Great. Thanks for joining us everybody. I'm Terrence Flynn, Morgan Stanley's U.S. Biopharma analyst. Very pleased to be hosting Royalty Pharma this afternoon. Joining us from the company, we have Pablo Legorreta, who is the company's Founder and CEO, and Terry Coyne, the company's CFO. Thank you both so much for being here. I just have to read a disclosure statement first before we get started. Please see the Morgan Stanley Research Disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Thank you both so much for being here. Really appreciate you taking the time to join us. Maybe I'd start just high level, Pablo. I think there's been a lot of focus on the ecosystem in general, just given a lot of macro policy concerns.
I know you guys just hosted a recent event at MIT where you were kind of focused on the biotech ecosystem. Maybe you could just give us your view on the state of play of the industry, health of the industry, because you've been in this business for a very long time and you've seen multiple cycles. Maybe tell us if this in your view, is kind of similar to prior ones or if there's anything different this time around. We'll start there.
Sure. Thank you. Thank you very much for the invitation to participate in this great conference. Yes, we did organize this conference at MIT. I'll just in half a minute, mention that we came up with this idea of creating a conference that doesn't exist in life sciences, which brings together senior leaders of biotech and Pharma. We had about 120 biotech CEOs, the CEO of Lilly and Merck also, and about 100 scientists, and five Nobel Prizes. It's a conference where we try to bring together these two parts of our ecosystem to talk and discuss what's going on in the industry, which is in a way your question—challenges, opportunities, and solutions—and also reflect on the trends. It's becoming a really, really cool conference. We do it one year at MIT in partnership with MIT, and then the following year at Cambridge University in partnership with Cambridge.
We've been doing it since 2019. It is a very unique event. I think maybe one way of thinking of what's going on in our industry in our ecosystem, it's sort of the best of both worlds. W hy? Because when I look at what's going on in terms of innovation in academia, at research hospitals all around the world, obviously there's a phenomenal, really incredible new development that has become a lot more present in investors' minds this year, which is China, the amount of innovation that's coming out of China, which is really unprecedented.
You see all of that and you say, we couldn't have a better time for our industry in terms of our understanding of human biology and then all of the new approaches, mechanisms of action, everything that's happening that actually has made a lot of things that were not druggable before now are druggable and potential treatments for disease. R eally the best I've seen in a long time. At the same time, there are a lot of challenges that we're facing, challenges from the funding perspective. It's not only what maybe a lot of people here live with, which is funding challenges for biotech from the markets, but also, as all of you know, we have funding challenges from a government perspective, which I think is unprecedented. It's really not good when I think about it because if there is an industry where the U.S.
leads the world with an incredible ecosystem that is so difficult to replicate when you look at, you know the university networks that exist in this country, the venture capital, you know sort of ecosystem, and not only that, but everything else, lawyers, like this whole ecosystem has been working together for 40, 50 years. It's being threatened somewhat by the funding cuts. I'm concerned because it could have a long-term impact and the U.S. could lose it's edge. That's why it's very challenging. Now, obviously for Royalty Pharma and the position we're in, with the capital that we have and a team that is really extraordinary, super talented, working incredibly well together, it's a great time for us. Last year we actually looked at 440 investment opportunities that we sort of diligenced, which is almost two a day.
We ended up doing only eight deals and deploying $2.8 billion of capital. This year looks incredibly robust in terms of our pipeline and the deals that we've already announced.
Great. Do you see a role that you mentioned a lot of the funding challenges. Where does private capital, public capital, where does that fit in now? Is there a bigger role for that in this environment, do you think? Or do you think we'll kind of come back full circle and we'll see a resurgence in these other sources? How do you think about it from that perspective?
I don't know what you mean by public capital, that you're referring to like government funding?
I mean, [crosstalk], and then again the private side, is there a bigger effort there given the scale back in the government funding. Just wondering if we can fill that void somehow in other mechanisms.
It's hard to fill the void of the government because a lot of the funding of the NIH is to basic research at academia. It's really hard to see how that's going to be filled. In terms of, like in our case, we can't really do much there. There are other organizations that are stepping in, private foundations that are stepping in for some of the gap. There's no chance it's going to cover not even, I don't know, 20% of the shortfall. In terms of other, again you said private, public, and what came to mind also is there's other private sources of capital, like maybe investment funds, private investment funds. There are obviously many that are raising capital to invest. Again, because the opportunities that we're seeing are incredible. They're unprecedented. It's a really rich pipeline that the whole industry has.
