In-depth analysis: Penetration into the US is a big plus
- Negatives largely priced in after correction by 63% from historical high in Sep 2021 and the stock now trades at c.9.6x FY22F EV/sales, close to trough valuation
- Sales generated from US market to drive growth in the coming three years
- Maintain BUY as market ignores two positives: 1) unlike most Chinese peers, BeiGene can penetrate the US – one of the few markets where prices can be raised; 2) maintain its US listing while many peers will be delisted
Net loss in 2022F expanded by 153% and TP slashed by 32%. We expand net loss in 2022F by 153% to US$1.42bn, similar to the net loss of US$1.41bn recorded in 2021A. After our communication with the company, we believe BeiGene needs to maintain its operating expenditure (marketing, admin, R&D) in 2022F at a similar level as 2021A at c.US$2.5bn to support over 35 ongoing clinical trials and marketing of three key products globally (Tislelizumab, Zanubrutinib, Pamiparib).
We also slashed our TP by 32% to HK$166. Reasons:
1.Our TP is derived from net present value (NPV) estimates of major products. A major reason for the TP cut is that we revised up the weighted average cost of capital (“WACC”) used to discount free cash flows for the next 10 years from 9.6% to 11.3% because: a) interest rate hikes globally; b) National Medical Products Administration (NMPA) has been tightening the requirements of clinical trials since 2021 which will increase the time and cost of clinical trials in the long run. For example, in Dec 2021, unless the drug developer states that the new drug is not suitable for children, NMPA requires clinical trials of a new drug to include children.
As BeiGene’s ability to export is stronger than Chinese peers, we believe its WACC should be lower than them, but higher than global peers. The mid-point between the average Chinese peers and global peers is 11.3%. So, we use 11.3%. We define peers as companies developing drugs with the same targets. A “target” is a molecule in the body, usually a protein, that is intrinsically associated with a particular disease process, which could be addressed by a drug to produce the desired therapeutic effect.
2. We lower our expected sum of free cash flows in next 10 years from US$13bn (2020F-29F) to US$12bn (2022F-31F), down 6%. The change is mainly because we have factored in price cuts of 10-50% in 2022 and 2024 for products sold in China. Since 2018, the National Healthcare Security Administration has organised six rounds of National tenders for drugs, and the average price cut has been 53%. This will continue as the government targets to raise the percentage of drugs procured for public medical institutes through the provincial /National tender platform from 75% in 2020 to 90% in 2025.
Negatives largely price in. After correcting by 63% from its all-time share price peak in Sep 2022, BeiGene is now trading at 9.6x enterprise value or EV (market cap minus net cash or add net debt) to FY22F sales, very close to its historical trough, and we believe the negatives are largely priced in.
Maintain BUY for two positives that are not priced in. We maintain BUY because:
Firstly: BeiGene has the strongest ability to penetrate the US market among Chinese peers. Entry into the US market is important as it is easier to raise price there. While many countries have been
lowering drug prices, drug prices in the US have been rising by 4-10% p.a. in 2016-20.
Chinese pharmaceutical companies’ penetration into the US market seems more difficult after the US Food & Drug Administration (FDA) rejected the application for launch of two innovative drugs by Innovent (1801 HK) and Hutchmed (13 HK) in 1H22 (see: U.S. FDA declines to approve two more China-tested drugs | Reuters). A major reason for the rejection is that US patients were not included in their clinical trials. Thus, the key is to include the US as one of its clinical trial locations. BeiGene has largest number of clinical trials running in the US or with the US being one of the locations for the trial, in both phases 2 and 3, it has 22 totally. Major Chinese peers have 1 to 6. In terms of number of drugs and indications involved, it is also the largest. BeiGene has 14 drug/biologic interventions (Chinese peers 1 to 9).
Among the BeiGene’s clinical trials carried out in the US, six have demonstrated superior efficacy or safety over major competing drugs based on available clinical data.
Four trials are said to address two targets and are potentially promising, namely, TIGIT and TIM-3. The target is a molecule in the body, usually a protein, that is intrinsically associated with a particular disease process, which could be addressed by a drug to produce the desired therapeutic effect. These drugs are potentially promising because they could be much better than competing drugs for a particular indication. The TIM-3 protein appears in multiple cells (e.g. T-cells, dendritic cells, macrophages, myeloid-derived suppressors cells, natural killer cells). As a result, the drug should be able to find this protein easily in the human body, making it easier to have an impact on the disease. For TIGIT, in Roche (ROG SW)’s phase 2 clinical trial for 1st line treatment of metastatic non-small cell lung cancer with high expression of PD-L1, it showed much higher objective response rate (“ORR”) relative to competing therapy (anti-PD-L1 monotherapy, 69% vs 24.1%),
Other than the trials above, trials involving the US as a location, completed and pending for U.S. FDA approval in 2022 are crucial for share price performance. BeiGene has two: A) Tislelizumab (PD1 antibody) for 2nd line treatment of Esophageal squamous cell carcinoma (ESCC). The U.S. FDA is committed to respond in Jul; and B) Zanubrutinib for treatment of chronic lymphocytic leukemia / small lymphocytic lymphoma (CLL/SLL). The U.S. FDA is committed to respond in Oct. We believe these drugs are likely to obtain the approvals. Firstly, unlike Sintilimab by Innovent and Surufatinib by Hutchmed, which solely relied on clinical data from China, BeiGene has included US persons in its trials (10-20% of patients). Thus, we believe there is high chance of obtaining approval from the U.S. FDA. Secondly, based on available clinical data, these drugs have demonstrated better efficacy over direct competitors in the targeted indications. In terms of ORR in 2nd line treatment of ESCC, Tislelizumab is higher than Pembrolizumab developed by Merck (MRK US) (20% vs 13%). In terms of ORR in treatment of CLL/SLL, Zanubrutinib is higher than Ibrutinib developed by AbbVie (ABBV US) (95% vs 89%).
Secondly: Investors are concerned that Chinese companies listed in the US stock market will be delisted. BeiGene is one of the few Chinese companies that should be able to remain listed and keep this equity raising platform.
After the Holding Foreign Companies Accountable Act was effective in 2020 in the US, the US Securities & Exchange Commission (SEC) can delist companies located in a foreign jurisdiction if it thinks the Public Company Accounting Oversight Board in the US is unable to inspect or investigate the financials. As of 21 June 2022, 150 companies have been identified for possible delisting (see: SEC.gov | Holding Foreign Companies Accountable Act (“HFCAA”) ), including BeiGene.
We believe BeiGene can avoid delisting in the U.S. stock market as it has changed its principal auditor for financial statements to be filed with the U.S. SEC from EY China to EY U.S. in Mar 2022. As of 22 Jun 2022, it is one of the very few Chinese biotech companies listed in the US to change its principal auditor to a US-based auditor. By doing this, its principal auditor will be directly under the supervision of the Public Company Accounting Oversight Board in the US and its financials can be inspected and investigated completely by the regulatory bodies in the US. The principal auditor can review the audit working papers prepared by the local auditor(s) in China. This satisfies the U.S. SEC’s requirement to maintain its listing status. Many US companies listed in the US, with business exposure in China have adopted the same practice, e.g. Texas Instruments (TXN US), Wynn Resorts (WYNN US). If BeiGene is delisted after the auditor change, those US companies would have to be delisted too. This is very unlikely. As such, BeiGene should be able to keep its fund-raising platform in the US stock market which is important for future growth.