As Lilly's pharma lineup delivers, cash-cow Elanco sets up for a much-anticipated IPO

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Eli Lilly is preparing to spin off its animal health unit, Elanco, in an initial public offering. (Eli Lilly)

Back in January 2015, Eli Lilly closed its $4.5 billion acquisition of Novartis Animal Health, making its unit Elanco the second largest veterinary-products company after Pfizer spinoff Zoetis. Elanco has been a reliable cash cow since then, but now Lilly plans to follow Pfizer’s lead and spin off its animal health unit in an initial public offering.

Lilly investors welcomed that news, which came as part of a second-quarter earnings report that handily beat analysts’ forecasts. Despite the black cloud that’s hanging over every Big Pharma today—namely the ongoing discussion in Washington about drug pricing—Lilly managed to pull in better-than-expected sales of most of its key products, including cancer drug Alimta and diabetes powerhouses Trulicity and Humalog.

Diabetes drug Jardiance, however, fell short of expectations—admittedly high, given that a 40%-plus increase wasn't enough.

Overall, Lilly reported revenues of $6.36 billion during the quarter, well above analyst expectations of $6.04 billion, and earnings per share of $1.50, trouncing expected EPS of $1.30. The company also upped its guidance for the full year, pegging 2018 revenues between $24 billion and $25 billion—which adds about $300 million to its previous forecast. Lilly predicts 2018 EPS between $3.19 and $3.29, about 30 cents higher at the midpoint of its projected range. Lilly’s shares rose more than 3% premarket to $91.90.

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Lilly executives decided to spin off Elanco after a strategic review last fall, CEO David Ricks said during a conference call after the earnings release. Ricks refused to put a potential value on the IPO, citing an SEC-mandated quiet period, but he said he expects the transaction to produce returns for shareholders in many different ways.

Casting off the animal health unit “will allow more focus,” he said. “Focus for Elanco on its priorities, allocating its capital to [growing] that business to serve its customers, and focus to Lilly, which for us … would be the human pharmaceuticals business, with many opportunities to invest in creating breakthrough products for patients.”

The company plans a debt offering in the third or fourth quarter of this year before the Elanco IPO, and it will dispose of its remaining interest in Elanco next year. Sales in the unit were flat year over year in the first half of the year at $1.6 billion.

In preparation for the spinoff, Lilly exited several underperforming animal health markets. It stopped producing Posilac, a supplement for increasing milk production in cows, for example, and it suspended the marketing of Imrestor, a treatment for mastitis in cows. Those moves contributed to a 1% sales decline in animal health, but the unit actually grew 8% without those products, Lilly said. The exits should be a positive for the IPO, because they remove “the overhang products from the broader animal health business,” wrote Evercore ISI analyst Umer Raffat in a note to investors.

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No doubt the biggest disappointment was Jardiance, which brought in sales during the quarter of $147 million, up 43% year over year but “surprisingly light,” said Credit Suisse analyst Vamil Divan, M.D., in a note to investors.

Part of that can be blamed on downward pricing trends in the diabetes market. Raffat reminded investors that Johnson & Johnson recently reported a drop in sales of its rival product, Invokana, “which speaks to pricing pressure in oral diabetes,” Raffat wrote.

Analysts are clearly worried about pricing, and President Donald Trump’s “blueprint” to lower drug prices generated plenty of questions during Lilly’s earnings call. But Ricks said it’s too early to worry. “As this blueprint’s been rolled out, I think our point of view is it’s a potentially sweeping set of changes,” Ricks said. “Let’s see what develops here in 2018 as those changes get implemented or not. Then on the back end is this important public conversation about how to reduce out-of-pocket costs for patients while preserving innovation and allowing market forces to prevail?”

Regardless of what happens with pricing trends, Ricks said he's optimistic Lilly would continue to deliver growth and returns to shareholders. Lilly’s decision to spin off Elanco is just part of that larger strategy, he said. Toward that end—and following the lead of many of its peers in Big Pharma that anticipate big benefits from the new business-friendly tax package—Lilly also announced a share repurchase program. It already bought back $5 billion in shares, and now it has authorized a new $8 billion share repurchase program.