Royalty Pharma plc Q1 FY2024 Earnings Call

Ladies and gentlemen, thank you for standing by. Welcome to Royalty Pharma First Quarter 2024 Earnings Conference Call. I would like now to turn the conference over to George Grofik, Senior Vice President, Head of Investor Relations and Communications. Please go ahead, sir. Good morning and good afternoon to everyone on the call. Thank you for joining us to review Royalty Pharma's first quarter 2024 results. You can find the press release with our earnings results and slides of this call on the Investors page of our website at royaltypharma.com. Moving to Slide 3. I would like to remind you that information presented in this call contains forward-looking statements that involve known and unknown risks, uncertainties and other factors that may cause actual results to differ materially from these statements. I refer you to our 10-K on file with the SEC for a description of these risks. All forward-looking statements are based on information currently available to Royalty Pharma, and we assume no obligation to update any such forward-looking statements. Non-GAAP liquidity measures will be used to help you understand our financial performance. The reconciliation of these measures to our GAAP financials is provided in the earnings press release available on our website. And with that, please advance to Slide 4. Our speakers on the call today are Pablo Legorreta, Founder and Chief Executive Officer; Marshall Urist, EVP, Head of Research and Investments; Chris Hite, EVP, Vice Chairman; and Terry Coyne, EVP, Chief Financial Officer. Pablo will discuss the key highlights, after which Marshall will give a portfolio update. Next, Chris will discuss our development-stage portfolio. Afterwards, Terry will review the financials. Following concluding remarks from Pablo, we will hold a Q&A session. With that, I'd like to turn the call over to Pablo.

Thank you, George, and welcome to everyone on the call. I am delighted to report a successful start to 2024 as we execute against our vision to be the leading partner funding innovation in the life sciences. In terms of the financials, we delivered 14% growth in Royalty Receipts. This represents our recurring cash flows, and the strong performance in our quarter reflects the quality of our diversified portfolio of more than 35 commercial products. Milestones and other contractual payments, which are more variable, declined, reflecting the high base effect of the year-ago quarter from a nonrecurring Biohaven-related payment. As a result, Portfolio Receipts, our top line declined to $717 million, which was in line with our expectations. Turning to capital allocation. Today, we're announcing an exciting transaction, which is expected to take our capital deployment to approximately $670 million. Marshall will take you through the details. But in summary, we have agreed to acquire royalties and milestones on Sanofi's frexalimab for approximately $525 million, including estimated transaction costs. This is an exciting development stage therapy with multi-blockbuster potential in multiple sclerosis and other immune indications. Following the 5% increase in our dividend in the first quarter, I'm also delighted to announce today a new commitment to grow our dividend by mid-single-digit percentages on an annual basis. Looking at our portfolio, we will have 15 development-stage therapies, which we estimate have the combined potential to generate significantly greater than $1 billion in peak royalties. Most of these therapies have blockbuster sales potential and are in development by premier global marketers. We believe our development stage portfolio is highly attractive and underappreciated by the market, and Chris will expand on the multiple potential events we expect over the next year. Lastly, I am pleased to reconfirm our 2024 full year guidance. We continue to expect Portfolio Receipts to be between $2.6 billion and $2.7 billion, based on expected growth in Royalty Receipts of around 5% to 9%. Consistent with our standard practice, our guidance is based on our current portfolio and does not include the benefit of any future transactions. Slide 7 shows our impressive track record of strong growth since our IPO. As I noted earlier, we delivered 14% growth in Royalty Receipts in our first quarter. This is the highest quarter growth rate we have achieved since the first quarter of 2022 and sets us up well to deliver our full year guidance. The slide also illustrates the variable contribution from milestones and other contractual receipts when we look at the overall trend in Portfolio Receipts. Overall, this track record of strong growth speaks to our ability to execute successfully and consistently against our strategy in the growing market for biopharma royalties. With that, I will hand it over to Marshall to update you on our portfolio.

