Innoviva: A Company Worth Owning

 

A Brief History

Innoviva (INVA) was founded in 1996 as Theravance Inc. Its main focus was discovering and developing drugs to combat several diseases, including respiratory.

In 2002 Theravance and GSK collaborated to develop and commercialise respiratory drugs, which led to the successful development of Relvar/Breo Ellipta, Anoro Ellipta and later, Trelegy Ellipta (FDA-approved in 2020). Under the agreement, Theravance received royalties for these products.

In 2014 Theravance split into two businesses with one arm, Theravance Biopharma, focused on research and development, while the other, Theravance Inc., became the royalty management company, later changing its name to Innoviva in 2016.

Innoviva’s only source of revenue has been its royalty business until recently.

 

Sarissa Capital Management Becomes a Shareholder.

Activist investor Sarissa Capital Management first appeared on INVA’s shareholder registrar in 2017. The highly regarded Alex Denner, a former senior managing director at Carl Icahn’s activist fund Icahn Capital, owns Sarissa.

As an activist investor, Sarissa invested in INVA to shake things up at the company.

Sarissa accused management of over-compensation for simply collecting royalties. Sarissa entered a proxy battle with INVA to elect board members to change the compensation policy and better allocate capital. The drawn-out fight ended with Sarissa winning and electing 2 board members.

As things stand today, Sarissa is one of the largest shareholders of INVA with over 10% ownership, while Mr Pavel Raifeld, a former Sarissa employee, is the company’s current CEO.

Sarissa’s involvement has resulted in a fundamental shift in the company, and INVA makes for an exciting investment because of this shift.

 

 

The Opportunity

INVA is no longer just a royalty business, as Sarissa’s involvement has resulted in significant capital allocation changes bringing in new avenues of revenue.

 

Royalty Business

The primary source of revenue remains the royalty business. Relvar and Anoro earned the company $312 million in revenue for Financial Year (FY) 2022.

The royalty business is expected to earn the company an additional $1.2 billion over the next 5 years.

 

Product and License Revenue

In 2022 INVA acquired La Jolla Pharmaceutical for around $210 million. La Jolla Pharmaceutical’s portfolio of products includes Giapreza, a treatment to raise blood pressure for adults with septic and other distributive shocks, and Xerava, a treatment for complicated intra-abdominal infections.

These products have resulted in a new revenue stream for INVA, bringing in just under $20 million in sales for the first quarter (Q1) of 2023 and are growing.

In 2022, INVA also acquired Entasis Therapeutics, gaining the company’s drug, Xacduro, which the FDA just approved for treating bacterial pneumonia caused by antibiotic-resistant strains of Acinetobacter.

Xacduro is an essential treatment as Acinetobacter infections results in high mortality rates and financial burdens on hospitals/patients, while up until Xacduro, there was no effective treatment.

While not all new FDA-approved drugs are successful due to the difficulties of commercialisation, the success of Xacduro significantly increased due to the strategic acquisition of La Jolla Pharmaceutical with its already established distribution within hospitals.

Given the current lack of effective treatment on the market, it is difficult to determine the exact market size. However, the US and Europe have up to 100,000 cases yearly, while less developed countries in Asia, South America and the Middle East have far higher cases. Current treatment costs over $3,000 per case, but Xacduro is still to be priced

Entasis has other products in the pipeline, including Zoliflodacin, an oral treatment for uncomplicated gonorrhoea. This drug is currently in phase 3, which should be completed by the end of the year. As an oral treatment, Zoliflodacin offers a painless alternative to the current injectable treatments on the market.

INVA also owns 69.4% of Armata Pharmaceuticals, with several drugs in its pipeline targeting antibiotic-resistant bacteria, plus several other investments with revenue potential.

 

The Market is Missing the Bigger Picture

With a market capitalisation of just $840 million (as of the time of writing), INVA is not on many investors’ radars. Still, the ones that are monitoring the company are not crediting management with the strategic changes:

One of the few analysts that follow the business assigned a Neutral Rating stating, “At current levels, we believe INVA’s shares predominantly reflect the value of the royalty portfolio, based on the relatively uncontroversial outlook for the company to achieve current and projected future royalty streams from end-market sales of the respiratory products by GSK,” (Goldman  Sachs Analyst, July 2022)

This comment was when INVA was priced at $14.37 per share versus the $12.82 share price today (21 May 2023). BUT INVA is far more than a royalty company and shouldn’t be valued purely on this revenue line alone!

