14 September 2016 Asia Pacific/Japan Equity Research Biotechnology (Biotechnology (Japan)) / MARKET WEIGHT Sosei Group (4565 / 4565 JP) Rating NEUTRAL* [V] Price (13 Sep 16, ¥) 17,260 INITIATION Target price (¥) 19,700¹ Chg to TP (%) 14.1 Market cap. (¥ bn) 291.59 (US$ 2.84) Transforming into a formidable R&D engine Enterprise value (¥ bn) 276.79 Number of shares (mn) 16.89 ■ Initiating coverage at NEUTRAL with a ¥19,700 target price (potential return Free float (%) 87.5 14.1%): We believe Sosei is on its course to become the global 52-week price range 25,730 - 3,595 biopharmaceutical company that it aspires to be. With the Heptares acquisition, *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. Sosei has changed into a company with an innovative pipeline addressing ¹Target price is for 12 months. important topics in pharma R&D globally. Our NEUTRAL rating is due to the [V] = Stock considered volatile (see Disclosure Appendix). limited upside to our target price. Research Analysts ■ View Heptares as the core of Sosei's future: Heptares' StaR (Stabilized Yen Ting Chen Receptor) technology is a powerful tool addressing a major obstacle in GPCR 81 3 4550 9936 (G-protein coupled receptor) drug discovery research and over the last 12 [email protected] months has attracted four major deals from major pharmaceutical companies Fumiyoshi Sakai potentially worth over $6bn. We are optimistic that this StaR technology will 81 3 4550 9737 [email protected] continue to attract interest and expect more deals to materialise. ■ Three pipeline products with blockbuster potential to watch: The current pipeline already addresses hot topics in the pharma industry. HTL9936 and HTL18318 for Alzheimer's disease, and the immuno-oncology drug HTL1071 are all drugs with blockbuster potential due to large market sizes and unique mechanisms. ■ Valuation/risks: Our target price is derived from a DCF model using a 6.95% WACC (risk-free rate 0%, ERP 6.75%, beta 1.05, cost of debt 3%) and a terminal growth rate of 2%. Risks to our assumptions include greater than expected development failures/progress, fluctuations in currencies, and changes in partnerships. Over the next 12 months, catalysts include quarterly sales results of the COPD (chronic obstructive pulmonary disorder) drugs, Seebri/Ultibro, out-licenced to Novartis, updates on pipeline developments and new deals. Share price performance Financial and valuation metrics Year 3/16A 3/17E 3/18E 3/19E Price (LHS) Rebased Rel (RHS) Sales (¥ mn) 8,151.0 26,500.0 17,600.0 24,300.0 40000 600 Operating profit (¥ mn) 1,075.0 15,700.0 6,800.0 14,300.0 30000 400 20000 Recurring profit (¥ mn) -3,297.0 14,500.0 5,700.0 13,250.0 10000 200 0 0 Net income (¥ mn) -1,432.0 12,800.0 4,400.0 10,050.0 EPS (¥) -93.6 759.4 261.0 596.3 Change from previous EPS (%) n.a. IBES Consensus EPS (¥) n.a. 780.9 479.0 735.2 The price relative chart measures performance against the EPS growth (%) n.m. n.m. -65.6 128.4 TOPIX which closed at 1322.99 on 13/09/16 P/E (x) -173.4 22.7 66.1 28.9 On 13/09/16 the spot exchange rate was ¥102.53/US$1 Dividend yield (%) — 0.1 0.1 0.1 EV/EBITDA(x) 123.5 16.6 35.3 17.1 Performance over 1M 3M 12M P/B (x) 9.5 7.5 6.8 5.5 Absolute (%) 1.1 11.8 354.8 ROE(%) -7.0 39.5 10.8 21.0 Relative (%) 0.6 5.2 364.3 Net debt/equity (%) net cash net cash net cash net cash Source: Company data, Thomson Reuters, IFIS, Credit Suisse estimates. