Royalty Pharma: Uncorrelated Yield From Pharmaceutical Product I

Background

Royalty Pharma plc (NASDAQ:RPRX) was founded back in 1996 by Pablo Legorreta as a private equity fund, which filed for an IPO in 2020. Royalty Pharma’s business model is in investing in pharmaceutical royalty streams to generate a non-correlated return.

Biopharma products historically generated consistent cash flow even during market downturns, as patients still take drugs when they get sick and many drugs are covered by government insurances. Furthermore, we see pharmaceutical royalties attractive in an inflationary environment, as unlike other sector, biopharma companies have historically increased drug prices well above the inflation rate year over year. Since 1996, Royalty Pharma has shown a meteoric rise and became a leader in the pharmaceutical royalty investing landscape (currently estimated to account for ~60% of the total capital deployed since 2012 and 84% of the deals larger than $500m) and played an important role in establishing drug royalties as an established asset class.

Beside traditional Royalties, Royalty Pharma has expanded into various types of innovative transactions (i.e., M&A financing for MorPhoSys(MOR)) and finances drugs in various stages (pre-approval (phase 2 and phase 3, and approved). Also, the company invests not only through a royalty monetization strategy (buying future royalty from royalty holders that can be a biotech, school, or individual inventor), but seems to invest in public equity and syndicated term debt.

We believe Royalty Pharma’s constant innovation and relatively aggressive strategy have allowed them to grow to a significant scale, reaching $2.1 billion adjusted cash royalty receipts during 2021 and transforming into an evergreen structure, where the company can consistently invest with its cashflow without relying on external financing. Not only that; Royalty Pharma has a formidable presence in the healthcare royalty investing space, but it has also consistently delivered outsized returns, with double-digit growth from the 2021 base in 2022 (based on the adjusted royalties).

Early January 2023, Royalty Pharma provided updates on the company’s strategy and announced the company’s first acquisition during JP Morgan’s annual healthcare conference. The key updates can be summarized as: a) a ~$1.1B deal to acquire royalty of Spinraza and pelacarsen from Ionis Pharmaceutical (IONS); b) the management’s positive forward-looking comments that emphasized continued strength in deal-making during 2023; and c) increased quarterly distribution by 5.3%. We like the positive comments regarding the general strategy and direction of the fund, but also we believe the two new updates in the CVD and SMA space can provide an additional degree of diversification and dependable cash flow to the current existing portfolio of Royalty Pharma.

Based on preliminary unaudited fourth quarter 2022 results, Royalty Pharma expects Net cash provided by operating activities (GAAP) to be approximately $2,140 million to $2,150 million for full year 2022. Additionally, Royalty Pharma now expects to deliver Adjusted Cash Receipts⁽¹⁾ (non-GAAP) for full year 2022 of approximately $2,785 million to $2,790 million, which is towards the upper end of its guidance range of $2,750 million to $2,800 million and represents growth of 31% year-over-year. This strong double-digit growth in Adjusted Cash Receipts reflects the strong performance of Royalty Pharma’s diversified royalty portfolio as well as the acceleration of payments related to Pfizer’s acquisition of Biohaven. Importantly, the growth in Adjusted Cash Receipts was achieved despite a significant decline in two of Royalty Pharma’s largest royalties in previous years, the HIV and DPP-IV franchises, highlighting the resilience of the business model with a unique ability to grow through royalty expirations. Source

Risks

Although safer than investing directly in a biotech exchange-traded fund (“ETF”) due to limited clinical risk, Royalty Pharma remains susceptible to macro risk around the biopharma sector, such as pricing, intellectual properties, etc. Furthermore, as Royalty Pharma also invests in pre-approved products as well, any failure in the candidates that they invested in can lead to binary capital loss, impacting the stock price. Furthermore, if the cash flow from the existing portfolio declines unexpectedly, Royalty Pharma plc may have to raise additional capital by issuing more shares in the public market.

Conclusion

Net-net, we are positive about investing in Royalty Pharma plc because of the following reasons: a) depressed biotech valuation increasing the deal-flow for Royalty Pharma; b) robust specialist investment team with more than 27 years of experience with a consistent track record gives high conviction on the future deals (lowering the risk of potential binary clinical risk); and c) strong balance sheet and growth in royalty cash receipts guided by the company, >10% CAGR on royalty cash receipts and high >80% cash flow margins.

We continue to maintain cautious about Royalty Pharma plc moving into 2023 due to the macro backdrop (from increasing interest rates) and recession concerns. We believe Royalty Pharma plc to be an excellent stock to get healthcare exposure for generalist investors who are looking for non-correlated yield but who are not willing to take a binary clinical risk. Moving forward, with the consistent performance of the fund, we believe the Royalty Pharma plc valuation will trend upward during 2023 and 2024.