Osiris Therapeutics (OSIR) has joined the biotech bull market of 2012 with an 80% return. Earlier this year Osiris became the very first company to have an approved product with a cell therapy as the main component. Investors have been optimistic ever since, but should they? The company is now valued at $320 million and there are a lot of investment risks in regards to this company; and there might be better plays in terms of overall value to sales potential.
Osiris Therapeutics and Valuation/Sales
Osiris is the developer of cell therapy product Prochymal, an approved product in both Canada and New Zealand for the treatment of graft-vs-host disease (GvHD) in children. The problem with Prochymal, and Osiris Therapeutics, is that the market has clearly overvalued the stock. The company operates in two segments, biosurgery (which returns revenue) and therapeutics (which includes Prochymal). The company's biosurgery segment achieved just $2.2 million during its last quarter, which was a 32% year-over-year gain. In 2013, the company should produce less than $15 million in sales, from this segment.
The biosurgery segment is not what has led to a $320 million market capitalization; it was the approval of Prochymal that transformed the company from a $150 million valuation to over $300 million. Therefore, investors must be expecting significant sales. Judging by its performance, a $150 million premium, it's fair to suggest that half of the company's valuation is a result of Prochymal, its approval, and its assumed potential.
In the process of due diligence and following Osiris Therapeutics I have yet to see one sales outlook for Prochymal that is based on the targeted market size and the presence of GvHD. The reason we don't see sales estimates are most likely due to the small market size for the product. Although Prochymal is one of the best options for patients with the disease, its specific use on children and the exclusivity to just Canada and New Zealand will not allow it to produce large sales figures.
GvHD is considered a "rare disease" by the Office of Rare Diseases. On the website orpha.net you can find information about rare diseases. Orpha considers a disease "rare" when it affects one person per 2,000. Orpha lists GvHD s prevalence as 1-9/100,000. When you consider that Prochymal is only approved for children, and the combined population for New Zealand and Canada is less than 39 million, then it is not hard to do the math and see that Prochymal's market potential is very limited.
Based on the best-case scenario Prochymal could reach slightly more than 3,500 patients; realistically its market is probably closer to 1,000 patients. Under the best case scenario revenue will be less than $32 million in 2013; and that is only if all the 3,500 GvHD patients are children and if Osiris is able to reach the entire targeted patient group. This means that Osiris is trading at almost 10 times next year's sales under a best-case scenario.
A Better Value/Upside Option in Cell Therapy
If we continue to use the same model to determine a company's upside/value (which is based on potential revenue), then there are other companies that might be more promising. Since Osiris is in the cell therapy space it is important that we look within the industry, as there are many who are investing in Osiris as a play on the growth of cell therapy.
In the last eight years, funding for cell therapy has been at all-time highs, including more than $3 billion in the U.S. and record global investments over the last two years. These investments have been in regenerative medicine, a space where cell therapy is becoming more prevalent. This is an industry that is expected to produce sales in excess of $1.4 billion by mid-decade, and should increase 10-fold in the years that follow. Therefore, it is easy to see why investors are choosing and wanting to invest in cell therapy, and have chosen to do so in 2012 as cell therapy companies have been among the best performers.
In my attempt to find a viable replacement for Osiris Therapeutics I turned to NeoStem (NBS), which might be presenting the best overall level of risk/reward and upside in the industry. It trades with a market cap of just $100 million, which is less than a third of Osiris' market cap. Yet NeoStem is in a Phase 2 study and has an equal amount of upside in terms of sales for 2013, with 100% top line growth. Its manufacturing business alone might have higher total sales in 2013 than the combined revenue for Osiris' two segments; yet like I said, NeoStem trades at more than a third of a discount to Osiris.
Earlier we assumed that $150 million of Osiris Therapeutics' valuation was in relation to Prochymal's approval; leaving a $170 million valuation for its revenue run-rate of less than $16 million. Therefore, with NeoStem having a late-stage potentially billion-dollar candidate that has produced very encouraging clinical results, and a manufacturing segment that is more than doubling in sales, we must ask what is the appropriate valuation for NeoStem?
NeoStem earns revenue as its manufacturing clients progress into later stage studies, and as it gains new clients. Thus, this particular segment is built to grow. Seeing as how the company is growing revenue by 100%, it's likely that the growth will continue into 2013 due to the number of late-stage clinical companies that are utilizing NeoStem's services. As a result, NeoStem could and should achieve sales near, or above, $30 million, conservatively. This means that NeoStem will achieve the same in sales as Osiris yet still has its most significant catalyst in clinical development with its cell therapy product AMR-001. Considering these two facts, it is hard to justify a $100 million valuation compared to Osiris' $320 million valuation. In my opinion NeoStem should have the greater value.
The reason that NeoStem is my choice as the best value play in cell therapy is because of its diversity, its growth, and its valuation. The company is trading at just over three times next year's sales versus Osiris' 10 times sales under a best-case scenario. This level of value seems to be above and beyond all others in the space. However, I had looked at other companies such as Neuralstem (CUR) and StemCells (STEM) as potential plays in the space.
Both Neuralstem and StemCells have great technology, good early results, and have the billion-dollar potential that an investor seeks. However, both companies are in the very early stages of development. It is simply too difficult to know whether or not a preclinical study is relevant, or if it will transfer to a larger study. In addition, both Neuralstem and StemCells will need heavy dilution throughout the clinical process; which should be expected. Both companies are attempting to treat diseases that could be revolutionary if either is successful, but with market caps of $65 and $80 million, I believe that both are fairly valued, rather than undervalued.
Looking ahead into 2013, with the development of AMR-001 and VSELs, NeoStem has the potential to become a much larger company. The company has already proved that with 10 million cells its myocardial infarction cell therapy, AMR-001, is successful. This one product alone has peak sales potential of $1.3 billion according to the company. When considering the outlook and upcoming data for AMR-001 and combining the growth and outlook for its manufacturing business, I believe that NeoStem is worthy of the $300 million market cap, and Osiris the $100 million market cap. In terms of risk/reward I think NeoStem is the clear winner, presenting the best upside in 2013, and because of Osiris' valuation, I believe NeoStem is the best and safest play in cell therapy.