EFTA01088033.pdf

Biotechnology Bank of America e Growth at a reasonable price - How much Merrill Lynch are you paying for a pipeline? Industry Overview Equity 1 19 April 2016 Biotech trading meaningfully below historical averages United States Biotechnology The Nasdaq Biotechnology Index (NBI) has underperformed the broader market, down 17% vs the S&P 500 up 3% year-to-date. Since the peak in July 2015 (4165.87), the NBI lying Huang is down 30%. With investors jittery on the outlook for biotechs and questioning current Reseatch Anatyst valuations, we took a closer look at the NPVs of the nine larger cap companies in our coverage universe. Savita Subramanlan Most value coming from base businesses Equity & Quant Strategist Given the significant decline across the board, we found that current valuations largely reflect minimal contributions from the pipeline with the exception of those with large Jill Carey Hall. CFA clinical trials underway that could offer high rewards if successful. Our analysis indicates Equity & Quant Strategist the base businesses for ALXN, AMGN. GILD, INCY, REGN, and VRTX reflect about 75%- MLPF&S 100% of current valuations with very little premium from the pipeline, whereas R&D heavy Qian Wang weights BIIB, BMRN. and CELG screen lower with their base businesses representing Research Analyst about 55%-65% of current valuations. On a multiple basis, most are trading at or below MLPCAS historical averages on forward P/E and EV/EBITDA. We highlight ALXN and REGN as two Aspen Mod stocks with above-peer growth and pipeline premium lower than prior levels. Reseatch Maya MLPF&S Large caps screen well in historical context We also reviewed historical forward PIE multiples for the last 10 years for the four large caps AMGN, BIIB, CELG, and GILD (see Chart 19-22). With the exception of AMGN which is trading slightly above, the other three are trading considerably below historical averages (4x-10x below). AMGN, BIIB, and CELG trade above historical lows (5x-6x above). GILD, however, is currently trading at its lowest forward PIE multiple as investors are concerned about the sustainability of the Hepatitis C (HCV) franchise. We expect the sector to recover after political rhetoric on drug pricing dies down after election. Top-down view: growth at a reasonable price From a generalist perspective, Biotech is the definition of GARP. The industry trades at significant a discount to history on most valuation metrics but has one of the highest projected long-term growth rates in the S&P 500. In fact. S&P 500 Biotech sports the best combination of low P/E versus high long-term growth expectations relative to all other groups (Chart 9). Risks of continued multiple compression include political uncertainty around Health Care (particularly in an election year) and a more hawkish Fed. Risks: Crowded & correlated According to our comprehensive fund holdings analycn, Biotech is the third most overweight industry within S&P 500. Within Health Care, active managers are 40% overweight relative to the benchmark But the buyside has been systematically reducing this overweight, which now sits at its lowest levels since mid-2011, and well below its average exposure since '08. The group could still be used as a source of funds for active managers if they want to close underweights in other areas of the market — in particular, cyclicals and commodity plays if the macro data continues to improve. But relative to the last several years, positioning risks are lesser. Also of note to stock-pickers: Biotech is now dominated by passive flows, and stocks have become increasingly correlated within the industry. BofA Merrill Lyndt does and seeks to do business with issuers covered in its research reports. As a result, Investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Refer to important disclosures on page 19 to 21. Analyst Certification on page 17. Price Objective Basis/Risk on page 16. 