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Valuation and Discounted Cash Flow (DCF) Analysis Case Study: Jazz Pharmaceuticals [JAZZ]

Detailed Stock Pitch

Note that this is a lengthy pitch and is not something you would recite in response to a simple interview question, unless the whole interview is an extended discussion of the company.

This is more appropriate for a formal presentation of a stock pitch or case study in an interview.

NOTES AND DISCLAIMERS:

Please do not construe this as “investment advice.” We are NOT recommending that you invest in any of the companies discussed here.

This is a tutorial about how to research and pitch companies that you think are interesting, and how to use what you’ve learned in this modeling course to support your arguments.

Table of Contents:

• Recommendation • Company Background • Investment Thesis • Catalysts • Valuation

o Comparable Public Companies o Precedent Transactions o Discounted Cash Flow (DCF) Analysis

• Investment Risks

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Stock Pitch – LONG Recommendation for Jazz Pharmaceuticals [JAZZ]

Recommendation

We recommend longing Jazz Pharmaceuticals [JAZZ], a specialty biopharmaceutical company, which currently trades at $129.45 per share, because it is undervalued by at least 50% and the market has underestimated the potential for price increases and patient growth for its key drug, Xyrem, and has also incorrectly assumed that generics competition will arrive sooner than it actually will.

Based on the points above, the company’s intrinsic value is very likely closer to $200 per share (a 55% premium to the current price) due to the higher cash flows generated by Xyrem (we estimate peak annual sales of $4.2 billion vs. market consensus of $2.0 billion).

Even with much more pessimistic assumptions, such as current consensus estimates, the company is still undervalued, with an intrinsic value of $140 – $150 per share.

Catalysts to increase its share price in the next 6-12 months include possible price increases for Xyrem, the launch of new marketing campaigns for Xyrem, and the settlement of the Roxane lawsuit, related to Xyrem generics.

Key investment risks include price increases being lower-than-expected, new outbound marketing efforts not working as well as expected, and generics entering the market sooner than expected.

We can mitigate these risks with put options, or by longing competitors that plan to produce and sell Xyrem generics.

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Company Background


Jazz Pharmaceuticals is a specialty biopharmaceutical company with headquarters in Dublin, Ireland. In the last fiscal year, the company recorded $872 million in net revenue, with EBITDA of $426 million (margin of 49%). It has grown its revenue at a 3-year CAGR of 71%, and has maintained EBITDA margins of between 38% and 50% the entire time. Its market cap is approximately $8.2 billion and its Enterprise Value is $9.1 billion.

Its key products include Xyrem (65% of revenue), which treats cataplexy and excessive daytime sleepiness (‘EDS’) in patients with narcolepsy; Erwinaze (20% of revenue) to treat acute lymphoblastic leukemia (‘ALL’); and Defitelio (newly acquired) for the treatment and prevention of severe Hepatic Veno-Occlusive Disease (‘VOD’), a potentially life-threatening complication. Products in other segments, such as hematology / oncology, pain, and psychiatry comprise approximately 15% of revenue.

The Company operates in both the US and Europe, but the bulk of its sales have been from Xyrem to patients in the US; it had 215 sales reps at the end of its most recent fiscal year, and it uses channel partners for distribution in regions outside of the US and Europe.

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Jazz Pharmaceuticals - Price-Volume Graph

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In Q1 of the company’s current fiscal year, it completed its $1 billion acquisition of an Italian company, Gentium, which developed Defitelio; this new drug is expected to grow to $300-400 million in sales over the long-term.

As of the time of this case study, using our own forward estimates for Jazz’s financials, the company traded at an LTM EV / EBITDA multiple of 21.5x, a 1-year forward multiple of 14.9x, and a 2-year forward multiple of 10.9x; its revenue multiples in the same time frame were 9.8x, 7.7x, and 5.9x, respectively.

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Investment Thesis

Currently, the market views Jazz Pharmaceuticals as a specialty pharmaceutical company that has performed well, but which also has limited upside for its key drug, Xyrem, due to low expectations for future pricing and volume increases, as well as the imminent entrance of generics into the market.

As a result, it trades at EBITDA multiples that are well below the median multiples for its peer companies, and at a share price that represents a substantial discount (possibly over 50%) to its true intrinsic value.

The stock is mispriced for the following reasons:

1. The company has the ability to increase prices substantially on Xyrem; historically, prices have increased by 30-60% per year, and our sources indicate that the long-term price could easily increase to $120,000 per patient per year from its current level of $50,000 – $60,000. Current market views imply that the price will increase to only $70,000 – $80,000 in the long-term. A long-term price closer to $120,000 per patient per year adds approximately $20.00 to Jazz’s share price, or a 15% premium above the current price.

2. The company’s awareness marketing campaigns for Xyrem will produce a higher-than-expected number of patients; specifically, close to 25% of the 157,000 total potential patients could eventually be on Xyrem, whereas current market views imply that only 15-20% will be on the drug. Capturing closer to 25% of the market adds approximately $10.00 to Jazz’s share price, or a 9-11% premium above the current price.

3. The market has incorrectly overemphasized Xyrem generics competition. While multiple competitor pharmaceutical companies have filed ANDAs, and while there is ongoing


litigation with Roxane, we do not see generics entering the market until FY 22 (vs. current market estimates of FY 19). Generics in FY 22 rather than FY 19 adds approximately $20.00 to the company’s share price, or a 15% premium above the current price.

Each of these reasons ties in directly to the company’s valuation and will make a substantial impact on the implied per share value.

When taken together, all these factors have a synergistic effect because, for example, generics entering in FY 22 rather than FY 19 also makes the Xyrem pricing and patient differentials more significant; the result is a share price of nearly $200.00, representing a 54% premium to the current price (and 54% exceeds the 15% + 15% + 10% from the factors above).

However, even if some of these reasons turn out to be incorrect, any one or two of the factors above represents a significant difference from the current market view of the stock and could result in substantial upside.

And if all of the points above turn out to be incorrect, then Jazz Pharmaceuticals is valued appropriately at its current stock price (if not slightly undervalued) and an investment would represent minimal downside risk.

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Catalysts

Catalysts in the next 6-12 months include:

• Possible price increases for Xyrem; • The launch of new marketing campaigns for Xyrem; and • The settlement of the Roxane lawsuit, related to Xyrem generics.

Catalysts #1 and #2 are interrelated and, together, make the most significant valuation impact; by itself, catalyst #3 also makes a big impact because generics entering the market in FY 22 rather than FY 19 results in a 15% premium to the company’s current stock price.

To determine the per share impact from these catalysts, we rely upon our own financial projections for Jazz Pharmaceuticals, which reflect the impact of all these catalysts together, as well as a set of “Street Case” financial projections, closer to research analyst consensus


estimates, that allow us to calculate the impact of each individual catalyst vs. market expectations.

We rely primarily on the Discounted Cash Flow (DCF) analysis to illustrate the impact of these catalysts, because it lends itself to projecting differences far into the future more so than the other valuation methodologies.

Catalyst #1 is significant because in the Street Case, the price of Xyrem grows from ~$54,000 currently to ~$72,000 in FY 18 before falling dramatically to $10,000 in FY 19 due to generics entering the market.

With our modified assumption, however, the price of Xyrem grows to $109,000 instead, which translates to an implied share price of approximately $149 in our DCF analysis, holding everything else constant.

