Orion & patents

There was a question to my previous article on Orion regarding patent expirations and why I think those have been already discounted in the price of the stock. The reason why I think patent cliff is already fully discounted is the fact that this is widely followed stock in Finland and probably by major stockholders around the world. Information about impending loss of patent protection has been in news for a long time know - especially regarding their Parkinson's disease drugs. Market has a habit of discounting all known information to stock price. However, I wanted to take a deeper look and here is what I found out mainly by reading what Orion has published.

According to Orion's Q3 2011 presentation, Entacapone molecule patent expires in November 2012 in EU. It expires a year later in USA (October 2013). This is the key patent for Stalevo, Comtess and Comtan, which are the best selling drugs of the company related to Parkinson's disease. Combined sales of these drugs was 252,7 million euros in 2010. All proprietary drugs for humans based on a molecule patented by Orion are listed in the following table. As you can see, there are not many of them:

Proprietary drugs for humans based on molecule originally patented by Orion

Stalevo enjoys data protection in EU until October 2013. Thus, it will probably take until 2014 that there will be generic competition for Stalevo in EU (this was an estimate in Orion's CMD 2010 presentation). Comtan has data protection in Japan until 2015. Stalevo has not been yet launched there.
It is in Stage III in R&D pipeline. When approved, it should get 6 year exclusivity (my own interpretation).

According to Wikipedia test data exclusivity is as follows:

• United States: 5 Years for new pharmaceutical chemical entities, 3 years for new indications for pharmaceutical drugs, and 12 years for biologic products.
• European Union: 8 Years (+ 2 Years market exclusivity + 1 year for new indication)
• Japan: 6 Years
• China: The government promised a protection period of 6 years for pharmaceutical drugs, when applying for membership to the World Trade Organization (WTO).

[More about what test data exclusivity means: See http://en.wikipedia.org/wiki/Test_data_exclusivity]

When generic drugs enter the market

Once it is possible for generic drugs to enter the market, they won't eat all of Orions profits overnight. Based on what I found from internet, it seems to be common that generics may take 50% of the market share in 12 months and 80% in 24 months. However, after that the decrease will be slow. The most loyal customers are left. Rather than slashing prices, the company behind the branded drug which has lost protection might actually increase the price of the drug rather than enter into price war with the generic alternatives. Whatever they do they are sure to lose revenue compared to time before the patent expiration.

In case of Orion, it will probably take until 2014 before the effect from losing protection in EU and US for some of its key drugs start to show in results. Meanwhile, a lot can happen. They may launch some new drugs or introduce existing drugs to new markets (like Stalevo for Japan). Also, existing sales of other product segments (>50% of the company) can grow.

Worst case scenario

In the event that they would fail in these actions and top line (net sales) would shrink gradually about 290 million euros by 2020 they could lose 70% of their bottom line unless they would adjust R&D and sales etc. costs. This is very unlikely scenario. Even if they would lose all that sales and get nothing offsetting that they would most certainly adjust their fixed costs (R&D, sales, general costs) to soften the impact on bottom line unless they were sure that investments to R&D and sales would pay off later.

Even in the worst case scenario I would expect them to be able to provide 6,5 euros worth of dividends from the company from years 2011-2020 discounted to this date with 5% rate. All this naturally assumes that they maintain the high payout ratio of over 90% of net result. And even if this worst case would happen you would still have a profitable company although that profits would be smaller and dividend yield not what it is now (compared to current stock price).


Looking at Orion's research areas

In the field of proprietary products, Orion's key compteneces are focused on selected areas of central nervous system disorders and critical care. In recent years, also urology and prostate cancer have become strong areas of expertise. I think these are cleverly chosen areas of expertise. They address mainly aging population. The pharmaceutical industry in general should get lift from this and the fact that the population in developing economies get increasingly wealthy leading to increased standard of living and better access to health care.

R&D pipeline of the company has so far produced 8 proprietary drugs four of which are for humans and four for animals. It has in-licensed patented products such as Enanton, Vantas and Kentera. The easyhaler product line is based on generic active substances. The company does R&D collaboration in cancer research.

