Orphan drugs, those treating rare conditions for small segments of the population, do not normally get much attention compared with the likes of a $12.9 billion Lipitor -- but their approval by regulators can still mean huge gains at small biopharmaceutical companies.
One company in particular has just started the last stage of clinical trials and could be as little as a year away from applying for new drug status. The company recently issued more shares on the secondary market to pay for ongoing development costs, with insiders and big-money investors quick to snap up shares and maintain their control of the company.
This may be a sign of good things to come.
Is A Blockbuster On The Way?
This company entered Phase III trials for its most promising asset in February and expects to complete clinical trials by October 2014. The asset, sebelipase alfa, is a recombinant form of the LAL enzyme, which could be used to treat a deficiency in people that causes fatty buildups in the liver and spleen. Earlier data on the enzyme showed that all patients showed continued improvement over a 12-week period.
Phase III trials are the last testing required before a new drug application can be submitted to the FDA. The enzyme has been granted orphan status, meaning that it has fast-track status for approval once an application is submitted and that it will enjoy a longer period of patent protection than other drugs.
Estimates for sales after approval are up to $650 million in the United States and Europe alone. That represents a third of the company’s current market cap and would be a game-changer for the shares.
Beyond sebelipase alfa, the company has four other assets all in early development and with expected revenue over $2 billion. With these small biopharma names, any progress or development in trials could mean big gains in the share price.
Insiders And The Smart Money
But those in the know are not waiting around for higher prices. Felix Baker, chairman of Synageva BioPharma (Nasdaq: GEVA), recently put down another $60 million bet on the company, increasing his stake to 14.3 million shares, equal to $901 million.
The purchase was in conjunction with the company’s secondary stock offering of 2.75 million shares to raise cash for future research and development. The purchase maintains Baker’s holding at about 35% of the total shares outstanding.
Institutional investors also have a strong position in the company: 94% of shares outstanding are in the hands of insiders or big-money players. These insiders and institutional investors recognize the potential of sebelipase alfa and will most likely hold on to the shares until a major developmental breakthrough.
High Risk, High Return
The issue with small drug developers is always their cash burn rate. Because it could be years before these firms sell a drug to a major pharmaceutical company or receive approval for a product, they burn through massive amounts of cash for testing and development.
Synageva had a burn rate of $31 million in 2012 after a rate of $15.6 million in 2011. The faster rate last year is mostly a result of an additional $20 million spent on research and development. This is expected of a company in the later stages of development, and the cash burn could be even higher this year.
If you are now worried that a company can last while burning through tens of millions a year, don’t be. Synageva had $285 million in cash on the balance sheet at the end of the last quarter and just raised another $189 million with its share offering. That’s enough to cover more than 15 years on last year’s cash needs.
Synageva won’t need that long -- the pipeline has some major revenue coming. The five assets have a combined worldwide potential revenue stream well over $2.5 billion a year.
For a valuation comparison, look at peer Alexion Pharmaceuticals (Nasdaq: ALXN). It carries an enterprise value-to-revenue multiple of 16.5. Even at a conservative $650 million in sales for sebelipase alfa, that means the enterprise value for Synageva could be $10.7 billion, more than seven times the current value, which would justify a share price of roughly $378 per share. That is 500% higher than the current share price -- and that's based on just one of the company’s five assets.
There could be an argument for a long-term investment in the shares, sticking around to see how trials develop on the other four assets. I do not generally hold small-cap biopharma stocks that long, and I wouldn’t suggest you do either. The stock has surged on news of Baker's bet, but there's still a good risk-return trade-off under $80 per share.
A fairly sizable short interest has built in the stock after the recent increase in price, just over 13% of the shares available. The stock has jumped 45% since the beginning of September, and that kind of increase in an early-stage company brings out the short sellers. The shares could give back some of their gains, but those potential losses would be nothing compared with the upside after Phase III completion or an FDA approval.
Rather than a price target, I would wait for developments in the sebelipase alfa enzyme before making sell decisions. The shares could surge on news that the company has completed Phase III trials and has applied for a new drug patent. From there, you could take some profits on some of the position and wait for a year on the rest of your holding. As an orphan drug, the application should not take more than a year to be reviewed and could lead to another pop in the shares.
I would cash out after any news on the new drug application and not wait for developments in the other four assets, which could take several years.
Risks to Consider: The final stage of trials for the company’s oldest drug is still a year from estimated completion, and Synageva still must file an application with the FDA after that. With any pharmaceutical developer, there is the risk that drugs just won’t work out; investors should diversify against that risk with holdings of several companies.
Action to Take --> Baker is optimistic on the future of the company to the tune of almost $1 billion, and GEVA could have a huge upside over the next couple of years. As with any speculative play, this shouldn’t be a large percentage of your portfolio -- but it’s worth a look on pipeline prospects.