Thanks, Pablo. I want to focus today on the exciting transaction we just announced for Sanofi's frexalimab. Slide 9 summarizes the details of the transaction and the scale of the opportunity. We have agreed to purchase a royalty interest in frexalimab from ImmuNext, a privately held biotech, and expect to pay approximately $525 million, including estimated transaction costs. In return, we will be entitled to receive a royalty ranging from high-single to low-double digits on worldwide sales. Also, we will share a minority of the royalty with the former ImmuNext shareholders on sales above $2 billion. Importantly, the royalty is long duration, running to 2041, which is central when we think about the returns. In addition to royalties, we will be entitled to receive significant potential milestones. In terms of the commercial opportunity, Sanofi has stated that frexalimab has the potential to achieve non-risk-adjusted peak sales of over EUR 5 billion across multiple indications. In our view, the multiple sclerosis opportunity alone has the potential to generate over $3 billion in peak sales based on its differentiated profile. Should frexalimab generate EUR 5 billion in peak sales, this would suggest peak annual Royalty Receipts to Royalty Pharma of over $400 million. Frexalimab is a first-in-class antibody with a novel mechanism of action targeting CD40 ligand. This pathway is thought to be involved in the development and progression of multiple sclerosis and may play a critical role in other immune diseases. Sanofi's Phase II data was recently published in the New England Journal of Medicine and highlights the clear potential of frexalimab as a high efficacy, non-lymphocyte depleting therapy for multiple sclerosis. Frexalimab significantly reduced disease activity, as measured by MRI, and the clinical relapse rate was close to 0 at 48 weeks. Importantly, the treatment was well tolerated with no notable safety signals. Based on this compelling profile, Sanofi has initiated Phase III clinical development in multiple sclerosis, with results and regulatory submissions anticipated for 2027. Phase II studies are also underway in type 1 diabetes and lupus, two immune diseases in which a role for the CD40 pathway has also been implicated. Slide 11 provides an overview of the fundamental drivers of our excitement in the exceptional opportunity offered by frexalimab. On top of the compelling Phase II efficacy, the differentiated mechanism of action may provide a potential safety differentiator versus existing high-efficacy multiple sclerosis therapies. We would also note that strong Phase II data in MS has historically been highly predictive of success in the Phase III setting. Furthermore, our statistical analysis confirms that Sanofi studies are well-designed and powered for success. Commercially, our proprietary U.S. claims analyses suggests that nearly 100,000 patients will have discontinued anti-CD20 therapy by the time frexalimab launches in 2028, a large addressable market that alone supports blockbuster potential for frexalimab although we anticipate use in a broader set of MS patients, if approved. Moving to Slide 12. Frexalimab checks all the boxes for us. Clearly aligning with our product selection framework, it's a potential first-in-class therapy with strong scientific rationale and a clear commercial position. It has very supportive Phase II clinical data, and it will be marketed by a leading global immunology company. Frexalimab is, as Sanofi describes it, a pipeline and a product across several immunology indications and importantly, has the potential to contribute significantly to our growth in our Royalty Receipts with an attractive return profile and long duration. And with that, I'll hand it over to Chris.

