NPS Pharmaceuticals (NASDAQ:NPSP) is a biopharmaceutical that focuses on developing best-in-class therapies for extremely rare diseases that would otherwise not garner much attention from other competitors. With this strategy in mind, NPSP develops drugs that will, in effect, have a monopoly over a certain disease for the life of the patent or longer. With one marketable drug, Gattex, and one drug currently pending FDA approval, Natpara, that could both potentially reach blockbuster status, the market is undervaluing the upside this company has to offer. In addition, NPSP receives royalties from numerous other drugs which create substantial sources of revenue.
NPSP's first marketable drug in history is Gattex, which treats Short Bowel Syndrome, or SBS for short. SBS is a potentially fatal disease in which the body is not able to absorb nutrients through normal means due to a lacking small intestine resulting from surgery or birth defect. Without the body's ability to absorb these nutrients, there is a small chance that the person will be able to survive without other methods such as parenteral support. In short, parenteral support bypasses the usual means of digestion, and instead feeds nutrients into the body by way of an automated pump or tube. This type of support usually requires the patient to be under home care, as the patient must be tethered to the pump for up to 8-12 hours per day, in the most extreme cases.
Gattex is the first drug that can help reduce or remove the need for parenteral support altogether for people diagnosed with SBS, and thus has a monopoly on the disease. Gattex increases the patients' freedom by letting them live normal lives, in many cases without the use of an IV. In addition, parenteral support can cost anywhere from $160,000 to over $500,000 per year. Priced at $295,000 per year, Gattex is in a very comparable price range and has much more to offer. Between the EU and US (the two markets Gattex has gained approval in), there are approximately 25,000 people who suffer from SBS, with about 60% being referred to as the addressable market.
Since SBS cannot be cured, the $295,000 per year is a long-term revenue source. If 2,000 people on average (13.3% of the addressable population) used Gattex for the next ten years, NPSP would recognize just under $6B in revenue. Assuming 13.3% of the addressable population is a fairly conservative estimate considering many analysts predict anywhere from 1,500 to 3,000 patients. The ten-year number assumes that zero revenue is derived from Gattex following the end of its market exclusivity, which is also highly unlikely.
There is substantial more risk in the profitability of Natpara compared to Gattex, since it is awaiting FDA approval on October 24, but clinical data has been strong thus far and there does not seem to be any reason for a rejection, especially considering it targets an orphan disease. Natpara treats hypoparathyroidism, which is the deficiency of the parathyroid hormone. This deficiency leads to substantial calcium deficiencies, resulting in many other complications.
The current treatment for this disorder is usually the supplementation of calcium and Vitamin D, with some extreme cases requiring an IV. Natpara was developed to gradually decrease the reliance of vitamin supplementation. Clinical data to-date shows that 53% of users decreased reliance by over half, with 43% of responders decreasing supplementation to near-zero amounts.
The market for Natpara is large for an orphan disease, with ~125,000 suffering in the EU and US alone, with 40% of patients being extremely symptomatic. Similar to Gattex, Natpara is not a cure, so revenue will be derived over the lifetime of the drug, or until a generic competitor is released when market exclusivity ends in 2025. The drug is estimated to be priced in the $50,000 range. The likely number of patients treated with Natpara seems to be around 20,000-25,000, on average, through 2025. Using the low end of this estimate, to err on the side of caution, 20,000 patients at $50,000 per year for ten years would result in $10B of revenue. The current market cap of $3B is just 30% of the revenue that could be derived from Natpara alone by conservative estimates.
Affordable Care Act
The implementation of the Affordable Care Act (Obamacare) in the US will increase the amount of people eligible for treatment through Gattex and Natpara. Whereas rare, pre-existing diseases would not be covered by insurance in the past in many cases, patients now have access to these types of drugs. This trend could easily lead to substantial portions of the addressable markets favoring these two drugs over the old methods of treatment, especially since there is a comparable cost to current deductibles. However, the ACA is more like the "topping to the ice cream". Even if this legislation was not passed, NSPS has one marketable drug in Gattex that has seen a strong success in its early lifespan, and Natpara which could easily reach blockbuster status, if passed.
NSPS is current operating at a loss of $0.06 in the most recent quarter, but this is expected to change in FY2014, according to management's guidance. With over $24M of revenue derived from royalties, NSPS has access to a "free" source of revenue that is expected to increase over time, as many of the drugs garner more attention from respective markets. This royalty revenue stream can also keep NSPS afloat in the case of a prolonged drought in which drugs are not being successfully developed. With a current ratio over 5, NSPS has the ability to meet short-term financial needs, which is crucial for a small pharmaceutical. In addition, almost 40% of revenue is reinvested into R&D, which I see as a huge plus. Instead of being satisfied with Natpara and Gattex, management is focusing on creating new drugs and bolstering the already existing pipeline of drugs that are currently in Phase 1 and 2 trials.
The valuation method I chose to use for NPSP is a sum-of-the-parts DCF. In effect, I projected out the cash flows through 2025 derived from Gattex and Natpara individually, added the cash flow from royalties, and discounted the summation accordingly. High-level assumptions include increasing R&D expense, but no other marketable drugs over the next ten years, Natpara approval at the end of this year, and substantial increases in operating expenses used towards marketing the drug.
My Gattex specific assumptions include on average 15% of the addressable market, or ~2400 patients. This number peaks in 2021, before decreasing to zero in 2024, when market exclusivity is up. For Natpara, I assumed on average 16% of the addressable market, or ~28,000 patients. The number of patients assumes that a large number of the highly symptomatic (40-50%) and about 14% of the remaining population utilize the drug. Revenue for Natpara peaks in 2024, with zero revenue from 2025 onwards. I assumed royalty revenues would stay mostly constant, with slight increases every other year in the range of 3%-5%. I discounted the cash flows back at a rate of 9% to arrive at a $39 target price. Sensitivity analysis on the WACC and percentage of patients from the addressable market ranges from the low $30s to the high $40s.
With potential revenue of $16B by conservative estimates between Gattex and Natpara alone through 2025, NPSP should be demanding a higher market cap. Considering the strong clinical data for Natpara, the chances of approval are extremely high, which means the downside risk the market is pricing in is overstated at this point. The success of Gattex, royalty streams from various successful drugs, and a decent pipeline should overshadow the small possibility of Natpara's rejection later this year. I recommend initiating a position in NSPS at current price levels and buying on any future dips leading up to the October 24th decision date. My price target for the next 12-18 months is in the $38-$42 range, but I suggest staying up to speed on news regarding the company, as this could change for the better or worse.
Risks to my recommendation include the current negative net income per share of ($0.06) in the most recent quarter, and the rejection of Natpara in October, which would inevitably lead to a decrease in the stock price. Also, the possibility that R&D is "wasted" is a potential risk for any drug company. There is no guarantee that R&D will lead to marketable drugs, revenue, or earnings in the future.
Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in NPSP over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.