Royalty Pharma plc (RPRX) Earnings Call Transcript & Summary

Great, everybody. Good morning again. Thanks for joining us for the next session. I'm Matthew Harrison, one of the biopharma analysts here at Morgan Stanley, and pleased to have Royalty Pharma with us. Quickly before we get started, I need to read a disclosure statement. Please note that all important disclosures, including personal holdings disclosures and Morgan Stanley disclosures appear on the Morgan Stanley public website at morganstanley.com/researchdisclosures. So please have the team of this. I'm going to turn it over to Pablo, who will make some opening comments, and then we'll jump into Q&A.

Thank you, Matt, and thank you for the invitation to join you this morning. And I'd like just to start by saying that in this session, we're going to be making forward-looking statements, and I'd like to refer you to our 10-K. But with that, let me start, and I thought what I would do to begin with is just give you, all of you, a little bit of background on Royalty Pharma. We're a new company, a new kind of biopharma company, very unique. And so it's a pleasure for me to be here to discuss Royalty Pharma and share why we are so excited about the future of our business. For those of you not familiar with Royalty Pharma, we have been a pioneer and leader in the royalty market for over 20 years. The royalty market itself is growing exceptionally strong as royalty funding in biopharma becomes more widely accepted and awareness grows, creating a sustainable tailwind for our business. As I have said before, I believe we're in the golden age of biopharma innovation. There are enormous needs for capital, and we play an important role in providing funding to facilitate continued innovation in the ecosystem. Further, we believe our business model is unique, offering many of the best attributes of biopharma without exposure to common industry challenges. We are agnostic to therapeutic area and can invest where the most exciting medical breakthroughs are happening. We provide investors with targeted exposure to a variety of blockbuster therapies such as cystic fibrosis or Imbruvica in hematology that are transforming the lives of thousands of patients, our portfolios of long duration with an average weighted duration of more than 40 years with excellent diversification across our top and bottom line. And at the same time, we also have an incredible capital-efficient business model as we convert a significant amount of our top line to cash which we continually reinvest through new acquisitions to replenish our portfolio. So what does all that mean from a business perspective? Let me provide some numbers for you. Since our IPO just a little over a year ago, we have announced $4.7 billion in Royalty acquisitions, across 9 transactions spanning 4 therapeutic categories and 17 medicines. And as I just mentioned, our cash conversion is incredibly strong with an 85% adjusted cash flow margin and our bottom line growing by 25% over the last 4 quarters. On our second quarter earnings call last month, we increased 2021 adjusted cash receipts guidance, this is our top line, to $2.08 billion and $2.120 million, so about $2.1 billion, guidance, which represents growth of -- 16% to 18% growth for the year versus the prior year. By all of our key metrics, I could not be more pleased with how our business is performing. In terms of our deal activity, we're very encouraged by the performance so far and expect these deals to generate growing royalties for us well into the next decade. We will point out that the consensus has also evolved positively for a number of our recent royalty acquisitions such as for Biohaven's NURTEC, Roche's Evrysdi and BioCryst's ORLADEYO. So essentially, these products are outperforming. In June, we announced an agreement to provide up to $2 billion in capital to MorphoSys to help facilitate mid-cap M&A, which are our biggest and boldest transaction since our IPO. While the cornerstone of that deal is TREMFYA, a leading immunology blockbuster market by J&J. We also gained significant royalties on gantenerumab for Alzheimer's disease, a Roche's drug and otilimab for rheumatoid arthritis. Both have Phase III expected in 2022, providing us with significant upside optionality. To finish, I want to take a step back and put our deal activity over the next couple of years, in perspective. Over our history, we have maintained a consistent and strong pace of capital deployment, investing a total of around $18 billion prior to going public. Since the start of 2020, we've continued the strong trend with $5.3 billion in announced transactions, putting us well above the run rate we had previously indicated for $7 billion of capital deployed over 5 years until 2025. I want to repeat, we've done already $5.3 billion in investments having guided for $7 billion of total capital deployed over the next 5 years. Now when we look back at our deals from 2016 to 2020, we deployed about $1.8 billion per year on average. As we discussed in our second quarter earnings call based on actual results and current consensus sales estimates, the level of capital deployment is expected to result in significant cash receipts 5 years later, about $350 million in average. In other words, every $1 billion of capital, we deploy, is estimated to translate to approximately $170 billion in royalty receipts 5 years into the future. What does that mean, it means our scale and expertise will enable us to diversify our portfolio and drive value enhancing long-term growth. So we remain as excited as ever about our pipeline and expect to continue to layer new cash flows -- cash flow streams on our existing business and deliver top-tier growth in biopharma. This is a remarkable time in the history of our industry with incredible innovation and groundbreaking therapies that are changing the lives of patients globally. We believe Royalty Pharma is uniquely positioned as a levered play on the innovation in life sciences. Thank you for the introductory remarks. And Matt, happy to answer all your questions.