Thanks, Marshall. I want to expand on the frexalimab transaction and highlight the broader potential of our growing development-stage pipeline, which we think is underappreciated by the market. A strong pipeline is central to our strategy. Instead of focusing on any one project in detail, we want to provide an overview of our current development stage portfolio. Slide 14 summarizes the key take-home messages. In short, since our IPO, we have assembled a portfolio that consists of 15 development stage therapies, which we believe have the potential to contribute greater than $1 billion combined peak annual royalties. Most of these therapies in development are potential blockbusters and are in the hands of powerful marketers. We have carefully managed the risk profile of this portfolio by selecting therapies that meet our product framework and that are primarily in late-stage development. We have also built in risk mitigating deal structures where possible. Lastly, we see the potential to begin unlocking the value of this exciting portfolio through multiple clinical and regulatory events, which we expect over the next 12 to 18 months. These include the FDA action date for KarXT, FDA filings for aficamten and pelabresib, and pivotal study results for seltorexant, Teva-749 and Tremfya in Crohn's. And in 2025, we expect outcomes data for pelecarsen, which has the potential to be a very significant royalty for our portfolio. Slide 15 highlights that we have deployed capital of close to $23 billion since 2012, with a healthy balance between approved and development stage therapies. Over the period, the majority of our capital has been deployed to acquire royalties on approved products. And even with the expansion of our development stage pipeline I just referenced, this weighting towards approved products has remained the case since our IPO. However, when we look on an annual basis, there is considerable variability in this mix, which reflects the opportunistic nature of our business. Slide 16 shows that our development stage pipeline has grown fivefold since our June 2020 IPO. The graphic on the right-hand side illustrates that our pipeline is nicely diversified by therapeutic area, including neurology, psychiatry, cardiology, cancer, rare disease and in immunology. When it comes to investing in development-stage therapies, we have a strong track record. On Slide 17, you can see that we have invested around $9 billion in this category and that our success rate has been high. Approximately 70% of our development stage investments have gone on to receive regulatory approval. Around 20% are still in development and only 10% have not reached the market. This record reflects our diligence process, including the product selection framework Marshall spoke to. Our ability to identify therapies with unmet and underserved patient needs and our large opportunity set. To balance the higher inherent risk versus approved products, we target returns in the teens for development-stage investments. Expanding on my previous point, on Slide 18, we believe we have a unique and powerful approach to development-stage investing. In terms of product selection, in addition to requiring strong proof-of-concept data, we often partner directly with the innovators so that we have access to additional insights into the clinical program and sales potential. Once we have made the product selection, we typically structure the transaction to include risk mitigation strategies, and also ensure we are strongly aligned with the interests of our partner. These strategies can include investing in post-pivotal study therapies, our deep due diligence supported by patient-level data and regulatory correspondence and receiving a portion of return through milestones and stage-investing, to name a few. You can see here a number of examples that illustrate our unique approach, including our investments in KarXT, aficamten, frexalimab and Merck-8189. Slide 19 is my final slide. It shows our late-stage development pipeline by potential peak sales and the associated royalty we could expect to receive. Importantly, these all have first or best-in-class potential and are supported by world-class marketers. The majority have multi-blockbuster potential. And in aggregate, we estimate the combined peak sales at over $25 billion on a non-risk-adjusted basis. Based on the respective royalty rates, this could potentially translate to over $1.25 billion in annual peak royalty to Royalty Pharma, with frexalimab and olpasiran potentially the largest individual contributors. I would also add that we are pleased with the positive news announced by Teva that Teva-749, a long-acting injectable version of the antipsychotic olanzapine, achieved its primary efficacy endpoint in the Phase III study and continues to have an encouraging safety profile. We look forward to additional updates in the second half of the year. As a reminder, in the fall of 2023, Royalty Pharma partnered with Teva to provide up to $125 million in R&D funding for the Teva-749 Phase III program. We will receive a milestone payment on FDA approval as well as low to mid-single-digit royalties on its sales. Given its emerging differentiated safety profile in a market with significant unmet need, we are excited about the commercial potential for Teva-749. This, once again, highlights our unique ability to identify attractive products across the biopharma industry and partner with innovators to accelerate development. As these products become commercial, they will contribute to our attractive compounding growth in the years ahead. To close, we have an exciting development stage portfolio, with multiple expected upcoming events so you can see why we expect to continue to deliver attractive compounding growth in the years ahead.

