You may be thinking; how can the bull and bear case on Relypsa (NASDAQ:RLYP) both be right?
Before we get to this, let's review in brief what's been surrounding the company over the last few months.
In October of last year, the company's lead asset Veltassa, received approval from The Food and Drug Administration (FDA). Veltassa is designed (patiromer for oral suspension) to treat hyperkalemia, a serious condition in which the amount of potassium in the blood is too high.
Relyspa is levering Veltassa primarily to treat chronic Hyperkalemia, a market in which there has been no real effective solution to date, and one that that has just begun to be developed and built.
A month later in 2015, AstraZeneca (NYSE:AZN) acquired ZS Pharma for its hyperkalemia treatment asset ZS9, a still yet unapproved drug which recently received a complete response letter (CRL) from The FDA, rejecting the drug based on a manufacturing issue.
AstraZeneca passed on Veltassa and decided to acquire ZS Pharma for $2.7B for its ZS9 asset which at the time it thought was the better of the 2 drugs. Our sources tell us that AstraZeneca basically outbid themselves, with the 2nd highest bid for ZS Pharma coming in at nearly $1B less.
In a nutshell, AstraZeneca overpaid for the ZS9 asset by a substantial margin.
In late November of last year, our sources also tell us that AstraZeneca approached Relypsa to inquire about potentially buying them as well.
But why would AstraZeneca do this? The company just acquired what they believed to be the definitive 'best-in-class' solution ZS9.
The answer we have heard is that AstraZeneca did not engage in proper due diligence, and found potential safety issues with ZS9 in the trials - serious adverse events such as Hypertension and Edema in which the company says are unrelated to the drug. However, our research says the potential safety issues are definitely connected to ZS9, but this is mostly a moot point. AstraZeneca likely has no intention of seeking a chronic treatment label for ZS9, and if it did, would likely not get it - it's not going to be in competition with Veltassa.
This is clear on several points, the most pertinent one being that AstraZeneca in its last earnings call flatly stated that they are restructuring their business model away from highly competitive markets, which has in part caused the company to consistently turn out poor earnings for some time now.
As acquisition rumors surfaced around Relypsa, the stock price soared to over $30 a share on Dec 7, 2015.
Relypsa bulls were celebrating, the twitter world was ablaze, but nothing transpired. Shortly afterwards, Relypsa decided to bring Veltassa to market sooner than they had originally planned to gain potential market leverage. From that time to present, the stock has seen excessive 'bashing,' and insane 'pumping' with both views offering up unreasonable and absurd price targets.
Subsequently, Relypsa's stock price fell from its December high to as low as the high $11 range, then bounced back to as high as nearly $26 a share in a relatively short period of time.
- Why the bulls and bears are both right - and wrong
The bearish view on Veltassa's prospects are primarily based on a false premise – which is that ZS9 will compete with Veltassa. As we have explained above, this will simply not be the case.
The bears that point out how Relypsa is not structured to go-it-alone are making a more persuasive case. This is where the super bulls fail in theirs. The best case modeling being touted by a few analysts with lofty price targets assumes that Relpysa is a mid to large cap pharma with a well-established sales team and boatloads of money to develop the chronic hyper k market.
Nothing can be further from the truth here as Relypsa's business model was designed to develop Veltassa for FDA approval, then acquisition – not to attempt to build the chronic Hyper K market on its own.
This means the company figured in contingency that it can go-it-alone for a short time – its business model is based mostly on being acquired by a bigger pharma.
This is why the higher price targets per a one-year period are wrong, notwithstanding the deterioration in the broader based biotech indexes. These price targets put out by many analysts do not factor in the business modeling aspect here, nor do they take into account how stock market conditions usually apply.
In a risk-off market, undeveloped small cap pharma’s without solid earnings receive far less speculation value than the ones that are. One-year price targets of $50+ under these circumstances are absurd.
However, where the bulls are right is in their assessment of Veltassa's potential to treat over 3 million patients suffering from Hyper K. But, the market is not clearly defined as it's a new market that needs to be built. As mentioned prior, this takes a lot of time and a lot of money, something Relypsa simply does not have to fully lever the Veltassa asset anywhere close to its full potential.
