Growth Opportunities but Uncertainty Around Core Drug

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Spectrum Pharmaceuticals (NASDAQ: SPPI) appears relatively cheap versus its peers with a P/E of slightly under 5 and return metrics (ROA, ROE and ROI) that are almost double that of other players. There may be an opportunity with Spectrum. While low P/E multiples are not a very good comparison metric for small- and mid-cap pharmaceuticals, discounted cash flow is more relevant since the stocks are tied to future drug earnings. That said, the return metrics are impressive as is the earnings growth in recent years. Spectrum may just be in the midst of some growing pains and there may be an opportunity for investors.

Spectrum Pharmaceuticals is a biotechnology company with integrated commercial and drug development operation. It focuses on hematology and oncology. The company used a no research, development only model (NARDO) in its oncology operations. In oncology, it current sells two drugs, Zevalin and Fusilev, with another two drugs, apaziquone and belinostat, in late-stage development. It also currently markets Folotyn.

Fusilev in the midst of correction

The company and stock have tended to trade along with the success of Fusilev. In the 2013 fiscal year sales guidance, Fusilev is expected to contribute 50% of revenue. Sales of Fusilev have declined in the recent quarter and management has guided for further declines in 2013, however the indication is that this is due to an inventory reduction of Fusilev due to the re-introduction of a generic. Management expects the order pattern to change but believes demand is stable from the clinics. The level at which demand stabilizes remains uncertain and this represents a key downside risk for the stock.

Other revenue expanding

Other drugs besides Fusilev are expected to account for the other 50% of fiscal year sales. The three primary ones are Zevalin, Folotyn and belinostat. While each faces its unique set of challenges, the general direction of sales from these drugs should positively contribute to growth at Spectrum.

Fotolyn was an underperforming drug acquired from Allos Therapeutics. Fotolyn performed well in the most recent quarter behind increased promotional activity by Spectrum and Spectrum may have helped the drug turn the corner.

Zevalin is used to treat non-Hodgkin’s lymphoma and has had very positive clinical data, however it has not sold well after three years of efforts. There were numerous issues over those three years and management believes it has addressed the issues behind the underperformance of Zevalin. The company needs to try and change this. Last, belinostat is still waiting for approval, but that is expected.

Competitors

A biopharmaceutical company, Celegene Corporation (NASDAQ: CELG), also markets drugs used to treat cancer and immune-inflammatory diseases. It does have a more diverse revenue stream, as it does not depends as much on one drug and receives royalties related to Focalin XR and the Ritalin family of drugs. Its P/E is significantly higher, as are other multiples versus Spectrum, but return metrics are lower as noted in the following chart. It is also a much larger company: a $50 billion market cap compared with Spectrum's of $426 million.

Biogen Idec (NASDAQ: BIIB) is another biotech firm that discovers, develops, and markets therapies for neurodegenerative diseases, hemophilia, and autoimmune disorders. It also has a much larger market cap of close to $50 billion and a much more diverse revenue stream. The more diverse revenue streams of both Celegene and Biogen should translate to higher multiples as the risk related to problems with a certain drug do not cause dramatic changes to the growth profile. For a smaller firm, the revenue streams associated with each drug are forecasted and then discounted to arrive at valuations. Firms with longer track records and greater number of drugs can be valued the same way or also by looking to multiples. 

Conclusion

Spectrum is an interesting company and has the potential to greatly grow sales over the next five years with the three drugs discussed, as well as others. That said, the uncertainty around 50% of sales with Fusilev probably makes it prudent for investors to see where sales levels begin stabilize.


Mike Thiessen has no position in any stocks mentioned. The Motley Fool recommends Celgene. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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