Thanks, Chris. Let's move to Slide 21. Royalty Receipts grew by 14% in the first quarter, reflecting the strength of our diversified portfolio. The key drivers of growth were the strong performance of our base business, notably our cystic fibrosis franchise and Trelegy, as well as the acquisition of incremental Evrysdi royalties. Portfolio Receipts, our top line, declined by 37%, reflecting the impact of nonrecurring items in milestones and other contractual receipts in the year ago quarter. Specifically, in the first quarter of 2023, we received a $475 million milestone payment following the FDA approval of Pfizer ZAVZPRET. As a result of this nonrecurring item, milestones and other contractual receipts declined to $12 million in the quarter. This decline was entirely consistent with expectations and fully reflected in our full year 2024 guidance. Slide 22 shows how our efficient business model generates substantial cash flow to be reinvested. Portfolio Receipts amounted to $717 million in the first quarter. As we move down the column, operating and professional costs equated to 8.4% of Portfolio Receipts. Net interest paid of $73 million reflected the semiannual timing of our interest payment schedule, with payments falling due in the first and third quarters. Moving further down the column, we have consistently stated that when we think of the cash generated by the business to then be redeployed into value-enhancing royalties, we look to adjusted EBITDA, less net interest paid, or as we call it, portfolio cash flow. This amounted to $584 million in the quarter, equivalent to a margin of around 81%. High level of cash conversion, once again, highlights the efficiency of our business model. Capital deployment in the first quarter was a little under $100 million, but will be approximately $670 million after we acquire the frexalimab royalty. Slide 23 shows that we continue to maintain significant financial capacity for future royalty acquisitions. In total, we have over $3.5 billion available through a combination of cash on our balance sheet, the cash our business generates and access to the debt markets. At the end of the first quarter, we had cash and equivalents of $843 million. Following the approximately $525 million of cash payments related to the ImmuNext transaction, this will take our cash and equivalents to approximately $320 million on a pro forma basis. When we turn to our borrowing position, on top of our $6.3 billion of investment-grade bonds, we maintain significant leverage capacity, which we can take up to 4x as the right opportunity arose. Furthermore, we have additional undrawn financial capacity from the $1.8 billion revolver. Taken together with our strong cash generation, we feel good about our ability to continue to execute transactions and create shareholder value. Slide 24 sets out our unchanged full year 2024 financial guidance. We expect Portfolio Receipts to be in the range of $2.6 billion to $2.7 billion. Let me walk you through our assumptions. First, within our overall top line guidance, we expect to deliver continued attractive growth in Royalty Receipts of around 5% to 9%. We anticipate the strength of our diversified portfolio will more than offset Imbruvica and Tysabri headwinds. Second, we face a high base of comparison in 2023 as a result of the $525 million of Biohaven-related payments we received last year. As you have seen today, the largest element, the $475 million ZAVZPRET milestone was received in the first quarter of 2023. Milestones and other contractual receipts are, therefore, expected to decline from around $600 million in 2023 to approximately $30 million in 2024. Lastly, our guidance assumes a negligible foreign exchange impact. Importantly, and consistent with our standard practice, this guidance is based on our portfolio as of today and does not take into account the benefit of any future royalty acquisitions. For the second quarter, we also anticipate Portfolio Receipts to grow in the high single digits compared to last year's second quarter. Turning to operating costs. Payments for operating and professional costs are expected to be approximately 8% to 9% of Portfolio Receipts in 2024. We continue to believe that the degree of margin protection provided by our unique business model is impressive. Interest paid for full year 2024 is expected to be around $160 million, with de minimis amounts to be paid in Q2 and Q4. This does not take into account any interest received on our cash balance, which was $6 million in the first quarter. With that, I would like to hand the call back to Pablo for his closing comments.

Thanks, Terry. Let me begin my concluding remarks by saying how delighted I am with our start to 2024. We delivered double-digit growth in Royalty Receipts. We strengthened our exciting development-stage pipeline, and we have announced a strong new commitment on our dividend growth. On my final slide, I want to highlight our incredible track record of consistently identifying exciting ways of biopharma innovation and finding ways to participate, from Rituxan, the first monoclonal antibody for cancer, to Gilead's HIV franchise to HUMIRA, where we invested in 2006 and it later became the industry's biggest selling product to more recent life-changing therapies like Trikafta for cystic fibrosis and Evrysdi for spinal muscular atrophy. And when we look ahead, we expect to see a number of the exciting development-stage therapies we talked about today joined this list, transforming the lives of patients with multiple sclerosis, cardiovascular disease and schizophrenia, among others. The ability to identify new waves of innovation and to constantly replenish our portfolio with life-changing therapies is our DNA, and we're confident that it can continue. With our simple, but powerful business model, our deep access to capital, we're confident we can continue to deliver attractive compounding growth over the remainder of this decade and beyond. With that we would be happy to take your questions.