11622320 EFTA01088033 Biotech Large-cap Biotech: crowded, but less so than historically Biotech is the most crowded industry within the S&P 500 Health Care sector: large cap active managers are 40% overweight Biotech relative to the benchmark (Chart 1). In fact, the two most overweight Health Care stocks in the S&P 500 by active funds are ALXN (2.7x the benchmark weight) and BIIB (1.9x the benchmark weight). But managers' overweight in the industry has been narrowing since mid-2013, when managers were more than 90% overweight Biotech relative to benchmark, and today the overweight is its narrowest since mid-2011, and about 10% below the average overweight since 2008 (Chart 2). Chart 1: Large cap managers: Health Care industry exposure (all styles) Chart 2:Large cap managers' relative weight in Biotech. 9/08-present 1.4 2.0 Biotechnology 1.9 - 0 1.2 1.8 - Life Sciences Tools 8 Seances 1.7 1.1 1.6 Avg. OA4 in Biotech Health Care Providers 8 Seances 91.0 1.5 Health Care Equipment 8 Supplies 1.1 1.4 1.0 II ow I 1.3 Pharmaceuticals 1.0 1.2 0.9 1.1 Health Care Technology 0.7 MMI 1.0 0.6 el' et It) §. = = = AC, -a. ;F. = m = m a a 0.0 02 0.4 0.6 0.8 10 1.2 IA 1.6 cS • Rel wgt vs Inclx • Rel wgt vs Seats Biotech Rd. Wg1. In Fund Holdings —Avg. overweight since '08 Scurce FxtSevLionsrxet BofA Merril Lynch US EquIty & US Quant Strategy Source. FactSeubonshares.BolA inernll LynchUS Equiry& US Quant Strategy Table 1: Large cap active manager? positioning in S&P 500 Biotech Biotech now dominated by passive flows stocks (as of March 2016) According to data from EPFR Global, while total US Relative Mkt Cap Weight (vs. V. Funds Biotech/Health Care assets under management in ETFs and Ticker Company (Smn) SSP 500) Owning mutual funds had closely tracked on another until 2013, since ALXN Alexion Pharmaceuticals. Inc. 33,324 2.70 23.2% then, assets in ETFs have greatly surpassed assets in mutual BIIB Biogen Inc. 59,555 1.87 29.8% funds. In tandem, Biotech stocks have become increasingly REGN Regeneron Pharmaceuticals. Inc. 43,347 1.68 15.9% correlated—see Chart 6. Today, US Biotech/Health Care is only AMGN Amgen Inc. 118,509 1.64 34.6% CELG Celgene Corporation 84,174 1.57 35.8% one-third active, two-thirds passive—the opposite of the overall VRDi Venex Pharmaceuticals Inc. 21,543 1.49 18.0% US AUM landscape, which is still two-thirds active (Chart 3 and GILD Gilead Sciences, Inc. 138,105 0.98 45.8% Chart 5). Year-to-date, both mutual funds and ETFs in this ABBV ANN*. Inc. 94,758 0.94 23.4% sector have seen outflows, but with larger outflows from ETFs BAT Baxalla. Inc. 27,250 0.71 11.0% following the elevated inflows over the past few years (Chart 4). Sauce FactSeuLicasharez BorA Mena Lynch US Equty di US Quant Strategy 2 Biotechnology 119 April 2016 Bankof America Merrill Lynch EFTA01088034 Chart 3: Current assets in US Biotech/Health Care mutual funds vs. EIFs Chart 5: Current assets in overall US equity mutual funds vs. ETFs US BiotechlHealth Care AUM Overall US Equity AUM Active, 33% Passive, 67% Source EPFRGlobvt BofA Merril Lynch Global Research Sotoce. Sofurcl.BoM memli Lynch US Equity & USPliant Strategy Chart 4: Cumulative flows ($mn) into US Biotech/Health Care mutual Chart 6: Avg. pair-wise correlation: S&P 500 Biotech stocks, 1Q05-1Q16 funds and ETFs, 5/03-present 0.8 30,000 0.7 25,000 20,000 0.6 15,000 0.5 10,000 0.4 5,000 0.3 0.2 (5,000) 05 06 07 08 09 10 11 12 13 14 15 16 03 04 05 06 07 08 09 10 11 12 13 14 15 —Mutual Funds — ETFs — Al. pee-wise correlation Sotrce SofA mead Lynch US Equity & US Pram Strategy Source ElfRGbNt BA Merril Lynch Global Research Growth at a reasonable price Large cap Biotech stocks currently look cheap vs. history on most metrics, with the exception of relative Price to Book (see tables). Political uncertainty, expectations of Fed tightening and the positioning unwind have all helped to compress multiples to five-year lows on relative Price to Sales and to historical lows on relative forward P/E Comparing S&P 500 sectors' and other Health Care industries' valuations to projected long-term growth rates, Biotech represents growth-at-a-reasonable-price: it has the lowest forward PIE, but among the highest expected long-term growth (Chart 9). Banker Amenca ".3" Biotechnology 119 April 2016 3 Merrill Lynch EFTA01088035 Chart 7: S&P 500 Biotech industry: relative Price/Sales (1993-3/2016) Chart 8: S&P 500 Biotech industry: relative fwd. P/E (1993-3/2016) 12.00 i 3.00 10.00 2.50 