Description

Thesis

• Structurally challenged Japanese pharma company; has single cash cow asset that goes-off patent in less than 12 months; assets purchased several years ago to backfill coming cliff are underperforming; sell-side has been slow to catch up to reality
• Sumitomo Dainippon Pharma (“Sumitomo”) is a Japanese pharma company whose primary markets are North America, Japan, and China
• The company currently has a single cash cow asset, Latuda
  • Latuda is a second generation antipsychotic used to treat psychiatric disorders (schizophrenia, depression associated with bipolar)
  • The drug goes off patent in the US in early calendar 2023
• Currently, Sumitomo generates roughly ¥500bn in sales and ¥375bn in gross profit
• ~40% of sales are attributable to Latuda; however, we estimate that Latuda generates a 90%+ gross margin, implying that it generates ~50% of aggregate GM; this implies that non-Latuda sales currently generate a gross margins of ~60%
• The ¥375bn of gross profit covers ~¥360bn of OpEx (¥90bn of R&D, ¥240bn of SG&A); so, with the impending rapid demise of half its gross profit (from Latuda’s loss of exclusivity) we expect the company will quickly begin losing money on an operating basis
• In 2019, the company’s primary hope to offset the coming Latuda cliff was Napabucasin, a treatment for pancreatic cancer with legitimate blockbuster potential; however, development was ended mid-year following an interim analysis of the Ph3 trial
• Sumitomo then struck a deal to purchase multiple subsidiaries from Roivant for total consideration in the ¥300bn range ($3bn); the purchase consisted of an early-stage pipeline and three late stage drugs nearing commercialization:
  • Gemtesa (vibegron) – treatment for overactive bladder
  • Orgovyx (relugolix) – treatment for prostate cancer
  • Myfembree (relugolix/estradiol/norethindrone acetate) – treatment for uterine fibroids (approved) and endometriosis (pending, with PDUFA date of Aug 2022)
  • Prior to the acquisition, Roivant had touted each of the three drugs as having $1bn (¥110bn) potential; if achieved, this would more than offset the ¥200bn+ in Latuda sales
  • However, it is now starting to look as if these targets were aggressive; launches have been underwhelming vs initial expectations; we think the three drugs in aggregate do ¥45bn in revs this fiscal year (Mar 2023) and ¥65-70bn next fiscal year (Mar 2024); ultimately, we think that reasonable estimates have the three in aggregate peaking at ~¥165bn in sales (or roughly half the original “$1bn each” potential) by 2030 before patent protection begins to expire
• Sumitomo’s other portfolio drugs (excluding Latuda and the Roivant drugs) are also highly unlikely to bail the company out from the Latuda patent cliff
  • There are puts and takes (growth and decline) amongst the various other drugs in the portfolio, but in aggregate they are in decline
  • Management’s forecast (detailed below) for the current fiscal year (Mar 2023) has the non-Latuda/Roivant drugs declining 13% in aggregate in ¥ terms, with Japan down 13% and NA/China down 13%; NA/China’s projected decline in constant currency terms is far more severe – down 30%
  • These declines are driven in part by aggressive price-downs by the national health services in Japan and China, respectively; annual pricing declines are a perpetual headwind for pharma companies operating in the two geographies

• Mar 2023 fiscal year forecast
  • Management’s Mar 2023 fiscal year forecast was a disappointment
  • The forecast is for ¥30bn of Core operating profit
  • This compares to sell-side estimates of ¥50-¥60bn prior to management’s guide, and ¥59mm last fiscal year
    • In addition, the forecast is half what management had projected a year-ago when it issued its mid-term business plan in May 2021; at that point is was calling for ¥60bn in Core operating profit; it attributes the weakness to a combination of forex and slower-than-expected market penetration of new products (i.e. Roivant)
    • Two other points worth keeping in mind, that further underscore the weakness of the Mar 2023 fiscal guide
    • Sumitomo will continue to have patent protection on Latuda in the US for the vast majority of the fiscal year (11 of 12 months)
    • ~ ¥20bn of the projected ¥30bn in Core operating profit is attributable to “Other income”, which it appears is primarily-related to the sale of a priority review voucher; so net-net the underlying operating performance is even weaker than it first appears
• Lack of catalysts
  • One of the things we especially like about the short in Sumitomo is the distinct lack of near-term catalysts
  • In the current fiscal year, the only remaining catalyst is an Aug 2022 PDUFA date for approval of Myfembree (currently approved for uterine fibroids) for the additional indication of endometriosis; note that the original May 2022 PDUFA date was originally pushed back by three months
  • Following this, the company has an air pocket of at least a year before any other major launch catalysts