And our first question comes from Chris Shibutani with Goldman Sachs.

Congratulations on the deal with frexalimab. The opportunity that is at the forefront, clearly in MS, but they're also in advanced clinicals. Maybe, Marshall, can you help us how you risk assess and think about the potential in the other indications? I think there's Sjogren's as well as type 1 diabetes and lupus, the latter 2, in particular, historically quite challenging.

Chris, absolutely. We are really excited to be adding frexalimab to the portfolio. And as you correctly observed, our - the core of our thesis and our view was really based on MS, where a very consistent and compelling set of Phase II data. As we mentioned, Sanofi is going forward in other indications, type 1 diabetes and lupus. Both are interesting. I think, certainly, we'll wait to see how the Phase II data there works out. There's not a lot of precedent data for CD40 in those areas, but I think they would definitely add potential sources of upside to the transaction. And then just as a reminder, Sanofi has said that in Sjogren's, they actually aren't going forward there in Phase II. But I think - but as we said, based on MS was really the base of this investment, and we're really excited to have this as part of the portfolio.

Our next question comes from Geoff Meacham with Bank of America Securities.

I have a couple of questions. First, regarding Marshall and frexalimab, can you explain the strategy related to the MS market and your approach to Tysabri? Do you believe that replacing the economics of Tysabri is a possibility in the long term, particularly given the current challenges in the MS market with generics? My second question, directed to Terry or Pablo, pertains to capital deployment. I noticed that there wasn’t much in terms of share buybacks when that was initially announced. Could you clarify the rationale behind the commitment to a dividend over buybacks? Considering your strong cash generation, I’d like to gain some insight into your thoughts on this matter.

Thanks for the question, Geoff. And I think Marshall can definitely take the question on frexalimab. And then I think Terry will talk about capital deployment and our commitment to dividend growth.

Absolutely. Geoff, just to quickly address frexalimab, the rationale for its development was not to fill any gap left by Tysabri. It emerges from our strategic approach to building our portfolio, which focuses on identifying high-quality products that meet the criteria of our product selection framework discussed earlier in the call. This is central to our strategy, and we are genuinely excited to have it in our portfolio. Regarding the commercial opportunity, while the current dominance of the CD20 class is significant and beneficial for patients, we believe that as the market evolves, there will be a demand for high-efficacy alternatives with different mechanisms of action, which is precisely what frexalimab provides. This forms the basis of our belief that it will be a valuable product for both patients and Royalty Pharma.

I want to quickly add to what Marshall said: Royalty Pharma has been very successful in investing in diseases like multiple sclerosis, highlighted by Tysabri, and we previously had a royalty on Tecfidera. Overall, we have invested $3.4 billion in MS with strong results, and with an additional investment of around $500 million, we believe this area still holds significant potential for improving current therapies.

Geoff, regarding your question on capital allocation, our top priority continues to be acquiring new royalties, as we believe this is the best way to generate long-term value. We have consistently paid dividends since our IPO and have been increasing it every year for the past 20 years. Since the IPO, we’ve seen growth in the mid-single digits or better, and we fully intend to maintain that growth rate. This commitment reflects our existing plans, and we wanted to make it clear to investors regarding our capital allocation. As for share buybacks, we view them as a valuable tool. When considering buybacks, we also think about the opportunities available to us. The team is quite active, and we are excited about the various opportunities ahead. While we can't predict when transactions will occur, this is a consideration in our capital deployment strategies. As I mentioned, our main focus for capital usage remains to be in acquiring new royalties.