For reference, here is a sensitivity showing the implied share price at various discount rates (our calculated discount rate is 8.07%) and various Terminal FCF growth rates, before the Xyrem pricing change:

With the Xyrem pricing increase taken into account, here is that same table:

Sensitivity - Terminal FCF Growth Rate vs. Discount Rate and Implied Share Price from DCF Analysis:

Terminal FCF Growth Rate:12938.9% (2.0%) (1.5%) (1.0%) (0.5%) - 0.5% 1.0% 1.5% 2.0%

6.5% 134.94$ 139.75$ 145.19$ 151.42$ 158.60$ 166.98$ 176.88$ 188.76$ 203.28$ 7.0% 126.84 130.96 135.60 140.85 146.85 153.78 161.87 171.42 182.88 7.5% 119.59 123.14 127.12 131.59 136.66 142.46 149.14 156.94 166.16 8.0% 113.06 116.15 119.58 123.42 127.74 132.63 138.22 144.68 152.20 8.5% 107.15 109.85 112.83 116.15 119.85 124.02 128.74 134.14 140.37 9.0% 101.78 104.15 106.75 109.63 112.83 116.41 120.43 124.99 130.21 9.5% 96.87 98.96 101.25 103.77 106.55 109.64 113.09 116.98 121.38 10.0% 92.38 94.23 96.24 98.45 100.88 103.57 106.55 109.89 113.64 10.5% 88.24 89.88 91.67 93.62 95.75 98.10 100.69 103.58 106.80

Discount Rate (WACC):


Key Takeaways: This one simple change adds anywhere from $15 to $30 to the company’s implied share price across the range of assumptions shown here.

We believe it is extremely likely that the company will announce another pricing increase within the next 6-12 months, and in each year after that, because:

• Historically, the price of Xyrem has increased by far more than our projected increases:

• During channel checks, our legal and pharmaceutical sources indicated that similar drugs have obtained significantly higher prices without pushback from insurance companies or regulators; a potential long-term price of $150,000 on other orphan drugs was quoted, so we believe a price up to $120,000 within 5-10 years is plausible.



6.5% 155.23$ 160.57$ 166.63$ 173.54$ 181.52$ 190.83$ 201.83$ 215.04$ 231.18$ 7.0% 146.17 150.75 155.90 161.74 168.41 176.11 185.09 195.71 208.45 7.5% 138.05 142.00 146.42 151.39 157.03 163.46 170.89 179.56 189.81 8.0% 130.73 134.17 137.98 142.25 147.05 152.48 158.70 165.87 174.23 8.5% 124.11 127.11 130.42 134.11 138.22 142.86 148.11 154.10 161.03 9.0% 118.08 120.72 123.61 126.81 130.37 134.34 138.81 143.88 149.67 9.5% 112.58 114.90 117.44 120.24 123.33 126.76 130.60 134.92 139.81 10.0% 107.52 109.58 111.82 114.28 116.98 119.96 123.28 126.98 131.15 10.5% 102.87 104.70 106.68 108.85 111.22 113.83 116.71 119.92 123.50



• One lawyer also indicated that Xyrem at 2x its current price would not be a problem,

and that orphan drug prices only get scrutinized once sales are “well over $1 billion” (i.e., once generics are about to enter the market anyway).

• So it is likely that when Jazz announces the next round of price increases, and they are more substantial than expected, the market will realize the true pricing power the company has and price it into the stock.

Catalyst #2 is significant because in that same Street Case, Xyrem patients grow from ~10,000 currently to ~30,000 by FY 23; with our own assumptions, however, the patient count grows closer to ~38,000 by the end of the period. That equates to a $144 implied share price in our DCF analysis.

For reference, here is the sensitivity table before we have modified the Street Case assumption:

And here it is with our modified assumption of ~24% of the total potential market (~38,000 patients) on Xyrem by the end of the period:



6.5% 134.94$ 139.75$ 145.19$ 151.42$ 158.60$ 166.98$ 176.88$ 188.76$ 203.28$ 7.0% 126.84 130.96 135.60 140.85 146.85 153.78 161.87 171.42 182.88 7.5% 119.59 123.14 127.12 131.59 136.66 142.46 149.14 156.94 166.16 8.0% 113.06 116.15 119.58 123.42 127.74 132.63 138.22 144.68 152.20 8.5% 107.15 109.85 112.83 116.15 119.85 124.02 128.74 134.14 140.37 9.0% 101.78 104.15 106.75 109.63 112.83 116.41 120.43 124.99 130.21 9.5% 96.87 98.96 101.25 103.77 106.55 109.64 113.09 116.98 121.38 10.0% 92.38 94.23 96.24 98.45 100.88 103.57 106.55 109.89 113.64 10.5% 88.24 89.88 91.67 93.62 95.75 98.10 100.69 103.58 106.80



Key Takeaways: This changed assumption adds anywhere from $10 to $20 to Jazz’s implied share price, across the range of assumptions shown here.

We are confident that Jazz can increase its market penetration via its new outbound marketing campaigns because:

• Just in the past 4 years, the number of patients on Xyrem has increased by nearly 40% without much outbound marketing or patient awareness campaigns.

• During channel checks, doctors we spoke with indicated that potentially ~25% of all narcolepsy patients might be on Xyrem eventually; another doctor indicated that the number of patients on Xyrem could eventually triple.

• The biggest problem reported by physicians is awareness – once patients with narcolepsy are properly diagnosed, nearly all of them take the medication. Generous coverage from insurance companies and other medical groups also helps with this uptake.

• Initial results from the company’s outbound marketing campaign have been positive, and we expect even more positive news within the next year.

As noted previously, catalysts #1 and #2 together are highly significant because they have a synergistic effect; we will examine the impact of all the catalysts together at the end of this section.

Catalyst #3, generics entering the market in FY 22 rather than FY 19, is significant because that adds 3 extra years of high-priced Xyrem revenue and cash flows to the company’s intrinsic value.



6.5% 150.05$ 155.23$ 161.09$ 167.79$ 175.52$ 184.55$ 195.21$ 208.00$ 223.64$ 7.0% 141.28 145.72 150.71 156.37 162.83 170.29 179.00 189.28 201.63 7.5% 133.42 137.25 141.54 146.35 151.81 158.05 165.25 173.65 183.58 8.0% 126.35 129.67 133.37 137.50 142.15 147.42 153.44 160.39 168.50 8.5% 119.94 122.85 126.06 129.63 133.62 138.11 143.19 149.01 155.71 9.0% 114.11 116.66 119.47 122.57 126.02 129.87 134.20 139.11 144.72 9.5% 108.79 111.04 113.50 116.21 119.21 122.53 126.25 130.44 135.18 10.0% 103.91 105.90 108.07 110.45 113.06 115.96 119.17 122.76 126.80 10.5% 99.41 101.18 103.10 105.20 107.50 110.03 112.82 115.92 119.39



Without that change, Xyrem sales peak at $1.5 billion in FY 18 and then decline to $250 – $300 million per year thereafter; with an FY 22 entrance instead, Xyrem sales peak at $2.3 billion in FY 21 before declining to ~$300 million per year thereafter.

Here’s what the DCF sensitivity looks like with an FY 19 entrance for the generics:

And here are the results when the generics entrance year is set to FY 22 instead:

Key Takeaways: The later entrance year adds approximately $20 – $25 per share to Jazz’s intrinsic value across the assumptions shown here.

