Over a five-year period of time, only Pharmacyclics (PCYC) has performed better than Jazz Pharmaceuticals (JAZZ). Yet, despite Jazz's five-year 8,000% return, the stock rarely finds itself in the headlines or even widely covered by analysts. In 2013, Jazz has more than doubled in value, now carrying a market cap of $6.7 billion. However, FBR Capital insists that Jazz shares are still priced very low. The firm's analysts reiterated a rating of "Outperform" and a $198 price target. The question I pose is this: Is Jazz really worth $200 a share?
Jazz Pharmaceuticals is a biotechnology company with headquarters in Ireland. The company markets and manufactures nearly a dozen different products.
Xyrem is the company's best-selling product, used to treat sleeping disorders. In the company's most recent quarter, sales for Xyrem topped $153 million, creating growth of 50% over last year.
Erwinaze, another product, is a component of a multi-agent chemotherapeutic regimen. The sales for this product were $44.1 million, growth of 39%, in Jazz's last quarter.
Prialt is used to treat severe chronic pain. Its sales more than doubled to $11 million in the third quarter.
Combined, these three drugs accounted for almost $210 million of the company's $232.2 million in third quarter sales, which equaled growth of 32.3%. In addition, Jazz is guiding for full-year sales of $870 million; this would be nearly 50% greater than 2012's revenue of $585.9 million.
With that said, Jazz is trading at 7.5 times its 2013 guided sales; given its growth, this ratio is not too expensive. Both Regeneron Pharmaceuticals and Celgene Corporation have less growth and trade at higher multiples. It is reasonable to think that Jazz's stock is supporting these levels.
Yet, Jazz's current price at $113 is not in question, but our goal is to determine whether $200 is a reasonable price target.
At $200, Jazz would trade with a market capitalization of $11.5 billion. This means that Jazz's multiple would increase to 13.2 times guided sales. Still, this multiple is not impossible in today's biotech market. Though it is definitely excessive… and definitely not reflective of a value investment.
Aside from strong sales growth, Jazz also has very impressive operating margins, at 39.6%. Furthermore, Jazz's margins continue to rise on a quarter-to-quarter basis, including its most recent quarter where earnings grew 127% compared to revenue growth of 32.3%.
The reason for Jazz's high margins is a combination of marketing efficiency, increased drug prices, and a low tax rate. According to FBR, Jazz could be a useful vehicle for tax inversion, and is a main reason the stock is worth $198.
In particular, Jazz pays a tax rate of 12.5% versus 35% for companies in the U.S. For a company with nearly $1 billion in expected revenue, this 22.5% differential has been highly useful, and could be useful to a potential acquirer.
Jazz: A Buyout to $200
Most investors remember Perrigo's (PRGO) $7 billion (plus $2 billion in cash) acquisition of Elan earlier this year. All Perrigo earned was a low double-digit royalty payment on sales of Tysabri. However, Perrigo also received the lower tax rate of 12.5%, which is expected to save the company $700 million annually.
Perrigo has 12-month revenue of $3.7 billion, making $700 million in savings very significant. If an equally large company (or an even larger company) acquires Jazz, it too can have annual savings of $700 million or greater.
Given Jazz's annual gross profit in excess of $500 million, and the presumed $700 million that a company the size of Perrigo could save by acquiring Jazz, is a $200 price target reasonable based on the likelihood of an acquisition?
If we assume a $200 price target, or a market cap of $11.5 billion, Jazz's annual net income and growth rate combined with the $700 million in tax savings implies a $1 billion annual benefit for the acquirer. Elan's $7 billion buyout (not including cash) would've paid for itself within 10 years, and that's not including profits on royalties of Tysabri. But with Jazz, a company of equal size to Perrigo would have to wait about 11 years for the acquisition to return a profit.
So accordingly, an acquisition of Jazz at $200 is similar to the price paid to acquire Elan earlier this year, although slightly more expensive. While there are great benefits for a company to enter Ireland for its low tax rate, $200 per share is not a "good deal" for Jazz. If we imagine a company twice the size of Perrigo, and the annual savings were greater, then Jazz would be a great buy at $200. Initially, Mylan showed an interest to acquire Elan -- and Mylan is significantly larger than Perrigo. Perhaps Mylan and Jazz would make sense?
Balance Sheet & Cash Flow
While I have already discussed Jazz's past growth, forward expectations, its profitability, and its valuation relative to revenue and net income, Jazz is also priced considerably well relative to its balance sheet and cash flow. To explain, let's compare Jazz to other companies of near equal fundamental size.
Operating Cash Flow (OCF)
The above chart shows key balance sheet and cash flow metrics for Jazz and three companies of similar fundamental size.
With the exception of Cubist, Jazz has the most cash and is priced the cheapest relative to the amount of cash on its balance sheet. Cubist is about half the price of Jazz relative to cash, but Cubist also has significantly slower growth and lower margins, as seen with operating cash flow.
With each company's valuation compared to operating cash flow, Jazz is by far the cheapest of the bunch. In fact, we could nearly double the valuation of Jazz and it would still be significantly cheaper than its peers, with the exception of Illumina. This fact might go a long way in validating a $200 price target on Jazz, as this metric alone shows how cheap the stock trades relative to its peers.
Lastly, Jazz's debt-to-assets ratio is in-line with its peers. A debt-to-assets ratio essentially identifies leverage, or the percentage of assets that are debt. For companies of this size, 25%-30% is the standard, which shows that Jazz does not face any great financial risks at this time.
Combined, the chart above further adds to the idea that Jazz's balance sheet and cash flow could support a price near $200, especially when you consider future growth. However, with Jazz priced over $100 should investors buy and use $200 as a target to sell?
Should $200 Be Your Target?
With corporate tax rates in the U.S. being so high, and after Elan's acquisition, rumors of a Jazz-takeout have really started to stir in the last year. FBR is the latest firm to reignite this flame, but is doing so with a price target that seems rather aggressive to the average investor. However, after a closer look, $200 does seem like a reasonable target, or a possible buyout price.
The answer to the primary question of whether or not Jazz is worth $200 a share is yes. The company's corporate tax rate makes it attractive on a cost savings basis for a larger pharmaceutical company, and its fundamental growth combined with its cheap stock also suggests significant upside. With that said, $200 right now on Jazz's current fundamentals is a bit pricey. However, this is a company that is still growing fast, and for this fact, future fundamentals could likely support such a price. Hence, Jazz might be an attractive acquisition target, as noted by FBR Capital, but even without being acquired, Jazz remains a solid investment opportunity from this point forward.