Next question comes from Chris Schott with JPMorgan.

This is Ethan on for Chris Schott. I just have 2 quick ones. So first off, with the 15 development stage assets that you noted, how do you think about the balance of Royalty's portfolio at this point? And maybe more specifically, as the company becomes larger and more diversified going forward, is there an ability or desire to view capital deployment more towards the development stage where you might get greater potential returns? And then the second question is just how you think about the 2025 Medicare Part D Redesign and any estimate on the impact to your portfolio at this point?

Sure. I would like Marshall and Chris to address the Medicare and other questions. At a high level, our business has been very successful over many decades, especially since we began investing in unapproved assets over a decade ago. We believe that maintaining a balance of 60-40 between approved and unapproved assets is a solid strategy for continued growth. Could it shift to 50-50? Absolutely. However, the 60-40 ratio reflects the total capital invested in both approved and unapproved categories. In reality, about $9 billion of our investment in unapproved assets has resulted in a high approval rate of around 70 percent, as noted in our presentation. Additionally, we have strong data on other candidates like KarXT, aficamten, and seltorexant, which we consider to have a high likelihood of approval. It's important to understand that the $9 billion represents our cumulative investment, and as some of these assets gain approval, it allows us to invest further in unapproved assets. As our business expands, we believe that maintaining an approximate balance of half in approved and half in unapproved assets will be a good goal for us. Marshall, over to you.

Great. The last part of your question concerned the 2025 Medicare Part D redesign. Like many, we are still considering the specifics on a product-by-product basis. However, I want to remind everyone that the Royalty Pharma portfolio has limited exposure to Medicare Part D. We've highlighted three significant products in our portfolio regarding the potential for IRA negotiation: Xtandi, Imbruvica, and Trelegy. The same conclusion applies to the Medicare Part D redesign; we do not anticipate a significant impact on our portfolio. We have a balance of higher-priced products and something like Trelegy, which is lower priced, resulting in different dynamics within the Medicare Part D redesign. The key point is that we currently have limited exposure, and as we continue to invest and enhance our portfolio with products like frexalimab, we will increase the diversity of our portfolio.

The next question comes from Peter Verdult with Citi.

It's Peter here from Citi. I have a few questions. First, regarding frexalimab, we really value this asset, so I want to clarify, Marshall, is its valuation still primarily focused on MS, or have you also included any placeholder value for lupus and type 1? That’s my first question. Second, there are many positive developments in the pipeline, but there have been some recent setbacks. I’d like to understand how you assess the risk profile of pelabresib, especially considering the emerging safety concerns. Lastly, Marshall, I need some clarification. When reviewing the ImmuNext press release, it mentions that frex sales have surpassed $2 billion, and the royalty structure has shifted from full royalties to a minority share. I want to confirm whether your earlier comment about receiving $400 million in royalties from EUR 5 billion aligns with what’s stated in that ImmuNext press release.

Pete, welcome to the call. To address your questions, first regarding frexalimab, our primary focus is indeed on MS. We take an optimistic view that additional indications could be pursued by Sanofi, which would enhance sales. While this isn't part of our core analysis, we appreciate investments like this that offer the possibility for indication expansion. As for pelabresib, there's not much new information beyond what’s publicly available. We're monitoring the situation like everyone else, but I encourage you to consider pelabresib within the larger context of our investment in MorphoSys. While pelabresib is an intriguing product, it was just a small aspect of the deal, which primarily centered around the valuable royalty on Tremfya that we established. Lastly, regarding the royalty structure, we retain a significant majority of the royalty. When sales surpass $2 billion, there is some sharing with the former shareholders of ImmuNext, but we still keep the majority share, which is a model we've implemented in past transactions as well.

Our next question comes from Umer Raffat with Evercore.

