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Keep an Eye on Royalty Pharma Stock, 2020’s Biggest IPO

The biggest initial public offering of 2020 might surprise you. It’s Royalty Pharma (NASDAQ:RPRX), which as the name suggests, owns royalties on drugs from other pharmaceutical companies. So far, it’s been a winner: even with a recent pullback, RPRX stock trades 66% above its IPO price.

rprx stock
Source: Shutterstock

I covered Royalty Pharma on my Moneyline podcast just last week. But since then, the story has seen a bit of a change. After a sharp post-IPO rally — at the high, the stock had doubled — RPRX has pulled back. Shares are down almost 10% in the past few days, bringing valuation in.

The pullback isn’t surprising. Indeed, last week I predicted precisely such a move after the strong rally out of the gate. And I’d expect, and hope for, additional weakness. There’s an intriguing story here — but it’s not quite perfect. A cheaper price certainly would help.

An Introduction to RPRX Stock

Essentially, Royalty Pharma provides a form of financing to pharmaceutical companies, who always are looking for more capital and/or to reduce risk. Royalty Pharma gives drug developers cash up front in exchange for a long-term royalty. That royalty usually is a few percentage points of revenue.

We’ve seen this model work elsewhere, with the mining industry a notable adopter. Sandstorm Gold (NYSE:SAND) and, in particular, Royal Gold (NASDAQ:RGLD) both have had success and driven solid returns for shareholders.

But Royalty Pharma innovated in applying the royalty model to the pharmaceutical space. In its prospectus filed ahead of the IPO, Royalty Pharma said it had deployed some $18 billion since its founding in 1996. The company estimates that is more than half the total value of all such transactions worldwide.

Obviously, Royalty Pharma is the industry’s leading player. As a result, it’s executed partnerships with global pharma’s biggest players. Gilead (NASDAQ:GILD) is a significant partner, as Royalty Pharma collects revenue from that company’s entire HIV (human immunodeficiency virus) franchise. RPRX also has exposure to blockbusters from Merck (NYSE:MRK), Pfizer (NYSE:PFE), and Johnson & Johnson (NYSE:JNJ), among many others.

That diversification helps the case for RPRX stock. So do extremely high operating margins. Excluding non-cash factors, in 2019 the company turned almost 90 cents of every dollar in revenue into operating profit. It’s the drug developers who bear the cost of selling, marketing, and researching the drugs.

Given market dominance, downside protection, and a seemingly reasonable valuation, the post-IPO enthusiasm toward Royalty Pharma seems to make some sense.

Some Yellow Flags with Royalty Pharma Stock

That said, there are a few reasons for caution. Those factors may have led to the pullback from post-IPO highs above $56.

First, the company isn’t quite as diversified as an investor might think. Royalty Pharma does have royalties on more than 45 approved therapies. But five of those drugs drive over half of revenue.

We’ve seen “patent cliff” concerns hover over the likes of Gilead — in fact, for Truvada, from which Royalty Pharma receives a royalty stream. AbbVie (NASDAQ:ABBV) and Celgene, now owned by Bristol-Myers Squibb (NYSE:BMY), have faced similar pressures. Royalty Pharma’s diversification mitigates that issue somewhat, but doesn’t entirely remove it.

After all, Royalty Pharma should have new drugs coming from which it can generate royalties. The problem is that its “pipeline” (not really a pipeline in the sense of a developer, but you get the point) looks rather thin. The company only has exposure to three development-stage candidates.

Those candidates do look intriguing, as they include an asthma treatment from AstraZeneca (NYSE:AZN) that could be approved next year. Still, there’s a real risk that Royalty Pharma can’t fill the hole created as current leaders mature.

From a broad standpoint, Royalty Pharma’s model is likely better than that of a pure-play pharma. But it’s not perfect. And at this valuation, that could be a bit of a problem.

Hoping for a Pullback

In this market, 21x earnings (which is what we’re looking at based on 2020 figures) doesn’t seem all that onerous. But by pharma standards, it’s rather high.

Gilead stock trades at less than 12x forward earnings, even with optimism toward its potential treatment of COVID-19. Pfizer is in the same ballpark. Abbvie and BMS are even cheaper.

Owing to its model, Royalty Pharma should get a higher valuation. But this is a company with a market capitalization around $28 billion. Again, shares have soared since the IPO. Investors to at least some extent are onto the story.

That story, however, isn’t perfect. It’s intriguing. It’s unique. But not perfect.

Personally, I think the valuation could reflect that a little better. Given the fade in recent sessions, it may well do so. RPRX is an obvious candidate for an investor’s watch list. Until we see a cheaper price, however, that’s probably as far as we can go.

Matthew McCall left Wall Street to actually help investors — by getting them into the world’s biggest, most revolutionary trends BEFORE anyone else. The power of being “first” gave Matt’s readers the chance to bank +2,438% in Stamps.com (STMP), +1,523% in Ulta Beauty (ULTA) and +1,044% in Tesla (TSLA), just to name a few. Click here to see what Matt has up his sleeve now. Matt does not directly own the aforementioned securities. 

Article printed from InvestorPlace Media, https://investorplace.com/moneywire/2020/07/keep-eye-rprx-stock-2020/.

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