• Sell-side estimates have been slow to come down, but they are finally doing so
  • Near-term rev estimates (next couple of fiscal years) have come down 10-15% over the past 6 mos, and longer-term (end of decade) rev estimates have come down ~25%; however, we still believe that they need to come down further
  • We believe that end of decade revenues will be closer to ¥400bn than the ¥500bn+ that is currently contemplated by the sell-side
• We expect that the near-term lack of potential (positive) catalysts in combination with continued sell-side estimate pressure and the looming Latuda patent cliff will continue to weigh on the shares

Business

• Geographic breakdown of pharma sales (TTM)
  • North America = 62%, Japan = 30%, China/Other = 8%

Valuation

• We use a DCF to value the business
  • We expect that post the current fiscal year with Latuda in sharp decline, Roivant drugs growing, and other portfolio drugs declining, revenues will range between ¥350-¥400bn
  • With Latuda gone, we expect GMs to settle into the low 60% range, yielding annual GP of ¥215-¥250bn
  • OpEx is the big swing factor; in the near-term we expected continued heavy spend to promote the Roivant drugs and continue pushing additional pipeline candidates through the approval process
    • Last year the company had ¥344bn of OpEx, we are modeling ¥330bn this year, ¥260bn next year, and declining to roughly ¥200bn by end of decade
  • Net-net this yields primarily operating losses over the time horizon of the DCF and de minimis value for the operating business
• As such, we think the primary value of the business at this point is the ¥85bn in net cash on the balance sheet, which equates to ~ ¥300/shr
• Price/book
  • A meaningful portion of Japanese sell-side analysts seem to focus on P/B as a relevant valuation metric
  • In this regard, Sumitomo is arguably “cheap”, as it trades at 0.7x current book; the 0.7x book multiple looks attractive vs the 5-year average of 1.4x BV
  • However, there are a few key points to keep in mind
    • The 5-year average includes a highly elevated period in 2018-19 when approval of potential blockbuster Napabucasin was expected; more recently, avg P/B has averaged 1x
    • Intangibles represent virtually the entirety of current book value; I believe that intangibles represent ~50% of current book value, and given our view on the trajectory of the Roivant products, these intangibles could be at risk of write-down

Risks

• No firm catalyst for revaluation; inappropriate valuations can persist for extended periods in Japan
• Optically cheap on P/B at 0.7x currently; mitigating factor is a potential meaningful write-down of intangibles associated with the Roivant purchase
• Company’s pipeline delivers a hidden jewel
• Meaningfully accretive purchase of new portfolio drug; company has ~ ¥350bn of cash and securities

As of the publication date of this report, we have short positions in the stock of Sumitomo Dainippon Pharma Co., Ltd. (“Sumitomo”). We stand to realize gains in the event that the price of the stock decreases. Following publication of this report, we may transact in the securities of the company covered herein. All content in this report represents our opinions. We have obtained all information herein from sources we believe to be accurate and reliable. However, such information is presented “as is,” without warranty of any kind – whether express or implied. We make no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results obtained from its use. All expressions of opinion are subject to change without notice, and we do not undertake to update or supplement this report or any information contained herein. This report is not a recommendation to short the shares of any company, including Sumitomo, and is only a discussion of why we are short Sumitomo.  This document does not in any way constitute an offer or solicitation of an offer to buy or sell any investment or security discussed herein or of any of our affiliates. This document is for informational purposes only. All market prices, data and other information are not warranted as to completeness or accuracy and are subject to change without notice. Our opinions and estimates constitute a best efforts judgment and should be regarded as indicative, preliminary and for illustrative purposes only.  The information contained in this document may include, or incorporate by reference, forward-looking statements, which would include any statements that are not statements of historical fact. Our forward-looking assumptions, expectations, projections, intentions or beliefs about future events may turn out to be wrong. These forward-looking statements can be affected by inaccurate assumptions or by known or unknown risks, uncertainties and other factors, most of which are beyond our control. Investors should conduct independent due diligence on all securities discussed in this document and develop a stand-alone judgment of the relevant markets prior to making any investment decision.

Catalyst

Continued decline of sell-side estimates; Roivant drugs continue to underperform; pipeline failures; value-destroying acquisition