Surprisingly, shares of Alexion Pharmaceuticals are still riding the tidal wave that produced gains in excess of 30% following its fourth quarter earnings. I say "surprisingly" because the company reported growth of just 37.9% year-over-year, yet as a $35 billion company it trades at a near unprecedented 23 times trailing sales. Hence, you'd think that such a hefty premium would require greater growth than 37.9%, but in the case of Alexion, such logic often takes a backseat, which becomes even more evident when you stop and process the recent notes by Wall Street firm Deutsche Bank earlier this month.
For those of you unaware, Alexion markets one product, Soliris, which treats rare blood and genetic disorders. Currently, it is approved to treat two rare diseases, but is being studied to treat another five in clinical trials. Reportedly, if Soliris proves beneficial in treating all of these diseases, and under a best-case scenario, it could eventually reach annual sales of $5 billion.
Therefore, if you look at peak sales, Alexion trades at seven times peak sales on Soliris; Pfizer trades at four times current sales.
Yet, according to Deutsche Bank, there is far more upside. Specifically, an eventual $40.55 billion market capitalization is tied to the potential performance of Soliris and a product called Asfotase Alfa for the treatment of severe hypophosphatasia, currently in registrational studies.
To explain, take a look at the Seeking Alpha "Breaking News" from February 10, and then we'll break this down as logically as possible.
- Alexion Pharmaceuticals (ALXN +3.9%) moves higher after Deutsche Bank raises its price target on the stock to $205 from $125, believing the market for Asfotase Alfa for severe hypophosphatasia is larger than Wall Street expectations.
- The firm sees a ~$1.6B opportunity for Asfotase Alfa, and given the patient mix, it thinks its assumptions could be conservative in its assumption that the blended average price per patient over time is ~$200K since it is below Myozyme ($600K) pricing.
Ok, just so you understand: A well-known firm increased its target market capitalization by nearly $16 billion because of a product with peak sales potential of $1.6 billion. Just so we're all on the same page, this represents a price/peak sales of nearly 10!
However, to give Deutsche Bank credit, the stock was already trading at $160 when they made their call, so even if we assume the $205 price target was on top of the $160 per share value assigned to Soliris, it would still represent a near $9 billion premium on a drug expected to reach $1.6 billion in peak sales.
As a result, Deutsche Bank assigned a valuation multiple of somewhere in the range of 5.6 to 10 times peak sales "potential" on a product with unknown potential.
What's this mean?
Here's the sad part: A lot of new biotech investors may not understand why this is so bad, or how this creates an enormous amount of risk long term. These investors consider these multiples as part of the norm.
In biotechnology, valuations are formed based on a drug's likelihood of FDA approval and its potential market success. Historically, drug companies have traded at three to 3.5 times sales, which is a reflection of an industry trading at or near peak sales. Therefore, historically, companies shouldn't trade beyond three to four time peak sales while in the clinical or growth stages. When a company like Alexion reaches a level where analysts are endorsing further upside despite a valuation that clearly exceeds logic, then we know that a problem exists.
In the end, fundamentals will always reign superior over unfounded enthusiasm, and in the case of Alexion, it really is hard to imagine any other scenario aside from a steep downward trend at some point in the future. Quite frankly, its fundamentals cannot support its valuation, and in time, this logic will come out on top.