We believe that an FY 22 entrance year for Xyrem generics is more likely because:



6.5% 134.94$ 139.75$ 145.19$ 151.42$ 158.60$ 166.98$ 176.88$ 188.76$ 203.28$ 7.0% 126.84 130.96 135.60 140.85 146.85 153.78 161.87 171.42 182.88 7.5% 119.59 123.14 127.12 131.59 136.66 142.46 149.14 156.94 166.16 8.0% 113.06 116.15 119.58 123.42 127.74 132.63 138.22 144.68 152.20 8.5% 107.15 109.85 112.83 116.15 119.85 124.02 128.74 134.14 140.37 9.0% 101.78 104.15 106.75 109.63 112.83 116.41 120.43 124.99 130.21 9.5% 96.87 98.96 101.25 103.77 106.55 109.64 113.09 116.98 121.38 10.0% 92.38 94.23 96.24 98.45 100.88 103.57 106.55 109.89 113.64 10.5% 88.24 89.88 91.67 93.62 95.75 98.10 100.69 103.58 106.80




6.5% 158.60$ 163.41$ 168.85$ 175.08$ 182.26$ 190.64$ 200.54$ 212.42$ 226.94$ 7.0% 149.79 153.92 158.55 163.81 169.81 176.74 184.82 194.38 205.84 7.5% 141.86 145.42 149.40 153.87 158.94 164.74 171.42 179.22 188.44 8.0% 134.68 137.77 141.20 145.04 149.36 154.25 159.85 166.30 173.83 8.5% 128.14 130.84 133.82 137.14 140.84 145.01 149.73 155.13 161.36 9.0% 122.16 124.53 127.13 130.01 133.21 136.79 140.81 145.37 150.59 9.5% 116.66 118.75 121.04 123.55 126.34 129.43 132.88 136.77 141.17 10.0% 111.60 113.44 115.46 117.67 120.10 122.79 125.77 129.11 132.86 10.5% 106.91 108.55 110.34 112.29 114.42 116.77 119.36 122.24 125.47



• All the lawyers with pharmaceutical experience we spoke with indicated that the courts

rarely decide against the company with the branded drug when it is “defended by a fortress of patents.”

• One attorney said that since the first Xyrem patents expire in 2019 and the last patents expire in 2024, it is unlikely that we’ll see any generics in 2019 or earlier.

• Another source said that he expects generics to enter the market in 2021 (i.e., the full effects will be apparent in 2022).

• The lawsuits Jazz has initiated against generics companies are heavily slanted in favor of Jazz, since it has to prove far less to show evidence of patent infringement (see the earnings call extract in the last section of this document).

We believe that the settlement of the Roxane lawsuit later this year, and the presumably positive results from that (e.g., Roxane does not have permission to market its generic version of Xyrem) will make the market realize that generics are further away than expected.

In the case that all the catalysts above transpire as expected, the company looks significantly undervalued according to our DCF analysis:

This outcome produces implied share prices closer to the $200.00 range, significantly above the implied share price when aggregating each catalyst’s value contribution separately.



6.5% 210.31$ 215.88$ 222.20$ 229.42$ 237.75$ 247.47$ 258.96$ 272.74$ 289.59$ 7.0% 199.48 204.26 209.64 215.73 222.70 230.73 240.11 251.19 264.49 7.5% 189.68 193.81 198.42 203.61 209.49 216.22 223.97 233.02 243.72 8.0% 180.77 184.36 188.34 192.80 197.80 203.48 209.97 217.45 226.19 8.5% 172.63 175.76 179.22 183.07 187.37 192.20 197.68 203.94 211.17 9.0% 165.15 167.90 170.92 174.27 177.98 182.13 186.80 192.09 198.13 9.5% 158.26 160.68 163.33 166.25 169.48 173.06 177.07 181.58 186.69 10.0% 151.87 154.02 156.36 158.92 161.74 164.86 168.32 172.19 176.54 10.5% 145.95 147.85 149.92 152.19 154.66 157.38 160.39 163.74 167.47



We will examine more extreme Downside scenarios in the next sections on Valuation and Risk Factors.

All of the factors above represent catalysts that could boost Jazz’s share price to our targeted range of $180 – $200 per share (40-50% price appreciation) in the next 12 months.

If they all come true and work as expected, the price may be near the upper end of that range; if one or more is false, a price near the lower end of that range is more plausible.

And even if multiple catalysts fail to pan out, the company is still moderately undervalued and could see 20-30% price appreciation in the next 12 months.

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Valuation

We have valued Jazz Pharmaceuticals using public comps, precedent transactions, and the DCF analysis.


At a high-level, here is what the company’s valuation looks like across these different methodologies, using our own figures for Xyrem pricing and volume increases and a generics entrance year of FY 22:

As shown above, the company’s current share price is below the share price implied by the median EBITDA multiples of the comparable companies, and is significantly below the share prices implied by our DCF analysis.

While it is significantly above the share prices implied by precedent transactions, we view that as the least relevant methodology here due to recent changes in the public markets and a lack of directly comparable target companies.

We will discuss each of the methodologies in more detail below, and show several sensitivities based on the key value drivers and catalysts above.

To value the company, we considered both “Street Case” financial projections as well as our own figures; the difference is that in our projections, Xyrem sales peak at $4.2 billion in FY 21, whereas in the “Street Case” they peak at $2.0 billion in FY 20:

7.0% - 9.0% Discount Rate, (1.0%) - 1.0% Terminal FCF Growth Rate:

LTM EV / EBITDA:LTM EV / Revenue:

12/31/2015E Reported P / E:12/31/2014E Reported P / E:

LTM Reported P / E:12/31/2015E EV / EBITDA:12/31/2014E EV / EBITDA:

LTM EV / EBITDA:12/31/2015E EV / Revenue:12/31/2014E EV / Revenue:

LTM EV / Revenue:Public Company Comparables:

Discounted Cash Flow Analysis:

Jazz Current Share Price

Precedent Transactions:

$0.00 $50.00 $100.00 $150.00 $200.00 $250.00 $300.00

Implied Share Price

25th to MedianMedian to 75th


Here are our own figures for the same time period:

Comparable Public Companies

To select comparable public companies, we used the following criteria:

ProjectedIncome Statement: FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23

Revenue:Existing Products:

Xyrem Sales: 578.6$ 766.6$ 975.1$ 1,205.9$ 1,447.1$ 1,709.4$ 1,975.3$ 276.3$ 301.4$ 301.4$ Erwinaze Sales: 203.4 234.2 266.6 300.7 336.7 346.8 385.8 397.3 439.6 452.7 Defitelio Sales: 57.8 79.8 107.1 140.7 182.0 209.3 240.7 276.9 318.4 366.1 Other Sales and Royalties: 142.0 156.2 168.7 182.1 193.1 204.7 214.9 225.6 234.7 244.0

Risk-Adjusted Pipeline Drug Sales:JZP-110 Sales: - - - 18.1 43.4 76.9 88.9 135.6 152.3 196.1 JZP-386 Sales: - - - - - - - - - -

Total Revenue: 981.8 1,236.7 1,517.4 1,847.6 2,202.3 2,547.1 2,905.6 1,311.7 1,446.4 1,560.5 Revenue Growth: 12.5% 26.0% 22.7% 21.8% 19.2% 15.7% 14.1% (54.9%) 10.3% 7.9%

Operating Income (EBIT): 248.4 529.2 663.1 812.5 971.9 1,134.6 1,281.1 518.0 576.4 624.9 Operating (EBIT) Margin: 25.3% 42.8% 43.7% 44.0% 44.1% 44.5% 44.1% 39.5% 39.9% 40.0%

Net Income: 163.8$ 402.7$ 512.5$ 651.4$ 782.1$ 930.2$ 1,050.5$ 424.8$ 472.7$ 512.4$ Effective Tax Rate: 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0%

Weighted Average Diluted Shares Outstanding: 61.6 61.6 61.6 61.6 61.6 61.6 61.6 61.6 61.6 61.6Diluted Earnings Per Share (EPS): 2.66$ 6.54$ 8.32$ 10.58$ 12.70$ 15.11$ 17.06$ 6.90$ 7.68$ 8.32$

EBITDA: 508.8$ 661.6$ 794.0$ 947.2$ 1,107.7$ 1,258.2$ 1,410.8$ 633.1$ 694.4$ 745.9$ EBITDA Margin: 51.8% 53.5% 52.3% 51.3% 50.3% 49.4% 48.6% 48.3% 48.0% 47.8%

ProjectedIncome Statement: FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23

