Seeking Alpha
What is your profession? ×
Long only, tech, biotech, research analyst
Profile| Send Message|
( followers)

Inovio Pharmaceuticals (NASDAQ:INO) went "into play" in July. After spending well over 12 months well south of $1.00 and sometimes south of $0.50, INO shot up to $3.03 per share, now its 52 week high, on August 6. Then it plummeted back down below $2.00, and at least temporarily leveled off this week to close at $1.44 on August 16. It is notable that Inovio got a similar spike, above $3, years ago on July 29, 2009.

Is Inovio just the latest small cap stock to become a football for day traders? Or was there a genuine discovery of value in the stock? I believe a mixture of both, and will sort those variables out as best I can.

By way of background I became aware of the predecessor of Inovio so long ago that I don't remember how I originally heard of it. Back then Inovio had an electroporation device, and I was not impressed with its outlook. I did start receiving regular email updates from Bernie Hertel, who is still head of investor relations. Then in 2009 Inovio Biomedical was combined with VGX to form Inovio Pharmaceuticals.

At some point there began to be intriguing results using electroporation for delivery of Dr. Joseph Kim's DNA-based vaccines. DNA vaccines have a different mechanism of action from historic vaccines, which typically use either attenuated (weakened) live viruses or killed viruses to prompt a human immune response. Dr. Kim is one of the co-inventors of DNA vaccines. The first DNA vaccines were approved for use in animals in 2005.

By 2012 I was following Inovio on a regular basis and I bought a tiny amount of INO on May 21, 2012 for $0.46 per share. I consider buying stock in a company that does not have its first revenue (unless you include revenue from grants), much less first profits, to be extremely risky. I also usually rule out stocks priced under $1.00. My point of buying a few shares was to make sure I watched INO more closely. My intent was to build a position if data from Phase II or later clinical trials came in positive. One thing that impressed me was Inovio's ability to win a variety of grants from prestigious institutions including NIAID (National Institute of Allergy and Infectious Diseases of the National Institutes of Health).

What Inovio has is a broad technology and a pipeline of specific instances of the technology. The most advanced vaccine product is in Phase II. Many of the products are preclinical. They have never been given to humans; they have only been studied in cell cultures or lab animals.

The argument against giving Inovio a high market capitalization is that most pre-clinical and Phase 1 therapies do not make it to market. They bomb out mostly in Phase I from toxicity, or in Phase II from lack of effectiveness or from side effects (adverse events) not previously observed in Phase I. Even good Phase II results sometimes turn out to be a statistical fluctuation from the small number of patients used, and then Phase III results don't meet the bar to get FDA approval. With FDA approval comes the need to sell the therapy somehow, and some therapies never become profitable even when commercialized.

Some biotechnology companies with a good story going into Phase II trials get very high market caps, and some get no respect at all, even with positive Phase II results. This is partly a quality issue. Sometimes it is difficult to predict the potential value a therapy will have if it gets FDA approval, or there is known competition and pricing and size-of-treatable population issues. Sometimes the Phase II data is way better than is needed to get FDA approval if just lined out to Phase III (so even if Phase III data is not as good, it is plenty good). And sometimes movers and shakers in the biotechnology investment world line up behind a loser (the crash comes when FDA denies the right to market) and sometimes the movers and shakers take hold of a negative story and refuse to invest in companies with therapies that do get FDA approvals and go on to make their investors money.

It pays to know basic statistics and biostatistics if you are investing in companies that are in clinical trials. It pays to be familiar with past FDA decisions, approvals and disapprovals and the reasons for them. But in the gray areas, even an expert can guess wrong. I like to think in probability bands: "given the phase III data submitted, I think there is a X percent chance of approval, a Y percent chance of rejection, and a Z percent chance the FDA will ask for more data before making a final decision."

Traditionally vaccines are not generally a high-priced item (there are exceptions). So to make money with a vaccine you want it to be broadly applicable: if all 300+ million Americans get a vaccine, even if you only get $3 profit per vaccination, you get a billion in profits ($3 is a number out of a hat. It is not indicative of the profit per dose of any particular vaccine on the market). Vaccines tend to run between $15 and $60 per dose retail in the United States (See CDC Vaccine Price List), but some common vaccines currently on the market run over $100 per dose. Novel vaccines that are more effective than traditional vaccines or that provide unprecedented immunity would likely be priced at the high end, much as HPV vaccines from Merck and GlaxoSmithKline are today. Profitability would depend on cost of goods sold (COGS) and operating costs.

As a broad generalization we can safely conclude that if Inovio is able to bring a vaccine to market, it should be able to show a profit. The specifics would depend on the disease prevented, the number of potential patients, and the pricing of competitive products, if any.

