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We wrote several articles on Pharmacyclics (NASDAQ:PCYC) when the stock was trading around $80-$90 in February 2013. At the time, we estimated that PCYC had an intrinsic value of $92, based on the assumption that PCYC's leading drug candidate ibrutinib would receive FDA approval in 2015 and start generating commercial revenues in 2016. Since then, the clinical programs have exceeded the street's expectations. On July 10, 2013, the company announced that it had submitted a new drug application for ibrutinib for CLL and MCL to the FDA (press release). If it receives a priority review, it would mean that a FDA decision could be expected in Q1 of 2014. Due to a high probability of FDA approval, ibrutinib could be in the market by 2014 - two years ahead of our original estimates. As a result of this new development, we have re-analyzed the revenue projections for PCYC and have derived an intrinsic value for the stock. Our analysis suggests that the current price of $110 is still undervalued. Since the critical catalyst is 6-9 months away, patient investors could position themselves at this opportune entry point to make at least a 20% profit.

Overview

We have previously written several reports on Pharmacyclics' business models, clinical programs, partnership agreements, and financial projections (Can Pharmacyclics' Incredible Run Continue?; How Much Revenue Could Ibrutinib Generate For Pharmacyclics?; Pharmacyclics' Financials And Its Partnership With Johnson And Johnson; Pharmacyclics: Financial Projection And Stock Valuation).

Pharmacyclics is a mid-cap biotechnology company ($7.6B market cap as of July 2013). Its lead drug candidate, ibrutinib, is a tyrosine kinase inhibitor that is currently under clinical development for chronic lymphocytic leukemia [CLL] and mantle cell lymphoma [MCL]. PCYC entered a partnership agreement with Johnson and Johnson (NYSE:JNJ) to co-develop and commercialize ibrutinib for B cell tumor indications in 2011. The deal amounts to $975 million of upfront and milestone payments to PCYC.

The CLL clinical programs are currently in phase III. However, promising data from interim analysis may have prompted the company to file a NDA in July 2013, seeking regulatory approval well before the clinical trials are completed in 2014. Similarly, the ibrutinib MCL clinical program was designated with "breakthrough" status, which means that the FDA will expedite the approval process despite limited clinical data. Thus, with existing clinical data, ibrutinib is likely to receive FDA approval for both CLL and MCL indication as early as Q1 2014. If everything goes as planned, PCYC could start generating commercial revenues from ibrutinib by mid-2014.

Revenue projection

PCYC's revenues will come from two sources: milestone payments from JNJ and ibrutinib net sales under the agreement with JNJ.

2012 is the first year PCYC reported positive earnings (PCYC 10K-2012-end-June30). The revenues were derived from milestone payments from its corporate partner, Johnson and Johnson . As the clinical programs draw closer to an end, more revenues from the JNJ partnership will be materialized between 2013 and 2016.

The JNJ partnership includes a $150M upfront payment and up to $825M in milestone payments, based upon continued development progress ($250M), regulatory progress ($225M), and approval of the product in both the U.S. and worldwide ($350M).

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By 2012. the deal had triggered $100M in milestone payments to PCYC, as a result of reaching development progress milestones (the enrollment of patients to the Phase III CLL and Phase II MCL trials). We estimate that PCYC could receive an additional $50M of development payments each year from 2013 to 2015 for the progression of other clinical trials. The company is likely to receive regulatory milestones (~$112.5M) in 2013 for filing 2 NDAs this year. The launch of ibrutinib in 2014 will also trigger commercialization milestone payments, estimated to be $170M, in 2014.

PCYC will share 50% of net profits from ibrutinib sales with JNJ. Based on our estimates, ibrutinib alone could bring in commercial revenues of $380M (2014) to $3.1B (2017) for CLL, MCL, and one other indication. These translate into about $190M (2013) to $1.5B (2017) revenues for PCYC.

Adding together the revenues and milestone payments, we estimate that total revenues for PCYC will be $162M (2013), $410M (2014), $626M (2015), $1.08B (2016), and $1.6B (2017). These revenue numbers will be used for a stock valuation below.

Earnings projection

As the company expands its clinical programs, we estimate that the company's combined R&D and SG&A expenses will be maintained at about 55% of its net sales. This translates to an operating margin of 30-35%, which is in line with comparable companies. Assuming the tax rates are in the 12% range, the net profit margins are ~26%-28%. Therefore, the projected earnings per share are $0.99 (2013), $3.15(2014), $2.71 (2015), $4.51 (2015), and $5.93 (2017).

Balance Sheet

Now, let's look at PCYC's balance sheet. As of March 2013, the company had approximately $545M total assets which included $510M cash and marketable securities, as well as $437M of shareholder's equity (PCYC 10Q March30-2013). Due to long-term losses, the accumulated deficit now stands as $335M. This is common for early stage biopharmaceutical companies before they turn profitable. The company has no long-term debt and plenty of cash. In addition, it can access loans from the JNJ partnership. Therefore, the company stands in good financial strength to upcoming clinical trials without further issuance of common shares.

Stock Valuation

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Table 1 summarizes the projected data inputs used for stock valuation. PCYC's cash flows from operations [CFO] are estimated to be between $72M and $456M from 2013 to 2017. We also factor in capital expenditures to be 5% of cash flow to operations. After subtracting capital expenditures from its CFO, PCYC's free cash flows increase from $70M and $433M (2017). The free cash flow numbers were used to derive PCYC's intrinsic value.

We utilized the Discounted Free Cash Flow model to derive PCYC's intrinsic equity value. Based on the free cash flow numbers from 2013 to 2017, a long-term growth rate of 5% and a 14% discount rate, the estimated per share stock value is ~$122.

This fair value is greatly impacted by long-term growth rates. For instance, a 5.5% growth rate would elevate the fair value to $128, whereas a 4.5% growth rate would bring down the fair value to $117.

We applied a 14% discount rate for PCYC's valuation. The fair value is affected by the discount rates. A 13.5% discount rate will elevate the intrinsic value to $132, whereas a 14.5% will reduce the value to $114.

PCYC is currently trading at $110 as of 8/12/2013. This price represents an 10% discount to its intrinsic value calculated in this article.

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Conclusion:

PCYC's valuation is largely dependent on future sales of ibrutinib both in the U.S. and in the global market. As the result of expedited commercialization of ibrutinib, PCYC will have positive retained earnings by 2015, according to our financial projection.

The promising outlook for ibrutinib sales suggests that PCYC could potentially be a takeover target. An intriguing question is whether PCYC might be acquired by JNJ. If so, when would such an acquisition occur? Before or after the approval of ibrutinib by the FDA? Is it in the best interest of JNJ to acquire PCYC or does the current partnership structure work to JNJ's advantage?

This report therefore provides a timely evaluation of its stock price and how much it is worth as a potential takeover target. Based on the earnings projection and stock valuation, we derive an intrinsic value for PCYC at $122. At current stock price, PCYC is traded at about 10% discount to its intrinsic value.

Links to PCYC reports:

Can Pharmacyclics' Incredible Run Continue?

How Much Revenue Could Ibrutinib Generate For Pharmacyclics?

Pharmacyclics' Financials And Its Partnership With Johnson And Johnson

Pharmacyclics: Financial Projection And Stock Valuation

PCYC investor site

PCYC 10K-2012-end-June30

PCYC 10Q March30-2013

New Drug Application for Ibrutinib Submitted to FDA-071013

Source: Expedited Drug Approval May Push Up Pharmacyclics' Value And Stock Price