Revenue:Existing Products:

Xyrem Sales: 773.7$ 1,083.1$ 1,455.7$ 1,902.2$ 2,391.3$ 2,959.2$ 3,551.1$ 4,218.7$ 376.8$ 376.8$ Erwinaze Sales: 203.4 234.2 266.6 300.7 336.7 346.8 385.8 397.3 439.6 452.7 Defitelio Sales: 57.8 79.8 107.1 140.7 182.0 209.3 240.7 276.9 318.4 366.1 Other Sales and Royalties: 142.0 156.2 168.7 182.1 193.1 204.7 214.9 225.6 234.7 244.0

Risk-Adjusted Pipeline Drug Sales:JZP-110 Sales: - - - 28.5 71.7 133.2 159.8 253.1 292.7 387.8 JZP-386 Sales: - - - - - - - - - -

Total Revenue: 1,176.9 1,553.3 1,998.0 2,554.3 3,174.8 3,853.2 4,552.3 5,371.6 1,662.1 1,827.6 Revenue Growth: 34.9% 32.0% 28.6% 27.8% 24.3% 21.4% 18.1% 18.0% (69.1%) 10.0%

Operating Income (EBIT): 348.7 697.0 911.7 1,169.9 1,453.2 1,768.0 2,064.2 2,432.8 677.4 749.1 Operating (EBIT) Margin: 29.6% 44.9% 45.6% 45.8% 45.8% 45.9% 45.3% 45.3% 40.8% 41.0%

Net Income: 246.0$ 540.3$ 716.3$ 944.5$ 1,176.8$ 1,449.6$ 1,692.6$ 1,994.9$ 555.5$ 614.3$ Effective Tax Rate: 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0% 18.0%

Weighted Average Diluted Shares Outstanding: 61.6 61.6 61.6 61.6 61.6 61.6 61.6 61.6 61.6 61.6Diluted Earnings Per Share (EPS): 4.00$ 8.78$ 11.63$ 15.34$ 19.11$ 23.54$ 27.49$ 32.40$ 9.02$ 9.98$

EBITDA: 609.9$ 830.9$ 1,045.5$ 1,309.5$ 1,596.8$ 1,903.3$ 2,210.4$ 2,592.5$ 798.0$ 873.5$ EBITDA Margin: 51.8% 53.5% 52.3% 51.3% 50.3% 49.4% 48.6% 48.3% 48.0% 47.8%


• Industry: Specialty pharmaceutical companies that sell primarily branded drugs • Financial: LTM revenue between $500 million and $2 billion • Geography: US-based companies (regardless of “headquarters location”)

Figures such as EBITDA were adjusted for impairment charges and write-downs, but overall we were quite conservative with add-backs. Net Income is based on GAAP Net Income as reported in each company’s filings, with no adjustments for non-recurring charges.

Below, we show the CY 2015E revenue and EBITDA growth rates and the corresponding multiples for the comparables:

Comparable Public Companies – Growth and Valuation Multiples, CY 2014E – CY 2015E

111%

38%

6%

32%23%

11%21% 18%

0%

20%

40%

60%

80%

100%

120%

Revenue Growth, CY 2014E – CY 2015E

11.6 x

9.7 x

1.9 x

5.9 x

4.1 x3.4 x

4.7 x

11.6 x

0.0 x

2.0 x

4.0 x

6.0 x

8.0 x

10.0 x

12.0 x

14.0 x

CY 2015E Revenue Multiples

NM NM

137%

36%

14% 10%

41%

22%

0%

20%

40%

60%

80%

100%

120%

140%

160%EBITDA Growth, CY 2014E – CY 2015E

85.8 x

NM9.2 x 10.9 x

20.5 x

6.9 x 9.7 x

22.7 x

0.0 x10.0 x20.0 x30.0 x40.0 x50.0 x60.0 x70.0 x80.0 x90.0 x

100.0 xCY 2015E EBITDA Multiples


Key Takeaways: Even though Jazz is growing both its revenue and EBITDA near the upper end of this range of comparables, its multiples are in the mid-to-low-end of the range, implying that the company is undervalued.

Note that the figures for comparables are based on research estimates, and that our own view of the company’s future performance barely even makes an impact in FY 14 or FY 15.

For reference, here’s the set of comparables with all the metrics and multiples shown:

While the revenue and P / E multiples show a more mixed picture than the EBITDA multiples, we view both of those as less relevant for the mostly profitable, cash flow-positive companies in this set.

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Precedent Transactions

We used the following screening criteria for the seller in each M&A deal:

Operating Statistics Capitalization Projected ProjectedEquity Enterprise Revenue EBITDA Reported Net Income Revenue EBITDA EBITDA Margin

Company Name Value Value LTM 12/31/2014 12/31/2015 LTM 12/31/2014 12/31/2015 LTM 12/31/2014 12/31/2015 Growth Growth LTM 12/31/2014 12/31/2015Alexion Pharmaceuticals, Inc. 31,143$ 29,697$ 1,779$ 2,171$ 2,569$ 697$ 1,074$ 1,306$ 330$ 472$ 1,123$ 18.3% 21.6% 39.2% 49.5% 50.8%Vertex Pharmaceuticals Inc. 15,689 14,079 1,002 574 1,211 (331) (478) 164 (369) (538) 119 111.0% (134.3%) (33.0%) (83.3%) 13.5%BioMarin Pharmaceutical Inc. 9,103 8,769 572 655 905 (96) (80) 65 (175) (142) 47 38.2% (181.3%) (16.7%) (12.2%) 7.2%Salix Pharmaceuticals, Ltd. 7,774 9,324 1,116 1,649 1,995 281 680 957 77 361 444 21.0% 40.6% 25.2% 41.3% 48.0%Cubist Pharmaceuticals, Inc. 5,866 6,038 1,086 1,206 1,483 233 259 295 (0) 26 48 22.9% 13.7% 21.5% 21.5% 19.9%United Therapeutics Corporation 5,861 4,781 1,161 1,255 1,387 463 629 690 250 400 441 10.5% 9.7% 39.9% 50.1% 49.7%The Medicines Company 1,699 1,533 709 775 823 96 70 166 22 (0) 106 6.1% 136.6% 13.6% 9.1% 20.2%

Maximum 31,143$ 29,697$ 1,779$ 2,171$ 2,569$ 697$ 1,074$ 1,306$ 330$ 472$ 1,123$ 111.0% 136.6% 39.9% 50.1% 50.8%75th Percentile 12,396 11,702 1,138 1,452 1,739 372 655 823 163 380 443 30.6% 31.1% 32.2% 45.4% 48.9%Median 7,774$ 8,769$ 1,086$ 1,206$ 1,387$ 233$ 259$ 295$ 22$ 26$ 119$ 21.0% 13.7% 21.5% 21.5% 20.2%25th Percentile 5,863 5,410 856 715 1,058 0 (5) 165 (88) (71) 77 14.4% (62.3%) (1.6%) (1.6%) 16.7%Minimum 1,699 1,533 572 574 823 (331) (478) 65 (369) (538) 47 6.1% (181.3%) (33.0%) (83.3%) 7.2%

Jazz Pharmaceuticals plc 8,196$ 9,089$ 923$ 1,177$ 1,553$ 423$ 610$ 831$ 80$ 246$ 540$ 32.0% 36.3% 45.8% 51.8% 53.5%

Valuation Statistics Capitalization Enterprise Value / Enterprise Value / Equity Enterprise Revenue EBITDA P / E Multiple

