Last week I detailed why I’m confident Gilead’s (GILD) remdesivir is getting to market to combat COVID-19. But there’s been a Bank of America note throwing cold water on the idea that remdesivir would be very profitable for the company. That assumption seems to be widespread, and in this article, I’d like to debunk that notion. Remdesivir has the potential to become the most profitable therapy in Gilead’s portfolio. I hope it will not, but everything depends on how wide COVID-19 spreads.
First, I’ll describe various misconceptions circulating in the analyst community.
For example, a healthcare equity strategist at Jefferies appeared on CNBC. But he followed the “race narrative” that I described last week as unhelpful. Then correctly identifies Gilead as a front-runner but thinks it is in a phase 1 trial in China.
This is actually being given to humans in China as well as the United States. Its safety in humans is clear because it has been tried for Ebola.
The Chinese trial enrolls 700+ people. 2/3rds will be given remdesivir (instead of the usual 50/50).
He also calls vaccines immaterial at best and expects Gilead to have to give a lot of them away for free. These are important misconceptions that come up in the Bank of America note as well, leading me to believe that ideas like this are widely held.
To summarize key misconceptions:
- There’s no money in vaccines.
- The company will need to give a lot of it away.
- Mostly the developing world will be affected.
- China may bypass the company and authorize the manufacturing of generic versions (which China seems to have done already as highlighted in an earlier note).
- China grants a patent to a state-run Chinese research institute for remdesivir against the coronavirus.
- Countries could try to apply WTO “compulsory license” meaning Gilead would receive royalties but others are allowed to produce it lowering total revenue.
- Gilead can only charge $260 in China instead of much more in the U.S. (Morning Stanley estimate).
This is going to be a chilly discussion because we are talking about human lives here. The stories of patients that I read to learn more about the disease, that recover or who tragically don’t make it move me too.
My job is to talk/think about the money so I’ll do that.
No money in vaccines
To an extent it is true that vaccines are not the most attractive area from a return on investment perspective. Because a vaccine usually is intended to be applied once and thereby protect you from a nasty disease for the rest of your life, it is very effective.
But it is harder to negotiate good money for something you apply only once and in a preventative manner. This means there is no pressing issue for the negotiating partner. However, that’s now how I envision the situation if remdesivir completes its trial. Here’s a very informative John Hopkins magazine article.
Here is a key passage that discusses the profitability dynamics behind vaccines (emphasis mine):
Vaccine experts blame the low profit margins on a number of factors. the American public has come to see vaccines as something of an entitlement. Notes Neal Halsey, MD, director of the School’s Institute for Vaccine Safety and professor in International Health, “We have the psychology that vaccines are very cheap.” As a society, he says, we don’t want to pay a fair price for prevention unless we detect a direct threat. Most diseases currently vaccinated against — the annual winter flu or childhood diseases such as measles, mumps, and rubella — either seem old-fashioned and unlikely to occur on an epidemic level, or strike the public as inconveniences that are easily survived.
Many critics within industry, however, lay the biggest share of blame at the feet of the U.S. government, which is America’s primary purchaser of vaccines — the result of Congress’s 1993 creation of the Vaccines for Children program. Under this program, which was established to improve vaccination rates among the poor, the government purchases more than half of the childhood vaccines used in the United States. Such purchasing capacity gives the federal government extraordinary negotiating power over price. The government asks for — and gets — deep discounts on many vaccines. Vaccine makers and their lobbyists argue that governmental price caps act as a big disincentive to producing vaccines that historically have been high-volume, low-profit items anyway. (Unlike antidepressants or cholesterol-lowering medicines, which are taken for years and have an ever-expanding target population, vaccines are administered on a rigid schedule and for only a limited number of doses.) Consider: In 1987, the CDC paid about $11 for a dose of MMR; today the price is only $15.50.
On a global level, the World Health Organization (WHO) operates in much the same way as the federal government does within the United States. According to Phil Russell, MD, senior advisor in the Office of Public Health Preparedness at HHS and a professor emeritus in the School’s Department of International Health, the WHO’s dual roles as regulator and customer wreak havoc with the vaccine market. “They want to vaccinate the most children possible and get the most vaccines at the cheapest price. They dominate the vaccine field and purchasing policy,” Russell says. “All of it comes down to a necessity to fully understand the economics of the issue and understand the responsibility of the dominant purchasers.”
To be fair, the price caps negotiated by the U.S. government have applied to existing vaccines only (such as MMR and DTaP), not to newer vaccines (like the chickenpox vaccine) still under patent. Manufacturers of the diphtheria-tetanus vaccine, for instance, can expect to be paid only 15 cents a dose by the federal government, whereas the new pneumococcal vaccine goes for $58.75, according to the March 15 issue of Science.
All the reasons why vaccines are generally not fairly paid for do not apply to remdesivir and current circumstances. Investors are defaulting to the heuristic “vaccins” do not pay while there is no basis for that being true in this case.
Remdesivir is not merely a vaccine. It is a treatment and has been administered on multiple occasions, under compassionate use basis, and likely saved those patients. If you’ve ever taken antibiotics after being ill with some nasty bacterial infection, you’ll know how entirely miraculous that experience is.
