Monday, January 31, 2011

Check Point Still Growing Strong

A super set of results from Internet Security specialist Check Point saw the stock price initially sell off, but I believe any weakness will provide a good entry point. There has been a lot of 'selling on the news' recently in the sector and Check Point doesn't seem immune.

Firstly, turning to the results, it was a substantial beat.
  • Revs of $318.5m vs. $306m estimate
  • Non-GAAP EPS of 73c vs. 69c estimates
  • Q1 Revs of $268-279m vs. $276m estimates
  • Q1 EPS of 59-62c vs. 62c estimates
They subastantially beat estimates but the Q1 guidance was a little lighter than analyst forecasts. However, it should be noted that this company traditonal guides under and then beats forecasts. I think the evidence suggests that Check Point will do the same in the coming quarter.

 Internet Security Sector Doing Well

In general the sector has reported positive results in the last quarter of 2010. For example, Fortinet gave very strong results, although Fortinet is more focused on the small and medium size market in Unified Threat Management. Check Point is more focused on larger enterprise solutions.

Indeed, the market seems to be on a similar growth path to what it was in 2009. This is notable because usually the first year of recovery is the strongest for corporate investment. I think this confirms that this sector is capable of super GDP growth.

In order to demonstrate this, I wanted to look at sequential revenue and deferred revenue growth.

Check Point Sequential Growth

Revenues and deferred revenues break down like this

(m)Q4 08Q1 09Q2 09Q3 09Q4 09Q1 10Q2 10Q3 10Q4 10
Seq growth %-10.4%14.7%4.5%16.5%-9.9%6.5%4.6%16.6%
Cur Defer Rev290.0283.1330.0322.8384.3380.9377.0362.9424.2
Seq growth %-2.4%16.6%-2.2%19.1%-0.9%-1.0%-3.7%16.9%
LT Defer Rev40.841.932.137.441.038.937.733.440.4
Seq growth %2.8%-23.4%16.4%9.8%-5.1%-3.0%-11.4%20.8%
Tot Defer Rev330.8325.0362.1360.1425.3419.8414.8396.3464.6
Seq growth %-1.7%11.4%-0.5%18.1%-1.3%-1.2%-4.4%17.2%

 This confirms that sequential revenues in the fourth quarter were comparable to previous years. In addition deferred revenues look similar. This is actually quite positive considering Check Point's revenues are shifting slowly towards selling a higher percentage of application solutions. Much of software companies deferred revenues comes from services paid for upfront, sometimes for a few years in advance. All of which augers well for future growth.

Check Point Outlook

Indeed, listening to the conference call the management sounded bullish about prospects. However, Check Point was cautious not to attribute the growth solely to industry acceleration. Management seemed to believe that the company is grabbing market share as well as generating growth.

One aspect that is favouring Check Point, is that its offering is a diversified and multi faceted approach. Check Point sells a variety of software blades of various applications. This means that average selling prices can expand as Check Point, sells more blades into its established base. The model is proving scalable.

However, it is not just about the established base, because the company seems to be generating new clients and this is demonstrable by looking at the deferred revenues. Cash flow generation and margins remain very strong and I would expect some analyst upgrades after these results.

Political uncertainty coupled with the general climate of selling tech after results may conspire to weaken the stock price and I think this could create a good buying situation.

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Sunday, January 30, 2011

Gilead Facing Challenges

It has been a difficult couple of years for investors in the stock of Gilead Sciences and, they could be forgiven for thinking that more headwinds are coming in 2011. A number of well documented issues have challenged the biotech and pharmaceutical industry. Firstly, US Health care reforms have hurt sales, put pricing under pressure and an increasing amount of the cost increases are becoming less tax deductible. Secondly, increasing patent expires are challenging the incumbent suppliers, Finally, European medical authorities are putting increasing pressure on prices.

Furthermore, Gilead has its own specific issues. One of the key drugs in its anti-HIV franchise (Viread) will see its patent run out in 2017. Viread made up 10% of product sales revenues in 2010. Gilead has been hit with pressure on HIV funding in the US and this could replicated worldwide.

However, as all good investors should ask themselves, is it already in the price?

Gilead Sciences Downside Priced in for 2011?

At the full year results Gilead reported product sales of $7.39bn and guided towards full year revenue of $7.9-8.1bn and as for the issues discussed above
This range includes the full-year impact of U.S. healthcare reform, which we estimate to be 5% to 6% of U.S. net product sales. It also includes the full-year impact of mandatory price decreases in several countries of the European Union, as a result of austerity measures

I've summarised some points from the guidance
  • Product Sales of $7.9-8.1bn
  • Non-GAAP product gross margin of 74-76%
  • Non-GAAP R & D $950m-1bn
  • Non-GAAP S G & A  $1-1.05bn
For Q4 revenues were actually down, but this is because of a reduction in royalties from Tamiflu as a result of a mild flu season in 09-10 causing de-stocking by customers. This is likely to correct itself in time, so is not an undue concern. It's time to look at individual product sales.

Consensus estimates

EPS ($)
PE ($38.21)18.212.510.

 It is clear that the market is discounting Gilead's growth potential, this is mainly to do with the expiry of patents for Viread in 2017. Viread is the reason why Gilead is so successful and this issue is critical to understanding this business. It will be discussed below. Turning to Gilead's marketed products.

Gilead Product Sales

A breakdown of yearly product sales


Gilead is very much an HIV based company and all of the drugs listed above-down to Emtriva- are Antiviral drugs. I'm going to focus on the HIV franchise first.

 HIV is primarily a sexually transmitted disease that infects CD4+ T cells, which causes the body to kill them. In turn, reduced CD4+ T cell levels causes the body to lose its immunisation capabilities and the body is vulnerable to infection.