 

 

Valuing INVA

How to value INVA is tricky, but that is why this investment opportunity exists.

We believe the right way is to value the business as a Sum-of-The-Parts (SOTP). Below we have gone through the company’s balance sheet and assigned values based on what we believe to be ULTRA conservative assumptions:

 

Business Line     Valuation Commentary
Relvar Revenue = $850 million 25% Discount $637.5 million Relvar expected sales for the next 5 years discounted to present value
Anoro Revenue = $175 million 25% Discount $131.3 million Expected sales for the next 5 years discounted to present value
Giapreza & Xerava Gross Profit = $54.6 million 4.0x Gross Profit $218.4 million Valued @ 4.0x gross margin (industry average = 4.8x gross profit)
Xacduro Gross Profit = $71.4 million 4.0x Gross Profit $285.6 million Valued @ 4.0x gross margin (industry average = 4.8x gross margin)
Zoliflodacin $0.00 million Assigned ZERO value as the drug may not be approved
Armata – convertible debt Debt owned = $32.8 million 25% Discount $24.6 million Only considered convertible debt investment – Q1 2023
Gate – convertible debt Debt owned = $21.5 million 25% Discount $16.1 million Only considered convertible debt investment – Q1 2023
ISP Fund Fund Value = $264.9 million 25% Discount $198.7 million Sarissa Capital manages the ISP Fund
Cash Cash =    $144 million 0% Discount $144.0 million Q1 2023
Total Asset Value     $1 656.2 million
Operating Expenses (OPEX) -$284.0 million 2 years of OPEX
Deferred Revenue -$2.0 million Q1 2023
Debt -$444.7 million Q1 2023
Other LT Liabilities -$70.1 million Mainly deferred royalty obligations- Q1 2023
Total Liabilities     – $800.8 million  
Equity Value     $855.4 million  
Share Outstanding 67.79 million
Value per Share     $12.62 per share  

 

The SOTP valuation above derives a value of $12.62 per share, which is not worth getting excited about when compared to the current share price of $12.82 (as of the time of writing). However, we believe this is a BASE/FLOOR price because of the conservative assumptions applied.

 

Conservative Valuations

  • Royalty Revenue – Assumed only 5 years of revenue and discounted by 25%.
  • Giapreza and Xerava – Valued using current revenue even though it has been growing over the last 3 quarters PLUS valued at a conservative gross margin multiple vs industry averages.
  • Xacduro – Valued based on only achieving a 60% market share in the US and EU ONLY, even though the drug has limited competition and is under review in China. Additionally assumed it will be priced at half of the ineffective treatments currently available.
  • Zoliflodacin – Zero value assigned. With a market size of $1 billion, it has the potential to be a significant contributor.
  • Armata and Gate investments – Have only valued the convertible debt portion of the investments, not the equity.
  • ISP Fund – The ISP Fund is invested in several healthcare stocks valued at $264 million. We have applied an additional 25% discount on this value even though the potential return could be much higher. We note that the ISP FUND investment is a negative because Sarissa manages it and could result in a conflict of interest. We prefer INVA to invest the capital themselves.
  • Royalty Collaboration Receivables – ZERO value even though receivables amount to $0.88 per share.

 

Upside Potential

By removing the 25% discounts applied above, INVA’s value increases to just under $20 per share. We applied these discounts as an extra margin of safety to our already conservative valuations.

The potential upside is far greater if any drugs, either in production or in the pipeline, succeed. Success is not unrealistic but impossible to value at this stage.

 

We are not alone in our thinking.

We are not the only ones who think INVA is an exciting opportunity. INVA, themselves, bought GSK’s 27% stake in 2021 for $12.25 per share while continuing to buy back shares, Sarissa continues buying, and even the CEO bought shares in March (but at a lower price).

While insider buying does not guarantee success, it gives us confidence that people with far more knowledge of the business believe it to be worth owning.

 

 

Conclusion

INVA offers an exciting investment opportunity because of its small market cap, as the market largely ignores the company. The few that follow it are still valuing the business based on its royalty revenue stream and not giving the company credit for its better capital allocation since the leadership change.

Based on our very conservative estimates, we believe INVA to be, at WORST, fairly valued at the current share price ($12.82 per share) with the potential to be worth significantly more given the portfolio of drugs it has either in production or in the pipeline.

While success is not guaranteed with any of its products or investments, we like the odds of at least one working out, given the pedigree of management and the board.

 

“Rule No. 1: Never lose money. Rule No. 2: Never forget rule No. 1.” – Warren Buffett

 

 

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