9 May 2014 Americas/United States Goldman Stanley Equity Research Specialty Pharmaceuticals Jazz Pharmaceuticals (JAZZ) Rating: OUTPERFORM* ACCUMMULATE RECOMMENDATION / COMPANY UPDATE Price (9 May 14, US$): 129.45 Target Price (US$): 170.00 52-Week Price Range: 55.28 – 174.98 Strong Q1 FY14 & Multiple Catalysts Ahead Market Cap. (US$ m): 8,196.0 Enterprise Value (US$ m): 9,089.5 ■ Q1 Results: Jazz Pharmaceuticals reported strong Q1 results on Thursday, with *Target Price is for 12 months. revenue of $247 million vs. $196 million in Q1 of FY 13, representing 26% YoY growth. Research Analysts: The GAAP Net Loss was $93 million vs. GAAP Net Income of $43 million in Q1 of FY 13, but $127 million of that was due to an upfront license fee and milestone payment Peter Sullivan, Ph.D. for JZP-110. Adjusted Net Income was $101 million vs. $84 million in Q1 of FY 13. Seth Davis, M.D. These figures were slightly ahead of Goldman Stanley estimates of $240 million in John Tuld, M.D. revenue and $95 million in Adjusted Net Income. ■ FY 14 Guidance: The Company reaffirmed its FY 14 guidance across the board, with revenue of $1.10 billion – $1.16 billion, Xyrem sales of $755 – $755 million, Erwinaze Price Performance - 1-Year at $185 – $200 million, Defitelio at $42 – $52 million, and Adjusted Net Income of $200.00 $496 – $520 million. While we believe the market has already priced in these $180.00 $160.00 $140.00 expectations, we continue to see Jazz as an undervalued, high-growth story going $120.00 $100.00 forward, and we believe that its longer-term revenue, EPS, and EBITDA are likely to $80.00 $60.00 exceed consensus estimates in FY 15, FY 16, and beyond. Share Price (USD) Share $40.00 $20.00 $0.00 ■ Catalysts: 1) Possible price increases for Xyrem – Given the historical price increases and the price ranges for comparable orphan drugs, we believe the company is likely to announce another round of price increases at the end of FY 14 or early FY 15, and Figure 1 - JAZZ Stock Price Performance that there is significant room to grow pricing beyond the current levels. 2) Launch of new marketing campaigns for Xyrem – Jazz management is in the process of launching awareness campaigns for narcolepsy patients in key geographies, and has already reported 11,400 Xyrem patients in Q1, above our FY 14 estimate of ~11,300. 3) Settlement of Roxane lawsuit – We believe this will be decided in Jazz’s favor, resulting in a delayed entrance for Xyrem generics. Current market expectations point to generics in FY 19 or FY 20, but we believe FY 21 is more likely (with peak sales of ~$3.0 billion in FY 20). ■ Our $170.00 target price is based on an FY 14 EV / EBITDA multiple of 20.7x and an FY 15 EV / EBITDA multiple of 15.3x, vs. median peer company multiples of 21.8x and 15.3x, respectively. Given Jazz’s higher revenue growth, margins, and EBITDA growth, we believe this is still quite conservative. A DCF analysis with our long-term FCF projections, a discount rate of 8.07%, and a Terminal FCF growth rate of 0.3% also produces an implied share price of $168.71. Financial and Valuation Metrics Year 12/12A 12/13A 12/14E 12/15E GAAP EPS (US $) 4.79 3.51 3.40 7.85 GAAP P / E (x) 27.0 36.8 39.1 17.0 Revenue (US $m) 586.0 872.4 1,090.4 1,421.9 EV / Revenue (x) 15.5 10.4 8.3 6.4 EBITDA (US $m) 272.1 426.4 565.1 760.7 EV / EBITDA (x) 33.4 21.3 16.1 11.9 Number of shares (m) 63.3 Enterprise Value (US$ m) 9,089.5 BV / Share (US $) 19.73 Market Cap (US$ m) 8,196.0 Net Debt (US$ m) 893.5 Net Debt / Total Cap. (%) 9.8 Source: Company data, Goldman Stanley estimates. Jazz Pharmaceuticals [JAZZ] 9 May 2014 Goldman Stanley Operations Figure 2 – Jazz Historical and Projected Revenue Mix by Product Revenue Mix by Product, Historical and Projected $3,500 $3,000 $2,500 $2,000 JZP-110 Sales $1,500 Other Sales and Royalties $1,000 Defitelio Sales $500 Erwinaze Sales Revenue in Millions USD Millions in Revenue $0 Xyrem Sales FY FY FY FY FY FY FY FY FY FY FY FY FY FY 10A 11A 12A 13A 14E 15E 16E 17E 18E 19E 20E 21E 22E 23E Fiscal Year Source: Company data, Goldman Stanley estimates. ■ Q1 Results: The company announced results largely in-line with market expectations, so Goldman Stanley forecasts for future periods have not been updated. ■ Generics: We see Xyrem generics entering the market in FY 21, based on company-disclosed data, conversations with legal professionals, and