It is possible to take the Inovio pipeline and estimate the profits per dose and number of potential doses that could be sold in a year or over the lifetime of the vaccine. You can build a spreadsheet model that is as complex as you like, with what-if scenarios, but it can't tell you what the results will be for clinical trials that have not even started yet. At this stage I believe intuitive ballpark estimates are more appropriate, assuming you have a good intuition.

Since the method used by Inovio is novel, it is hard to estimate COGS, but my guess is that with current DNA technology, on a mass scale production would not be very expensive as a percent of revenue. Operating expenses could be estimated using industry averages, but they tend to be high in proportion to revenue when a company is small. A company aggressively pursuing growth (as Onyx Pharmaceuticals (NASDAQ:ONXX) showed) can keep upping R&D expenses to the point that there is cash burn instead of current profits. The value of the stock then comes from future products from an expanding pipeline.

As I said, I already bought INO at $0.46 per share in May 2012. I sold 20% of my stake at $2.56 on August 5, and bought shares back at $1.46 on August 16.

Note that market capitalization would be $285 million at $1.50. At $3.00 that would be $570 million.

Before saying why I think INO should be worth more than $1.50 per share right now, one more thing about the dash up to $3.00. It was partly based on the circulation of the idea that Merck (NYSE:MRK) was preparing to acquire Inovio. Merck is a partner of Inovio, and to some extent the acquisition would make sense. However, the first article I saw on the idea basically just said the acquisition would make sense. Later I saw the stock being hyped in chatter as a likely takeover target. That's how rumors get started, and that's how you can lose money by reacting quickly to a rumor that late turns out to not be true.

If you count everything in the current pipeline, including collaborations, INO has ten chances to get FDA approval and start earning back all the dollars put into research. However, some of the therapeutic targets being pursued have wrecked many attempts to create a vaccine. HIV, for instance. Researchers have been trying to create an effective HIV vaccine practically since HIV was first discovered. INO's vaccine is pre-clinical. Maybe it is the golden key that unlocks the door, but until Phase II data is in, I would have to say it has a 1-in-10 chance at best.

HPV (Human Papillomavirus) has a better shot, but there are already conventional HPV vaccines approved and on the market. INO's HPV passed Phase I and is in Phase II. It not only has to work, it has to work better than what is currently on the market to be of commercial value. I would consider good Phase II results to be proof of concept. But there is already proof of concept as animal disease DNA vaccines are on the market and appear to work.

My eye is on the Influenza DNA Universal Pandemic vaccine. It has completed Phase I. This vaccine could be arguably better than current flu shots. It would still have to be reasonably priced, but the market is huge and global. Hence big bucks if approved by the FDA and then other agencies around the world.

The problem with the Malaria vaccine is that malaria is not much of a problem in the U.S. It would be a big health and science coup, given a century of failure to produce a working malaria vaccine. But for volume sales it would have to be subsidized by governments or non-profits in the mainly impoverished areas where malaria is prevalent. Still, on a global scale, and over time, it would generate substantial profits.

I like Inovio because it has 10 shots on goal with a technology that has already had some good results with animals.

But I really like Inovio because it has a platform. With one success, say HPV or influenza, INO would have the funds to create vaccines for any needed purpose. It could come to dominate the entire field of vaccines.

So it's easy to imagine Inovio have a billion dollar market capitalization in a few years and a multi-billion market cap in a decade. On the other hand, if the first few vaccines fail in Phase III, investment dollars for further R&D could dry up, leaving INO with a market cap of zero, or whatever the IP would sell for.

I actually don't think the $3 price spike was crazy, even if it was driven by rumors and day traders and computer algorithms. It was a taste of things to come, but it anticipated a lot. If an Inovio therapy gives us Phase II results that make it statistically likely that a Phase III trial will be successful, then $3 might become the low end of the range rather than a one-day spike. Inovio would then have a market cap over $500 million, not unreasonable in anticipation of having a platform for bringing multiple innovative vaccines to market. If a market cap of a billion were achieved, that would seem to price in at least one FDA approval.

On the other hand, if data eventually comes in showing Inovio really has multiple commercially viable vaccines, in particular flu and HIV vaccines, the sky is the limit. Investors (in that hypothetical scenario) would rue not buying in at $3 per share.

CEO Joseph Kim has often spoken at investor events. He will be making a number of presentations in September, starting at Rodman & Renshaw on September 10. You can also view the last presentation, made on June 27, at the Inovio web site.

Disclosure: I am long INO, ONXX. 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.