Great. Pablo, thank you. Thanks for the comments. I appreciate that. You touched on this a little bit in your opening comments, but I think one of the top questions people have or maybe not even a question, just what they're trying to get a handle on is sort of how to think about the reproducibility of the great results that you've seen in the past and about the -- essentially the durability of this business model. So maybe if you could just comment broadly on how you think about that and why you have such a positive outlook on being able to deploy capital to turn it into Royalty flow over the long term?

Sure. Thanks for the question. Terry, why don't you answer specifically the returns that we've seen over time. But just big picture before Terry does that. As I said, we are in an unprecedented time in this industry, life sciences with all of the knowledge that has been built over the last 20, 30 years, our understanding of biology, mapping of the human genome, neo approaches, gene therapy, cell therapy. I mean we couldn't be at a better time to be investing in this industry. And in terms of reproducibility, I've been doing this for over 2 decades, and it's a question that came up a lot over the years, but I think that track record that we have been able to deliver to investors privately. And now we're starting as a public company to be a testament of how we can, every year, deploy capital in a very, very attractive way with positive returns and really fueling long-term growth. We've done it for 20 years. And honestly, the opportunities today are just much bigger than they were many, many years ago. And why is that? Because when we started, we were funded exclusive with equity capital. We did not have access to debt. Our cost of capital was high. We fixed that by starting to use leverage and lowering our cost of capital that allowed us to open up the market of academic royalties, which we did in 2003, expanding our market opportunity. And then in 2012, we innovated again, the first time was using leverage which had never been done with portfolio of pharmaceutical royalties, the second time in 2012 by starting to invest in unapproved products, and then really opened up the market of all of these biotech drugs that are being developed where we can actually go and fund all of these biotech companies and big pharma. So the market opportunity for us now is much, much bigger. But Terry, I'll pass it on to you to provide some perspective on the returns.

Yes, sure. So this is a question that comes up all the time is sort of the reproducibility of the returns as more competition comes along or returns kind of contract. And we're in a unique position where we can track the returns on every single investment that we make down to the decimal point. So we -- unlike a large pharma does M&A, might be a little bit tougher to really decipher what the returns are on a particular investment. But for us, it's actually very simple. So when we look back over the past 10 or so years, the returns have been very consistent and very consistent with what we've guided, which is high single to low double-digit unlevered returns on approved products and teens returns on development stage products. And we've had a healthy mix of both. And what we showed actually on our second quarter earnings call, we showed a slide that just track how the investments that we've made since the beginning of 2020 have tracked versus consensus, as a proxy, just to give you -- people a sense of how things are tracking above, in line, below. And by and large, we're seeing consistent performance where everything is tracking at least in line, and we have a couple of products that are significantly outperforming where consensus estimates have increased by more than 10%. And we only have one product and it was a smaller investment that's lagging a bit. For now, we'll see what happens with that. But overall, the returns have been very predictable. The other thing I would add, as a result of this predictability, it allows us to efficiently use leverage in the business to really enhance those returns. And I think that, that's something that we as a team feel as something that is consistently overlooked, is that when you're able to get sort of, call it, 10%, 12% return on an investment and you're able to use leverage and fund 1/3 of it with debt, the returns that you can achieve on the equity component of that investment are significantly enhanced. And we've been able to do that sort of year in, year out and it's really a function of our business model, and it's a major strategic and competitive advantage for us.

Thanks, Terry. Pablo, you touched on this, well, actually both you and Terry touched on this. But I think also one of the top questions is just about people are seeing more and more companies talk about royalty financing or getting into buying royalties in the pharma space. So I think it would be helpful just to remind people some of your competitive advantages here beyond your track record, including your cost of capital and basically how you continue to win on new transactions?

