Complex Royalty Structures And Drug Pricing Pressures Will Erode Long-Term Cash Flows

Catalysts

About DRI Healthcare Trust

DRI Healthcare Trust acquires and manages pharmaceutical royalty streams to generate long duration, cash flow based returns for unitholders.

What are the underlying business or industry changes driving this perspective?

• The growing reliance on complex, preapproval and synthetic royalty structures to secure target returns increases execution and regulatory risk at the very point where management is leaning into this strategy, which could compress revenue growth and lead to further fair value write downs similar to Vonjo that weigh on earnings.
• Exposure to assets in highly specialized markets, such as thyroid eye disease and niche oncology indications, concentrates risk in small patient pools where any safety signal, label restriction or competing mechanism can quickly erode expected market share, undermining long term royalty receipts and pressuring adjusted EBITDA margins.
• Intensifying competition from large pharma owners of originator products and other royalty funds in a booming royalty deal market is likely to bid up acquisition prices, forcing DRI either to accept lower risk adjusted returns or to move further out the risk curve, both of which threaten future net margins and per unit cash earnings.
• Increasing global scrutiny on drug pricing and reimbursement, including U.S. policy shifts like Medicare discount rules and incentive programs such as MIPS, has already triggered impairments and headwinds in assets like Vonjo and Omidria and is poised to weigh on pricing power for new deals, putting structural pressure on revenue growth and normalized cash receipts.
• Management’s plan to reinvest internalization driven cost savings into headcount and growth initiatives just as the opportunity set skews toward higher complexity and higher risk transactions raises the likelihood that operating expenses outpace realized cash flow growth, diluting EBITDA margins and constraining future distributions and earnings per unit.

Assumptions

This narrative explores a more pessimistic perspective on DRI Healthcare Trust compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming DRI Healthcare Trust's revenue will grow by 1.8% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -26.9% today to 3.5% in 3 years time.
• The bearish analysts expect earnings to reach $7.1 million (and earnings per share of $1.3) by about December 2028, up from $-52.2 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as $107.2 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 94.6x on those 2028 earnings, up from -13.1x today. This future PE is greater than the current PE for the CA Pharmaceuticals industry at 14.8x.
• The bearish analysts expect the number of shares outstanding to decline by 2.05% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.12%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The company is benefiting from strong secular demand for innovative specialty therapies, with total cash receipts up 12 percent year over year and key franchises like Orserdu delivering 51 percent royalty growth, which could continue to support resilient and growing revenue and earnings.
• Ekterly and the newly acquired Veligrotug and VRDN-003 royalties provide long dated exposure to large and expanding markets, such as thyroid eye disease where the market is expected to grow from around 2 billion dollars to over 3 billion dollars, potentially driving sustained growth in royalty receipts and net margins over the next decade and beyond.
• The internalization of management has already produced adjusted EBITDA margins of 84 percent and management expects further operating leverage, so ongoing cost efficiencies and scale benefits could support expanding margins and rising earnings despite asset specific headwinds.
• Disciplined capital allocation, including a robust pipeline of royalty opportunities, significant undrawn credit capacity and continued unit buybacks that reduce the unit count, may enhance per unit cash earnings and support the unit price over the long term.
• Portfolio diversification across numerous therapeutic areas and mechanisms, combined with conservative underwriting where even challenged assets like Vonjo have cumulative and expected receipts exceeding original cost, may limit downside from individual drug setbacks and stabilize aggregate revenue and adjusted EBITDA.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for DRI Healthcare Trust is CA$14.9, which represents up to two standard deviations below the consensus price target of CA$19.91. This valuation is based on what can be assumed as the expectations of DRI Healthcare Trust's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of CA$22.88, and the most bearish reporting a price target of just CA$13.7.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $204.5 million, earnings will come to $7.1 million, and it would be trading on a PE ratio of 94.6x, assuming you use a discount rate of 6.1%.
  
• Given the current share price of CA$17.07, the analyst price target of CA$14.9 is 14.6% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.