Interesting Value Proposition Despite Setback - PART III
Shas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In this concluding part of our study of Clovis Oncology (NASDAQ: CLVS), we will perform a valuation of the company based on the P/E multiple valuation method. In part 1, we analyzed the investment thesis behind Clovis, and in part 2, we detailed its product pipeline and cash position. I urge you to read both parts to understand what follows better.
Stock Valuation of Clovis Oncology
We believe the market is undervaluing this stock because of the market's skewed perception of the importance of CO-101 for Clovis. CO-101 was admittedly very important for Clovis; however, it has more juice than that in its drug pipeline. Dozens of articles we sampled on Clovis had discussed CO-101 almost exclusively, possibly leading to the above market perception. However, here, as we have tried to show, the CO-1686 and CO-338 are strong drug candidates that could create value for Clovis independently of CO-101. The valuation model will try to justify this point and show that if these two products are thoroughly factored in, the stock price has considerable upside potential.
Note that we have not factored in the risks of a failed trial here. If any one of the trials fail, there will be a different model for that; if both trials fail, there may probably be no CLVS and no valuation model!
Please refer to the following table for stock valuation. We have made a few assumptions while carrying out this valuation exercise for company's shares using a P/E multiple valuation method.
- The company mentioned that the royalties for CO-1686 and Rucaparib would be paid if sales milestone of $500 million is achieved. Based on this statement, we assume that both the drugs have potential to achieve sales of at least $500 million within a year of launch, as the partner companies have predicted and determined their sales royalty payments based on that. Another complex calculation could be made based on statements here (the Credit Suisse presentation) about the patient potential; however, we have used the simpler alternative here. Note here that we have assumed a simple growth rate model here, with justifications based on sources here, here and here. As these sources show, the market has seen growth rates of above 20% right before the downturn. With new drugs arriving now, and the economy slowly escaping the downturn, we have assumed a simple growth of $100 million per year for every year after launch.
- As mentioned by the company that sales royalties would be around 15% of the net sales and the royalties could aggregate up to $120 million (CO-1686) and $170 million (Rucaparib) (please refer to Table 3). We back-calculated the maximum sales potential of both the drugs.
- In case of CO-1686, 15% royalty is being paid to Avila (owned now by Celgene (NASDAQ: CELG) while for Rucaparib, 15% is being paid to Pfizer (NYSE: PFE) and 10% to AstraZeneca (NYSE: AZN).
- Operating Expenses and Other Income/ (Loss) increase by 10% per annum.
- Total shares outstanding is as is. We have not considered the possibility of options, secondary issues etc because it is difficult to factor in such unknown quanitities without specific news. However, we did consider them while conservatively reducing our price target by $6 at the end of the valuation.
- P/E ratio for FY12, FY13 and FY14 is taken from Nasdaq website. In FY15, when Clovis starts generating revenues, provided the regulatory approvals are in place, the P/E ratio (5.8) is assumed to be 50% of that of industry. This is a conservative estimate, given that its current PE ratio is a little less than half that of the industry. Once the trials succeed, the PE ratio will probably increase; however, as I said, we are being conservative.
- According to the valuation model, fundamental price of CLVS stock in FY13 should be $16.03 and in FY14, it should be $35.97, provided Rucaparib's Phase I/II trial was successful and Phase III trial has been launched. The price differential is $19.94.
- We assume that there is 50% probability of Rucaparib's Phase I/II trial being successful - this assumption of probability statistic has been defended above. We believe that the market will start pricing in the event even before the Phase I/II trials' result are announced by June 2013. Thus the stock should be trading at (16.03+19.94/2) = $26.00 even before announcement of Phase I/II trial results.
- Being on the conservative side, we are quoting the target price of $20 before announcement of trial results by June 2013.
Table 4: Stock Valuation
Conclusion: CLVS stock was listed at $13 in November 2011, when the upcoming price catalyst i.e. results of clinical trials of CO-101 were nearly 12 months away (due in December 2012). The stock price reached $21.49 on 09-Nov-12 as the market priced in some probability of success for trial of CO-101. However, it dropped to $12.50 on announcement of negative news results of CO-101 trial on 12-Nov-12.
The stock is currently trading at $15.48 (open price on 03-Dec-12). I believe the recent pullback in CLVS provides a very good BUY opportunity. I think the market will again start pricing in the possibility of positive results of PI/II data for NSCLC and initial efficacy data for Rucaparib that is due by June 2013. On account of that, the stock has potential to reach $20 even before announcement of trial results by June 2013.
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