patently absurd

Biotech Rally Needs a Health Warning

Asia's lofty valuations may be as questionable as those in the U.S.
Photographer: Andrew Brookes/Getty Images
CELLTRION INC
+5000.00
As of 10:37 PM EST
309000.00 KRW
BIOCON LTD
-14.45
As of 10:37 PM EST
558.00 INR

Biotech is bursting back to life in the U.S., and the enthusiasm is being felt across the Pacific. 

The crown jewel of the rally in Asia is South Korea's Celltrion Inc., whose shares have soared 43 percent in the first month of 2018. While the surge has been driven partly by the stock's impending upgrade from the small-and-mid-cap Kosdaq index to the benchmark Kospi, many investors are betting on Celltrion's potential in biosimilar drugs -- near-identical copies of another company's medicines that can be manufactured once the original's patent expires. 

Strong Medicine

Celltrion Inc. jumped 44 percent this year on buying by foreign investors

Source: Bloomberg

Testifying to investor appetite, the Korean firm in July sold shares in its marketing arm at the top of the marketed range. Celltrion Healthcare Co. has since risen 241 percent on the junior board. Combined, the two companies now have a market value of $55 billion.

Elsewhere, Samsung Biologics Co., which develops biosimilar drugs through subsidiary Samsung Bioepis Co., soared 172 percent in the past year. And India's Biocon Ltd. has climbed 82 percent. 

The Asian biotech companies have a big market to aim at. Warren Buffett compared ballooning U.S. medical costs to a "hungry tapeworm" in announcing Berkshire Hathaway Inc.'s move into health care on Tuesday in partnership with Amazon.com Inc. and JPMorgan Chase & Co.

As of 2016, biologics totaled more than $130 billion in sales and accounted for nine of the 15 most sold drugs globally. In theory, if one goes off the patent cliff, incoming generic manufacturers should have no trouble snatching away cost-conscious patients. 

Market Tonic

The top seven biologics drugs generated over $60 billion in sales between them in 2016

Source: Nomura Securities

Of the top 10 biologic drugs, six have already lost their exclusivity in Europe. The U.S., by far the world's largest market, isn't too far behind. Biosimilar drugs can generate $50 billion in sales by 2025, estimates Nomura Securities. 

Look at Celltrion's drug pipeline and it isn't hard to see why the company is so well liked by foreign investors. The Korean drugmaker has already introduced two treatments to replicate Roche Holding AG's cancer-fighting Rituxan and Johnson & Johnson's top-selling arthritis remedy Remicade, the third- and fourth-most valuable biologics drugs. It's also filed for approval of its cheaper version of Herceptin, another cancer-fighting drug marketed by Roche, which generated $7 billion of sales in 2016.

Plenty of skeptics remain. In 2016, Rituxan and Remicade reaped just over $10 billion in sales in the regions where Celltrion has approval; by comparison, the two listed Celltrion entities generated little more than $1.2 billion. In late January, U.S.-based hedge fund Lakewood Capital Management disclosed a short position in Celltrion Inc., arguing the company's true revenue and profit are probably 50 percent below reported levels.

High Temperature

U.S. hedge fund Lakewood has disclosed a short position in Celltrion, calling its valuation "distorted and absurd"

Source: Bloomberg

Setting aside questions over its accounting, an immediate worry is heated price competition. Celltrion already has Novartis AG to contend with in the fight for Rituxan customers, and Samsung Bioepis for Remicade. Price-cutting is even more severe for Herceptin, with Mylan NV and Biocon first in the ring

And it still remains to be seen how lucrative the U.S. market will prove. Celltrion shares fell as much as 5.8 percent Thursday after the company said it received a warning letter from the U.S. Food and Drug Administration concerning Remsima, its biosimilar of Remicade. The agency is asking for additional information on observations it made about the Remsima production process, the drugmaker said. Celltrion Healthcare dropped 6.1 percent.

Since biosimilars aren't necessarily exact replicas of the original drugs, the FDA has delegated to individual states to decide whether pharmacies can dispense cheaper generic versions. 

Sell-side analysts aren't providing much help. Korean analysts are notoriously slow to update research and valuations. Of the 21 that cover Celltrion, a mere three rate it a sell, but the consensus sees the shares at only 194,371 won in 12 months -- 40 percent below the current market price.

Japan's Nomura is an exception, starting coverage of the two Celltrion stocks on Jan. 16 with sell ratings. While praising the firm for its pipeline and factory expansion, the brokerage said the company was overvalued because the shares were trading beyond their five-year historical average. After a brief dip, they have rebounded.

Behind the Curve?

While 17 of 21 analysts covering Celltrion rate the stock a buy, the average price target is now 39 percent short of the market

Source: Bloomberg

Biotech offers more of a challenge for investment analysts than the broader technology sector. Whereas everyone can chime in on tech, you have to understand the chemistry, the drug pipeline, the government regulations, and have a reasonable estimate of the probability of drug approvals, to cover biotech. Just looking at historical price-to-earnings ratios won't do the trick. 

Asia's biosimilar drugmakers promise to prosper by curing diseases at a deep discount. That's nice for patients. But for investors, these businesses should probably carry a health warning until results start to justify their feverish prices.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Shuli Ren in Hong Kong at sren38@bloomberg.net

    To contact the editor responsible for this story:
    Matthew Brooker at mbrooker1@bloomberg.net

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