Third, in 2013, Amgen’s management made a questionable capital allocation decision: the company purchased Onyx Pharmaceuticals at a 40%+ premium for $9 billion in cash while halting its own share repurchase program. At the time, the company said that its buyback would remain halted until 2016. Based on corporate filings, during the deal negotiations, Amgen had concerns about Onyx’s lead compound, Kyprolis, and renegotiated to reduce the price. Since the acquisition closed, Amgen has disclosed that while the ASPIRE trial for Kyprolis met its clinical endpoints, its sister FOCUS trial failed to show clinical benefit and introduced potential concerns over renal‐adverse events. Instead of the Onyx purchase, Amgen could have accretively repurchased over 10% of its shares outstanding, at the depressed valuation of just 4x sales. Beyond Onyx, we question whether the return on Amgen’s $17 billion in M&A spending since 2002 (on top of the aforementioned $32 billion in R&D spending) has been economically justified, both in absolute terms and also relative to other transactions in the sector. We are challenged to identify any “home‐run” acquisitions and, while still early, believe that most of these transactions will turn out to show mediocre returns.
We believe that Amgen management can directly address all three sources of legitimate investor frustration and, based on our discussions to date with management, we believe that they will. While we applauded Amgen’s first steps in July to target the company’s inflated cost structure by rationalizing its US facilities footprint and creating centers of R&D excellence in San Francisco and Boston, we believe much more can and should be done. Immediate actions Amgen can take to create shareholder value include: 1) Focusing its R&D efforts; 2) Providing long‐term margin guidance demonstrating a commitment to reducing a bloated cost structure; and 3) Creating clarity on additional shareholder returns.
We have also asked the company to seriously consider a more radical option, one first proposed by Geoffrey Porges at Sanford Bernstein. It is well‐established that disparate business units generally benefit from operating separately due to distinct corporate cultures, superior efficiencies, and a greater focus for employees and management alike. Given the diverse nature of its assets – cash‐generative Mature Products and R&D‐intensive Growth Products – we believe that Amgen could benefit from a separation into distinct operating units with separate financial statements and should seriously consider separating into two companies (e.g., a MatureCo and a GrowthCo). Internally, each business would have different priorities: MatureCo would focus on efficiency and cash flow, while GrowthCo would emphasize product development and innovation. Externally, each business would be valued with different metrics: MatureCo on a dividend yield and GrowthCo on a peer‐based sales or earnings multiple. Our own extensive diligence suggests that a break‐up of Amgen is feasible and that purported constraints such as tax strategy and supply chain management can be managed.
A separation of Amgen into MatureCo and GrowthCo would likely be very well received by investors. We expect that MatureCo would receive a valuation based on its dividend yield while GrowthCo would be valued, like peers, on a high growth multiple on earnings, reflective of the burgeoning pipeline. Importantly, however, we believe that a separation would not just be good for shareholders, but that it is a more effective way of running each business. In particular, we believe that the benefits to GrowthCo would be the most meaningful: talent retention, more rapid decision making, and ultimately, accelerated development of new therapies to improve countless lives. We urge Amgen management and a committee of independent directors to conduct their own in‐depth evaluation of this strategic option and share their findings with investors.
We believe there are three ways to win in Amgen, depending on the path management takes from here. If Amgen is simply valued at one turn below its pharmaceutical peers at 17x earnings – a change we expect to be driven by management’s current restructuring plans – the stock should be worth $189 per share by the end of 2016. If Amgen fully seizes the opportunities outlined in our recommendations to focus its R&D, announce structural expense reductions, and accelerate capital deployment, we believe 2017 EPS will reach $12.82 (versus consensus of $11.12 currently), implying a share price of $218 on the same multiple. We see the most upside, however, in the scenario where Amgen strategically separates into two standalone business, as we have encouraged management to consider.
In two years, we expect that such a separation could create almost $249 per share in total value, over 80% upside to the current share price.
CEO Bob Bradway and his team have been open‐minded and receptive to our ideas to date and we firmly believe that the company is at an inflection point. The company’s upcoming Analyst Day presents an excellent chance for Amgen management to take bold action and provide clear direction for the company, its investors, and its employees. We hope to maintain our constructive dialogue with management as the company moves towards closing its valuation gap.”
It’s been a year since the publication of Third Point’s investor letter and Amgen Inc. (NASDAQ:AMGN) shares managed to return nearly 9% since the end of September 2014.
