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Isis Pharmaceuticals (ISIS) engages in the discovery and development of antisense drugs. It follows a business model wherein after an initial discovery, it partners with different companies for further development of the drugs. It receives royalty from its partners when the drugs are finally marketed. Currently, the company partners with Sanofi (SNY), Atlantic, GSK (GSK), Biogen (BIIB), Teva (TEVA), OncoGenex (OGXI), AstraZeneca (AZN), Pfizer (PFE), iCo, Achagon, and Xenon for development of its various early discoveries. This business model enables Isis to focus on its core competency which lies in early discovery of antisense drugs.

In this article, I have tried to value the company's equity primarily on the basis of its upcoming and existing drugs.

Product pipeline

The company's product pipeline mainly focuses on various therapeutic areas, such as cardiovascular, cancer, metabolic, neurodegenerative, and other inflammatory diseases. Presently, the company's five compounds are in the final stages of development and are on the verge of getting approved.

ISIS-SMNRx: Spinal Muscular Atrophy, or SMA, is caused by the deficiency of protein in the survival motor neuron gene, or SMN. The symptoms include muscle weakness in the spinal cord area. Currently there aren't any treatments for SMA. Capitalizing on this opportunity, Isis is developing SMNRx, a drug for SMA treatment. According to the NIH, the occurrence rate of SMA is 1/8,000 childbirths globally. Also, there are as many as 35,000 SMA patients in the U.S., Europe, and Japan.

Kynamro: Earlier this year, Isis, in conjunction with Sanofi, launched an injection, Kynamro, for patients with homozygous familial hypercholesterolaemia, or HoFH, in the U.S. market. It is an inherited condition in which the body is unable to remove the bad cholesterol from the blood, thereby causing a cholesterol disorder. However, the drug carries a warning regarding the possible side effect of serious liver toxicity. Once the risk of liver toxicity is mitigated, the injection has a fair probability of receiving approval for the European market as well.

ISIS-TTRrx: This is a drug used to treat transthyretin, or TTR, amyloidosis. It is a genetic disease in which TTR accumulates as fibrils in the heart, peripheral nerves, and gastrointestinal tract. As the TTR fibrils accumulate in the tissue, it interferes with normal tissue function, and the disease worsens. The company is working on two different types of TTR amyloidosis, familial amyloid cardiomyopathy and familial amyloid polyneuropathy. Currently, there are 50,000 patients affected by these two types of TTR amyloidosis worldwide.

Custirsen: This is a drug targeted towards clusterin, a cell survival protein. This protein increases the effectiveness of chemotherapies. During the tests, the drug showed improved results in several currently available chemotherapies. Also, it enjoys FDA's fast track designation for the treatment of metastatic prostate cancer. The drug was initially discovered by Isis and OncoGenex, and was later licensed to Teva Pharmaceuticals. The drug is currently under phase 3 evaluation.

ISIS-APOCOIIIrx: This is a drug for patients with high triglycerides and Type-2 diabetes. The drug will be used to reduce apolipoprotein C-III, or apoC-III, production and triglycerides, which will reduce the chances of cardiovascular diseases such as heart attacks, strokes, and pancreatitis. ApoC-III is responsible for regulating triglyceride metabolism in the blood. Additionally, people with higher triglycerides have higher probability for Type-2 diabetes. Approximately 50,000 people worldwide have higher triglycerides and Type-2 diabetes.

I have summarized the above mentioned drugs and the company that is working alongside Isis for the development of the drug.

DRUG

PARTNER

CURRENT POSITION

ISIS-SMNRx

Biogen Idec

Phase II

Kynamro

Genzyme

Approved in U.S.

ISIS-TTRrx

GSK

Phase III

Custirsen

Teva/OncoGenex

Phase III

ISIS-APOCIIIrx

-----

Phase II

Valuation

Since the company has different products in its pipeline, it would be appropriate to use sum-of-the parts NPV analysis to arrive at the market value of the company's equity. To value different products, I will apply a standard multiple of five times to the royalty received from each of the drugs and then discount it back at appropriate rates to arrive at the net present value, or NPV.

The expected contributions from each of the drugs are:

1. Applying a multiple of five times to the expected royalty contribution from ISIS-SMNRx of $356 million in 2019, and discounting it back at 35%, we get a NPV of $342 million from the drug.

2. Similarly, since Kynamro has already been approved in the U.S. and will likely receive approval in Europe, a discount rate of 25% will be appropriate for the drug. Therefore, with an estimate of $702 million as royalty in 2017, and a multiple of five times, the NPV from the drug is $1.26 billion.

