Investment process: Leveraging sector expertise
BPCR’s investment strategy relies on ongoing screening of a large number (>200) of potential opportunities. Individual investment selection is based on detailed analysis of the underlying product collateral, including the clinical utility of the product, competitive landscape, IP situation, pricing, reimbursement (insurance and Medicaid/Medicare coverage), the marketer’s strength, as well as the opportunity’s safety record, physician adoption and sales history. In performing this analysis, Pharmakon Advisors relies in part on Royalty Pharma’s internal analyst team (seven analysts with a medical degree or background in biochemistry, biology or material sciences) based on the shared services agreement it has signed with Royalty Pharma. Importantly, in some instances, it may benefit from Royalty Pharma’s solid understanding of the underlying asset. This is developed through its acquisition of a royalty interest at an earlier stage than BPCR’s investment. Pharmakon will conduct primary market research and may also use third-party market research. The future sales potential of respective drugs is evaluated based on direct discussions with external experts and leading physicians. Moreover, the investment manager may rely on market research in the form of physician studies to examine safety, familiarity, usage and acceptance of respective products by practising doctors, as well as engagement of regulatory and manufacturing consultants. Finally, outside counsel may be leveraged to evaluate IP rights and the patent estate of the royalty collateral.
Pharmakon Advisors also examines the structure of royalty investments. It pays particular attention to the expected yield and duration, quality (ie, strength and enforceability) of collateral, coverage ratios (calculated as commercial licence value to the amount of debt outstanding), priority of payments, as well as cash flow projections and their impact on expected maturity and duration.
In the case of senior secured loans and unsecured debt, apart from examining the products marketed by the borrower, the fund manager also evaluates its credit profile and how the potential investment is structured. In terms of the borrower’s credit metrics, it takes into consideration expected product margins, coverage ratios (projected free cash flow to total debt and/or EV to debt), access to equity markets to raise fresh capital, quality of the management team, production capacity, as well as overall capital structure and other existing liabilities. The analysis of the investment structure is largely concentrated on the expected yield and duration, quality of collateral, covenants, call protections, structural yield enhancement (eg, additional coupons linked to sales) as well as access to liquidity in the case of listed stocks.
BPCR seeks investments with predictable cash flows and significant downside protection. Importantly, when evaluating new investment opportunities, BPCR is solely focused on approved products, thus avoiding the risks associated with drug development and clinical trials. If the borrower, in addition to approved drugs, also has products in late-stage clinical trials, these are not assumed to reach the market, hence giving BPCR a safety margin. To further minimise the risk, BPCR may include revenue and profitability covenants to loan agreements or provide debt funding in tranches depending on product sales ramp-up. Following investment, BPCR monitors its assets regularly and remains in contact with the borrower’s management. Moreover, the investment manager and BPCR’s board hold quarterly meetings to discuss the level of exposure to market risk at a portfolio level.
Current portfolio positioning
BPCR’s portfolio structure at end-September 2018 is presented in Exhibit 4. Following the recent Amicus Therapeutics deal, BPCR became fully invested (although it has recently completed a new placing raising US$305m of gross proceeds). Importantly, we appreciate BPCR’s efforts to increase the exposure to floating-rate loans. Following the Amicus deal (concluded-post balance sheet date) and advancement of the Sebela loan as well as the second tranche of the Tesaro loan, floating-rate debt investments represent around 62% of BPCR’s portfolio. For a detailed examination of the underlying drugs, please see our initiation note.