The therapy areas of research are:

• central nervous system
• oncology (cancer)
• critical care
• inhaled medical products
• generics
• animal health

R&D pipeline

Stage III (i.e. last clinical phase for marketing authorisation):

• Easyhaler combined formulations for asthma and COPD (chronic obstructive pulmonary disease)
• Stalevo for Japanese market (Parkinson's disease)

Stage II:

• Androgen receptor antagonist for advanced prostate cancer (partner: Endo Pharmaceuticals)
• Alpha 2c receptor antagonist for Alzheimer's disease
• Alpha 2c receptor antagonist for Raynaud's phenomenon

Stage I:

• More effective levodopa product for Parkinson's disease
• Dexmedetomidine (non-intravenous) for pain management (partner: Recro Pharma)

Pre-clinical:

• Projects for prostate cancer, neuropathic pain, Parkinson's disease and Alzheimer's disease

Clinical phases typically last as follows according to Orion:

• Phase III (last stage): More than 3 years
• Phase II: 1-3 years
• Phase I (first stage): 1 year

Orion

During the past week I added Orion to our porfolio. It's a Finnish pharmaceuticals and diagnostics company that derives most of its sales from Europe. Orion pays out most of its profits as dividends. From 2011 it is expected to pay dividend which gives approximately 8,5% yield at current stock price (14,27 euros). I continuously screen Finnish companies and currently Orion is top on that list. The reasons for that are:

• Good past growth
• Good margins
• Excellent ROA, ROI and ROE
• High dividend yield
• Moderate valuation (currently P/E 2011 below 10)

Orion has demonstrated steady growth during last years and had net sales of 849,9 EUR million in 2010. Orions return on equity is excellent. It has been over 30% between 2006 and 2010 reaching 40,7% in 2010 after taxes. Most of company´s net sales comes from two segments

• Patent protected "proprietary products" 44%
• Specialty products 35%

As with all other companies in the pharmaceuticals sector expiry of patents is topical for Orion too. The most important Parkinson's drug patents and product protections will expire in 2012-2013. These drugs contributed 252,7 EUR million to the top line in 2010. I believe patent expirations are already discounted in the stock price and explain the low valuations.

Updated Analysis on Talvivaara

Talvivaara Mining Company Plc. (LSE: TALV; Nasdaq OMX Helsinki: TLV1V) has an open-pit Nickel mine in Sotkamo, Finland. The project leverages one of the largest known sulphide nickel resources in Europe. Talvivaara has 1121 million tonnes of mineral resources in ”measured” and ”indicated” categories and additional 429 tonnes in category ”inferred” (no reserves). Mine life is expected to be close to 50 years. Talvivaara uses a process called "bioheapleaching" to extract the metals from ore.

Production at the mine started in October 2008 and production ramp up is still ongoing. The annual production target for 2011 has been cut multiple times and is now iterated to be minimum 16,000 tonnes of Nickel (it was supposed to be 30,000 tonnes). In the Talvivaara capital markets day 2011 (17th of November) the company estimated the 2012 production to be between 25,000 and 30,000 tonnes of Nickel.

At full planned capacity (50,000 tpa of Nickel) the mine will also produce approximately 90,000 tpa of zinc, 15,000 tpa of copper and 1,800 tpa of cobalt. According to Talvivaara CMD 2011 presentation: "All processes and equipment exist for the 50,000t production level, and have been proven to be capable of running at full capacity "

Also uranium can be extracted profitably from the ore as by-product. Talvivaara has already made an agreement with Cameco regarding building a uranium extraction plant and delivering uranium. The current environmental permit is for 30,000 tonne annual capacity and does not cover uranium extraction.

Back in February I published An Analysis of Talvivaara Mining Company which needs to be updated to reflect the recent guidance. Talvivaara is now experiencing serious headwind pushing stock price to all time lows:
• production problems
• environmental problems leading to bad press, investigation by police and public pressure from Minister of Environment (Ville Niinistö – the chairman of the Green party)
• nickel price has been falling significantly since February (from $28000 USD/tonne used in my first analysis to $18000 USD/tonne used in this update)
• overall economic uncertainty

Valuation of Talvivaara Mining Company

For this update I used the following metal prices:
• Nickel $18000 USD / metric tonne
• Copper $7500 USD / metric tonne
• Cobalt $28500 USD / metric tonne
• Zinc EUR 350 / t + USD 268 / t (Nyrstar 1.25Mt streaming agreement)
• Uranium (Yellow Cake) 55 USD/lb (82 EUR/kg)

Treatment charges are estimated as follows:
• Nickel: 3000 USD/t (2012), 2500 USD/t (2013-2014), 2000 USD/t (2015)
• Copper: 25% treatment charge
• Cobalt: 44% treatment charge

EUR/USD = 1,35

Table 1. Value of production (30ktpa Nickel)

*) Streaming contract.