Company Name Value Value LTM 12/31/2014 12/31/2015 LTM 12/31/2014 12/31/2015 LTM 12/31/2014 12/31/2015Alexion Pharmaceuticals, Inc. 31,143$ 29,697$ 16.7 x 13.7 x 11.6 x 42.6 x 27.7 x 22.7 x 94.4 x 66.0 x 27.7 xVertex Pharmaceuticals Inc. 15,689 14,079 14.1 x 24.5 x 11.6 x NM NM 85.8 x NM NM NMBioMarin Pharmaceutical Inc. 9,103 8,769 15.3 x 13.4 x 9.7 x NM NM NM NM NM NMSalix Pharmaceuticals, Ltd. 7,774 9,324 8.4 x 5.7 x 4.7 x 33.2 x 13.7 x 9.7 x NM 21.5 x 17.5 xCubist Pharmaceuticals, Inc. 5,866 6,038 5.6 x 5.0 x 4.1 x 25.9 x 23.3 x 20.5 x NM NM NMUnited Therapeutics Corporation 5,861 4,781 4.1 x 3.8 x 3.4 x 10.3 x 7.6 x 6.9 x 23.5 x 14.7 x 13.3 xThe Medicines Company 1,699 1,533 2.2 x 2.0 x 1.9 x 15.9 x 21.8 x 9.2 x 76.9 x NM 16.1 x

Maximum 31,143$ 29,697$ 16.7 x 24.5 x 11.6 x 42.6 x 27.7 x 85.8 x 94.4 x 66.0 x 27.7 x75th Percentile 12,396 11,702 14.7 x 13.5 x 10.6 x 33.2 x 23.3 x 22.2 x 85.6 x 43.8 x 20.1 xMedian 7,774$ 8,769$ 8.4 x 5.7 x 4.7 x 25.9 x 21.8 x 15.1 x 76.9 x 21.5 x 16.8 x25th Percentile 5,863 5,410 4.8 x 4.4 x 3.8 x 15.9 x 13.7 x 9.4 x 50.2 x 18.1 x 15.4 xMinimum 1,699 1,533 2.2 x 2.0 x 1.9 x 10.3 x 7.6 x 6.9 x 23.5 x 14.7 x 13.3 x

Jazz Pharmaceuticals plc 8,196$ 9,089$ 9.8 x 7.7 x 5.9 x 21.5 x 14.9 x 10.9 x NM 33.3 x 15.2 x


• Industry: Pharmaceutical companies • Financial: LTM revenue between $200 million and $2 billion • Geography: North American companies (regardless of “headquarters location”) • Time Horizon: January 1st, 2009 to May 9th, 2014 • Other: We considered only sales of entire companies rather than minority/majority

stakes; sales of both private and public companies to both strategic and financial sponsor acquirers, in all geographies, were considered

This criteria produced the following set of precedent transactions:

Key Takeaways: While the LTM multiples here are much lower than the multiples from the comparable public companies, we do not view this set of M&A deals as particularly relevant because the criteria is so broad; the single most comparable transaction here is likely the Shire / ViroPharma deal, which has a revenue multiple of 9.5x and an EBITDA multiple of 69.0x.

Jazz Pharmaceuticals plc - Comparable M&A Transactions Operating Metrics Valuation MultiplesTransaction Transaction EV / EV /

Equity Enterprise LTM LTM LTM LTMAcquirer Name Target Name Date Value Value Revenue EBITDA Revenue EBITDA

Mallinckrodt plc Questcor Pharmaceuticals, Inc. 04/07/2014 $ 5,291 $ 4,802 $ 891 $ 517 5.4 x 9.3 xForest Laboratories Inc. Aptalis Holdings Inc. 01/08/2014 2,900 2,900 688 315 4.2 x 9.2 xShire Pharmaceutical Holdings Ireland Limited ViroPharma Inc. 11/11/2013 4,200 4,097 430 59 9.5 x 69.0 xSalix Pharmaceuticals, Inc. Santarus, Inc. 11/07/2013 2,600 1,980 338 82 5.9 x 24.3 xEndo Health Solutions Inc. Paladin Labs Inc. 11/05/2013 1,600 1,348 264 93 5.1 x 14.5 xAkorn, Inc. Hi-Tech Pharmacal Co., Inc. 08/27/2013 640 536 231 48 2.3 x 11.3 xValeant Pharmaceuticals International, Inc. Medicis Pharmaceutical Corporation 09/03/2012 2,600 2,329 764 191 3.1 x 12.2 xTPG Capital, L.P. Par Pharmaceutical Companies Inc. 07/16/2012 1,900 1,976 1,035 237 1.9 x 8.3 xNovartis AG Fougera Pharmaceuticals Inc. 05/02/2012 1,525 1,525 429 173 3.6 x 8.8 xTakeda Pharmaceuticals U.S.A., Inc. URL Pharma, Inc. 04/11/2012 800 800 600 76 1.3 x 10.5 xGenomma Lab Internacional SAB de CV Prestige Brands Holdings, Inc. 02/21/2012 834 1,263 403 119 3.1 x 10.6 xNestlé Health Science S.A. Prometheus Laboratories Inc. 05/24/2011 745 659 519 139 1.3 x 4.7 xPfizer Inc. King Pharmaceuticals LLC 10/12/2010 3,600 3,225 1,565 349 2.1 x 9.2 xEndo Pharmaceuticals Holdings Inc. Qualitest Pharmaceuticals 09/28/2010 1,200 1,176 309 58 3.8 x 20.2 xCelgene Corporation Abraxis BioScience, Inc. 06/30/2010 2,923 2,789 397 (23) 7.0 x NMAstellas US Holding, Inc. OSI Pharmaceuticals Inc. 05/16/2010 4,000 3,414 441 176 7.7 x 19.4 xDainippon Sumitomo Pharma America Holdings, Inc. Sepracor, Inc. 09/03/2009 2,600 2,347 1,334 306 1.8 x 7.7 xGlaxoSmithKline plc Stiefel Laboratories, Inc. 04/20/2009 3,050 3,450 900 288 3.8 x 12.0 x

Maximum 4,802$ 1,565$ 517$ 9.5 x 69.0 x75th Percentile 3,144 859 275 5.3 x 14.5 x

Median 2,154$ 480$ 156$ 3.7 x 10.6 x25th Percentile 1,284 399 78 2.1 x 9.2 x

Minimum 536 231 (23) 1.3 x 4.7 x


Many of the other sellers are not orphan drug companies, so their business models are significantly different. Also, many of the other sellers were not tax inversion candidates, so the multiples paid were lower.

If you look at the premiums paid for a similar set of specialty pharmaceutical M&A deals, the numbers tell a very different story:

So we believe the premiums paid for this set of transactions are more meaningful than the revenue or EBITDA multiples.

Return to Top.

Discounted Cash Flow Analysis

We used the DCF analysis over a 10-year period as our primary valuation methodology, with the following assumptions:


• Xyrem: Revenue grows from $569 million in FY 13 to $4.2 billion in FY 21, with patients

growing from ~11,000 to ~35,000, and the average price per patient per year growing from ~$54,000 to ~$122,000; revenue drops to ~$300 million per year thereafter due to generics.

• Erwinaze: Revenue grows from $174 million in FY 13 to $453 million in FY 23, driven by patients growing from ~540 to ~1,044, and price per patient per year growing from ~$323,000 to ~$434,000.

• Defitelio: Revenue grows from $45 million in FY 13 (attributed to Gentium; not in Jazz’s consolidated financials) to $366 million in FY 23, driven by worldwide patients growing from ~1,200 to ~2,430 and the average price per patient growing from ~$37,000 to ~$151,000.

• Other Segments: JZP-100 is released in FY 17 and it grows to $388 million in risk-adjusted revenue in FY 23, assuming a 60% risk adjustment factor; no contribution from JZP-386; “Other” grows from $129 million in FY 13 to $244 million in FY 23.

