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Sarepta (NASDAQ:SRPT) Therapeutics develops RNA-based drugs. It currently trades based on the expected value of eteplirsen for treatment of Duchenne muscular dystrophy (DMD). A window of uncertainty has emerged which has reduced the conservative expected value of eteplirsen. This creates a window of opportunity for investors to gain deeply discounted long exposure to the other drugs in Sarepta's pipeline.

Eteplirsen Upside Overview

Seeking Alpha's Bryce Itsvan has published a synthesis of financial models for Sarepta. Although some figures have changed in recent months, his estimations of potential market size remain valid. US market size (peak sales) for eteplirsen is estimated at a midpoint of $720MM, with identical market size for Europe. This suggests peak sales potential of $1.5B.

Sarepta currently has a market cap of $1B, which derives from the possibility that eteplirsen (and other drugs, but mostly eteplirsen) may be successful. In a successful worldwide scenario for eteplirsen, Sarepta could ultimately be worth $192 per share.

Basically, that upside comes from annual eteplirsen peak sales potential of $1.5B and a 6x multiplier on sales. Sarepta shares currently trade in a range in the mid-twenties, so $192 suggests upside of 9x over the timeline of eteplirsen's maturation. 9x might seem like a big jump, but that would simply be the value of the company growing in alignment with year-over-year revenue. Virtually all biotech companies growing from pre-revenue to revenue have jumps like this -- assuming they get past pre-revenue.

Of course $192 should not be considered a "price target" for trading of the stock currently, because the figure must be adjusted marginally for present value, and the figure must be adjusted much more for risk. Clearly SRPT at $27, analyst and investor consensus is that Sarepta has a great deal of risk.

Eteplirsen is the primary asset in the company, and therefore risks to eteplirsen represent the primary set of risks to the company. As I will explain below, these risks are "known unknowns," meaning if something goes wrong for eteplirsen it will probably be something investors already expected (in this case trouble with the FDA).

If approved in the US, eteplirsen has a strong probability of dominating the global DMD market. However, recent events have cast doubt on the certainty, timeline, and cost of eteplirsen approval in the US.

Eteplirsen Approval Overview

Sarepta's eteplirsen data show very promising, statistically significant results in walking ability improvement. Walking ability is frequently referenced by clinicians as the primary measure of early treatment effectiveness in DMD cases, because muscle loss in limbs precedes fatal muscle loss in other organs.

Sarepta has also been shown to target the dystrophin biomarker with remarkable consistency -- although 12 patients may not seem like many, the fact that 100% of them showed biomarker response indicates extremely robust statistical reliability (oversimplification, but try to flip a coin heads 12 times in a row).

Drisapersen is a competing drug which recently failed. Less than 30% of patients showed dystrophin biomarker response. This failure of drisapersen led the FDA to view Sarepta's eteplirsen with skepticism, because both drisapersen and eteplirsen target the same DNA manifestation (although through different methods).

The consensus among analysts and investors is now that the FDA will require Sarepta to conduct a placebo-controlled study. This would significantly increase the time, cost, and uncertainty of trials. However, there is still a small chance the FDA will approve eteplirsen earlier.

Specific Risks Investors Should Know

Although Sarepta has a couple hundred million in cash and an annual burn rate around $100MM, placebo-controlled trials could eat through this cash and incite another capital raise. Based on these problems, analysts and investors now consider eteplirsen to be more risky. They have discounted eteplirsen's expected value and in turn Sarepta's valuation. Effectively, Sarepta's present-value averaged price targets have been cut in half from $40 to $20. The recent walk-study update currently making the rounds in the news is a positive but is unlikely to revert targets to anywhere near $40.

There is not at this time a competing drug that could present a risk to investors. The specific risks that Sarepta investors should know about are therefore highly concentrated in the FDA's approach to eteplirsen. This includes the risk that the FDA could demand a study which is impossible for Sarepta to practically carry out due to the small size of the patient test subject population. Even if the FDA demands a study which is possible, there is a high risk Sarepta will raise money to help meet FDA demands, and as a result dilute the current base of shareholders. There is also a likely risk that the FDA's demands will extend the timeline of trials by several years, thereby reducing the present value of eteplirsen. Those are the specific risks investors should know about and those are the risks which have been priced into the stock.

How Sarepta Trading Will Evolve Beyond Eteplirsen

Eteplirsen is not Sarepta's only drug. It is of course the flagship drug. Typically investors look to such drugs to provide traction to expected value of other pipeline drugs (in Sarepta's case, this refers to its phosphorodiamidate morpholino oligomer (PMO) antisense technology).

The market has been so caught up in the details of eteplirsen's uncertain approval that it has forgotten the relevance of eteplirsen's existing promise. Sufficient data already exist to suggest that eteplirsen is a scientifically remarkable application of Sarepta's proprietary PMO competency. Thus the relevance of eteplirsen extends beyond DMD's potential market of $1.5B; eteplirsen speaks to Sarepta's far more colossal potential in parallel RNA applications.

Typically the approval of a flagship drug and the multiplier effect on subsequent pipeline drugs will happen simultaneously. So there is a "bundling" of eteplirsen with the market's expected value for other PMO drugs. As approval of eteplirsen has been theoretically postponed by a couple years, so too has the potential validation of Sarepta's overall approach to RNA modulation.

Where there is bundling, there is potential for unbundling, and unbundling can exert jaw-dropping movement in a stock's trading range. In the near future, probably 2014, the dust will settle in the FDA's correspondence with Sarepta. The market's "working memory" will then have room to process the long-term valuation of PMO.

Through its core competency in PMOs, Sarepta claims to have the ability to "alter the safety and efficacy profiles of different drug candidates, even if they are sequenced to target the same DNA." For example, both drisapersen and eteplirsen modulate the splicing of the dystrophin RNA transcript, but eteplirsen has an improved safety and efficacy profile.

Only 13% of patients have genotypes favorable to eteplirsen, so Sarepta is developing several other drugs for DMD. These drugs are in preclinical testing but as a whole represent several billion dollars in potential annual revenue. Beyond DMD, Sarepta is assessing and developing treatments for kidney diseases, infectious diseases, and dermatological disorders. Personally, I am particularly intrigued by the company's early proof-of-concept research in drug-resistant bacteria, as I believe we have reached "the end of antibiotics."

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Of course, no company receives credit for the full potential of all proof-of-concept technology. There is a variable spectrum on which technology companies are given credit for their future endeavors. For example, companies like Google (NASDAQ:GOOG) are assumed to have the ability to convert several of their nascent research projects into revenue, while companies like Microsoft (NASDAQ:MSFT) are assumed to have less of such ability.

A discussion will be had about where Sarepta lies on this spectrum. When this happens, I suspect Sarepta will receive substantial credit for its pipeline. Analysts in passing acknowledge this pipeline currently but it really has not factored into market valuation. I believe this will change when the dust settles with the FDA and eteplirsen; as a result I think Sarepta could very easily revert to $45 before 2015 -- simply though the reappraisal of the full range of assets in the company, without assuming any improvement in the prospects for eteplirsen.

In summary: Sarepta investors can currently get a discount on the upside of the full pipeline because the market is preoccupied with the risks surrounding eteplirsen.

Source: How Sarepta Trading Will Evolve