The trust has recently funded US$100m as part of the second tranche of the Tesaro loan. Originally, BPCR planned to advance US$148m. However, to remain in line with its exposure limits to a single investment (30% of NAV), it has assigned US$48m to other investors. Compared to initial assumptions, this has increased the weighting to the first tranche, which has a slightly higher coupon rate (LIBOR+8.0% compared with LIBOR+7.5% in case of the second tranche). The loan is primarily backed by rights to Zejula, a PARP inhibitor used to treat recurrent ovarian cancer. Zejula’s sales in H118 quadrupled to US$102.8m from US$25.9m in H117, but the company lowered its FY18 sales guidance to US$225–235m from the previous US$255–275m, predominantly following the revision of expectations for market penetration of PARP inhibitors for ovarian cancer maintenance treatment in the US. We understand that the uptake in the case of maintenance treatment products that are not first-line therapies is usually slower in comparison to new products for treating diseases with no prior cure available. PARP inhibitors display a very high adoption rate for ovarian cancer specialists; this is much slower for community oncologists, who are confronted with only a few ovarian cancer cases per year and consequently may not have fully realised the importance of this treatment option yet.
The current Evaluate Pharma consensus for 2018 sales of Zejula stands at US$228m, which is within the range guided by the management and implies a 109% y-o-y increase, broadly in line with what is expected for Lynparza (+106%) and somewhat below the consensus estimate for Rubraca (+132%). Zejula’s consensus for 2020 fell from US$895m at the beginning of the year to US$549m currently. Tesaro recently completed the enrolment to the PRIMA Phase 3 monotherapy trial in first-line ovarian cancer regardless of biomarker status, which is irrespective of BRCA mutations. The interim safety data will be presented at the ESMO conference in October and the final dataset on the PRIMA trial will be published towards the end of 2019. Potential success would significantly improve the sales potential for Zejula. However, it must be noted that BPCR made the loan investment even without taking into account this potential boost to sales given its focus on approved and commercial-stage products and indications. Pharmakon Advisors remain confident that the sales outlook for Zejula’s approved indications more than covers Tesaro’s future obligations under the BPCR loan.
For other recent portfolio developments, the trust has provided additional funding of the total expected purchased payments linked to Bristol Myers Squibb, bringing the outstanding amount to US$46.0m at end-August 2018. Overall, BPCR committed to funding an estimated US$140–160m in 2018–2020 with this respect. Finally, the seed assets (limited partnership interest in BioPharma III and the RPS Note) continue to amortise and represent only c 9% of NAV (vs 24% at end-2017).
Exhibit 4: Portfolio composition as at end-September 2018
Counterparty /borrower |
Asset |
Underlying products |
Fair value (US$m) |
Expected maturity |
Coupon/royalties |
Fees and other |
% of net assets |
Tesaro |
Senior secured loan |
Zejula, Varubi |
322.0 (both tranches) |
21 November 2024; Make-whole: two years |
Libor + 8.0% (tranche A), Libor + 7.5% (tranche B); Libor is subject to a floor of 1% and certain caps |
Funding fee: 2% on each tranche; Amortisation: two-year interest only then 3% quarterly; prepayment: 3%/2%/1% before second/third/fourth anniversary of tranche A |
30% |
Sebela |
Senior secured loan |
Suprep, Brisdelle, Analpram, Naftin, Lotronex |
194.2 |
1 May 2023 |
High single-digit floating coupon (uncapped) |
Quarterly amortization starts post-Q318; funding fee 1.5%; other fees were not disclosed, but are in line with comparable deals |
17% |
Amicus |
Senior secured loan |
Galafold |
150.0 |
28 September 2023 |
Libor 3M +7.5% |
Amortisation: four years interest only, then quarterly; funding fee 2%; prepayment fee not disclosed but in line with comparable deals |
14% |
Novocure |
Senior secured loan |
Optune |
150.0 |
7 February 2023; Make-whole: 2.5 year |
9% (fixed) |
Amortisation: bullet at maturity; prepayment fee at 2% or 1% prior to the third or fourth anniversary |
14% |
Lexicon |
Senior secured loan |
Xermelo, sotagliflozin |
124.5 (first tranche) |
18 December 2022; Make-whole: 3 years |
9% (fixed) |
Amortisation: bullet at maturity; prepayment: 2%/1% before fourth or fifth anniversary of tranche A |
11% |
BioPharma III |
Limited partnership interest |
- |
62.2 |
Various maturities through Q321; most loans have make-whole clauses |
12% average (various coupons between 9-13%) |
Most loans have pre-payment premiums |
