Trophy Asset Spotlight #2: Royalty Pharma

November 01, 2022

What if I told you you could get royalty payments for every sale from some of the most successful drugs in the world?

I’m talking about best-selling drugs from Pfizer, Johnson & Johnson, Merck, Celgene, Gilead, AstraZeneca, BioCryst, Vertex, and more.

Drugs like Humira*, Remicade*, Lyrica*, and Imbruvica.

The company collecting royalty payments on every sale of many top selling drugs is Trophy Asset Holding, Royalty Pharma (RPRX). 

You see, pharmaceutical companies spend tens of billions of dollars on developing bleeding-edge cures and treatments. It can take up to $2 billion to bring a drug through all three clinical trials.

If approved, these companies then spend billions more on marketing.

Therefore, it can take years before a company earns a positive return on its investment.

This is where Royalty Pharma steps in. They pay these pharmaceutical companies a certain amount of money in exchange for a royalty on that particular drug.

It’s a win-win.

Pharmaceutical companies get to take chips off the table by de-risking their investment. Royalty Pharma gets a royalty on the respective drug over the rest of the drug’s patent life. Their average royalty duration is 13 years. (A drug usually has a patent life of 20 years.)

It’s not just pharma companies looking to Royalty Pharma.

It’s universities. Hospitals. Non-profits. And also small-mid cap companies.

All have their own respective reasons for working with RPRX.

Royalty Pharma collects royalties on 45 commercial products — 12 of which are blockbuster drugs taking in more than $1 billion in revenue. It’s got another 12 in the development stage.

It truly is the behemoth in this space. And checks off every box when it comes to qualifying for our Trophy Asset Pillar.

1) Dominant Market Share

First, it is the market leader. Longtime readers know we like to invest in monopolies or pseudo monopolies.

Monopoly companies, on average, returned double that of the S&P 500 benchmark during 2001-2010.

Royalty Pharma has become the market leader over the past 20 years. Its market share is around 60% since 2012 in overall biopharma royalty deals. But has an 83% market share on deals over $500 million.

Meanwhile, their size and reputation gives them the lowest cost of capital in the industry. Their current average interest rate on their long-term debt is just 2.2%. Most of their debt doesn’t mature for another 10+ years, too.

So this makes it quite an easy hurdle to make their interest payments — assuming they invest well. Which they do. They target 10-15% annual returns on their investments. So the “carry” — the difference in royalty receipts minus interest payments — allows the cash flow to the bottom line and invest in more deals.

2) Premium Business Model

The royalty business model is one of the best out there.

We’ve discussed royalty businesses before when we initiated a position in Texas Pacific Land Trust (TPL) back in February 2022.

(We booked a 36% gain in 4 months by selling 1/3 of our position. But have added onto the position over the following months. Our clients are up at least 45-50% on average on their TPL positions.)

Here’s what we said about the royalty business in the TPL missive:

“The royalty business is the best business in the world. There’s no need for capital expenditure, overhead, etc… The drilling company takes care of that. Which means almost all of the royalty revenue flows straight to TPL’s bottom line.”

RPRX sees similar margins because of its royalty business model.

Once invested, there’s no incremental cost to RPRX.

The pharmaceutical company is responsible for commercializing it. Producing it at scale. Etc.

This is what leads to incredible margins.

It’s got 80% gross profit margins. And nearly 65% earnings before interest, taxes, depreciation, and amortization (EBITDA) margins.

This asset-light business allows RPRX to take those profits and reinvest into future royalty streams.

3) Rising Dividend

Royalty Pharma’s business model allows it to return tons of cash to shareholders.

It went public in 2020. And has increased its dividend by an average of 12.5% the past two years.

Management has rightfully said their primary use of free cash flow is to reinvest into future royalty streams. But we still expect dividends to increase by 10%+ over the following years.

We’ve written about the compounding effect of rising dividends when discussing one of our other Trophy Asset companies — Zoetis.

Royalty Pharma doesn’t have a long track record yet. But we expect it to become a dividend compounding machine for years to come.

Final Takeaway

CEO Pablo Legoretta states we’re in a “Golden Age of Life Sciences.”

It is estimated that only the unprofitable pharmaceutical companies will spend more than $1 trillion over the next decade to develop and produce new drugs.

These companies were using cheap debt to finance their development. They’ll need a new source of funding now that we’re in a higher interest rate world.

There’s no better company primed to take advantage of this massive secular tailwind.

The best part is Royalty Pharma checks all the boxes we look for in a Trophy Asset.

It’s got:

  • Dominant market share

  • A premier business model

  • Growing dividends

We plan on holding RPRX for the long term. And will let the power of compounding dividends work its magic. Here’s what we said about compounding dividends in our spotlight of Zoetis:

“That’s the beauty of compounding.

That is why we plan on holding Zoetis for the long term. They are the dominant player in their space. And they’re shareholder-friendly. The exact definition of a Trophy Asset.

We have several other companies within our Trophy Asset pillar that are growing their dividends by double digits annually… with plenty of room to spare.

We expect these companies to be in our portfolio for years to come. Assuming they continue to increase their dividends like years past, we’ll be earning high dividend yields over the long term.

But our Trophy Asset companies aren’t ones to make front page news every day. Their businesses don’t capture investors’ wildest imaginations — Ones that could 10x in a couple of years.

Investors would rather go for the moonshots. Just like they’d rather put it all on red or black at the roulette table.

Our Trophy Asset companies are plain vanilla. Great businesses that dominate their industries and gush cash. Then successfully return that cash back to us shareholders.”

Royalty Pharma isn’t going to make front page news. And we’re fine with that.

RPRX’s dividend yield stands at 1.8% today. Plus we expect them to grow the dividend by 10%+ annually.

The only thing we have to do is… nothing.

We suggest you do the same with your respective Trophy Assets.

Good investing,

Lance

*RPRX’s royalty share expired as these drugs are now approved for generics.

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