Sure. Thank you. So you talked about how, now it's much more common for biotechs to consider royalty funding and having us as a partner to help them fund late-stage trials. And there's no question that there's been a massive change, looking back 5 years, 10 years ago, but even 5 years ago, and Chris Hite, who joined us, who was running life sciences investing banking at Citi will tell you that it has now become pretty standard at boardrooms, boardroom discussions where the boards are asking management teams have you considered royalty as the funding mechanism for our trials. And in many cases, it's also the management teams who have just realized that it's just an incredibly attractive way to fund their pipeline. So that has become much more mainstream, and we are incredibly well known. We've cultivated relationships with many management teams for decades. Just like the MorphoSys deal that we did this year, we've known that company, I visited that company more than 10 years ago and have kept dialogue with them. And when the opportunity came to help them in this very important M&A transaction, we were there. We structured the transaction that was a win-win for them and for us. So there's no question that there's just -- the business has changed, and it's also just because of the massive needs of capital in the industry. But going to your question about the advantages we have, when we were private before the IPO, we were funding the business, the company with floating debt that would cost us LIBOR plus 150 for the Terminal A, LIBOR plus 2% for the Terminal B, and it was always 5 and 7 years. Never longer than 7 years and we would have to constantly refinance the debt. When we went public, we then started to issue bonds and we replaced $6 billion of debt that we had with bonds that were $1 billion of 30-year, 20-year, or 10 years or 7 years. So we ended up extending the duration to 14 years versus less than 7. And the cost of debt went down from over 4 because it was LIBOR plus 1.50% to 2% and LIBOR was historically, say, at about 2%, sometimes lower, sometimes higher, but say 2% and we would have to fix it with a swap that would cost us another 50 basis points. And now we've issued $6 billion of debt after the IPO and another $1.3 billion this year at a fixed coupon of 2.1% in average. So realized that we lowered the cost of debt by half, which is remarkable and extended the duration by more than 2x. But it's not only that, it's also the fact that now as a public company, now we're much more visible. Management teams know about us, can see this company as a sizable company that could become their partner and help them fund R&D. And that has opened a lot of doors. It's really -- it's intangible things that we see every day of how -- there's a lot more receptivity among management teams and boards to work with us to fund their business. So we have a lot of advantages. Scale is another huge advantage. We did a $3 billion deal when we bought the cystic fibrosis royalties, $3.3 billion, of which $2.5 billion we allocated to the unapproved part of the investment, which were the doubles and triples and $800 million to be approved drug, which was Kalydeco. So we put $2 billion in unapproved, $2.5 billion. We could do that because of our scale. It did not create a concentration of risk problem. We have so much value on things that were approved that it was a totally manageable risk. And we can do that now at even greater scale. Now my -- I'll remind you that today, we've invested over $7 billion in unapproved assets over the last 8 years since we started in 2012 or 9 years. Of that $7 billion, 88% got approved with some pretty good track record. The team does an amazing job identifying products and diligence in them and negotiating transactions. But I think today, the unapproved part of the portfolio is really low. It's about $0.5 billion. So it's something where we could start to add a lot more investments in unapproved products that will add significant upside potential to returns, and that's very exciting to us because that's where the need in the industry is. A lot of these biotechs that have gone public now need capital to fund the late-stage trials. And the fact that they went public and got money from the capital markets was just an amazing thing because they were able to fund Phase I, Phase II. And now we're going to start to talk to them about funding Phase III and we can really work with them and help them in that situation.

Great. Maybe there are a handful of products that you probably get asked on a lot but I want to talk about the outlook for. But maybe before we do that, just to touch on one of the points that you made, you talked about sort of mid-cap M&A or mid-cap to mid-cap M&A. I think, I can't remember you that's quoted a figure, but I think there are 40 or 50 companies with sort of an approved product but not much of a pipeline beyond that or need to finance that pipeline. So how do you think about the size of that opportunity? And those -- and I guess the second question is related to those companies historically have not really been able to do M&A. So do you think this opens up a large opportunity to them as well?

We think it does open a very, very large opportunity that actually was almost inexistent in the past. If we look years ago for many decades, M&A in Life Sciences was dominated by big pharma buying biotechs. And I think it has definitely changed, particularly over the last year, 18 months, where we have seen a retrenchment of big pharma M&A. In part, I heard people talk about maybe antitrust issues where maybe it's more difficult for the big companies to buy smaller companies because they have an existing drug that is -- anyway, the antitrust problems. And I think what's a really new development that is really exciting is all of these biotech companies that have a true products that are doing well with market caps of a couple of billion to maybe $10 billion, some even north of $10 billion, but where -- we can be the ideal partner for them. The partner of choice to partner with them like we did with MorphoSys and facilitate an M&A transaction where it becomes a win-win for them and for us. And that's a big opportunity for us, one that I think is going to drive the investment pace, accelerate the investment pace in a very meaningful way. If you look at our investments, we did $2.3 billion in 2019, $2.4 billion in 2020, last year, $2.8 billion this year. So this year, of the $2.8 billion, $800 million was more of our plain vanilla conventional deals where we're going to fund a Phase III trial for a biotech or we buy a royalty from an existing biotech or big pharma, which we've done. But I think the real opportunity -- big opportunity for us is M&A, and it was a $2 billion deal this year. Could we do a deal or 2 every year? Possibly, we're going to be very selective, but it's unpredictable. When we went public, we guided to maybe over 5 years, a couple of M&A transactions, 2 or 3. But with this new development where I think it is becoming clear and clear that it may be a totally new thing for mid-cap biotechs to actually go and look our targets, maybe we're going to see an uptick in M&A in that sector, mid-cap biotech. And in that case, we're going to be there, we're going to work with them, help them achieve that. So that could accelerate even the investment pace. When we went public we guided to $7 billion of investments over 5 years, about $1.5 billion per year. And as you can see, over the last 3 years, it's been over $2 billion every year, $2.3 billion, $2.4 billion and $2.8 billion over the last 3 years. So we're definitely investing at a much more rapid pace. The $7 billion that we guided, I think we've done over $5 billion already just in '18 -- actually, really 1 year since when we went public last June or 1.25 years. So I think it's very exciting and M&A is a big opportunity.