8.00 2.00 6.00 W A 1.50 4.00 .1 1.00 2.00 0.50 93 95 97 99 01 03 05 07 09 11 13 15 93 95 97 99 01 03 05 07 09 11 13 15 —Relative P/S —Avg —Relative Fwd PIE -Avg SCUM FacrSet. Both.MemllLynchUS Equity & US Quant Strategy Sauce. Fac6et.BolA Mend Lynch US Equity & US Quant Strategy Table 2: S&P 500 Biotech - relative valuations vs. history (1992-3/2016) Chart 9: Biotedt growth at a reasonable pike Implied upside (downside) S&P 500 sectors and Health Care industries Fwd P;E vs. Consensus LTG (as of Metric Current Avg. to get back to UT avg. 3/31/16) Relative PG 2.6 2.0 -21% 22x Relative NS 3.0 5.1 71% 21x Cons. Staplos• Life So Tools Relative Fed PI 0.7 1.3 78% 20x 8 Svcs Relative NOCE 1.1 1.9 74% 19x HC Eqpt 8 Note based on aggregate %Suiten multiple miaow to S&P SOO milurie 18x Slehl. • Coos. Disc. Source FacrSet. BOO .Memll Lynch US Equity & USQuaStrategy r. 17x I 18x 15x 14x Telecom Industrials • Rharrna • 13x Financials 12x C• Biotech) 11x 0.0 2.0 4.0 8.0 8.0 10.0 12.0 14.0 16.0 18.0 20.0 Consensus Long-Tenn Growth Sauce. FaciSet.80% Mend Lynch US Equity & US Quant Strategy Valuations reflect mainly base businesses for most We reviewed the net present values (NPVs) for ALXN, AMGN, BIIB, BMRN, CELG. GILD, INCY, REGN, and VRTX — taking apart the base business (BB) vs pipeline contributions. Based on our analysis, the BBs for ALXN. AMGN, GILD. INCY, REGN, and VRTX reflect about 75%-100% of the current valuation with little premium from the pipeline. This should be viewed favorably in a nervous market and could protect against significant downside in a market downturn and offer upside if pipeline assets report favorable clinical data. Of these. AMGN, REGN. and VRTX will report later-stage clinical data in 2016 that could meaningfully drive shares higher, including Repatha outcomes data for AMGN, interim Praluent outcomes data for REGN. and VX661/Kalydeco and early triple combo data for VRTX. In addition to clinical read-outs on new indications for Saris, ALXN also has two product launches (Strensiq and Kanuma) that began late last year; we believe the long-term market opportunities for these are not reflected in the price. Not surprisingly. heavy weights BIIB, BMRN, and CELG screen lower with their BBs representing only 55%-65% of current valuations. We believe these are justified given the number of late-stage large trials each have underway that could significantly accelerate growth in the next few years. BIIB has Phase 3 aducanumab in Alzheimer's and Phase 3 anti-LINGO in multiple sclerosis data. BMRN has multiple catalysts over the next 12 months, including updates for BMN190 for Batten's disease. 30mcg data for BMN111 for achondroplasia, and preliminary data for BMN270 for Hemophilia A. CELG has the PDUFA date for Revlimid for patients with non-del-Sq myelodysplastic syndromes (MDS) on April 16 and Ozanimod data in 1H1 7. 4 Biotechnology 19 April 2016 ," Bankof America 40 Merrill Lynch EFTA01088036 Table 3: Company NPVs by drug /LINN $11 $21 $24 $15 $49 SO $42 $120 $162 74% Tecfidera Interferon Tysabri Others Net cash Pipeline Total Price % base biz BIIB $78 $40 $23 $38 ($2) $94 $177 $271 65% Revlimid ThatNIdaza Pomal s CELG $49 St $9 $5 $6 ($9) $44 $63 $107 59% HCV HIV Others Net cash Pipeline Total Price % base biz GILD $43 $40 $5 $4 S8 $92 $99 92% Eylea Praluent Dupilumab Sarilumab Net cash Pipeline Total Price % base biz REGN $244 $39 S14 5117 $297 $414 72% widup and sari $244 $39 $22 $7 S14 $88 $326 $414 79% Solids Strenslq Kanuma Net cash Pipeline Total Price % base biz ALXN S125 $25 SI8 ($8) ($4) $160 $155 103% ALXN w!compelition $65 $25 SI8 ($8) $58 $100 $155 64% Alduraz me Na la BAIRN S5 $13 S3 $29 $2 $34 S52 S86 60% Kal d VRTX $15 $58 $3 S7 $76 $83 91% Jakall Baricitinib Net cash Pipeline Total Price % base biz INCY $37 $20 $1 $19 $58 $77 75% Source Sof/WNW 4naltictateessych Banker Amenca 4"3" Biotechnology 19 April 2016 $ Merrill Lynch EFTA01088037 Alexion (ALXN) I Buy I C-1-9 I $204 ALXN specializes in the research and development of rare and ultra-rare orphan diseases. Its flagship product is Soliris (eculizumab) for the treatment of paroxysmal nocturnal hemoglobinuria (PNH) and atypical hemolytic-uremic syndrome (aHUS). The