ImClone Systems' ( IMCL) Erbitux seems likely to become a successful colon cancer treatment, but it would come at the price of higher-than-expected royalty payments, prompting Citigroup Smith Barney to downgrade the stock. Shares of ImClone were off $8.67, or 13.1%, to $57.37 after Citigroup analyst Yaron Werber lowered his rating to hold from buy, telling investors royalty payments would be more than four times greater than he previously anticipated. With sales of Erbitux expected to surpass $1.5 billion by 2008, royalty payments could eat into Erbitux's profitability, prompting the analyst to cut his price target to $72 from $90. Shares closed as high as $86.79 on July 1. "In our view, the requirement for ImClone to pay royalties for intellectual property relating to sales of Erbitux is not widely appreciated by
Wall Street," said Werber, in his downgrade. "Following our analysis, we now estimate that ImClone's net royalty obligations could reach 6.5% vs. our previous expectations for 1.5%. (The brokerage does and seeks to do business with the companies covered in research reports.) If the drug is approved for the treatment of other cancers, such as those affecting the head and neck, in the second half of 2005, as expected, Werber said that ImClone alone would be solely responsible for some royalties paid to Aventis ( AVE) and the University of California, because it had obtained the rights to certain patents before partnering with Bristol-Meyers Squibb ( BMY) on the drug. Instead of 41% of Erbitux sales, the analyst said that ImClone stood to receive 34.5% of sales. With ImClone issuing no guidance related to royalty payments regarding Erbitux, Werber's view is an estimate based on limited conversations with the company and an analysis of the company's second-quarter results, which were released on July 21. While the company did not issue any royalty guidance last week, Werber told investors the company may be in a position to discuss royalties in the third quarter, once it had negotiated with licensors for the drug. In the meantime, he recommended they avoid buying shares until more visibility was provided.