Okay. Great. Maybe we can tick through a couple of products, which I now sort of comment a lot. So maybe the first one is there was some recent asthma data from AZ. You guys have a stake in that. Maybe you could just talk about the opportunity and the size of that potential Royalty?

Terry, do you want to take that question?

Sure. Yes, we were excited last week, AstraZeneca announced that both Phase III trials of PT027 were successful, and we're entitled to low single digit royalty on that and also some fixed payments as well. So we're really, really excited about that. We think it's a pretty interesting product, pretty big unmet need for that for -- in asthma, obviously. And I think we're very excited about the sort of long-term potential of that product. And again, like it's another example of our ability to identify products that we think have a high probability of clinical success, hopefully, it can be a very important commercial product as well.

All right. And then I guess second thing is you obviously have a royalty on IMBRUVICA, the patent term there or recently became, I guess, clearer on the length of the patent term there. So maybe just talk about the incremental contribution from that as well.

Sorry, Pablo.

Go ahead, Terry.

Okay. Yes. So we previously expected our IMBRUVICA royalty to expire between 2027 and 2029. But following the recent court decision and AbbVie's public disclosure that they don't expect generics entry in the U.S. prior to March 2032. Our position is that we're entitled to royalties on IMBRUVICA in the U.S. until 2032. So yes, that was an important update from AbbVie.

Okay. Okay. Good. And then obviously, a large component or a decent component of royalties is from cystic fibrosis. There's -- I guess there's a couple of things going on this. So maybe you could just comment on the first one, which is I think you and Vertex may have a different position on the royalty outlook for their next-generation triple. So maybe just give us your thoughts on what's upcoming there and how that may impact your royalty contribution from CF?

Terry, do you want?

Yes, sure. So, yes, it's an important product, important franchise for us. So this comes up a lot, as you can imagine. And so just to sort of unpack the sort of royalty on the new triple. So there's obviously 3 components. The tezacaftor component is clearly royalty bearing. And that would bring the royalty rate overall on the new triple to 4%. The deuterated version of Kalydeco that is a component of the new triple. We believe that, that's simply Kalydeco and that it should have the same royalty rate as Kalydeco. So that would bring the royalty rate to 8%. Now clearly, there is a -- Vertex has a different opinion on that. And then the last component is, at this point, we just don't know whether it's royalty bearing. And so that would really be a question for Vertex. But that sort of 8% is not all that different than the blended rate that we end up getting with Kalydeco -- sorry, with Trikafta. But sort of taking a step back, we obviously looked at the data that was disclosed, I guess, probably about a month ago now. And when we looked at the data, we didn't see anything to suggest that it was clearly differentiated from Trikafta from an efficacy perspective. We haven't -- we will wait to see more data if and when it's presented. But at this point, there was nothing from our observation to suggest that it was -- it's a clearly better product than Trikafta. Trikafta, remember sets a really high bar. And Vertex has talked about the fact that this product has transformed the lives of many patients with cystic fibrosis. So we expect that it's going to continue to be a very contribution to our business over the long term. But at the same time, we're continuing to invest every year. Pablo talked about, it's been multiple billion dollars years -- the last couple of years. We feel really good about the momentum of the business. I think sometimes people maybe overlook the fact that just the sheer sort of volume of things that we add to the portfolio. Over the last 2.5 years, we've added more than 20 products or potential product, couple of them are in development. But going forward, over 5, 10 years, it's going to be significant numbers of additional products that we add to the portfolio, some with significant upside potential, we hope. So we feel really good about the sustainability of the business and any one product is not going to be a key driver of our overall outlook and of our overall growth potential.

Maybe just adding to what Terry was saying. I think there's been a lot of confusion about this because the reality is that, as Terry highlighted, we believe that the base royalty is going to be around 8%, which is very close to what we're getting now based on what he explained. And then I think the other important thing to realize is that this, as we continue to invest, is going to become less and less -- a smaller part of the portfolio, trending down towards 1/10 of the portfolio in maybe 3, 5 years from now. Maybe what I'm saying adding those investments over the next 3 years is going to add so much cash flow that eventually past the second half of this decade, it should get to about 10% or less.

Okay. Great. Well, that's clear, and thanks for your outlook on the business, and thanks for your time today. We very much appreciate the comments.

Thank you for the invitation to talk to you and to the investors. Thank you very much.

Thanks, Matt.