company also recently launched two new drugs for metabolic indications in late-2015: Strensiq for hypophosphatasia (HPP) and Kanuma for lysosomal acid lipase deficiency (LAL-D). ALXN also has a robust clinical pipeline that could bring as much as six product launches to market by 2018-2019. We view ALXN's product portfolio and pipeline as undervalued, and think there is room for significant upside if data for ALYN1210, SBC- 103. and additional Soliris indications continue to read out positive and the Strensiq and Kanuma launches track well. With most of ALXN's value still coming from its BB, it should remain somewhat shielded from significant downside in the event of continued market downturn. We note, however, that as the most overweight biotech in our coverage, we may see more outflows if repositioning continues. Chart 10: ALXN product and pipeline portfolio NPV $180 $160 $18 $140 $56 $120 $100 • $80 $25 $60 $125 $40 $20 so $20 ALXN ALXN w/competition -$40 ■ Solids ■ Strensiq ■ Kanuma ■ Net cash ■ Pipeline Source BarAMeir II 1)11:h Gant cteseaqh est males NPV assumptions for marketed products Each valuation scenario assumes ($8)/sh net cash NPV. The scenarios above also account for Strensiq sales through 2024 gradually ramping up to about $1.48 in sales as well as Kanuma sales through 2025 gradually ramping up to about $1.06. We use a WACC of 9.3%. No Solids competition scenario Our first ALXN valuation scenario is based on Soliris revenues through 2025 unimpeded by biosimilar competition, with modest growth, translating to a Soliris NPV of 5125/sh. Soliris, Strensiq. and Kanuma in this scenario account for over 100% of ALXN's value. Bloslmllar competition to Solids This scenario assumes Soliris revenues quickly grow to peak sales of $4.36 in 2020 and then face biosimilar competition in 2021and a decline in sales through 2025. This case provides for a pipeline NPV of 556/sh and the BB accounting for 64% of the company's overall value. 6 Biotechnology 19 April 2016 Bankof Amenca 40" Merrill Lynch EFTA01088038 Amgen (AMGN) I Neutral I C-2-7 I $181 AMGN has one of the larger product portfolios of our coverage. Led by Enbrel and Neupogen/Neulasta. AMGN's products bring in over $208 in revenue per year. AMGN's products are currently under the threat of biosimilar competition, with the first biosimilar to Neupogen (Zarxio) launching at a 15% discount in September 2015. AMGN however, continues to convert its own pipeline assets into products (i.e. Repatha) to fill these holes. With most of the company's value coming from its base business, we view AMGN as a secure short term story, with potential for upside coming from Repatha cardiovascular outcomes data in 2H16. Chart 11: AMGN product and pipeline portfolio NPV S180 S160 - S140 S120 - S100 $49 $80 - $60 - $15 S40 - $24 $20 - $0 $11 AMGN 420 • EM - Neupo • Enbrel • Repatha • Others Net cash •Pipdine Source BortaterrALywheoballiesearch estimates NPV assumptions for marketed products Our AMGN product NPV valuation assumes product sales through 2025. a WACC of 9.4%. and Wish net cash. We grouped AMGN's erythropoiesis stimulating agents (ESAs), Epogen and Aranesp. together and assumed gradually declining sales through 2025 due to introduction of biosimilars and applied a similar analysis for Neupogen/Neulasta and Enbrel sales. This provided NPVs of S11/sh for ESAs, 521/sh for Neupogen. and 524/sh for Enbrel. AMGN's recently launched cholesterol lowering drug, Repatha, came out to $1 S/sh, assuming a rapid launch over the next few years and peak sales of $4.28. Grouping AMGN's other marketed products together, we arrived at a 549/sh NPV. These products account for 74% of AMGN's price, leaving 542/sh for the pipeline. Bank of America e Biotechnology l 19 April 2016 7 Merrill Lynch EFTA01088039 Biogen (BIIB) I Buy I B-1-9 I $370 BIIB specializes in developing drugs for treating multiple sclerosis (MS). Lead by Tecfidera, BIIB's products b ing in around $9B per year. However, with slowing growth in the MS franchise BIIB's pipeline is all the more important. Important data readouts in BNB's Alzheimer's and MS p'peline will drive growth for the time being. We are confident in the results of these