Yeah. Okay. Great. Maybe we'll just pivot over to capital allocation. I know you guys have laid out a pretty clear framework there. Maybe, Terry, if you could just speak to us about kind of where you sit right now with respect to leverage and also the pace of additional share repurchases on the forward outlook here.
Yeah. We're in a great position from a leverage and firepower perspective. Our leverage is kind of in the low threes. We actually raised an additional $1 billion of debt. We did $2 billion, but $1 billion of it was a refi, and $1 billion in new debt last week. The amazing thing about the business is just the cash flow that we're producing. It gives us a lot of firepower every quarter to go and deploy capital. We have a lot of access to the debt markets. As far as the capital allocation priorities, we've said it's going to be dynamic. That is really how we truly believe, how we really think about it is that we're going to allocate capital to where we can generate the best returns. If it's buying royalties, then we're going to allocate capital there.
If it's buying back our stock, it's allocating capital there. If neither of those are attractive, then we'll be patient. I think that we try to look at everything through that lens and maintain a lot of discipline when we're allocating capital. This year, through the first half of the year, we returned $1.3 billion of capital to shareholders. It was a really good first half of the year from a record from a capital return perspective. In the second half of the year, we've accelerated our investment activity significantly. It's just because we're seeing such amazing opportunities. We did Revolution Medicines' deal. It's up to $2 billion. We did just recently Inveltra, and that was almost $900 million upfront. Just last week was Zenith, which was a smaller deal, but really something we're really.
Great. I know we were just talking before about the Investor day you guys are hosting later this week. Maybe can you give us just a preview of kind of some of the key themes or the things that we should think about? I know you're not going to do a full unveil today, but just give us a sneak preview.
We don't want to steal our thunder. It's two days away. I think our goal with that Investor Day is we've been a public company for five years. We get a lot of questions, a lot of the same questions. I think our goal is to really answer all of those questions that investors have at that Investor Day. I think it should be a great event. Hopefully people come away with a much deeper understanding of why this business model is so powerful, why we have such a sustainable competitive advantage, and why we're going to be a great performing company over the next decades to come.
At 10:30 A.M. on Thursday, anybody that wants to come, you're all invited. I think what we're going to do also is take a deeper dive in aspects of our business that we have realized investors would like to learn more about, things that we've never sort of reviewed or disclosed. I think it's going to be pretty interesting for investors.
Yeah. Okay. Great. We'll stay tuned. You alluded to this a little bit, I mean, both of you in your prior remarks, just the current deal landscape. As you look forward, maybe just talk to us about the opportunities there, but also the structure of some of these deals, what you're seeing. Is there any shift in terms of what the preference is right now from companies that you're talking to in terms of how some of these deals are structured? What that means for the forward outlook.
Sure. I think Terry mentioned this Revolution Medicines transaction that we did, $2 billion. I look at that transaction, and I'm incredibly proud of it, super excited about it. Not only because of that specific deal, but because of the implication that that has for what we see as the ecosystem and for Royalty Pharma. Royalty Pharma is a business that over more than two decades has tried to continuously innovate, do things in new ways, not stay still. We were initially sort of close and front. We became a perpetual vehicle. We started in 2012 to invest in unapproved products, and we created what we call synthetic royalties when we give money to a company like Revolution Medicines to fund trials. Then the royalty that did not exist gets created contractually. They just agreed to pay us a royalty. That's why we call it a synthetic.
Constant innovation to make the opportunities get bigger and bigger for us. In 2020, we went public and that lowered our cost of capital dramatically, where we have today a WACC of 7% or so. Another thing that we did this year that I think is really, really important, and we could talk about it if you have an interest in it, is the internalization of the management company. We were managed by an external manager, and we sold it to the manager. Now we're like a regular public company. Really important. It was an impediment for many investors to actually invest. We heard that from many investors, the structure is a problem. If I look at this Revolution Medicines transaction, I also see it as really important. Why?
Because it was a way of Royalty Pharma telling the ecosystem, to biotechs, we can be an alternative to a big pharma partnership. Traditionally, biotechs were working on their product, would generate data, and at some point, maybe after phase two, would try to do a big pharma partnership with a big company to fund phase three, get a lot of capital for phase three, depending on the indication, depending on the product, but also because they wanted to have a partner for marketing, worldwide distribution. That historically was what happened.