• Operating Margin: This starts at 39% in FY 13 and stays in the 40-45% range throughout most of the period; sales reps grow from 215 to nearly 600 by FY 21, gross margins stay in a similar range, and R&D as a percentage of revenue increases from 5% in FY 13 to 10% by FY 23 as the company spends more to develop pipeline drugs.

• Taxes: An 18% effective cash tax rate was used, in-line with historical levels and the company’s expected future tax rate, taking into account the Irish corporate tax rate of 12.5% and taxes on income earned in other countries.

• Discount Rate: We used a baseline rate of 8.07% for WACC, based on the comparable companies, Jazz’s current and optimal capital structure, an Equity Risk Premium of 7.00%, and a Pre-Tax Cost of Debt of 3.42% based on the YTM of the company’s most recent debt issuance.

• Terminal Value: We used a baseline Terminal EBITDA multiple of 12.0x and a baseline Terminal FCF Growth Rate of 0.3%, which both imply very similar intrinsic per-share values ($195 – $200).

Here’s the DCF analysis down to the Unlevered FCF and EBITDA line items:


Note that Q1 of FY 14 had already passed as of the time of this investment recommendation. As a result, we used adjusted figures that excluded Q1 Unlevered FCF.

We also used the mid-year convention for the discount periods, along with a stub period reflecting the first ~35% of the year.

For reference, here is the baseline output of the DCF analysis under both the Multiples Method and the Perpetuity Growth Method for the Terminal Value calculation:

ProjectedUnlevered Free Cash Flow Projections: FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23

Revenue: 1,176.9$ 1,553.3$ 1,998.0$ 2,554.3$ 3,174.8$ 3,853.2$ 4,552.3$ 5,371.6$ 1,662.1$ 1,827.6$ Annual / Annualized Revenue Growth Rate: 34.9% 32.0% 28.6% 27.8% 24.3% 21.4% 18.1% 18.0% (69.1%) 10.0%

Operating Income (EBIT): 348.7 697.0 911.7 1,169.9 1,453.2 1,768.0 2,064.2 2,432.8 677.4 749.1 Annual / Annualized Operating Margin: 29.6% 44.9% 45.6% 45.8% 45.8% 45.9% 45.3% 45.3% 40.8% 41.0%

Less: Taxes, Excluding Effect of Interest: (62.8) (125.5) (164.1) (210.6) (261.6) (318.2) (371.6) (437.9) (121.9) (134.8)

Net Operating Profit After Tax (NOPAT): 285.9 571.5 747.6 959.3 1,191.6 1,449.8 1,692.6 1,994.9 555.5 614.3

Total Adjustments for Non-Cash Charges: 328.1 221.0 244.6 280.1 317.3 345.3 393.4 450.8 213.5 226.1

Total Changes in Operating Assets & Liabilities: (29.8) (55.4) (50.6) (63.1) (71.0) (79.1) (80.6) (97.0) 423.6 (20.4)

Less: Capital Expenditures: (14.1) (20.2) (28.0) (38.3) (50.8) (65.5) (81.9) (102.1) (33.2) (38.4)

Annual Unlevered Free Cash Flow: 570.1 717.0 913.6 1,138.0 1,387.1 1,650.4 1,923.5 2,246.6 1,159.3 781.6 Unlevered Free Cash Flow for Remaining Quarters: 489.9 717.0 913.6 1,138.0 1,387.1 1,650.4 1,923.5 2,246.6 1,159.3 781.6 Net Present Value of Free Cash Flow: 477.8 655.9 773.4 891.5 1,005.5 1,107.0 1,193.9 1,290.3 616.1 384.3

Normal Discount Period: 0.647 1.647 2.647 3.647 4.647 5.647 6.647 7.647 8.647 9.647Mid-Year Discount Period: 0.323 1.147 2.147 3.147 4.147 5.147 6.147 7.147 8.147 9.147

Annual Free Cash Flow Growth Rate: 67.5% 25.8% 27.4% 24.6% 21.9% 19.0% 16.5% 16.8% (48.4%) (32.6%)

Annual EBITDA: 609.9 830.9 1,045.5 1,309.5 1,596.8 1,903.3 2,210.4 2,592.5 798.0 873.5 Annual EBITDA Growth Rate: 43.0% 36.3% 25.8% 25.3% 21.9% 19.2% 16.1% 17.3% (69.2%) 9.5%


Terminal Value - Multiples Method: Terminal Value - Perpetuity Growth Method:

Baseline Terminal EBITDA Multiple: 12.0 x Baseline Terminal FCF Growth Rate: 0.3%Baseline Terminal Value: 10,482.1$ Baseline Terminal Value: 10,489.7$ Implied Terminal FCF Growth Rate: 0.3% Implied Terminal EBITDA Multiple: 12.0 x

NPV of Terminal Value: 4,958.5 NPV of Terminal Value: 5,158.4 Sum of NPV of Free Cash Flows: 8,395.7 Sum of NPV of Free Cash Flows: 8,395.7

Implied Enterprise Value: 13,354.2$ Implied Enterprise Value: 13,554.0$

% of Implied EV from Terminal Value: 37.1% % of Implied EV from Terminal Value: 38.1%

Plus: Cash & Cash-Equivalents: 251.4$ Plus: Cash & Cash-Equivalents: 251.4$ Plus: Equity Investments: - Plus: Equity Investments: - Plus: Other Non-Core Assets, Net: - Plus: Other Non-Core Assets, Net: - Plus: Net Operating Losses: 71.4 Plus: Net Operating Losses: 71.4 Less: Total Debt: (1,198.6) Less: Total Debt: (1,198.6) Less: Preferred Stock: - Less: Preferred Stock: - Less: Noncontrolling Interests: (17.6) Less: Noncontrolling Interests: (17.6) Less: Unfunded Pension Obligations: - Less: Unfunded Pension Obligations: - Less: Capital Leases: - Less: Capital Leases: - Less: Restructuring & Other Liab.: - Less: Restructuring & Other Liab.: -

Implied Equity Value: 12,460.7 Implied Equity Value: 12,660.6

Diluted Shares Outstanding: 63.445 Diluted Shares Outstanding: 63.449

Implied Share Price from DCF: 196.40$ Implied Share Price from DCF: 199.54$ Premium / (Discount) to Current: 51.7% Premium / (Discount) to Current: 54.1%

Exercise ExerciseType: Number: Price: Dilution: Type: Number: Price: Dilution:

Options A: 0.604 7.37$ 0.581 Options A: 0.604 7.37$ 0.582Options B: 0.948 4.00 0.929 Options B: 0.948 4.00 0.929Options C: 1.590 26.09 1.379 Options C: 1.590 26.09 1.382RSUs: 1.164 1.164 RSUs: 1.164 1.164

Total: 4.053 Total: 4.057


And here are the most relevant sensitivity tables based on the key variables in this analysis:

Sensitivity – Xyrem Annual Prices Increases vs. Xyrem Market Penetration:

Key Takeaways: Even if we’re off by 10% on both of these key assumptions, the company’s implied share price is still $180.93, which is a 40% premium to the current price. The most likely implied value is between $180 and $220 per share based on this analysis.

Downside Sensitivity – Xyrem Annual Prices Increases vs. Xyrem Market Penetration

Here is the output from a more extreme “downside” case for our own Xyrem assumptions:

Key Takeaways: For Jazz to be overvalued, both of our estimates for the Xyrem annual price increases and its market penetration would have to be incorrect by over 40%, or, alternatively, our estimates for the market penetration would have to be wrong by more than 50%.

