Expert Financial Analysis and Reporting

The New Press Release

Bristol-Myers Squibb’s stock declined from $55.49 at the close on Thursday January 19 to $49.23 at the close on Friday January 20. This was due to a terse press release on January 20^th that read “Bristol-Myers Squibb Company announced today that it has decided not to pursue an accelerated regulatory pathway for the combination of Opdivo plus Yervoy in first-line non-small cell lung cancer (1st L NSCLC) in the U.S. based on a review of data available at this time. In order to protect the integrity of ongoing registrational studies, the company will not be providing additional details.”

The press release offers little information to interpret, but it appears to be the case that Opdivo may have failed to achieve a data hurdle (undisclosed) in the CHECKMATE-012 (CM-012) and CHECKMATE-568 (CM-568) trials. Many investors, including me, were hopeful/ optimistic that BMY could file for approval in 1^st L NSCLC in 2H, 2017 based on combined data from both trials. This announcement appears to rule this possibility out.

Background on BMY’s Clinical Trial Strategy in 1st L NSCLC

Before I go into my investment opinion, let me review the clinical trial program of BMY. It is very important to understand that  BMY has underway a very large trial in 1st L NSCLC called CHECKMATE-227(CM-227) that is focusing on the role of the combination of Opdivo and Yervoy in this cancer stage. It also is conducting CM-012 and CM-568 that are non-randomized phase 2 trials of the combination of Opdivo and Yervoy in 1st L NSCLC.

CM-227 is a large, randomized study that plans to enroll 2220 patients in a four armed trial in 1stL NSCLC. It compares: (1) Opdivo, (2) Opdivo plus Yervoy, (3) Opdivo plus chemotherapy and (4) chemotherapy. This is a landmark trial that should go a long way toward addressing the proper use of Opdivo (and comparable products) in 1^st L NSCLC. BMY believes that Opdivo combined with Yervoy will be shown to be the superior treatment option.

The data from CM-227 is probably going to be released in 1H, 2018 and if BMY has to wait for this data, it would mean that approval of the Opdivo plus Yervoy combination (assuming success in the trial) could be obtained in 2H, 2018. It is possible that an interim look at this trial could lead to an earlier filing, but this is a long shot. BMY also added an arm to CM-568 that compares the combination of Opdivo, Yervoy and chemotherapy to chemotherapy alone. This also could lead to an earlier filing (an even longer longshot), but it is difficult to assign a probability to either occurrence.

The market now believes that Opdivo has fallen substantially behind Merck in the 1^st L NSCLC market. Merck gained approval for Keytruda as monotherapy in October 2016 to treat patients with PD-L1 expression > 50%; such patients account for about 25% of the 1^st L NSCLC. Merck then announced on January 10^th that the FDA had accepted a sBLA filing for the combination of Keytruda and chemotherapy that presumably will address most of the market. The filing was assigned a priority review by the FDA and a PDUFA date of May 10, 2017. The filing was based on data from a small data set (123 patients) from one cohort of a phase 2 trial. I will discuss this shortly.

Investment Opinion

This new setback for BMY on January 20 comes on top of the disappointment announced on August 5, 2016 that the CHECKMATE 026 trial which was intended to gain approval of Opdivo as monotherapy in 1^st L NSCLC had failed to reach its endpoint and the January 10, 2017 announcement that the FDA had accepted the filing of MRK for the combination of Keytruda and chemotherapy in 1^st L NSCLC had been accepted. BMY’s stock hit a closing high of $77 on July 14, 2016. The combination of these three major disappointments along with a flat EPS outlook for 2017 has caused many investors (understandably) to give up on the stock as evidenced by the current stock price of $49.

I recommended the stock on December 19, 2016 in my report Immuno-Oncology is Probably The Most Explosive Commercial Opportunity in All of BioPharma; My Investment Picks are Bristol-Myers Squibb (BMY, Buy, and $57.14) and Agenus (AGEN, Buy, $4.28). I would urge interested readers to review this report. This was before the two most recent setbacks for the stock that occurred in January, 2017.

