Analyst: More Lilly R&D failures likely to trigger 'savage cost cuts'

Eli Lilly CEO John Lechleiter

Eli Lilly rattled analysts today with a cautionary note on some growing market pressures that will make it difficult to hit its $20 billion revenue projection for 2014, which is intended to be its trough year as generic competition combined with a long drought of meaningful new drug approvals combine to take a heavy toll. And it's getting prepared to trim expenses, following a pay freeze announced three months ago.

Following its habit of making bullish projections in the face of repeated setbacks in the clinic, the company ($LLY) spotlighted its three top prospects for a 2014 approval, outlining its pipeline advances and ignoring its reversals. But at least one prominent analyst, Mark Schoenebaum at ISI, wants to know what Lilly plans to do if some of the big prospects in Phase III lose as badly as the last set. And he suggested that a big, painful restructuring--the same kind of reorganization that hit Merck ($MRK) and AstraZeneca ($AZN) and already changed the face of Pfizer ($PFE)--may be the only route left without big new sources of revenue to look forward to.

"One of the most important questions on investors' minds around the margin expansion guidance is the following: Will LLY hit this guidance EVEN IF THE PIPELINE LARGELY FAILS?" queries Schoenebaum in a note to investors. "The operating margin expansion guidance, when originally given, was linked to the company's expectation for pipeline success. At the analyst meeting today, we would like to understand if there if a "Plan B" exists--i.e. if the pipeline does not perform as mgmt currently expects, could the company still hit its 2019 margin target? Plan B would be painful as it would likely involve savage cost cutting in the face of continued pipeline disappointments."

As the analyst notes, there are two distinct schools of thought about Lilly's pipeline. One, represented by Tim Anderson at Bernstein, is that Lilly's broad pipeline of late-stage assets will rescue the company from the loss of patents on the company's top drugs. The bear view, though, is that more failures of high-profile programs--like the recent Phase III failure of ramucirumab for breast cancer or last year's fiasco with the solanezumab flop in Alzheimer's--will leave Lilly no way out except with a restructuring. And that would alter CEO John Lechleiter's long-term plan for staying the course with in-house research.

Lilly's position is simple: Everything is great.

In its release today the company repeated a mantra that has dominated discussions about the company's prospects. The company has 13 drugs in late-stage development, including three--dulaglutide, empagliflozin and ramucirumab (for gastric cancer)--that could be approved next year.

"We've undertaken extensive efforts to transform our company to address the challenge of patent expirations and the demands of patients and payers for greater value from medicine," Lechleiter said in a statement. "Today, we're seeing our strategy bear fruit, backed by clinical data that strengthens our confidence in our innovation-based strategy and in our ability to return to growth."

Lilly's perfect bull case, though, is riddled with holes. Ramucirumab looks distinctly less valuable in the gastric cancer arena than it would have for breast cancer. Empagliflozin is another SGLT2 drug for diabetes, an area that is already competitive and subject to a high safety standard at the FDA. Even if approved many analysts don't believe it can hit the blockbuster mark.

Lilly's credibility here has been further damaged by a bad miss on Amyvid, an imaging agent for Alzheimer's that looked like a sure thing a few years ago, when the company bought it out in an $800 million deal. The FDA finally approved it after some delays, but Medicare recently came down with a final rejection on reimbursements in all but a handful of cases.

The big drug in Lilly's pipeline is dulaglutide, which has amassed a positive and promising cache of late-stage efficacy data. Anderson projects peak sales for the diabetes drug at $1.7 billion in 2020. That's not enough to make up for the patent losses, but it would go a long way to providing some credibility for an R&D group that is drawing an increasing level of critical scrutiny.

The litany of clinical failures at Lilly over the past 2 years has threatened to pick apart management's best-case scenario, a trend that's been underscored by a growing number of reports picking up on the steady diet of R&D failure at the pharma giant. Today, Lilly's weakening financial condition forced shares down 4%. One strong push now could derail Lilly's carefully constructed narrative. 

In the meantime, Lilly says it will cut costs to make good on its bottom line projections for next year, as the blockbuster numbers from Cymbalta bleed off the books. And it will go ahead with a $5 billion stock buyback to help keep investors content until new drug approvals can start coming through.

- here's Lilly's release 
- read the story from Reuters on cost cutting