This is Mike DiFiore in for Umer. Congrats on the deal. A few for me on frexalimab and then one follow-up. On frexalimab, would you be able to quantify the minority share of royalties? Like what percentage you get above $2 billion? And also the total amount of milestone payments and the cadence of them. And also on Slide 11, regarding the unmet need, it implies that there is significant opportunity after patients discontinue anti-CD20s, which also implies that either patients are still not too far along in their disease after they can discontinue or they had entered the non-relapsing SPMS phase, and that frexalimab can be efficacious in this setting. What gives you confidence that this may be the case? And I have a follow-up.

Sure. Just to clarify everything, we haven't specified the exact amount of sharing. However, to reiterate the answer to Pete's question, we retain the majority of the royalty above $2 billion. Regarding the milestones, we haven't provided much detail. We mentioned in our press release, or rather in the slides, that nearly half of the purchase price could potentially be recouped through what we consider high-probability milestones, offering some context on the scale. As for the unmet need, we want to clarify that we're not making a statement on secondary progressive MS at this time. However, when we analyze our claims data, we notice that patients are on CD20 therapies for an extended period. While these are effective medications, we observe that patients do discontinue over time. This population will likely be significant by the time frexalimab is launched. At recent MS and neurology conferences, experts are beginning to discuss some long-term side effects associated with chronic B-cell depletion. When we consider all of this, it suggests that there is a compelling and substantial market for frexalimab. Nonetheless, we believe its application extends beyond this specific group. We're really focused on highlighting the unmet need for new mechanisms of treatment, and we believe that frexalimab is well positioned to address this gap.

Got it. And then my follow-up is just on the pace of deals. Can we expect the deal pace to pick up in the back half of the year? Recognizing that today's deal was phenomenal. And how might the higher for longer outlook on interest rates factor into the types of deals that Royalty Pharma is considering?

Yes. Chris can take the question on deal flow and what to expect, and I think maybe Terry can talk about interest rates.

Thanks, Mike, for the question. We continue to see a very robust environment regarding potential investments, and we're excited about the opportunities available to us. While it's difficult to predict when deals will materialize, we are very encouraged by the current funnel and the opportunities ahead.

And then on rates, Mike, I think what we've tried to reiterate is that our business is really agnostic to the rate environment. And we've been sort of highlighting this with the deals that we've done, I think even including the deal today, which we think is going to generate really attractive returns, longer term. But I think that the key for us is that we feel like we're able to continue to maintain the same spreads above our cost of capital on new investments regardless of the rate environment. And so you'll see that as rates are sort of as they drifted higher, we are targeting slightly higher returns. And I think that really shows how our business really is agnostic to the rate environment.

Next question comes from Steve Scala with TD Cowen.

Just to be clear on frexalimab, it sounds as though type 1 diabetes and lupus are not part of the initial deal, maybe you can confirm that. But is subcutaneous formulation part of the initial deal? And what aspects of the molecule were the toughest for you to become comfortable? So that's the first question. Second question, Chris, you mentioned milestones for this year. Apologies if I missed it, but did you mention the PDE10A inhibitor Phase II data from Merck, which is expected? And if not, why didn't you mention it? And then the last question is you've gotten the obesity question, I think every quarter for a while now. And every quarter, you say you're always looking. But within obesity, does RPRX have a preference for oral versus subcutaneous, muscle sparing versus not muscle sparing and degree of weight loss. So in other words is, more the better, always the case? Or is it not necessary for the masses, so you're not necessarily pursuing that?

Thank you for the question, Steve. To clarify, the terms of the frexalimab deal may be a bit confusing for some. The license we have allows us to receive royalties on all potential indications for the product, and all of those are included. We needed to be confident that this product would achieve a strong level of sales in MS to consider it an appealing investment with attractive returns. We are quite optimistic about it reaching over $3 billion in MS sales, and we see potential in other indications as well, particularly in type 1 diabetes and lupus, where we will also receive royalties. Beyond the $525 million upfront payment, there will be some profit-sharing with ImmuNext's shareholders for sales exceeding $2 billion, but the share we retain will be a significant majority of the royalties above that threshold. In terms of milestones, we estimate that out of the total milestones associated with the license, totaling just over $400 million, around $240 million are high-probability milestones related to actions like filing and dosing in other indications and Phase III trials, which we believe are likely to occur. This aspect adds to the attractiveness of the deal. Now, let me pass it over to Marshall to discuss Merck and then obesity.