When you see all of those transactions, there are so many examples where biotechs would do this kind of deals, and, you know, half of the economics would go to big pharma, maybe 50/50, you know, in the U.S., and then big pharma would market the product outside of the U.S., and the biotech would retain royalty, ex-U.S., 10%, 20%. Losing a lot of the economics, but also losing control, because now you have a partner, and you have to share control with a partner. What we did with Revolution Medicines is put in place a $2 billion transaction, significant scale, of which $1.25 billion is for a high single-digit royalty, around 7%, versus the company giving 50% of the economics to a big pharma partner. Just realize the difference there.
They also retained operational control, huge flexibility in terms of how they want to design the trials, run the trials, whatever they want to do with their company. We're passive. That is why I think it was so important. We did this deal, announced it, and in a matter of a week or two, we got a dozen calls from many other biotech saying we'd like the same thing. Obviously, that's great for us, a lot of potential new opportunities. Now we're going to be careful, and it's a high bar because we want the right product, the right management team, everything has to fall in place. It was a really interesting transaction from our perspective. I think the company, Mark and his team were phenomenal, also recognized that this was a sort of groundbreaking transaction for us and for the industry. We're very excited about that.
How do you think about returns on that type of deal versus some of the maybe like more traditional stuff you used to do under some of the prior models as you think about what you're targeting from a returns perspective?
Yeah. It's consistent with what we've outlined, where we said that for approved products, we're looking for IRRs in the high single digits, lower double digits. We haven't done a high single digit deal in a long time, so it's been more in that double digits range. For development-stage products, in the teens. This is a development-stage product, so it's in that range. The great thing is it's also super long duration. It's something that's going to go for many, many years, and we'll be able to collect those cash flows for a very long time as well. That's the other dynamic that we look at, the multiple on our investment, and we think that this will be very attractive from that perspective.
Remind us of the.
It's really, when you think about it, we always say that we want to do transactions which are win-wins. That's really the mentality that we have when we go into a transaction. This one is such a clear win-win because this company got a huge amount of capital, very flexible. They don't have to draw all of it. $500 million of the $1.25 billion have to be drawn, but the rest is optional. For the debt that we put in place, which is $750 million, $250 million has to be drawn, but the rest is optional. What better structure could a biotech have? They have the capital there they needed, and they can execute. On our side, we obviously partnered with a phenomenal company, phenomenal management team with a great product. It's a great transaction.
What does the mix look like going forward as you think about that mix between on market and development-stage, and then maybe as it goes into the synthetic side? How are you targeting that mix? Has there been any shift there versus the last 12 months or so?
I think, if you look at what's happened over the last 12 years since we started to invest in unapproved, we've deployed about $27 billion of capital, of which a little bit more than $10 billion is in unapproved late-stage products, and the rest, about $16 billion, is in approved. That makes it about 60/40 roughly, and in a specific year, it could be higher or lower. I think this year we might be higher than 60% in unapproved, 70-80%, something like that in unapproved. Over a three-year period, it sort of averages out to that. A really important thing is that, because we always share this concept and these numbers with investors, 60/40. One of the things that I've realized recently is investors shouldn't really, they shouldn't expect that the risk we have is exposure when you look at our assets being sort of 40% to unapproved.
Not at all. What happens is, that's what happens over time, right? Things get approved. As things get approved, the risk is completely transformed to something that is now approved. It's no longer. The exposure that we have at any given point to things that are not approved is much lower. It's more like $2 billion to $2.5 billion. What that gives you is more like 10% of our assets are in things that are not approved. What's great about it is that we're deploying a huge amount of capital in things that are not approved, but because they eventually do get approved, that number has stayed pretty constant at about 10%.
It's basically relatively low risk, and it almost makes me feel that we should maybe put a little bit more in unapproved, take that to 15%, 20% because it's still a very reasonable ratio of exposure to unapproved versus approved.
Yeah. Do you see that? I mean, it sounds like the answer is probably yes, but given the inbound that you're getting, do you see this as an important growth driver as you think about it? I mean, again, 12 sounds like a lot, a big number from an inbound call perspective, like, again, an increasingly big opportunity set for you guys.
It's going to be a mix. It's really, it's so hard to say sitting here where we're going to allocate capital. Next year, it could flip completely from this year. I think we kind of try to take a more of a high-level view of let's focus on the best products that are having the biggest impact on patients, and then let's figure out how to invest in them. Whether that's a product like Revolution Medicines, the Aficamten, which is in phase three, we think it's going to be an amazing product for pancreatic patients. Let's figure out how to invest in that. Ruxolitinib, it already exists. The actual capital out the door from Ruxolitinib was larger than the capital out the door for Aficamten because the way that investment was structured is that it's staged. We invest more over time as it is de-risked.
