Stock of the week: Galapagos

Summary:
- Galapagos and Gilead Science announced deeper cooperation over the weekend
- Gilead to invest massive amounts of money in Galapagos
- Two promising projects in late-phase clinical trials
- Solid cash position hints at near-term sustainability despite lack of profits
- Galapagos (GLPG.NL) rallied on cooperation news and broke significantly above the upper limit of the upward channel

Galapagos (GLPG.NL) is a relatively small European biotech company but has gathered some attention at the beginning of this week. The company surged on Monday thanks to the news of expanded alliance with one of its major partners. In this short analysis we will take a look at Galapagos and its dealings with Gilead Science.

Just like many other small biotech companies, Galapagos struggles to make a profit. The company keeps burning through cash as it is waiting for a discovery that will provide it with a steady source of income. However, the company managed to deliver two consecutive quarters of net profit in the second half of 2018 for the first time. Source: Bloomberg, XTB Research

Galapagos is the Belgo-Dutch research company focusing on discovery and development of medicines with novel modes of action. The company was founded in 1999 as a joint venture of two biotech companies, Tibotec and Crucell. Galapagos has a business model often used by small biotech companies. Namely, Galapagos partners with bigger biotech firms and runs drug development programmes with them. Once a predetermined goal is reached, Galapagos is entitled to a “milestone” payment from its bigger partner. Once a candidate drug reaches late-stage clinical trials, Galapagos’ partner gets an option to license the programme and market the drug. Galapagos later gets a portion of drug sales as royalties.

Galapagos’ major strength is its rich portfolio of drugs in various phases of clinical trials. This is also the prime reason why the company is such a desired target for big, multinational pharmaceutical companies. This is a win-win situation as those big, biotech companies often lack their own drug pipeline to support operations in the future while companies like Galapagos often lack the resources to expand research. Galapagos partnered with Servier, the French pharmaceutical company, in order to develop a drug for osteoarthritis together. The company also works on drugs for inflammatory diseases with MorphoSys, the German company, and Novartis, the Swiss pharmaceutical giant. Finally, the company cooperates with Gilead Sciences, major US drugmaker, on the development of inflammatory and autoimmune drugs. This last partnership is also the cause of Monday’s surge of the Galapagos stock. Namely, the two companies announced that they will deepen the alliance.

Research and development (R&D) expenses are often seen as a driver of future earnings. On the chart above one can see that R&D expenses of Galapagos greatly increased in the past few years. Ratio of R&D expenses to revenue declined from Q3 2017 to Q3 2018 as the company saw rising revenue. Source: Bloomberg, XTB Research

According to the press release, Gilead will invest a total of around $5.1 billion in Galapagos. The investment consists of an upfront payment of $3.95 billion and $1.1 billion investment in Galapagos stock. In turn, Gilead’s stake in Galapagos will increase from 12.3% to around 22%. However, Gilead has also signed an agreement that prevents it from boosting stake in Galapagos above 29.9% over the next ten years. Given significant discrepancies between size of Galapagos and Gilead Science, the latter could simply acquire the European company but instead it decided to leave the company with quite a high degree of independence. Under the terms of the agreement, Gilead will appoint two members to the Galapagos’ board. The biggest benefit of the investment for Gilead is, of course, increased access to Galapagos’ drug pipeline and the right to exclusively market those drugs in some of the world’s top markets, including the United States, once they pass clinical trials and get regulatory approval.

As Galapagos is barely turning in any profits and its R&D expenses are on the rise, one may be concerned about the possibility of the company running out of cash. However, Galapagos has a strong cash position as pictured on the chart above. Declining ratios may looks somewhat worrying but the company still have enough cash to cover its expenses over the next 10 quarters. Keep in mind that these are end-Q1 figures and do not reflect major investment from Gilead. Source: Bloomberg, XTB Research

The key project in Galapagos’ pipeline is Filgotinib. It is a drug targeted for treatment of inflammation and auto-immune diseases, like for example rheumatoid arthritis or Crohn’s disease. The drug has entered phase 3 clinical trials and Gilead-Galapagos alliance will seek regulatory approval for it before the end of 2019. To understand the business potential of this product, let’s remind that another drug used in the treatment of rheumatoid arthritis - Humira, developed by the US company AbbVie - is the world’s best selling medicine with sales close to $20 billion in 2018. Another Galapagos’ drug, that is in phase 3 clinical trials, is aimed at treating the idiopathic pulmonary disease. Galapagos estimates that as much as 75000 people are diagnosed with the disease each year. 

When it comes to marketing, Galapagos will have exclusive rights to market Filgotinib in the Benelux countries and will get a half of profits from some of the other European countries. Apart from that, Galapagos will get a total of $1.3 billion milestone payments once Filgotinib gets approved and will receive royalties of 20-30% of profits in countries outside Europe. The latter drug mentioned in the previous paragraph will yield Galapagos $395 million in milestone payments upon receiving of the US approval but Gilead will get full rights to it. Apart from the two drugs mentioned, Galapagos has over 20 project in early-development stage that may secure a promising future for the Dutch company.

Galapagos (GLPG.NL) managed to close above the upper limit of the long-term upward channel (started in mid-2015) in the previous week. However, the true bombshell news were dropped over the weekend when Galapagos announced deeper cooperation with Gilead. Stock rallied this week, gaining around 20% and reaching the highest levels in history. Note that the range of the breakout is more or less equal to the breadth of the channel that kept prices in check for around 4 years. Source: xStation5