I recognize that one of the most common mistakes that an analyst can make is to continue to recommend a stock after substantial disappointments like those suffered by BMY. I also recognize that there may not be any market moving news until 1H, 2018 when topline data from CM-227 is announced and that EPS in 2017 will be roughly flat with 2016. This could mean that the stock may be hard pressed to keep abreast of the market and could underperform. I recognize these concerns, but I am continuing my Buy recommendation. Here is why.

I think that the Opdivo/ Yervoy combination could be disruptive in immuno-oncology and after results from CM-227 are reported in 1H, 2018 that the world could turn upside down in BMY’s favor and the stock price could be gripped with enthusiasm of the same magnitude that drove it to $77 in 2016. There is also some modest chance that an interim look at the CM-227 data might provide some excitement before then (possibly 2H, 2017). There is also a reasonable chance that consensus expectations that MRK’s Keytruda has won the competitive battle against Opdivo in 1st L NSCLC could be dampened or reversed. I discuss why shortly.

I reiterate that I am staying with my Buy recommendation. The primary reason for this opinion is based on the belief that regardless of the near term prospects (next year or so) of Opdivo in 1st L NSCLC, BMY will be a major beneficiary of the enormous growth potential in immuno-oncology. The pervasive pessimism on BMY despite what I believe is an excellent long term investment outlook also encourages me. While I differ from Warren Buffet on some aspects of investing (he would never buy a biotechnology stock), I am greatly influenced by his thinking and I would cite two of his quotes as reasons for my remaining positive on BMY. He said:

• Investors should remember that excitement and expenses are their enemies. And if they insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.
• The best thing that happens to us is when a great company gets into temporary trouble. We want to buy them when they're on the operating table.

Another reason for my remaining with the stock is that the current dividend yield is 3.12%. This compares to the 2.02% yield on the S&P 500. I expect the dividend to grow faster than the S&P 500 over the next five years. This should attract value investors and give downside protection over the next year as we await clinical data from CHECKMATE- 227 that could excite investors.

There Are Competitors to Opdivo Other Than Keytruda

In addition to the issues relating to Keytruda and Opdivo, investors are also concerned about new emerging competition. Astra Zeneca is conducting a phase 3 trial (MYSTIC) that is looking at the combination of durvalumab (targets the PD-L1 ligand instead of the PD-1 receptor targeted by Opdivo and Keytruda)) and tremelimumab (a CTLA-4 inhibitor like Yervoy). This trial plans to enroll 1092 patients and may conclude in mid-2017. It has three arms which compare (1) durvalumab as monotherapy, (2) durvalumab combined with tremelimumab and (3) chemotherapy. Neither durvalumab nor tremelimumab have been approved or extensively studied. Also, AZN recently made some trial design revisions to MYSTIC that raise some questions.

There is not meaningful data on which to judge the potential for success in the MYSTIC trial but if successful, AZN might also enter the 1st L NSCLC nine months to a year before BMY in a best case scenario from AZN’s standpoint. In addition, Roche is expected to have data later in 2017 about the combination of Tecentriq (targets the PD-L1 ligand like durvalumab) combined with chemotherapy. All of this has been troubling to investors as

Thoughts on the Fundamental Outlook

My best judgment that the combination of Opdivo plus Yervoy has the potential to dominate the treatment of 1st L NSCLC starting in late 2018 is unchanged. However, the potential delay in approval until 2H, 2018 gives Merck’s Keytruda a marketing headstart of over one year for this indication and this this could also hurt sales of Opdivo in 2^nd L NSCLC as patients treated with Keytruda in the first line setting are unlikely to receive Opdivo in second line.

I believe that the action of the stock reflects a consensus investor view that Merck’s Keytruda has upstaged Opdivo as the dominant drug in treating 1st L NSCLC and that AZN and Roche will also take meaningful market share in immuno-oncology. Many believe that BMY has lost the market lead in immuno-oncology. In considering this position and my view on BMY, here are the issues that I am thinking about.