Another dynamic in pricing is that we don’t want to pay a fair price unless we identify a direct threat. COVID-19 is rapidly spreading around the world and thousands of people are dead. The newspapers are filled with it. We’ll potentially have to dramatically change social behavior to deal with it. By the time this is available, a threat is highly likely to be perceived. Social behavior that will wreck the economy as we know it.
There will be a lot of pressure not to pinch pennies but get this out there and start limiting the impact of COVID-19 on society and the economy. The government tends to purchase vaccines in bulk to administer to children and this limits the price that can be negotiated. That isn’t the case here. The vaccine becomes available in limited quantities. Various producers are ramping up capacity and then some kind of system will need to be devised to distribute the available supply. It is likely that demand for the treatment will far outstrip supply and I think that – at least at the outset – use as a vaccine will be limited. It will be needed as treatment for unfortunately very sick individuals.
The same goes for international use. The WHO normally plays a large role in the negotiations around vaccines, but this will be an entirely different dynamic. The discussion should not be focused on the lowest price and greatest quantity but the speed and making this available to as many people as possible.
Finally, all these dynamics don’t apply to vaccines that are still under patent, like remdesivir. And these are generally compensated much more fairly for. Morgan Stanley fears that it will be only ~$250 per application in China.
In an earlier article, I’ve argued why that would be great. The profitability of remdesivir is most sensitive to how widely it spreads not the dollar value per application.
Currently, it looks like COVID-19 is in 50 countries. Countries in the developed world as well as frontier markets and everything in between.
China moved heaven and earth to stop it from spreading but couldn’t. Now its population is going back to work. Macron sees no other option than to live with it. COVID-19 is going everywhere. The first endemic case popped up in the U.S. There is no reason to think the U.S. experience of spreading will be much different from other countries. CCOVID-19 could very well be another disease the global population will have to learn to live with.
The global population is about 7.7 billion and over 50% of people live in urban areas. If it becomes a disease that survives through time, very well possible, it may be useful for years. It seems quite reasonable to me that 1-2 billion people will need to be vaccinated within years and billions more over time. Gilead’s gross profit margin is about 80%.
In the past, pandemics have killed up to 500 million people and infected a multiples of that. Even in worlds without megacities, ubiquitous airplanes, trains and open borders.
It is not key whether Gilead is getting $100 or $500 per treatment (sure, a Gilead shareholder would prefer $500), but it is not what drives the economics. The market is pricing in a couple of billion in value. Whatever the revenue turns out to be it is 80%-90% gross margin (~100% if Gilead gets royalties from other producers). Gilead’s trailing twelve-month EBITDA is about $7 billion. COVID-19 has the potential to make a major difference for the company.
At $260 per treatment, it takes ~30 million treatments to double Gilead’s EBITDA.
You can build all kinds of complicated models but everything depends on spread. Initially, this should be a windfall for Gilead as they hold the key to limiting lasting personal as well as economic damage. In the longer term, it may still have legs as a required vaccine that’s still under patent.
Bank of America argued adding $12 billion to Gilead’s market cap based on remdesivir is too much. First of all, I don’t think $12 billion has been added to Gilead. It has outperformed the iShares Nasdaq Biotechnology ETF (IBB) by about 6% over the last month (since news of remdesivir started breaking). That corresponds to about $6 billion. Second, if you are paying $6 billion for an option with the potential payoff characteristics I’ve illustrated above, that’s very cheap.
Giving it away
In the grand scheme of things, I think this is negligible.
The developing world pays lower prices
Macron thinks we have to live with it. It’s in Italy, Germany, and since today, an endemic case in the U.S. This is not an emerging market story.
China will steal it
Since some analysts raised the possibility China will just take it, the country stamped off on three remdesivir patents by Gilead. This sounds like a big risk, but I don’t think it is. Sure, China will try to negotiate a good price for its people. But not compensating Gilead fairly will really turn off a lot of global companies from working with China, will result in a lot of political pressure, and finally, China represents 16% of global GDP. They are an emerging superpower. It has become a relatively wealthy country. It will want to get its economy going, and it will be willing and is easily able to pay for that. There is not a great reason to assume they won’t pay fairly. If you fear that, just discount the expected revenue a fair bit. It doesn’t matter, this will still look like a monstrous opportunity.
The first few years this will make the most money. It is very important for humankind that production ramps up. If producers pay Gilead royalties that is unencumbered by much overhead, it is a very valuable income stream that falls straight to the bottom line.
WTO compulsory license
I would not be surprised if Gilead needs to license remdesivir. But it is important that remdesivir gets everywhere fast if it is effective and receiving unburdened royalties. Again, the value to Gilead is most dependent on how many people are treated.
The bottom line here is that there are great scenarios and there are good scenarios. It is hard to envision bad scenarios. At the beginning of the year, no one investing in Gilead ascribed much value to remdesivir. Now it has a shot at becoming its top moneymaker and save the world. Finally, it all comes with a free option because remdesivir looks like it works against all coronaviruses. There is always a chance we’ll see another aggressive coronavirus outbreak in the future.
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Disclosure: I am/we are long GILD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.