6% |
Depomed* |
Senior secured loan |
Nucynta, Gralise, Cambia, Zipsor, |
N/A |
April 2022 |
10.75% (with a floating component) |
2.25% up-front funding fee |
N/A |
Valneva* |
Senior secured loan |
Ixiaro |
N/A |
2018 |
9.5% coupon plus 2.0-2.6% royalty of Valneva’s share of Ixiaro/Jespect sales |
- |
N/A |
iRhythm* |
Senior secured loan |
Zio Patch |
N/A |
2021 |
N/A |
Amortisation: interest-only for the first four years; straight-line for the last two years |
N/A |
Bristol Myers Squibb |
Priority Royalty Stream |
Onglyza, Farxiga |
46.0 |
31 December 2059 or such other date TBA |
No Coupon; Expected high single digit return |
N/A |
4% |
RPS |
Senior secured loan |
21 products |
38.4 |
2019 |
12% (fixed) |
Quarterly payments applied to principal after interest |
2% |
Cash and other |
- |
- |
144.5 |
- |
- |
- |
3% |
Total |
- |
- |
1081.8 |
- |
- |
- |
100% |
Source: BioPharma Credit, Edison Investment Research. Note: *Depomed, Valneva and iRhythm are part of BioPharma III portfolio.
New investment: Amicus Therapeutics
On 20 September, BPCR announced it had entered into a definitive loan agreement for a US$150m senior secured loan with Amicus Therapeutics, a biotech company focused on the treatment of rare metabolic diseases. As the five-year loan has a floating coupon rate of LIBOR plus 7.5% (subject to a floor of 1% and certain caps), we appreciate BPCR’s increased exposure to potential further interest rate increases in the US. Additionally, the loan arrangement includes a funding fee at 2%. The loan is interest-only for the first four years.
The proceeds will be used for the acquisition of Celenex, a private clinical-stage gene therapy company that is a spin-off of the Nationwide Children’s Hospital in Ohio, with the worldwide development and commercial rights for 10 gene therapy programmes in Phase I/II, pre-clinical or discovery stage. The loan proceeds will be also spent on development costs spread over several years. However, according to BPCR’s investment policy, the loan investments may be secured solely by approved products. In the case of Amicus, the loan will be permanently backed by commercial rights to Galafold (migalastat), a product used for adult treatment of Fabry disease, a rare X-chromosome linked genetic disease (connected with a defective gene, GLA) occurring predominantly in males with an incidence of about one per 60,000 births. Usually it manifests itself between three and 10 years of age with multiple symptoms including chronic pain and shortens life expectancy by 10 to 20 years with damage to the skin, kidneys (renal failure is the main cause of death), cardiovascular system (heart) and central nervous system (brain and muscle control) with increased stroke risk.
The disease has no cure although gene therapies might potentially be developed in the future (this is not likely to happen within the next few years). Existing treatments are either palliative (pain relief) or involve repeat fortnightly injections of enzyme replacement therapy (ERT), which remove some of the excess glycolipid with a recombinant form of GAL, either Shire’s Replagal (agalsidase alfa) or Sanofi’s Fabrazyme (agalsidase beta). However, injected enzymes cannot access the brain and, as a result, central nervous system symptoms persist.
Galafold (migalastat) was approved for EU-wide marketing on 26 May 2016 and it was also approved for Japan in March 2018. The FDA approved it for sale in the US on 13 August 2018. Some of its key advantages are that it is orally administered and less expensive than ERT, as the drug itself is priced in line with ERT, but the treatment does not involve accompanying expenses such as nurses, injections, and so on). Moreover, the active GLA is produced inside the cell where it is needed and consequently there is no risk of an immune response, which occurred in case of some patients with replacement enzymes, limiting the effective dose. This may potentially prove more effective in the longer term, but this has yet to be confirmed. However, we expect a steady rather than rapid adoption rate, as patients need to be rotated out of treatment therapies that work (even if they are less effective) and because Galafold’s clinical added gains are not yet entirely clear. The latter is underpinned by a comment from the National Institute for Health and Care Excellence, which suggests that there remain ‘important limitations and uncertainties’ over the data set on Galafold; however, we believe this is typical for rare disease trials (due to limited number of patients, high interpatient clinical variability and the lack of clear endpoints). Although no head-to-head trials have been conducted so far, it seems that Galafold’s effectiveness is comparable with ERT.