studies being positive, given the previously demonstrated efficacy and think the relative cheapness of the stock offers an attractive buying opportunity ahead of these binary data points. Despite a relatively high pipeline valuation, BIIB still has a significant revenue base that should be somewhat protective against downside. Of note, BNB is the second most overweight company in our coverage relative to the S&P, and so remains at risk downside from repositioning. Chart 12: BM product and pipeline portfolio NPV $300 $250 $200 $150 - $38 $23 $100 $50 - $78 SO BIIB -$50 - ■ Tecfidera • Interferon ■ Tysabri ■ Others ■ Net cash Pipeline Souse BotA Moral Lptil °thatResearch emanates NPV assumptions for marketed products Our BIIB product NPV valuation assumes Tecfidera sales through 2028 and Avonex/Plegridy (Interferon Franchise). Tysabri and other product sales through 2025. We use a WACC of 8.8% and assume $(2)/sh net cash. The Interferon Franchise is currently at $40/sh, assuming a gradual decline in sales from now through 2025. Tysabri ($23/sh) sales should behave similarly. We model Tecfidera sales increasing through 2022 then gradually decreasing, translating to a $78/sh NPV. All other revenues gradually increase from now until 2025 and make up $38/sh NPV, leaving $94 for BIIB's pipeline. In this scenario, the BB accounts for 65% of BIIB's value. 8 Biotechnology 119 April 2016 Bankof Amenca Merrill Lynch EFTA01088040 BioMarin (BMRN) I Buy I C-1-9 I $109 BMRN is the second largest orphan drug developer, after ALXN. Its product portfolio currently consists of Naglazyme for Mucopolysaccharidosis type VI (MPS VI), Aldurazyme (sold by Genzyme) for MPS I, Kuvan for Phenylketonuria (PKU) and Vimizim for MPS IVA. Current growth is driven by Vimizim sales, which should bring the company to break- even by 2017. With much less of its valuation coming from its BB and strong clinical science backing up its pipeline drugs, we view BMRN as a strong growth opportunity. Chart 13. BMRN product and pipeline portfolio NPV $100 am' S90 $80 S70 - $60 - S50 - $40 - 529 S30 - $20 - $10 - .5 $0 BMRN • Aldurazyme Naglazyme • Kuvan • Vimom • Net cash Pipeline Source 6oIAMeudl Woch Cithateese.yth estmates NPV assumptions for marketed products Our BMRN product NPV valuation assumes revenues through 2025, a 9.1% WACC and $21sh in net cash. Aldurazyme and Naglazyme are currently valued at $5/sh and $13/sh, assuming very moderate revenue growth through 2025. Kuvan is only valued at $3/sh, with sales growth until 2020, when it loses exclusivity and generics enter the market Vimizim ($29/sh) shows a much more rapid revenue growth, with peak sales of just under S1B in 2025. These represent 60% of BMRN's value and leave $34/sh for BMRN's pipeline. Minket Amenca 4,* Biotechnology 19 April 2016 9 Merrill Lynch EFTA01088041 Celgene (CELG) I Buy I B-1-9 I $125 CELG's clinical specialty is multiple myeloma (MM). primarily headed by its lead product, Revlimid. however Otezla for plaque psoriasis is in the midst of a strong launch that should also help boost revenue growth. Other products include Thalomid for MM and Erythema Nodosum Leprosum, Vidaza for treatment of refractory anemia and chronic myelomonocytic leukemia, Pomalyst for MM. and Abraxane for metastatic pancreatic cancer, non-small cell lung cancer, and breast cancer. CELG's BB plays a smaller role in CELG's overall valuation in relation to the other large caps and so an approval for Revlimid for non-del-5q myelodysplastic syndromes (PDUFA April 161 and positive data readouts for Ozanimod for MS and ulcerative colitis (2017) could mean greater upside, but the company is less protected in the event of a poor market environment. Chart 14: CB.G product and pipeline portfolio NPV $140 - S120 - S100 $80 $60 - S40 - S20 - $49 $0 CELG -S20 ■ Revlimid ThaWidaza ■ Pomalyst Abraxane ■ Olezla Net cash ■ Pipeline Souse BorA Mead' LpithCictiateese.yth estmates NPV assumptions for marketed products Our CELG product NPV valuation assumes revenues through 2020 for Vidaza. 