1. The market for checkpoint modulators used as monotherapy and in combination with other anti-cancer drugs is in its infancy and is poised for rapid growth. The first checkpoint inhibitor Yervoy was approved in 2011 and there are now four checkpoint inhibitors approved-BMY’s Yervoy and Opdivo, MRK’s Keytruda and Roche’s Tecentriq. Sales of these drugs were approximately $6 billion in 2016. By 2022, there should be several other drugs approved and analysts are forecasting sales for this class of drugs of $33 billion by 2022.This is not a zero sums game in which just BMY or MRK or Roche or Astra Zeneca or some other company will win. A rising tide lifts all boats and the checkpoint modulator space is riding a wave akin to a tsunami. As first movers in the space BMY and MRK can be expected to be the two predominant players.
2. It is not a certainty that the combination of Keytruda and chemotherapy will gain approval; indeed there is good reason to believe it might not. The sBLA filing is based on data from one cohort of the phase 2 KEYNOTE-21 trial that enrolled a limited number of patients and the data is immature (not a long patient follow-up). It randomized only 123 patients so that there were probably about 61 or 62 patients who received Keytruda plus chemotherapy and about the same number who received just chemotherapy. The median patient follow up was only 11 months. The primary endpoint was response rate or shrinkage of the tumor and at this early look there is no evidence of an overall survival benefit. I find it extraordinary that the FDA is willing to consider approval of this combination with such limited, early data and most notably without survival or progression free survival data.
3. BMY has stated that its studies (phase 1 and 2) suggest that the addition of chemotherapy to Opdivo does not produce a survival benefit. It further believes that the combination of Opdivo and Yervoy will lead to a survival benefit. If BMY’s hypothesis is substantiated by the CM-227 trial, MRK’s lead in 1^st L NSCLC will be short lived as Merck does not yet have any product like Yervoy to combine with Keytruda.
4. BMY and MRK still have a substantial first mover advantage in cancers other than NSCLC. ClinTrials.gov lists 331 trials in which Opdivo is being studied either alone or in combination with other drugs, radiation or chemotherapy in many different types of cancer. The comparable number for MRK’s Keytruda is 427, for Roche’s Tecentiq is 108 and for AZN’s durvalumab is 147. Generally, the BMY trials are more advanced than the competition because it was the first mover in the immuno-oncology space.

Earnings Outlook

Management provided guidance late last year after Keytruda was approved. Based on this I am estimating that sales in 2016 will increase 16% and EPS (of $2.85) will increase 42%. Because of sales declines in older products and the setback of Opdivo in NSCLC it appears that sales in 2017 could be up only slightly (say 1%) and EPS could be up about 3% to $2.95.

On Another Matter, Merck Agrees to Pay Bristol-Myers to Settle Patent Litigation

Merck announced it agreed to enter into a settlement and license agreement with Bristol-Myers Squibb Company and Ono Pharmaceutical who discovered and developed the PD-1 antibody Opdivo (nivolumab). This resolves the worldwide patent infringement litigation related to infringement of key Opdivo patents by Keytruda.

Under the settlement and license agreement, Merck will make a one-time payment of $625 million to Bristol-Myers Squibb and Ono and provide royalties on the worldwide sales of Keytruda for a non-exclusive license to market Keytruda in any market in which it is approved. For global net sales of Keytruda, Merck will royalties as follows:

• 6.5 % of net sales occurring from Jan. 1, 2017 through December 31, 2023; and
• 2.5% % of net sales occurring January 1, 2024 through December 31, 2026.

BMY will receive 75% of these settlements. This results in a onetime payment to BMY of $469 million and a royalty on Keytruda sales of 4.9% from January 1, 2017 through December 31, 2023 and 1.9% from January 1, 2024 through December 31, 2026.

An article in Seeking Alpha did a calculation that suggested that the net present value on this settlement (pretax) is $2.5 billion, which is 3% of the current market valuation. The approach taken in the article appears reasonable to me and I won’t repeat the exercise. The expected royalty on consensus projected Keytruda sales of $3.8 billion in 2018 is $186 million. At the current tax rate of 22%, this amounts to $0.09 per share.