Sales in FY17 stood at US$36.9m following the mid-2016 EMA approval and 9M18 sales reached US$58.6m. Consequently, Amicus believes it is on track to achieve the higher end of its FY18 guidance at US$80–90m. This compares with current Evaluate Pharma consensus estimates at US$88m (with US$172m and US$237m expected in 2019 and 2020, respectively). We estimate that the global market for Fabry disease in 2017 was worth c US$1.3bn, with Replagal sales at US$472m and Fabrazyme revenues at US$816m. It is important to note that clinical diagnosis can be difficult and needs a confirmatory enzyme test. Any patient on ERT could transfer to Galafold if they have an amenable mutation. Although there is no completely reliable estimate of the number of current ERT patients treatable with Galafold, Amicus believes this figure is around 35–50%. We estimate that even if 20% of patients switch to Galafold (which corresponds to an achievable market of around US$240m), it would suffice to service the loan given low marketing costs (rare diseases are treated normally in specialist centres and there is usually a very engaged patient community) and high repeat, chronic use prescription rates. Moreover, there is additional market opportunity from patients not treated with ERT. In conjunction with the current Amicus cash position at US$564m as at end-September 2018, we believe the deal has a comfortable safety margin for BPCR.
Capital structure and fees
Pharmakon Advisors receives a management fee equal to 1% of NAV less US$100,000, calculated monthly (ie, 1/12 of 1% of NAV on the last business day of the month minus 1/12 of US$100,000) and payable quarterly.
The investment manager is also entitled to a performance fee of 10% of NAV accretion over the respective 12-month performance period ending 31 December, subject to a high watermark and hurdle rate of 6% per year. Importantly, if BPCR's shares trade at an average discount to NAV of at least 5% during a rolling three-month period, the investment manager should use 50% of the corresponding performance fee for market acquisitions of shares.
In addition, BPCR will incur ongoing expenses. These include the fees of the board members, company secretary, administrator and registrar, as well as other operating expenses such as legal, advisory, PR and listing fees. The ongoing expenses ratio at 31 December 2017 stood at 1.2% of NAV per year. This may decline modestly as BPCR’s portfolio grows.
As at 18 October 2018, BPCR held only US$55.4m in cash (unaudited figure). BPCR has recently converted the outstanding C shares to ordinary shares (following the deployment of the proceeds in the Amicus deal) at a ratio of 0.9898. Moreover, the trust announced the results of its placement of new ordinary shares at an issue price of US$1.025. It initially targeted gross proceeds of US$150m to fund further investments (and outstanding potential commitments). However, due to strong investor interest, it increased the offering to US$200m, which was still oversubscribed (the final gross proceeds raised were US$305m).
Currently there is no debt at the BPCR level, but the trust is exploring the option of using debt at trust level. BPCR has a leverage cap of 50% of NAV calculated at the time of the drawdown. However, the fund manager is only allowed to incur indebtedness on behalf of the company of up to 25% of NAV without prior approval of BPCR’s board.
A continuation vote will be put to shareholders at the first AGM following the fifth anniversary of initial admission (27 March 2017) and, if passed, at the AGM held every third year thereafter. Furthermore, a vote will also occur within two months from the end of any 12-month rolling period where BPCR’s shares have, on average, traded at a discount in excess of 10% of NAV. However, BPCR’s board may execute share buybacks as a means to limit the discount volatility and potentially provide an additional source of liquidity at attractive price levels. Please refer to the issue prospectus for more detailed share repurchase guidelines. The trust has not executed any buybacks yet.