Pharmacyclics, Part 1: Can The Incredible Run Continue?

| About: Pharmacyclics, Inc. (PCYC)

The stock price of Phamacyclics (NASDAQ:PCYC) has rocketed in the past 12 months from $25 to $90. The attributed catalysts are positive events associated with its clinical trial programs on chronic lymphocytic leukemia (CLL) as well as its receiving "breakthrough' status from the FDA for its clinical programs on two other B cell tumors. The questions we would like to address are: is the stock price over-extended? Is there still upside on this stock? What is the intrinsic value for the company? Will it be a takeover target? Are there hidden risks that are not reflected in the current stock price? In other words, what are the downside risks? We will address these issues in a 4-part report. Part 1 is an overview of PCYC's business model. In Part 2, we will review its clinical programs, target markets, and projected revenues. In Part 3, we will analyze its financial strength and its partnership with Johnson & Johnson (NYSE:JNJ). In Part 4 we will conclude with a financial projection and stock valuation for PCYC.

Part 1: Business Overview

Pharmacyclics is a biotechnology company based in California. Although the company was founded in 1991, there was little progress in its business model until 2006 when PCYC acquired therapeutic programs from Celera Genomics. The programs included the Btk inhibitors, HDAC inhibitors, and Factor VIIa inhibitors.

PCYC was able to bring these therapeutic programs to fruition. Its lead drug candidate, ibrutinib, is a tyrosine kinase inhibitor that specifically blocks the activity of Btk, an important kinase that regulates B lymphocyte activation and migration. PCYC initiated its first clinical trial in chronic lymphocytic leukemia (CLL) in 2009 and has since completed several Phase II trials of ibrutinib either as a monotherapy or combination therapy in relapse and naïve CLL patients. The clinical outcomes were outstanding with regard to overall response rates, progression free survival, and adverse effects.

In December 2011, PCYC entered into an important partnership agreement with Johnson & Johnson to co-develop and commercialize ibrutinib for B cell tumor indications. The deal amounts to $975 million of upfront and milestone payments to PCYC. The strategic partnership provided the company with much-needed capital and expertise to expand its clinical trials worldwide. At present, PCYC and JNJ have launched several Phase III clinical trials on ibrutinib for CLL. We estimate that clinical results will not become available until late 2014 or early 2015, which means that the highly anticipated FDA approval of ibrutinib may not occur until late 2015.

In addition to CLL, the company and JNJ also initiated ibrutinib clinical trials on other B cell tumors, including mantle cell lymphoma (MCL). The FDA has recently designated the ibrutinib MCL clinical program with "breakthrough" status, which means that the FDA will expedite the approval process despite limited clinical data. If ibrutinib is able to reach its clinical endpoints, it may receive FDA approval in 2015.

With the high probability of ibrutinib approvals for both CLL and MCL in 2015, PCYC will start generating commercial revenues from ibrutinib in 2016. PCYC is also investigating ibrutinib in other B cell tumors, including diffuse large B cell lymphoma, multiple myeloma, and follicular lymphoma. Therefore, additional revenues could come from one or more of these indications.

Based on our estimates, ibrutinib alone could bring in commercial revenues of $500M (2016), $1.22B (2017), $2.24B (2018), and $3.7B (2019).

Regarding its financials, as of December 2012, the company has total assets of $355 million. This includes $262.5M in equity and $92.6M in liabilities. The company has cash and marketable securities of $317 million. Without long-term debt and plenty of cash, as well as the ability to access loans from the JNJ partnership, the company stands in good financial strength to fund most of its clinical programs without further diluting its common shares. We emphasize this point because the company previously had a history of issuing common stock to fund its clinical programs and diluting shareholder value.

PCYC currently trades at $90. With ~74 million shares outstanding, it has a market cap of $6.3B. The stock has skyrocketed since it initiated its first CLL clinical trial.

There are several potential risk factors associated with PCYC. First, the current stock price has incorporated most positive outcomes, including FDA approval of ibrutinib for CLL indication, as well for MCL. Any setback in the clinical trials could potentially send the stock price down 10-20%. Second, how fast can the company bring the drug to market after approval? Third, competition is on the horizon. PCYC's drug will compete with drugs already on the market. In addition, several drugs are in late stage trials for CLL and MCL. Nonetheless, there is still a potential positive surprise for the stock if the company is acquired by JNJ or another pharmaceutical company.

By incorporating the information available to us, we provide a forecast for PCYC's financial projections and estimated earnings from 2013 to 2017. Using projected free cash flows, we derive an estimated fair value for PCYC around $92. Thus, the current stock price seems to be fairly valued.


PCYC corporate presentation-Jan2013

PCYC financial results-Dec2012

PCYC 10K-2012-end-June30

>>Go to Part 2

Disclosure: I am long PCYC, JNJ. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.