuck With” Assets, Thinking Long Term

Though its diverse holdings signify a relatively agnostic approach to therapeutic areas, Lloyd says some markets match its business model better than others. The firm prefers “relatively uncrowded areas where there is a lot of unmet need” such as oncology, he said, while quickly-evolving areas such as hepatitis C are more uncertain.

That’s essential for a firm whose bets are almost exclusively long-term ones. Lloyd said that while pharmas tend to think quarter-to-quarter and even VCs aim to flip their holdings in three to five years, Royalty Pharma doesn’t tend to sell its royalty rights after acquiring them. “It’s a very unusual business, and a deeply analytical one,” he said. “We do a lot of diligence on a drug, but then we’re stuck with it. We don’t control sales. We make an investment decision, then it’s buy-and-hold.”

Occasionally, that’s backfired. Reddoch named its $110 million purchase of Yale University’s rights to HIV drug Zerit (stavudine) as one of its few money-losing transactions. The compound’s sales trajectory never matched Royalty Pharma’s expectations as Gilead’s Viread (tenofovir) gained popularity. Reddoch said the firm hopes to avoid products from which the marketer might lose interest, and prefers to focus on top sellers that will be major priorities for pharmas.

Royalty Pharma hopes to build upon the creativity it has applied of late to dealmaking. Its recent acquisition of a mid-single-digit royalty on Pharmacyclics Inc. and Johnson & Johnson’s late-stage blood cancer candidate ibrutinib from Quest Diagnostics Inc. for $485 million includes a risk-sharing arrangement with venture capital firms. (Details have yet to be announced.) And last year’s deal with Sunesis Pharmaceuticals Inc. for royalties on Phase III leukemia candidate vosaroxin included a variety of contingencies based on trial results that could give Royalty Pharma variable royalty rates as well as an equity stake in the company.

Royalty investing is becoming more popular, but it’s still not for everyone. “It’s one of the most unique and rewarding ways to participate in the financing of health care,” explains Reddoch, a Ph.D. molecular biologist and former Wall Street analyst who joined the firm five years ago. “You have to be patient, and think long-term. You have to crystallize your views. It’s very different from being a stock picker.”