That is a really good thing for us, but also good for them because the cost of capital actually declines over time as well for them. Sitting here today, it's really tough to say. I think for over five years, it will be in that probably, you know, two-thirds approved or maybe it's 60%. The rest will be on a development-stage. Still, we're always focused on investing post-proof of concept where the dollars are bigger, where we can really get more confidence in the probability of success and the commercial potential of a product.
Okay. Great. Maybe just one, I mean, Pablo had mentioned, you know, the ecosystem in China. Can you lean into that with your model? Is there an opportunity there? Like, do you think of rolling this out there at scale, or is that something where maybe there's like some select opportunities? Are there, you know, IP challenges that you have to consider? I mean, maybe just speak to that a little bit more.
It's early days, but it's a market that we have been paying attention to for like a decade. Myself and my colleagues, Marshall, Terry, we've been to China regularly and met some of the companies that are today in the headlines, in GRUI and BetaFarm and Psylabs, Bioshield, which is now B1, years ago, and started a relationship with it. It's so early days. If you look at the amount of innovation coming out of China, the number of licensing deals that have taken place between Chinese-originated products and Western companies, I think the number was that last year about 30% to 35% of the licenses involved a Chinese-originated product, which is incredible. It is a big opportunity, and it's going to get bigger. What's so exciting for us is that it could be a huge opportunity. Why a huge opportunity?
If you think about it, all of those Chinese companies will need a company in the West, in the U.S. or Europe, to commercialize the products. The number of royalties that exist on all of those products that are being generated out of China is higher than the royalties on the products coming out of U.S. biotech or European biotech. Those companies need the funding. They will end up monetizing the royalties to fund their own products, with the hope that eventually over time, they can build businesses and maybe not have to license the products. It's an opportunity that we're super excited about, and I think it's just going to grow. I think Royalty Pharma is ideally positioned to take advantage of this opportunity, and we're going to step up our resources towards China.
The other point to make, and this is one of our directors at Royalty Pharma mentioned to me, it's very interesting, but a royalty is something really special because equity, there have been issues with equity investments in China, significant investment. Given the political issues that exist now between the countries, it's not the easiest thing, for a U.S. company, U.S. investor to invest in Europe, it's easy, no problem. To invest in China, there might be issues, political issues, and even things like how do you liquidate an investment as an investor? I made personal investments in China, and it's very difficult, you know, to take the money out, to monetize the investment. What this director was telling me is a royalty is totally different. It's not equity, so you're sort of under the radar, right?
You could do a royalty deal to bring capital to this company, and, you know, it's not equity, so it's not, you know, in the headlights. The other thing that is important to mention is that the very, very likely case when we make investments in products that have been originated in China is that the payer for us will be a U.S. or European company, which is what happened right now with this Inveltra deal that we did. We bought it from B1, you know, formerly Baijing, global company. John Euler is trying to position that company as a global company. He's doing a remarkable job. The payer is Amgen. We've looked at many other assets where the payers are, you know, the top U.S. and European companies.
From our perspective, the credit risk, you know, and the payer will still be, you know, the companies that we know really well and we deal with all the time.
Yeah. Okay. Great. The other one on the high level I wanted to ask about is just, you know, there's still a lot of focus on the policy front, kind of Most Favored Nation, Inflation Reduction Act. I know you guys have spoken about this before, but as you think about the types of deals that you're pursuing, you have a lot of flexibility, obviously. How is that, either, I guess on Inflation Reduction Act, we have more visibility and Most Favored Nation less visibility, but how is that impacting your opportunity set and what you're pursuing or thinking about right now on the forward?
Yeah. I think the great thing about Royalty Pharma is we're just, as these developments come along, we add it into our thinking, and it doesn't slow us down. If anything, it can create opportunities that weren't there before. I don't, none of us feel like IRA has slowed us down. It's something we think about. We have to have an understanding of the potential impact there, but it's not something that has held up any potential investments. As far as MFN goes, it's so difficult in the position that we are right now to even speculate on what's going to happen there. Overall, for Royalty Pharma, we're in a fortunate position where our government exposure is actually relatively low compared to other companies. Our Medicaid is a little less than 10%. Medicare is kind of in the teens. Taken together, government is in the low to mid-20% range.