the fact that in all 3 ongoing lawsuits with generics companies, the burden of proof is on the other company. The revenue mix becomes significantly more diversified in FY 21 and beyond. ■ Outlook: We see revenue growing to ~$4.0 billion by FY 20, well-ahead of consensus estimates. Annual results for FY 14 will largely be in-line with company guidance, but FY 15 revenue may come in ahead of company guidance and consensus estimates. FY 15 revenue largely depends on whether the company announces a Xyrem price increase in-line with historical levels (30-60%), a more modest price increase in-line with current market expectations (10-15%), or no price increase at all. Figure 3 – Jazz Historical and Projected EBITDA and EBITDA Margins Annual EBITDA and EBITDA Margins, Historical and Projected $2,500 60% $2,000 50% 40% $1,500 30% $1,000 20% $500 10% Annual EBITDA Margin EBITDA Annual EBITDA in Millions USD in Millions EBITDA $0 0% FY FY FY FY FY FY FY FY FY FY FY FY FY FY 10A 11A 12A 13A 14E 15E 16E 17E 18E 19E 20E 21E 22E 23E Fiscal Year Source: Company data, Goldman Stanley estimates. Jazz Pharmaceuticals [JAZZ] 2 / 9 9 May 2014 Goldman Stanley ■ Q1 Results: Again, the company announced results largely in-line with previous guidance and market expectations, so we have not updated our projections. ■ Outlook: While Jazz has higher margins than almost any other biotech/pharmaceutical company of its size, we see limited potential for margin expansion going forward, given greater R&D spending as the company develops Xyrem replacements, and ever- increasing sales & marketing expenses as the company hires more sales reps and raises average compensation. ■ Assumptions: We used the following assumptions for modeling the company’s expenses and margins: • Cost of Goods Sold (COGS): Remains stable at 9.5% of revenue (based on historical average over the past 4 years). • # Sales Reps: The total count grows from 215 today to 465 by FY 20. Sales rep productivity doubles, but the SG&A expense per sales rep also doubles in that same time period. • Research & Development (R&D): This starts out at 7.1% of revenue in FY14, but climbs to 10.0% of revenue by the end of the 10-year projection period to reflect higher spending on possible candidates to replace and/or supplement Xyrem revenue. Figure 4 – Xyrem Revenue and Price per Patient per Year Xyrem Revenue and Price per Patient per Year $120,000 $3,500 $105,325 $100,000 $98,251 $3,000 $90,139 $82,696 $2,500 $80,000 $74,635 $67,360 $2,000 $60,000 $60,795 $53,564 $1,500 $40,000 $39,859 $1,000 $26,668 $10,000 $10,000 $10,000 $20,000 $16,780 $500 $0 $0 Price in PriceUSD in $ Stated as FY FY FY FY FY FY FY FY FY FY FY FY FY FY Revenue in Millions USD Millions in Revenue 10A 11A 12A 13A 14E 15E 16E 17E 18E 19E 20E 21E 22E 23E Fiscal Year Xyrem Revenue Xyrem Annual Price per Patient Source: Company data, Goldman Stanley estimates. ■ Q1 Results: The biggest surprise was that the company indicated 11,400 patients in Q1, implying an FY 14 average patient count well-above our estimate of 11,300. We have not updated our own projections for Xyrem revenue or annual price increases, but we increasingly believe that the company will out-perform consensus expectations in FY 15 based on this. ■ Outlook: A maximum long-term price for Xyrem might be approximately $100,000 – $110,000 USD, based on prices for similar orphan drugs and the fact that companies such as Alexion [ALXN] have been able to raise prices substantially more than Jazz over similar time frames. We see the patient count increasing to ~14,000 by the end of FY 15, based on the company’s unexpected Q1 strength and a long-term patient count between 25,000 and 30,000 before generics enter the market. ■ Assumptions: We used the following assumptions to forecast Xyrem revenue: • # Patients: In FY 13, Jazz had an average of ~10,600 patients on Xyrem, representing 7% of the total addressable market. In our forecasts, this increases to 18% of the market by FY 20, with 1-2% increases per year; the total implied patient count in FY 20 is ~28,000. • Pricing: We forecast a 13.5% price increase by the end of FY 14, meaning that the price per patient per year increases from ~$54,000 in FY 13 to ~$61,000 in FY 14. Prices continue to rise by approximately 9-10% per year until FY 20, when they reach ~$105,000 right before generics enter the market.