2023 for Thalomid, 2024 for Otezla and Pomalyst, 2025 for Revlimid, and 2026 for Otezla. We use a WACC of 10.3% and assume ($9) in net cash. The biggest chunk of CELG's value comes from Revlimid, which accounts for $49/sh NPV. Revlimid revenues should continue rapid growth as it remains a staple for MM treatment and expands indications. until 2022 when Natco is able to produce limited amounts of generic drug. Vidaza and Thalomid ($1/sh NPV) sales should continue to decrease as generics enter the market Pomalyst sales should ramp up to a peak of $2.36 in 2023 when it loses patent protection in EU and US (2024); Pomalyst accounts for $91sh NPV. Abraxane ($5/sh NPV) sales should gradually grow until it faces patent exposure in 2026. Finally. Otezla, CELG's most recently launched product accounts for $8/sh NPV and should see rapid growth to peak sales of $4.06 in 2024. when it loses patent protection. These products represent 59% of CELG's NPV, leaving $44 attributable to its pipeline. 10 Biotechnology 119 April 2016 Bankof America 40' Merrill Lynch EFTA01088042 Gilead (GILD) I Neutral I B-2-7 I $104 GILD's specialty is in antiviral indications. Its two largest product portfolios are in hepatitis c virus (HCV) and human immunodeficiency virus (HIV). These two segments brought in over $308 in revenue for GILD in 2015. Its primary source of growth has come from its HCV franchise (Harvoni and Sovaldi) however, as sales slow down due to competition, it is on GILD to find a new source of revenue growth. With the vast majority of GILD's value coming from these two businesses, the company remains relatively protected against downside, but we wait to see what kind of pipeline GILD is able to build through in-licensing and acquisition to determine potential upside. Chart 15: GILD product and pipeline portfolio NPV $120 - $100 - $80 • 660 - 640 - S20 - $0 GILD •HCV • HIV •Others • Net cash • Pipeline Source BMA Menai Lrx11GlobalResearch esumates NPV assumptions for marketed products Our GILD product NPV valuation assumes product revenues through 2030 for HCV and other products, through 2029 for HIV, a WACC of 7.9%, and $4/sh NPV net cash. GILD's most valuable asset is their HCV portfolio at $43/sh NPV. This assumes an approximate 9% decline in revenues per year through 2023 due to an increase in marketed competition. GILD's second biggest money maker is its HIV franchise, valued at S40/sh. HIV sales overall should grow for the next couple years, as Genvoya sales gear up, but loss of patent protection for Atripla, Truvada and Viread in 2018 initiates a decline in HIV sales through 2029. Other products, including Ambisome. Letairis, Ranexa, Zydelig. and Cayston should contribute very mild growth and account for $S/5h NPV. The BB represents 92% of GILD's NPV with only $8/sh from its pipeline. Banker Amenca 4,* Biotechnology 19 April 2016 11 Merrill Lynch EFTA01088043 Incyte (INCY) I Buy I C-1-9 I $90 INCY's only currently marketed product is Jakafi (ruxolitinib) an oral Janus-kinase (JAK) inhibitor indicated for the treatment of Myelofibrosis (MF) and Polycythemia Vera (PV). two bone marrow disorders. With only one marketed product, INCY's valuation is very pipeline heavy. This gives it a lot of potential for growth if epacadostat and other early pipeline drugs have positive data readouts, which we expect to be the case, given the differentiating safety profile and strong efficacy epacadostat has demonstrated thus far. However, this also puts INCY in the hands of the market as it ramps up Jakafi sales. Chart 16: INCY product and pipeline portfolio NPV S90 S80 S70 519 S60 S50 S40 S30 S20 $37 S10 SO INCY • Jakali Baricitinib ■ Net cash ■ Pipeline Source BoMAMeu I Lpch Global Research estimates NPV assumptions for marketed products Our INCY product NPV valuation assumes revenues through 2030 for Jakafi and baricitinib for rheumatoid arthritis, a WACC of 9.3%, and $1/sh net cash. Note that while baricitinib (RA) is still technically in the pipeline, we treat it like a marketed product in this analysis because of its high probability for FDA approval. Our analysis currently values Jakafi at $37/sh, with sales gradually increasing to a $1.78 peak in 2026, followed by steep drop off when its patents expire. Baricitinib should see a similarly moderate sales growth to a $1.18 peak in 2029. when its patents expire. Baricitinib represents $20/sh NPV. The BB comprising these two products makes up 75% of INCY's NPV with $19/sh coming from the pipeline. 