If Relypsa was a full-fledged mid to large cap pharma, the company’s higher price targets would definitely be warranted – it’s not. Relypsa retains full rights to Veltassa until 2030, a huge plus for a bigger pharma with the resources it would take to correctly build the Hyper K market.
However, the bulls need to understand that big pharma does not need an asset like Veltassa, nor are they 'hot' for this type of asset like they are for oncology assets. However, Veltassa will make a correctly suited big pharma a substantial amount of money over time which we estimate peak sales in excess of $1.5B, with margins around 80%, and potentially $10B or more of revenue in the asset's patent cycle through 2030.
Under Relypsa's current business structure, it would be fortunate to reach $200M in peak sales with Veltassa. This is why big pharma will not pay a big premium here as many super bulls wrongly assume. If Relyspa does not sell to a bigger pharma soon, it will begin to lose the leverage it gained from bringing Veltassa to market earlier than was first anticipated.
Bear cases we have evaluated on Relypsa, especially one from a Morgan Stanley (NYSE:MS) analyst are equally absurd, if not more so. This particular analyst assigns a price target of $9 a share as a one-year target price for Relypsa.
As well, He assumes that the company will go-it-alone and also ignores the Relypsa’s business model, notwithstanding that his firm has a direct relationship with AstraZeneca - this potential bias is freely disclosed in his analyst reports. To be fair, Relypsa also has analyst firms that do business with them that likely have a bias as well - to the upside.
This particular analyst has a history of being all over the place concerning the Hyper K space. Interestingly enough, he downgraded ZS Pharma not long before AstraZeneca acquired the company. As mentioned prior, his firm has a business relationship with AstraZeneca, so he likely has a bias much in the way a defense lawyer 'hires' an expert witness to advocate for his client's behalf, say in a murder trial for example where an insanity plea has been entered into by the defense while the prosecution is seeking a murder conviction.
Investors should take note of this when they read any upgrade or downgrade from an analyst. Be sure to note if an analyst’s firm has a business relationship with the company they are bullish on, or one with a potential competitor that could potentially influence them to have a bearish bias.
- Likely outcome for Relypsa
Recently, Relypsa took out a loan for $150M for the reason described by the company's chief financial officer as "strategic optionality." In other words, the loan here is a standard move to gain leverage when a company is being shopped by an investment bank.
One well-known bear publication brought this loan into question as stating that it is a bad loan. Well, once again their view assumes the company will go-it-alone indefinitely and if this were the case, it would be a bad loan - it's not the case as Relypsa is for sale.
Per our sources, we have heard there are 3 interested companies. We have no word on who these companies are, but we speculate they are AstraZeneca, Takeda, (OTCPK:TKPHF), and Galencia.
We also think it's possible that Allegan (NYSE:AGN) may also have interest in Relypsa.
We think AstraZeneca has interest in Relypsa because it covers them in case ZS9 fails to win approval after it resubmits a New Drug Application (NDA) for ZS9. This is a distinct possibility here as its safety trial was pushed back with results expected later this year. Of note, the trial design was changed slightly by removing randomization from the dosing.
It's our opinion that if ZS9 ever does win approval, it won't receive a label to treat chronic Hyper K. After spending $2.7B on ZS9, this type of failure would be a bold slap in AstraZeneca’s face, so a Relypsa acquisition can be spun in a positive way for the company and act as a stop gap for them, a way to 'save face' if you may.
If we had a time machine to go back to 2013, it would be likely that Relypsa would fetch north of $60 a share in an acquisition, but this is not 2013, and we are in a much different biotech market, with bigger pharma moving away from general care acquisitions and much more towards high margin unmet need ready-built-markets, specifically in specialty care and oncology. Considering the above along with the fact that Relypsa cannot correctly lever the Veltassa asset on its own under its current business structure, our target price for a Relypsa acquisition falls between $26 and $32, or roughly the $1.2B to $1.5B range based on 45M shares fully diluted.
A combined analyst opinion at Tipranks.com rates Relypsa a moderate buy, with a consensus one-year price target of $30.56 a share, within our acquisition price target range. We think Relypsa will be acquired by the end of July of this year.
Disclosure: I/we have no positions in any stocks mentioned here.
