I have to admit that this is a delayed response to the humorous "analyst" valuations, or target prices, presented during the analysts' upgrades of Geron (GERN).
When Piper Jaffray and Needham both upgraded Geron, around December 10th, 2013, both cited $10 as a reasonable target price, based on a Discounted Cash Flow model.
I cannot fathom building a revenue model, then discounting it, before answering three fundamental questions:
- How much does Imetelstat cost?
- How much will it be available for?
- How many people will use it?
The analysts cited did not provide us with such details. In this article I will attempt to do that.
High prices for biotech medicine are not out of the ordinary. Just check this Harvard blog to find that $200k has almost a dozen. We know that Jakafi from Incyte (INCY) -- costs $84,000 per patient per year. It would have been my hope that Imetelstat will cost less, but this does not seem possible.
Let us go over the three questions above, then build a discounted cash flow model of the company. Whenever there is an assumption, I will opt for the most conservative -- at the risk of alienating the Geron bulls -- and it is up to the reader to replace other numbers if they disagree.
In this discussion, I will refer to Geron's Q3-2013 quarterly statement. After all, as I have indicated in my two earlier articles, Geron is a changed company and with Imetelstat as its only drug. Hence, earlier earnings reports are of little value, since they are tainted with multiple endeavors and projects. It is safe to assume that Q3 had Geron focused on helping Dr. Tefferi of the Mayo Clinic with the MF study. Geron's latest take on this study can be found in the JPM 2014 conference presentation.
As is now well publicized, that study was fully operational, with at least 24 patients during Q3. According to this report, Geron outsource manufacturing, and places costs of the trials into its Research and Development Expenses, according the quarterly statement. Page 18 of this statement lists clinical trials cost at $1.913 million. Though, Geron was still winding down other trials, to be on the conservative side, we will attribute all costs to the MF trial.
It is fair -- even a bit conservative -- to assume that 50% of the R&D cost goes into labor and G&A, while the other 50% goes to manufacture medicine for the patients. Hence, $40k/patient/quarter is a decent average cost of Imetelstat per each of the 24 continuing patients. If anything, examining the regiment that was used in the trials, is it is clear that the number should be closer to $30k/patient/quarter for maintenance (one 9.54mg/kg dose every third week) at current manufacturing costs.
Considering the limited production, it is quite fair to expect that costs will drop significantly for production of Imetelstat, if and when it is approved as a drug. An extremely conservative number for mass production would be 50% of current clinical trial cost. In essence, $15-20k/patient/quarter. Hence, a $80k/patient/year in Imetelstat cost is a very conservative number that I am comfortable with.
As we have answered the cost aspect of Imetelstat, the next question would be that of price. As it turns out, if Geron wants around a 20% net profit margin, after G&A and manufacturing cost, then they should be talking about a $150k/patient/year! The assumed G&A is based on multiplying the current annualized G&A by 10 fold to account for a fully staffed company -- with outsourced manufacturing -- capable of handling the full patient, doctor, partner and vendor population.
As for how many people will be able to benefit from Imetelstat as a medicine, it is clear that all MF patients have no alternative, as there is no existing "cure" nor are there any on the horizon. After all, Imetelstat seems to be the only Telomerase inhibitor that currently works.
To continue our conservative line, we shall assume that only 1/3 of the patients will opt-to/afford Imetelstat. For MF, that would mean around 4,300 of the 13,000 that live with the disease and an additional 1,000 per year newly treated patients from the 3,000/year newly diagnosed.
If you are to add the MD and AML populations, then you would be talking about a population of 110,000 patients with around 28,000 of new cases each year. A third (1/3) of that would be 36,00 and 9,200 respectively.
To arrive at a discounted cash flow model, I will make these outrageously conservative assumption -- enough to upset the Geron bulls.
- The company will not sell anything till year 2020
- The maximum patient capture is 33% of the population
- The company will spend 10 fold its current G&A to service such patient population
- The company will cease to generate revenue after patent expiration in year 2025
In addition I will assume that
- A reasonable annual rate of return is 12%
- A reasonable inflation is 3%
Note that under these outlandish assumptions -- actually Discounted Cash Flow Model implies a ridiculously low PE for this biotech company for all of its history -- and if Geron is to only attempt to address MF alone, then the following spreadsheet suggests that it would be fairly valued at $650 million today, making it fairly valued (at such low PE for its expected life).
On the other hand if you are to think that it will capture 50% of the population then the valuation today should be closer to a $1.2 billion.
In essence, as we have assumed that the company is only generating revenue for 6 years, you can roughly think as the discounted cash flow model assuming -- more or less -- a PE of 6. So, if you think that Imetelstat can cure MF, then whatever PE you would be assuming to be reasonable for a pharma -- let alone a biotech -- then this PE divided by 6, is roughly the discount factor that GERN is being offered currently in the market at!
Now, if you do believe that the company can capture 33% of the MF-MD-AML population, but no ET or other Leukemia patients, then Geron today should be a $9 billion company. That is, under the given assumptions, GERN should be trading today around $60 according to the following spreadsheet!
I understand that I have left the path between now and approving and marketing Imetelstat uncovered by this analysis, but even if GERN is to double its outstanding shares in between, then doubling the ridiculously low PE, implied by the discounted cash flow model, will still make these valuations reasonable if not conservative!
Of course, each investor is advised to run their own analysis and valuation, but in essence, my analysis suggests that the company is currently grossly undervalued. I am still at a loss as to why valuations that came out of the professional analysts were as low as noted in the December upgrades. Nevertheless, this current opportunity would not have existed otherwise. Hence, we should be thankful for whatever logic internal to such investment firms that led to such evaluation.
As always, I should remind myself and others that biotech investing is highly speculative and will only pay off with diversification and over a very long time horizon.