Sure. Regarding Merck, I believe most of Chris' comments concentrated on the later stage programs in our pipeline. Just a reminder, 8189 has a Phase IIb trial that will be announced soon. That might be why it wasn't discussed as much as some other topics, but we are still enthusiastic about its potential and look forward to further developments. In terms of obesity, you'll likely receive a similar response from us. Your question touches on a crucial point: there are various approaches to address what is clearly a significant and appealing market. We are continuously exploring opportunities within all those different dynamics, including delivery methods and biological factors. Our overall perspective is that there will be opportunities for multiple types of products suitable for different patients at various stages of managing their obesity, which will create further possibilities. We will maintain our opportunistic strategy of identifying the right opportunities at the right times that align with our goals and those of our partners.

One moment for the next question. The next question comes from Terence Flynn with Morgan Stanley.

This is Dan on for Terence. I was just wondering on Tremfya in Crohn's disease at this point, kind of how you're thinking about market share capture and the indication and views on the competitive profile versus SKYRIZI?

Sure. Thanks for the question on Tremfya. So that's one that we remain really excited about. So I think with the recent updates from Janssen, where we were as part of our thesis when we added that to the portfolio and continue to be excited about the potential in IBD, the data so far that we've seen looks very compelling and competitive. And just as important in this space, as data is the strength of the marketer and the scale of their platform behind it. And so we're really happy to have this product in the hands of J&J, who is one of the biggest marketers in this space, and we think we'll be able to maximize the value of Tremfya in IBD in the IL-23 class, which is attractive and growing really nicely.

The next question comes from Di Zhao with UBS.

This is Di on behalf of Ash. We have one for frexalimab. It seems like CD40s have accomplished the history with thromboembolic events. So I understand from your perspective, like frexalimab may not have this issue, but has Sanofi provided you any data beyond what was shown in the Phase II that gives you strong conviction on assets here.

Sure. Marshall, why don't you take this question?

Yes, that's a good question regarding the history of these antibodies. We examined that history closely during our diligence process, and the team did an excellent job. We also benefited from collaborating with the ImmuNext team, who contributed significantly to the development of frexalimab, using insights gained from first-generation antibodies, which had a safety issue. What reassured us were two key aspects: firstly, the antibody's engineering and design incorporated changes aimed at eliminating that risk, supported by substantial basic science and preclinical work. More importantly, clinical data shows that a significant number of patients have been treated, and particularly in the MS data, these patients have now been under treatment for over a year without any safety signals. This gave us confidence that the concerns associated with first-generation antibodies were addressed, and we look forward to gaining further insights into frexalimab's clinical profile in MS and other indications in the future.

I show no further questions at this time. I would now like to turn the call back to Pablo for closing remarks.

Sure, thank you. Before we conclude today, I want to emphasize an important point for our shareholders and analysts. We announced a significant deal today, showcasing how Royalty Pharma consistently identifies highly promising potential blockbusters from strong companies. Our presentation illustrates our ongoing investments in some of the most exciting new drugs across various innovation phases. Additionally, we've focused on our impressive pipeline of unapproved products that we've built over the past decade or five years of investment. We want to highlight the substantial potential that Royalty Pharma holds in these unapproved products, which we expect to advance over the next two to three years, leading to significant milestones as we have data readouts and approvals. This aspect of Royalty Pharma is often underappreciated, and we are very excited about it. I want to thank everyone on the call for your continued interest in Royalty Pharma. If you have any follow-up questions, please feel free to reach out to George Grofik and his team. Thank you, everyone.

This does conclude today's conference call. Thank you for your participation. You may now disconnect.