Xyrem Annual Price Increases - Differential to Base Case Estimates:19954.0% (20.0%) (15.0%) (10.0%) (5.0%) - 5.0% 10.0% 15.0% 20.0%(20.0%) 163.89$ 166.28$ 168.74$ 171.27$ 173.88$ 176.56$ 179.33$ 182.17$ 185.10$ (15.0%) 169.68 172.22 174.83 177.52 180.29 183.15 186.08 189.11 192.22 (10.0%) 175.47 178.16 180.93 183.78 186.71 189.73 192.84 196.04 199.33 (5.0%) 181.26 184.10 187.02 190.03 193.12 196.31 199.59 202.97 206.45

- 187.05 190.04 193.11 196.28 199.54 202.90 206.35 209.91 213.56 5.0% 192.84 195.98 199.21 202.53 205.96 209.48 213.11 216.84 220.68 10.0% 198.63 201.92 205.30 208.78 212.37 216.06 219.86 223.77 227.80 15.0% 204.42 207.86 211.39 215.04 218.79 222.64 226.62 230.71 234.91 20.0% 210.21 213.80 217.49 221.29 225.20 229.23 233.37 237.64 242.03

Xyrem Market Penetration - Differential to

Base Case Estimates:

Xyrem Annual Price Increases - Differential to Base Case Estimates:19954.0% (80.0%) (70.0%) (60.0%) (50.0%) (40.0%) (30.0%) (20.0%) (10.0%) (0.0%)(80.0%) 88.44$ 89.30$ 90.20$ 91.16$ 92.18$ 93.26$ 94.40$ 95.61$ 96.90$ (70.0%) 97.05 98.33 99.68 101.12 102.65 104.26 105.98 107.80 109.73 (60.0%) 105.65 107.35 109.16 111.08 113.12 115.27 117.56 119.99 122.56 (50.0%) 114.25 116.38 118.64 121.04 123.58 126.28 129.14 132.18 135.39 (40.0%) 122.86 125.41 128.12 131.00 134.05 137.29 140.72 144.36 148.22 (30.0%) 131.46 134.44 137.61 140.96 144.52 148.30 152.30 156.55 161.05 (20.0%) 140.06 143.47 147.09 150.92 154.99 159.31 163.89 168.74 173.88 (10.0%) 148.67 152.50 156.57 160.88 165.46 170.32 175.47 180.93 186.71 (0.0%) 157.27 161.53 166.05 170.84 175.93 181.33 187.05 193.11 199.54




We do not see this as particularly likely, given the company’s history of price increases and the feedback received from medical and legal sources on the company’s outbound marketing results thus far.

Sensitivity – Xyrem Annual Prices Increases vs. Xyrem Generics Entrance Year

This table on the annual Xyrem price increase differentials and the entrance year of Xyrem generics yields a similar result:

Key Takeaways: Even if generics enter as early as FY 18 or FY 19, in-line with consensus views, the company still appears to be undervalued. Even if prices rise by 10% less than expected, there is still an opportunity for a 12% – 15% gain.

Downside Sensitivity – Xyrem Annual Prices Increases vs. Xyrem Generics Entrance Year:

Key Takeaways: For Jazz to be overvalued, generics would have to enter the market in FY 16 or earlier, or they would have to enter in FY 17 and our annual price increase estimates would have to be incorrect by 50% or more.

Xyrem Annual Price Increases - Differential to Base Case Estimates:19954.0% (20.0%) (15.0%) (10.0%) (5.0%) - 5.0% 10.0% 15.0% 20.0%

FY14 117.02$ 117.79$ 118.60$ 119.43$ 120.30$ 121.20$ 122.14$ 123.11$ 124.12$ FY15 121.45 122.25 123.09 123.96 124.87 125.80 126.77 127.78 128.83 FY16 127.37 128.27 129.19 130.15 131.14 132.16 133.22 134.32 135.45 FY17 134.54 135.58 136.65 137.76 138.90 140.08 141.30 142.55 143.85 FY18 142.96 144.23 145.53 146.87 148.25 149.67 151.13 152.63 154.18 FY19 152.49 154.06 155.67 157.33 159.03 160.78 162.58 164.43 166.33 FY20 163.11 165.07 167.09 169.16 171.28 173.47 175.71 178.02 180.39 FY21 174.61 177.04 179.54 182.11 184.75 187.46 190.25 193.12 196.07 FY22 187.05 190.04 193.11 196.28 199.54 202.90 206.35 209.91 213.56

Xyrem Generics - Entrance

Year:

Xyrem Annual Price Increases - Differential to Base Case Estimates:19954.0% (80.0%) (70.0%) (60.0%) (50.0%) (40.0%) (30.0%) (20.0%) (10.0%) (0.0%)



Year:


This seems exceptionally unlikely, given that not a single market participant expects generics before FY 18, and that a 50% differential to our price increase projections implies a Xyrem price of only ~$80,000 in its peak sales year.

Sensitivity – Defitelio Annual Prices Increases vs. Defitelio Market Penetration:

Turning our attention to Defitelio, the other drug that could potentially move Jazz’s stock price, here’s a sensitivity showing the impact of differentials to our assumed price increases and market penetration:

Key Takeaways: This part of Jazz’s business makes almost no difference to its implied share price; similar logic applies to JZP-110 and JZP-386.

Erwinaze is also a smaller portion of the company’s business, which is why we did not examine it here – plus, our channel checks did not yield unique insights into that business line.

Valuation Conclusions

Based on this analysis, it seems like Jazz is undervalued by anywhere from 20% (conservative estimate) to 50%+ (our belief based on these financial projections). Even with Street Case consensus financial projections assumed, the company is still undervalued by around 10% at its current stock price.

Return to Top.

Investment Risks

The top risk factors include:

Defitelio Annual Price Increases - Differential to Base Case Estimates:19954.0% (20.0%) (15.0%) (10.0%) (5.0%) - 5.0% 10.0% 15.0% 20.0%(10.0%) 192.85$ 193.84$ 194.89$ 195.99$ 197.15$ 198.38$ 199.67$ 201.03$ 202.46$ (7.5%) 193.33 194.35 195.42 196.55 197.75 199.01 200.33 201.73 203.21 (5.0%) 193.81 194.85 195.96 197.12 198.34 199.64 201.00 202.44 203.96 (2.5%) 194.29 195.36 196.49 197.68 198.94 200.27 201.67 203.15 204.70

- 194.77 195.86 197.02 198.25 199.54 200.90 202.34 203.85 205.45 2.5% 195.24 196.37 197.56 198.81 200.14 201.53 203.01 204.56 206.19 5.0% 195.72 196.88 198.09 199.38 200.74 202.17 203.67 205.26 206.94 7.5% 196.20 197.38 198.63 199.94 201.33 202.80 204.34 205.97 207.68 10.0% 196.68 197.89 199.16 200.51 201.93 203.43 205.01 206.67 208.43

Defitelio Market

Penetration - Differential to



1) Xyrem prices increasing by lower-than-expected percentages; 2) Outbound / awareness marketing efforts not working as well as expected; and 3) Xyrem generics getting approved and entering the market sooner than expected.

We’ll address each of these risk factors in turn and explain how to mitigate them:

Xyrem Prices Increasing by Lower-Than-Expected Percentages

This is one of the key risks to our investment thesis, because we assume that the price for Jazz’s key drug Xyrem more than doubles before the patents expire and generics enter the market.

If the company announces no price increase for Xyrem this year, or a lower-than-expected price increase, this could reduce market expectations for future price increases as well.

As shown below, however, our estimates for the annual price increases would have to be incorrect by upwards of 40% for the company to be overvalued:

So Jazz’s share price could potentially decline to the $90 – $100 range if pricing expectations in the market suddenly fall to a much lower level.