Table 2. Value of production (50ktpa Nickel)

*) Streaming contract.

Table 3. Value of potential uranium production

The following calculation assumes:

• Operational costs for 2012 (and Nickel production level 30ktpa in general): 250 MEUR
• Operational costs for production level 50ktpa of Nickel: 375 MEUR (Assuming basically 90% of OPEX being tied to the level of production)
• Depreciation etc. 2012: 45 MEUR and 50 MEUR from thereof
• Finance costs: 30 MEUR per year
• Corporate tax level 26%
• Talvivaara stock quote in Helsinki 18.11.2011: 2,42 EUR
• Number of Stocks (millions): 250 (2012), 263 (2013-2014), 290 (2015)
• Attributable to owners: 84%
• Uranium extraction begins late 2012 and it takes until end of 2013 to repay Uranium extraction facility construction ”loan” to Cameco. 

Table 4. Estimated profit levels and P/E

Talvivaara stock price appears to already discount the 30,000 tpa production level (est. 2013). Uranium extraction, if permitted by authorities, will have significant impact on bottom line (est. 2014). Further upside comes from operating at full capacity of 50,000tpa (est. 2015; if permitted by authorities) and ”operation overlord” (expansion to 100,000tpa production). Talvivaara states that they have also excellent near-mine exploration potential especially between Kolmisoppi and Kuusilampi deposits.

There is nothing Talvivaara can do about Nickel prices. There is, however, a lot it can do about environmental problems and bad press. If not handled properly these might become blocking points for uranium extraction and ramp up to full capacity (not to mention production expansion / mine area expansion).

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Full disclosure: Long Talvivaara at the time of writing.

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Notes:

 

MEUR = million euros

tonne (t) = metric ton = 1000 kilograms

kt = kilotonne = 1000 tonnes

Mt = Megatonne = Million tonnestpa = tonnes per annum

 

Interesting article about rare earth companies

Streetwise Reports interviewed recently John Kaiser the editor of Kaiser Research Online about rare earth companies. He singles out several companies that have a chance to be producing towards end of this decade (2016-2017) by stating: “The world does not need dozens and dozens of these deposits, however, which is why I think the race has already pretty much been wrapped up by companies Quest, Rare Element Resources, Tasman Metals and Avalon Rare Metals..”. He talks about companies with heavy rare earths prospects [Please check my earlier post about rare earths on why some rare earth elements are more rare than others].

 

His estimate is that Tasman’s Norra Karr deposit could take care of Europe’s needs for 50+ years. The problem with Norra Karr is that it “involves a mineral that has never been commercially exploited. So a key milestone is the publication of a preliminary economic assessment based on a bench scale-established metallurgical flow sheet that establishes the recoveries and the associated energy and reagent costs.”

Note that the following companies mentioned in the interview are sponsors of The Critical Metals Report: Commerce Resources, Quest Rare Minerals, Tasman Metals, Rare Element Resources. Note also that John Kaiser stated that he personally and/or his family own shares of the following companies mentioned in this interview: Quest Rare Minerals and Tasman Metals.

 

The author of this blog also owns shares in Tasman Metals at the time of writing (11/11/11). Please also note that investment into exploration stage companies is highly risky.

Exposure to Emerging Markets via an ETF

A while ago I decided to start a new position in Vanguard MSCI Emerging Markets ETF (NYSE: VWO). The fund holds 540 equity components mainly from Asia (55%) and Latin America (21%). There are mostly large cap corporations scattered over great many industries. Banks (18%) are the largest sector, which is typical to emerging markets.

Country exposure: China (16%), South Korea (15%), Brazil (14%), Taiwan (11%), India (7%), South Africa (7%), Russia 6%), Mexico (4%) and a whole bunch of countries at 3% or below. The largest holdings are Petroleo Brasileiro (2,11%+1,75%), Samsung (2,78%),  and Gazprom (2%) at the time of writing.
In my previous post I discussed direct stock holdings vs. owning an ETF. This particular ETF meets my general conditions for a good ETF:

• seems to directly own the stocks as far as I can tell (as opposed to playing with swap-contracts)
• low expense ratio (0,22%; source XTF)
• average ask/bid ratio of just 0,03% (source: XTF)
• XTF ranks the fund in 78th percentile with regards to structural integrity (takes into account many things such as previously mentioned metrics as well as tracking error etc.)

Vanguard is a big player. This one ETF alone has market capitalization of $46,2 billion USD.