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 14 September 2016 Table of contents Key charts 3 Investment thesis 4 On pace for best performance in company history in FY3/17 4 Transformation into a world-class R&D engine through Heptares 4 Clinical pipeline featuring two blockbuster hopefuls in Alzheimer's disease and one immuno-oncology 4 Earnings forecast summary 5 Near-term catalysts 5 Risks 5 Opportunities 6 Valuation 6 Company history 7 Transforming into a world-class R&D engine 8 Heptares' StaR technology addresses a key challenge in GPCR drug discovery 8 Three blockbuster-class drugs in development pipeline 11 HTL9936 and HTL18318: Reviving an old target 11 HTL1071: A new oral immuno-oncology drug class 12 Earnings trends 13 Valuation 15 Earnings model 17 Appendix: Management team and top shareholders 20 Management team 20 Shareholder structure 21 Sosei Group (4565 / 4565 JP) 2 14 September 2016 Key charts Figure 1: Sosei revenue breakdown by source Figure 2: FY3/17 is on course to be the strongest earnings year in Sosei's history and to be surpassed in FY3/22 Upfront and R&D fees Allergan upfront EPS (¥) Revenues (¥ bn) Royalties Milestones 80 2,500 2,160 63 2,000 1,827 3 Others 1,709 60 55 52 1,512 3 1,500 47 3 16 3 9 12 1,074 40 36 7 1,000 759 3 712 27 28 6 596 611 24 25 3 5 4 500 18 4 5 44 261 20 4 5 37 40 40 4 127 14 28 37 8 3 -94 20 0 4 2 2 17 17 2 11 1 6 0 2 4 FY3/15A FY3/16A FY3/17E FY3/18E FY3/19E FY3/20E FY3/21E FY3/22E FY3/23E FY3/24E FY3/25E FY3/26E -500 Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates Figure 3: Breakdown of Sosei's royalty streams by Figure 4: Pipeline is mostly accounted for by Heptares product Revenues (¥Bn) Ultibro Seebri HTL6636 HTL1071 HTL18318 Other Product Phase Indication 20 NorLevo Marketed Female contraception 16.3 Sosei Loramyc (SO-1105) Phase III Candiasis 16 QVM149 Phase III Asthma (developed by Novartis) 3.3 HTL9936 Phase I Alzheimer's disease; schizophrenia 11.9 12 HTL18318 Phase I Alzheimer's disease; schizophrenia 1.9 3.4 8.6 HTL-1071 Phase I Solid tumors 1.7 0.9 CGRP Antagonist Pre-clinical Migraine 8 6.5 3.9 5.8 0.9 2.4 Heptares 5.4 0.6 1.1 M4 Agonist Pre-clinical Psychosis 4.7 0.1 4.0 1.1 1.1 1.2 1.0 1.0 1.1 Dual M1 & M4 Agonist Pre-clinical Cognitive impairment; psychosis 4 3.1 0.9 2.1 2.3 0.8 0.7 Orexin OX1 Antagonist Pre-clinical Smoking cessation 1.2 4.0 4.3 4.6 4.7 4.7 4.7 0.7 0.6 3.1 3.6 2.3 0.6 1.3 1.5 mGluR5 Modulator Pre-clinical Neurological disorders 0 0.5 FY3/15A FY3/16A FY3/17E FY3/18E FY3/19E FY3/20E FY3/21E FY3/22E FY3/23E FY3/24E FY3/25E FY3/26E APP13002 Pre-clinical Ocular infection Activus APP13007 Pre-clinical Ocular inflammation JIT-2001 Pre-clinical Cardiovascular indication JITSUBO JIT-1007 Pre-clinical Rare disease Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse Figure 5: Major events for Sosei from FY16-17 Figure 6: Forward P/E at a discount compared to peers Peptidream Sosei FY2016 FY2017 Forward P/E (x) JCR Eisai Q2 Q3 Q4 Q1 Q2 Q3 Q4 Kyowa Hakko Kirin Ono 180 160 P1, HTL9936 P1, HTL1071 Alzheimer's disease Solid tumors; 140 Trial immunooncology readouts 120 P1, HTL18318 Alzheimer's disease 100 80 Phase 1, M4 agonist Phase 1, M1/M4 agonist 60 Psychosis Alzheimer's disease 40 Trial Start Phase 2, HTL9936 P2, HTL18318 20 Alzheimer's disease Alzheimer's disease 0 P1, CGRP antagonist Migraine Commercial Quarterly updates on Seebri/Ultibro sales Source: Company data, Credit Suisse estimates Source: Thomson Reuters, Credit Suisse Sosei Group (4565 / 4565 JP) 3 14 September 2016 Investment thesis On pace for best performance in company history in FY3/17 On 7 April, Sosei Group signed a $3.3bn+ deal with Allergan for several drugs for neurology. The deal includes a $125mn upfront payment, and in 1Q FY3/17 Sosei recorded ¥15bn in revenue which already surpasses the entire annual sales of ¥8bn in FY3/16. Although the company also plans to increase investments in R&D, we forecast EPS of ¥759, which is six times the previous high set in FY3/14. Given the Allergan mega- deal, we view FY3/17 as an anomaly and expect EPS to come down 66% YoY to ¥261 in FY3/18. However, we still forecast a long-term growth trajectory, expecting steady milestones from an interesting pipeline, new collaborations, and royalties and expect Sosei's revenues to grow at a CAGR of 17% from FY3/18 (next fiscal year) to FY3/26. Transformation into a world-class R&D engine through Heptares Sosei was originally known for having a development strategy consisting of drug reprofiling (developing old drugs for new indications).