Interestingly, even if we use the “research consensus” figures and examine the same sensitivity table, Jazz’s implied share price is not that much lower:

Xyrem Annual Price Increases - Differential to Base Case Estimates:19954.0% (80.0%) (70.0%) (60.0%) (50.0%) (40.0%) (30.0%) (20.0%) (10.0%) (0.0%)(80.0%) 88.44$ 89.30$ 90.20$ 91.16$ 92.18$ 93.26$ 94.40$ 95.61$ 96.90$ (70.0%) 97.05 98.33 99.68 101.12 102.65 104.26 105.98 107.80 109.73 (60.0%) 105.65 107.35 109.16 111.08 113.12 115.27 117.56 119.99 122.56 (50.0%) 114.25 116.38 118.64 121.04 123.58 126.28 129.14 132.18 135.39 (40.0%) 122.86 125.41 128.12 131.00 134.05 137.29 140.72 144.36 148.22 (30.0%) 131.46 134.44 137.61 140.96 144.52 148.30 152.30 156.55 161.05 (20.0%) 140.06 143.47 147.09 150.92 154.99 159.31 163.89 168.74 173.88 (10.0%) 148.67 152.50 156.57 160.88 165.46 170.32 175.47 180.93 186.71 (0.0%) 157.27 161.53 166.05 170.84 175.93 181.33 187.05 193.11 199.54




In this scenario, generics enter the market in FY 21 and Xyrem revenue only reaches $300 million in FY 20 and the patient count is cut in half by FY 20 and the price remains almost the same, rising to only ~$58,000 by then. Even with all this, the company’s minimum implied share price is still $83.34.

This scenario is exceptionally unlikely, so we believe that, at worst, this risk factor would result in Jazz’s share price dropping to the $90 – $100 range.

We could hedge against this risk by buying put options with strike prices in that range. Doing so would limit our losses to only 20% – 30% vs. a potential upside of over 50%.

Outbound / Awareness Marketing Efforts Not Working as Well as Expected

The impact of this risk factor is largely the same as the one discussed above, since the market penetration and pricing increases are closely linked.

For this risk factor, an announcement that the Xyrem patient count has not increased by the expected amount (e.g., the company is tracking only ~11,000 or ~11,500 total patients for FY 14 rather than ~12,500) could trigger realigned market expectations.

Once again, under the same logic and the same tables as above, we believe that in the worst case scenario the company’s share price might decline to $80 – $90, and a more likely “negative outcome” would be something in the $90 – $100 range.

We could once again hedge against this risk by purchasing put options with strike prices in the $90 – $100 range, reducing our potential downside to 20% – 30%.

Xyrem Generics Getting Approved and Entering the Market Sooner Than Expected


(80.0%) 83.34$ 83.60$ 83.87$ 84.15$ 84.43$ 84.73$ 85.03$ 85.34$ 85.66$ (70.0%) 89.39 89.78 90.19 90.60 91.03 91.47 91.93 92.39 92.87 (60.0%) 95.44 95.97 96.50 97.06 97.63 98.22 98.82 99.44 100.08 (50.0%) 101.49 102.15 102.82 103.52 104.23 104.96 105.72 106.49 107.29 (40.0%) 107.54 108.33 109.14 109.97 110.83 111.71 112.61 113.55 114.50 (30.0%) 113.59 114.51 115.46 116.43 117.42 118.45 119.51 120.60 121.71 (20.0%) 119.64 120.69 121.77 122.88 124.02 125.20 126.41 127.65 128.93 (10.0%) 125.70 126.87 128.09 129.34 130.62 131.94 133.30 134.70 136.14 (0.0%) 131.75 133.06 134.41 135.79 137.22 138.69 140.20 141.75 143.35




This is perhaps the biggest risk factor because it makes the most significant impact on the company’s valuation when examined individually.

Even though Xyrem is patent-protected until 2024, the first patent expires in 2019, so generics could potentially enter anywhere in that time frame – or even before that.

Three different pharmaceutical companies have filed Abbreviated New Drug Applications (‘ANDA’) with the Food and Drug Administration (‘FDA’) requesting approval to market generic versions of Xyrem.

Roxane Laboratories was the first to challenge Jazz with a generic version of Xyrem, and the company responded with a patent infringement lawsuit against Roxane; the outcome will be decided later this year.

Legal challenges have also arisen from Amneal Pharmaceuticals and Par Pharmaceuticals, though the exact settlement dates for those are unknown.

If the Roxane case goes against Jazz, it may result in generics entering the market far sooner than anyone expects – perhaps in the FY 15 or FY 16 time frame.

As shown in the table below, such a change would mean that the company is currently overvalued by up to 15%:

With a 0% differential to the assumed price increases, each “earlier-than-expected entrance year” reduces Jazz’s intrinsic value by $5 – $15.

While this is a serious risk factor, the company has already taken numerous steps to confront these legal challenges. Witness, for example, the following exchange from the Barclays Healthcare Conference earlier this year:




Year:


So the company is proactively defending itself with lawsuits that are heavily slanted in its favor (the burden of proof is on the generics companies), but even in this worst case scenario, we could still hedge against the risk from generics by purchasing put options with strike prices in the $110 – $120 range.

Additionally, we could long the stock of competitors that stand to benefit from the introduction of Xyrem generics, such as Mylan [MYL].

One final point to consider is that both JZP-110 and JZP-386 extend the Sleep drug franchise that Jazz currently maintains with Xyrem, and will likely benefit from the company’s existing patient and doctor base.

If they make it through clinical trials and come to market in the future, they could conceivably replace lost Xyrem revenue over time.

The Worst Case Scenario

Another risk is that we could be wrong about everything outlined above, from the Xyrem price increases to the market penetration to the generics entrance year.


Here’s what the “worst case scenario” sensitivity looks like, assuming generics in FY 15:

So even if Xyrem turns into a disaster where the revenue drops to almost nothing starting next year, the company is still worth at least $75 – $80 per share, simply on the strength of its other products.

There is relatively little “Balance Sheet protection” here because the company only has $251 million of cash, which equates to $4.23 per share. Tangible Assets minus Liabilities is actually negative, so there is also minimal protection available from asset sales.

However, we could hedge against this extreme downside scenario with:

• Protective put options, purchased at strike prices of $75 – $80 • Longing companies that intended to produce and sell Xyrem generics • Longing peer companies that produce and sell orphan drugs in completely different

market segments

There is another option as well: the company could sell off its Erwinaze and/or Defitelio franchises.

It recently acquired Gentium, the company that produces Defitelio, for ~$1 billion USD, so it is reasonable to assume that they could re-sell the franchise for approximately the same amount.

Erwinaze is tougher to gauge, but with over $200 million in projected FY14 revenue, a price of up to $2 billion might be plausible given the drug’s orphan status and the multiple paid for Gentium.

Therefore, selling off these divisions would give the company approximately $3 billion in cash, which equates to a per share value of $50.51.


(80.0%) 77.89$ 77.97$ 78.05$ 78.13$ 78.21$ 78.30$ 78.39$ 78.49$ 78.59$ (70.0%) 81.22 81.33 81.45 81.57 81.70 81.83 81.97 82.12 82.26 (60.0%) 84.54 84.69 84.85 85.02 85.19 85.37 85.55 85.74 85.94 (50.0%) 87.87 88.06 88.26 88.46 88.68 88.90 89.13 89.37 89.62 (40.0%) 91.19 91.42 91.66 91.91 92.16 92.43 92.71 92.99 93.29 (30.0%) 94.52 94.79 95.06 95.35 95.65 95.96 96.28 96.62 96.97 (20.0%) 97.85 98.15 98.47 98.80 99.14 99.49 99.86 100.25 100.64 (10.0%) 101.17 101.52 101.87 102.24 102.63 103.03 103.44 103.87 104.32 (0.0%) 104.50 104.88 105.28 105.69 106.11 106.56 107.02 107.50 107.99




This is still far below the “worst case scenario” share price in the sensitivities above, but it does show that there are additional options for mitigating the key investment risks.

We would need to conduct additional research and do more valuation work to highlight the best candidate(s) for hedging purposes, but we might start the process with those ideas.

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