12 Biotechnology 19 April 2016 Bankof America 40" Merrill Lynch EFTA01088044 Regeneron (REGN) I Buy I B-1-9 I $525 REGN. a perennial MI powerhouse, currently only markets Eylea for wet macular degeneration and Arcalyst for cryopyrin-associated periodic syndroms (CAPS). However, it also books revenues for Praluent (alirocumab) from its collaboration with Sanofi and ex-US revenues for Eylea from its collaboration with Bayer. With only one marketed product, it would seem that REGN's NPV would be very pipeline heavy, but with a strong base of Eylea sales. REGN's value mainly comes from its products. We view this as a very attractive opportunity, given the protection it would have against a market downturn from its BB and the growth opportunity from its late stage pipeline. In addition, REGN is screening cheap, compared to historical valuations. Note however, that as the third most overweight biotech relative to the S&P 500, repositioning remains a risk. Chart 17: REGN product and pipeline portfolio NPV S450 - S400 - 5350 - 5300 - S250 - S200 - 5150 - 5244 5244 5100 - S50 - 50 REGN REGN wldupilumab and sarilumab ■ Eylea ■ Praluent ■ Dupilumab ■ Sarikirnab ■ Net cash Pipeline Source Bole Mean !ovenGlobalResearch estimates NPV assumptions for marketed products Each valuation scenario above assumes Eylea and Praluent revenues through 2020. 514/sh net cash NPV and a 10.3% WACC. Eylea's $244/sh NPV assumes revenue growth to $4.0B peak sales in 2019. Praluent's $39/sh NPV assumes growth to 2020 sales of 51.0B. In this scenario, the BB accounts for 72% of REGN's total NPV, with the pipeline representing 5117/sh. Valuation with dupilumab and sarilumab factored in We incorporate dupilumab and sarilumab into our second scenario because of the clinical success they have shown in the late stages of development In this case, our analysis gives dupilumab for atopic dermatitis and asthma an NPV of 522/sh, assuming sales quickly grow to 51.8B in 2025. Our analysis also gives sarilumab for RA 57/sh NPV from the collaboration with Sanofi. Accounting for the potential approvals of dupilumab and sarilumab, REGN's BB represents 79% of its total NPV, with the pipeline offering $88/sh. Bank of Amenca "gra" Biotechnology 19 April 2016 13 Merrill Lynch EFTA01088045 Vertex (VRTX) I Neutral I C-2-9 I $108 VRTX is the current market leader in the cystic fibrosis (CF) space, however, competition is currently intensifying. Its two leading CF products currently generate $1.O6 in revenue and despite only just becoming profitable, almost all of the company's NPV comes from its product portfolio. While protective against downturn, we think most of its product revenue growth is already baked into its price. Cash generation from its growing product portfolio should allow the company more flexibility to continue diversification of its internal pipeline candidates and development collaborations. For now, we look to the expansion of Orkambi and VX661 combination indications and development of early stage CRISPR. cancer and pain management assets. We should see data from these toward the second half of the year. Chart 18: VRTX product and pipeline portfolio Npv S90 S80 $7 S70 S60 S50 S40 S30 S20 S10 515 SO VRTX ■ Kalydeco ■ Orkambi ■ Net cash ■ Pipeline Source KofAMeeril lrthCicballiesta.th em mate,. NPV assumptions for marketed products Our VRTX product NPV valuation assumes revenues through 2O27, an 11% WACC, and $31sh net cash. Our analysis values Kalydeco at $15/sh NPV. assuming revenue growth until 2O25-2O27, when EU and US patents expire. Orkambi (SS8/sh) is VRTX's largest growth opportunity and expected to generate $2.28 of revenue in 2025. before it loses patent protection the next year. The BB of these two products represents 91% of VRTX's total NPV, with S7 attributable to the company's pipeline. 14 Biotechnology 19 April 2016 Bankof America 40 " Merrill Lynch EFTA01088046 Chart 19: Historical Price-to-Earnings Ratios for AMGN, BIIB, CELG, and CAD 40 19 year aeate,. MiGN • 13 la NO -182a COG •272i OLD 16,7x 2S0x 20L0x 1O0x Gox 0.0a —AUG11 0 —MO —OLD Source FariSet Chart 20: Historical Price-to-Earnings Ratios forMIN %Mx 70.0% 00. 