Sunday, December 7, 2014

Some Preliminary Due Diligence Items -- That Might Well Reduce The "Net Price" Merck Ultimately Pays For Cubist

Just for grins. . . over my Sunday morning OJ, coffee and cherry yogurt (and a ripe banana!), I read just a little bit about Cubist's existing SEC disclosed contractual relationships -- primarily involving the way it makes Cubicin® (daptomycin). Cubist licensed the rights to make and sell drugs containing daptomycin as an active ingredient, from Eli Lilly & Co., over 14 years ago, now.

Through the end of last year, Cubist had paid Lilly almost $590 million in royalties on Cubicin. I strongly suspect that should Merck decide to acquire Cubist, given the number of new patents, and follow-on "evergreening" patent applications Cubist now holds on variations of the compounds, Merck might secure a reduction in the amounts paid to Lilly, going forward. Perhaps a significant reduction, too. [And that would lower the effective price Merck paid. A similar reduction might well be had -- with Novartis, as successor to Chiron, on other Cubist antibiotic licenses and manufacturing agreements.]

In addition, Cubist sources the vast majority of its API for daptomycin from one supplier -- ACS Dobfar, S.p.A. It is highly likely, given that the ACS Dobfar supply agreement is now terminable at year end 2014, Merck could make the API directly, or source it less expensively -- than this current EU-based provider. APIs are the "raw materials" -- for making this antibiotic. Again, significant reductions in the costs of raw materials will drive down the effective price Merck pays for Cubist.

Finally, Merck may well start to play much rougher with Teva (Teva has an "authorized generic" deal with Cubist for daptomycin) -- perhaps even arguing that the deal violates FTC pay to delay rules. There are others circling, including Hospira and Strides, that are trying to invalidate Cubist's patent position, and sell a generic version of one or more Cubist antibiotics. With Merck's "early 1980s era Schwartzenegger" rippling legal muscles, Cubist will be a much more formidable opponent in these pieces of litigation. Here, size. . . matters. No longer will these once larger rivals be able to bludgeon capitulation from tiny Cubist (by threat of years upon years of $50 million legal fees spent, per product, per dispute) -- no, Merck will end almost all of that nonsense. Again, such a muscular stance will, in the longer run, greatly enhance the margin Cubist might retain on its branded products.

So -- without additional fanfare, here are my diligence notes, with links, embedded (it is just a "quick first glance" rundown):
. . . .Novartis, under the October 2013 amendments to the 2003 Chiron license agreement: After the acquisition of Chiron by Novartis, in 2006, the license agreement and manufacturing and supply agreement were assigned to a subsidiary of Novartis.

In the United Kingdom, France, Germany, Italy, Romania, Spain, Switzerland, and Greece Novartis gets additional payments and rights if Cubist subsequently launches a tedizolid containing product. In addition, if Cubist launches a combinaiton product in the above geographies containing tedizolid, and Cubicin (daptomycin), Novartis will be credited with a rebate to its sales (relieved of a portion of its) royalty obligations on all of Novartis's sales of the drugs. . . .

Eli Lilly & Co. -- per latest SEC Form 10-K:

Cubist is required to pay royalties to Eli Lilly on worldwide sales of Cubicin. In July 2003 and March 2005, Cubist entered into amendments to the restated license agreement and issued to Eli Lilly an aggregate 2,599,792 shares of common stock valued at an aggregate of $28.0 million in consideration for single-digit reductions in the royalty rates payable to Eli Lilly. In September 2003, Cubist issued 38,922 shares of common stock valued at $0.5 million as a milestone payment to Eli Lilly upon Cubist receiving FDA approval for the commercial sale of Cubicin. The aggregate payments of $28.5 million were recorded as intangible assets within the consolidated balance sheets and are being amortized through 2016, which was the estimated remaining life of the license agreement with Eli Lilly on the dates of the transactions. The amortization of these intangible assets is included in cost of product revenues within the consolidated statements of income.

As of December 31, 2013, in addition to the milestone payments made in stock, Cubist has made payments to Eli Lilly of approximately $588.6 million for royalties on sales of Cubicin, which were paid in cash. Unless terminated earlier in accordance with its terms, Cubist's license agreement with Eli Lilly expires on the later of: (a) the expiration of the last-to-expire of the patents assigned or licensed under the agreement; and (b) the end of the tenth year from the date of first sale of Cubicin in any of the U.S., Canada, Japan, the United Kingdom, or UK, Germany, France, Italy, Spain, Switzerland, Netherlands or Belgium in which know-how royalties are due under the agreement. . . .

ACS Dobfar S.p.A -- API contract on Cubicin (most recent 10-K):

Cubist must purchase a certain percentage of its requirements for Cubicin API from ACSD, and we pay ACSD for Cubicin API based upon a volume-based pricing schedule. Our agreement with ACSD is currently set to expire on December 31, 2015, but will extend for an additional two-year term, provided that we negotiate in good faith a revision to the prices charged for Cubicin API based on ACSD's then current costs to manufacture Cubicin API unless: (a) the agreement is earlier terminated in accordance with its terms; or (b) we notify ACSD by December 31, 2014, that we do not desire to extend the term. . . .

Teva (most recent SEC Form 10-K) --

Teva's patent infringement settlement agreement also provides that, for the period that Cubist's license to Teva is in effect, Teva will purchase its U.S. requirements of daptomycin for injection exclusively from us. We are required to use commercially reasonable efforts to satisfy Teva's requirements. The supply terms provide that we will receive payments from Teva for product supplied by us reflecting two components: one based on the cost of product revenues plus a margin, and the other based on a specified percentage of gross margin (referred to as net profit in the supply terms) from Teva's sales of daptomycin supplied by us. The supply terms also provide for a forecasting and ordering mechanism, and that Teva will determine the price at which any such daptomycin for injection will be resold and the trademark and name under which it is sold, which may not be confusingly similar to our trademarks. In addition, under the supply terms, Teva may instead supply on its own or from a third party and sell its generic daptomycin for injection product in the event of specified Cubist supply failures or if the arrangement is terminated due to our uncured breach or bankruptcy.

The settlement agreement will remain in effect until the expiration of the term of the license granted by us to Teva and the expiration of a non-exclusive, royalty-free license granted by Teva to us under any Teva U.S. patent rights that Teva has the right to license and that may be applicable to Cubicin and the daptomycin for injection product to be supplied by us to Teva. Each of us and Teva may terminate the settlement agreement in the event of a material breach by the other party. In addition, each party may terminate the license granted by it to the other party in the event of a challenge of the licensed patents by the other party. The Federal Trade Commission, or FTC, or the Department of Justice, or DOJ, could seek to challenge our settlement with Teva, or a competitor, customer or other third-party could initiate a private action under antitrust or other laws challenging our settlement with Teva. . . .

I may look some more, or I may offer additional analysis on these details, should we read a definitive press statement from either of the companies involved, come Monday. Off to cut and trim a tree. Be excellent to one another.

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