3. For Custersin, a projection of $46 million as royalty in 2017 multiplied by five and discounting it back at 30%, leads to the NPV of $91.6 million.

4. ISIS-TTRRx is expected to contribute royalty of $86.7 million as per the NPV method using a 50% discount rate.

5. Finally, ISIS-APOCIIIrx is valued at $377 million by assigning a five times multiple to the 2019 royalty estimate of $700 million and discounting it back at 50%.

(Amounts in USD million)

PRODUCTS

ROYALTY

YEAR

DISCOUNT RATE

PRESENT VALUE

ISIS-SMNRx

356

2019

35.00%

342

Kynamro

702

2017

25.00%

1260

Custersin

46

2017

30.00%

91.6

ISIS-TTRRx

-------

-------

50.00%

86.7

ISIS-APOCIIIrx

700

2019

50.00%

377

The total NPV contribution from these five drugs is $2.15 billion. Also, with an expected contribution of $100 million from its existing compounds, the total contribution from the company's product pipeline will be $2.25 billion.

Assumptions:

1. The standard multiple of five times used in calculations is subject to certain assumptions such as the overall revenue generated from the drug and the overhead costs that the company bears to sell the drug. Generally, a drug that generates annual revenue of more than $1 million and exhibits overheads to sales ratio of less than 40% is valued at five times its NPV contribution.

2. The discount rate used for arriving at the NPV is different for each drug. The discount rates have been taken into account, considering the estimated cost of equity and the estimated terminal growth rate that each drug possesses. I have used a discount rate of 35%-50% for drugs that are currently under phase two and 25%-30% for drugs that are under phase three.

Impact of share issue and additional borrowings

In May 2013, Isis expressed its intention to offer 9 million shares to the public and an optional 1.35 million shares to the underwriters. The shares are to be issued at $19.00 each, and if fully subscribed, will fetch $196.65 million for the company. For now, it remains unclear as to how the proceeds will be deployed by the company. The fresh issue will dilute the existing shareholding pattern, and if the company is unable to generate the required return from these proceeds, the earnings per share, or EPS, of the company may turn downwards. If the issue is fully subscribed, the company's outstanding shares will rise to 112 million.

Last year, the company had a financial leverage of 0.71 because of negative earnings, with a total interest expenditure of $21.15 million and long-term debts of $221 million. On June 27, the company borrowed $2.5 million under the loan agreement entered into with RBS Asset Finance in 2008, for equipment financing. With this borrowing, the total amount borrowed by Isis under this agreement increased to $29.9 million. The additional borrowings will increase the interest expenditure by approximately $250,000 annually. This will further deteriorate the company's financial leverage, as the company already incurred a loss of $1.7 million in the first quarter. The deteriorated financial leverage may impact company's return on equity.

Investments, Cash, and Debts

Estimating cash balance and short-term investments of $613 million and debts of $201.25 million, the market value of equity turns out to be $2.66 billion. With the year-end estimate of 112 million as the company's outstanding equity, the value per share should be approximately $23.

Market value of equity = Royalties + (Cash + Short-term investments) - Debts

= 2250 + 613 - 201.25

= 2661.75 (USD million)

Note: The above mentioned share issue has been taken into account in the calculation made above.

Stock price movement

From the beginning of the year, the company's stock price has almost doubled. There was a sudden 10% upside in the stock price when Kynamro received approval for the U.S. market (Jan 2013). On Jan 30, almost 8.8 million shares of the company were traded.

Last month Isis saw its stock price move up by around 30% after it declared impressive phase-2 data on ISIS-APOCIIIRx.

This increased activity shows the strong susceptibility of the company's stock price to the approval of a drug. Investors should remain aware whenever the company approaches the approval of a drug. However, it appears the current stock price accounts for all possible positive catalysts that could continue to drive the price upwards.

Hence, I expect the stock price to decline from the high levels it has currently reached.

Conclusion

Isis's strong product pipeline indicates it to be an active player in the antisense market. Also, its collaboration with leading pharmaceutical companies makes its business model worth watching. The expertise in early antisense drugs discovery gives it an upper hand when compared to its peers.

Therefore, taking into account the cash flows from all of its near end approval and existing drugs, short-term investments, cash balance, and debts, the company's equity should have a value of approximately $23 per share whereas it is currently trading around $30.00.

I strongly feel the stock price should rebound to lower levels. I recommend a sell on this stock.

Source: It's About Time To Jump Off The Isis Bull Boat