50. 40.0% 30.0x 20.0x 10.0% 0.0% CV CO 0 Sougefacdc Chart 21: Historical Price-to-Earnings Ratios for INCY 10.ax Amax 00.0x 50.0x <0.0x 30.0x 20.0x 10.0x 0.0x t2 a S Source. FaciSet Chart 22: Historical Price-to-Earnings Ratios for VRTX l0x 70x 00x 1' 50x 40x 30x 20x 10x Ox Source FauSet Banker Amenca Biotechnology I 19 April 2016 15 Merrill Lynch EFTA01088047 Price objective basis & risk AlexIon Pharmaceuticals Inc. (ALXN) Our 5204 price objective for ALXN is based on a discounted cash flow analysis using a WACC of 9.5% and a terminal growth rate of 2.25%. Risks: (1) failure to meet expectations for Soliris sales and/or launch of Strensiq (asfotase alfa) for HPP and Kanuma for LAL-D. (2) government drug pricing focus on ultra-orphan products, (3) failure to advance key pipeline products, including Soliris in new indications. Amgen Inc. (AMGN) Our price objective of 5181 is based on a 17x multiple on our 2016 EPS estimate. Our non-GAAP EPS excludes stock option expense, amortization of intangible assets, restructuring charges, and other non-cash expenses. The 17x multiple is supported by AMGN's strong cash Row generation and dividend payouts. The choice of our multiple is in line with the 17x where other large biotechs are currently trading. Downside risks to our PO are: 1) greater-than-forecast decline in ESA, NEUPO and Enbrel revenues, 2) greater-than-expected price pressure in Europe, 3) potential drug pricing system restructuring in the US. 4) failure to bring out new pipeline products. Upside risks to our PO are: 1) a less-than-forecast decline in key product revenues from competition, 2) better-than-expected new product uptakes, 3) potential new pipeline products. Mogen Inc. (BIIB) We assign BIIB a PO of 5370, based on a 20x multiple on our 2016E non GAAP EPS. This is in-line to a slight discount compared to its large-cap peers, which we believe is warranted given slower growth. Downside risks to our P0: 1) MS market headwinds beyond what we model, 2) pipeline setbacks. 3) Tecfidera potential competition advancing. BloMarin (BMRN) Our 5109 PO is based on a probability-adjusted NPV analysis that includes 559 for marketed products Aldurazyme, Naglazyme. Kuvan, Firdapse, and Vimizim, and 548 for pipeline candidates (511 for BMN-190. 512 for Peg-Pal, 54 for BMN-701, 520 for BMN- 111). as well as 52 in cash. We use a WACC of 9.5% and a 2.5% terminal growth rate. We assign varying probabilities of success for the different pipeline assets based on development stage and available clinical data to date. Downside risks to our PO are: 1) disappointing Vimizim launch, 2) delays in product approvals, 3) delays in pipeline development, 4) unexpected safety findings, and 5) greater than expected competition. Celgene Corp. (CELG) Our 5125 price objective for CELG is based on a 22x multiple on our 2016 adjusted non- GAAP EPS estimate. We assume a multiple expansion and a premium to its peers given the consistent high growth and depth of pipeline. Risks to our price objective are 1) slower-than-expected growth from product sales, particularly Revlimid, 2) slower-than-expected launches of Otezla. and 3) pipeline setbacks. Gilead Sciences Inc. (GILD) Our price objective of 5104 is based on an 8.5x multiple on our estimate of 2016 non- GAAP EPS. We believe GILD should trade at a significant discount to its large-cap peers 16 Biotechnology 19 April 2016 Bankof Amenca 40" Merrill Lynch EFTA01088048 given concerns on the long-term sustainability of its HIV and HCV franchises and lack of late-stage pipeline assets. The upside risks to our price objective are 1) faster-than-expected growth from product sales, particularly Harvoni/Sovaldi, 2) less-than-anticipated pressures on pricing, 3) weaker-than-expected competition, and 4) greater and faster progress with pipeline. The downside risks to our price objective are 1) slower-than-expected growth from product sales, particularly Harvoni/Sovaldi 2) greater-than-anticipated pressures on pricing, and 3) slower progress with pipeline. Incyte Corporation (INCY) Our PO of 590 is derived from a probability-adjusted NPV ana