We're always reinvesting. When we make an investment, we will be thinking about the potential impact of MFN and exactly what we did on the deals that we've done this year. We've taken that into consideration, and we think we've added some great products to the portfolio. I think we feel like we're in a pretty, pretty good spot there.
Okay.
If anything, you know, some of these things create opportunities.
Yeah. What I know, we have a lot of time left, but some of the newer product launches, I have a bunch of questions on these, Tremfya, Cobenfy, Aficamten coming up. As you look at the opportunity set for some of these, anything you want to highlight to investors as you think about it? I know we're always watching our own estimates, but also consensus estimates. As you think about the opportunity set, is there anything that you think is underappreciated by investors broadly on some of these newer market opportunities? Maybe it's going back to your point on Revolution Medicines deals, like the duration of XYZ component. Is there anything that you'd point us to that you think is super underappreciated right now in terms of the opportunity set?
Every single asset has some unique characteristics. Tremfya is one where we've been saying that this product is going to outperform since the day we bought it, and it's continued to do that. It's having a great launch in IBD. I think we're super excited about that product. Cobenfy is doing really well. Everyone in this room is probably following that launch just as closely as we are. I don't know that we have some major insight there. Aficamten is a product that we're really excited about, and hopefully, we'll see a really strong launch next year.
Maybe just one thing to comment on that is, you know, Terry talked about products that we invested in when they were approved, like Tremfya, and others that were not approved. If you just look at the portfolio of products that we have that are not approved, and there's a dozen of them, I think what investors maybe have not appreciated is the scale. You know, we deployed significant capital there. When you look at those products and you look at, you know, like analyst consensus for the sales of all of these products, and I'm talking there about the Aficamten, Ruxolitinib, the Teva product, and others, as a group, we think that, you know, they have, based on analyst estimates, the potential to generate $2 billion plus of revenue over the next sort of five years. Very significant.
Yeah. It's not like we have to wait a long time. I mean, we really feel like our pipeline is totally underappreciated. If you put this pipeline in our pipeline in any other company, it would be all anyone would be talking about with those companies. It doesn't really get a lot of interest from Royalty Pharma for whatever reason, but it's a really, it's an amazing pipeline of products that are all, you know, going to have, some have already had cards turned over, then a bunch that are going to have cards turned over in the next couple of years. We think that, you know, we're really optimistic.
Is it more the POS or more the market opportunity?
It's both. It's both. We have to, for Royalty Pharma, we can't just get one of those right. That is the difference about how we think about the world, you know, it's not just like, oh, is it going to get approved and then is somebody going to buy it? It's, is it going to get approved and is it going to sell? Is it going to be important for patients and are payers going to pay for it? We have to get that part right in order to actually make a return.
Yeah. It's different than venture capital, right? Venture capital, they have to get the event right and then the stock goes up and they exit. In our case, it's the approval and it's the commercial potential of the product. I think what has been underappreciated is the scale, but also, you know, I think we've had just a great track record there. The $10 billion that has been deployed, I think 70% have gotten approved. There's been about a little bit less than 10% of write-offs, but we have another 20% of products that have had great data. I think the vast majority will get approved, if not all of them, and will launch, I think, pretty well. When you look at the products, the 70% that have gotten approved, and you look at the failures, in reality, the success rate is about 91%, because measured against regulatory events.
There's still 20% where they haven't had a regulatory event approval, but it will come, and I think those are likely to get approved. It's a pretty high track record.
Is there, on the pipeline, the 12 that aren't approved, is there, I mean, Eli Lilly, as I know, an area that you guys have kind of doubled down on. You have a couple of investments there. I'm assuming that's one of the important ones. Is there another one or two that you'd point us to, to think about in terms of the de-risking that we should focus on? I mean, that's in Revolution Medicines.
That's an obvious one that we're super excited about. Ruxolitinib is one that we're really excited about that, you know, we think could be a very big product. We have a very big royalty rate on that one, yeah, for multiple sclerosis.
Yeah. TremfeneMab?
TremfeneMab.
I think it's going to look really, really exciting.
[guess] people should spend some time looking at the pipeline, I think.
I'm sure this sounds like we'll get a preview of Thursday.
Yes. Yes.
All right. Thank you both so much. Really appreciate the thoughts and the time today. We'll see you again Thursday.
Thank you. Excellent. Thank you.
Thanks, Terry.
Take care.