HIV therapy usually consists of a various combinations of four different classes of drugs.

  1. Nucleo-side/tide reverse transcriptase inhibitors (NRTI) are the first class of antiretroviral drugs and inhibit reverse transcription by incorporating into the growing viral DNA chain
  2. Non-nucleoside reverse transcriptase inhibitors (NNRTI) inhibit reverse transcription by binding on a different site of the enzyme
  3. Protease inhibitors (PI) prevent viral replication by inhibiting the activity of proteases
  4. Integrase inhibitors (II) block the action of integrase which is a viral enzyme that integrates the viral genome into the host cell
Gilead's strategy is to protect its leadership in HIV by releasing new combination of these drugs in order to offer a multi-therapy approach. This strategy inevitable involves a certain amount of cannibalisation.

Gilead HIV Combination Drugs

HIV FranchiseMode of ActionStatus
Truvada/TMC278NRTI*2+NNRTINDA Filing
ElvitegravirIIPhase III results 2011
QuadNRTI*2+NNRTI+PK EnhancerPhase III results 2011
CobicistatPhase III results 2011

Viread (tenofivir) is an NRTI and is Gilead's first major antiviral. Sales have peaked and the drug is in decline for HIV, however, Gilead has succeeded in establishing it as treatment for Hepatitis B.

Truvada is the first combination drug for Gilead and combines Viread (tenofivir) with another NRTI called Emtriva (emtricitabin). Truvada is priced lower than its successor Atripla and should still see good sales.

Atripla is the next in the sequence and combines Truvada (tenofivir+emtricitabin) with an NNRTI called Sustiva (efavirenz) from Bristol Myers Squibb.

Truvada/TMC278 is a combination of Truvada (tenofivir+emtricitabin) with a different NNRTI called TMC278 (rilpivirine) from a subsidiary of Johnson & Johnson (Tibotec). It was NDA filed in late 2010 but Gilead received a 'Refuse to File' letter from the FDA. According to Gilead this is due to some technical information which-although embarrassing-should be dealt with in a resubmission in a few months. It is intended to replace Atripla. This is useful as Sustiva will go off patent in 2013.

Elvitegravir is an II which is in late phase III trials. If approved, it will be the second II on the market after raltegravir, of which, it is being compared to in  the trial. It maybe combined with a PI in future.

Quad is the latest combination drug in Phase III trials and results are due later this year. It combines Truvada(tenofivir+emtricitabin) with elvitegravir and Cobicistat. A phase II trial has demonstrated that it is non-inferior to Atripla. Link here

Generic threats to Gilead in HIV Therapy

The patents for Sustiva (used in Atripla) will expire in 2013 and it is prudent to assume that generics will be on the market. This is a thread to Gilead because patients may be able to reduce costs by taking generic Sustiva plus Truvada instead of the more expensive Atripla. Indeed, this is partly why TMC278/Truvada and the Quad regimen are being developed. There is a danger that the cost savings will not be outweighed by the benefits of TMC278/Truvada. Quad is aimed at treatment experienced patients.

Furthermore, Viread will start to lose its patents in 2017 and there is already significant competition from a large Indian generic manufacturer Cipla. Viraday is a generic version of Atripla that Cipla sells worldwide for a fraction of the cost. Indeed, Cipla claims to be the worldwide leader in generic anti HIV therapy sales.

Moreover, if Cipla and others establish themselves in the US via selling generic Sustiva to be combined with Truvada than they could be establishing a foothold with which to launch much cheaper generic copies of Truvada when the Viread patents start to expire in 2017.

 I consider this is to be a significant threat.

Gilead Not Just About HIV

As outlined above Gilead has significant non HIV products, the most interesting being Letairis in pulmonary arterial hypertension (PAH) which is seeking to grab market share from industry leader Tracleer. Letairis has the benefit of being a once a day regimen, however Actelion have replied to the threat and have Macitentan in late stage development. This drug (once a day regimen) is demonstrating potency and doesn't have the liver toxicity issues of the other two. If successful in phase III, this drug could crimp Letairis sales growth.

Gilead also has a couple of drugs in development for Hepatitis C (HCV) including a polymerase inhibitor and a protease inhibitor. Gilead looks to be a little bit late to the party here. Both Vertex and Merck intend to start marketing their own protease inhibitors this year. In fact Vertex is interesting for other reasons too.

Vertex Pharmaceuticals a Good Fit for Gilead

If Vertex is successful in getting Telaprevir approved then it could become a target for a larger company. Immediate focus would shift towards its partner Johnson & Johnson, but I think that Gilead is an equally likely acquirer.

It appears that Gilead's existing strategy for Hepatitis C is similar to the multi therapy approach taken with HIV. However, Gilead may change tack. The company is generating billions in cash, has patent expiry issues and could generate significant synergies by adding the Vertex pipeline to its own. Johnson & Johnson is already partnering Gilead with TMC278/Truvada and in any case, is developing its own HCV drugs. Either one of the two is a potential acquirer of Vertex.

Is Gilead a Stock to Buy?

I'm going to take a pass here. I'm not convinced the evidence is exciting enough to get too excited by TMC278/Truvada and the prospect of it replacing Atripla. Gilead needs this to happen because Sustiva is coming off patent in 2013. I think Gilead could face competition from cheap generic Sustiva being taken in combination with Truvada. More on the subject of TMC278/Truvada here

Longer term, the patent expiry for Viread is hanging over Gilead. Similarly, Actelion's rival drug for PAH (Tracleer) is going off patent in 2015. This means that cheaper generics could threaten future Letairis sales, as well as a successful phase III for Macitentan

However, it is worth monitoring developments at Gilead. The company needs to make an acquisition.

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More on Vertex here:

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