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I didn’t think Avanir Pharmaceuticals (NASDAQ:AVNR) was going to get approval for Neudextra and I was wrong. So in keeping with good journalism, I decided to write a follow up article. Of course, I could write one listing the reasons why the company is overvalued to make up for the fact I was wrong, but I see I was beaten to the punch. Instead, I decided to turn my focus on helping longs answer the question I have seen floating around the message boards: What is the true value of the stock?

To do so I had to make a few assumptions:

  • I have heard sales projections from $350M to $600M. Any valuation today has to be based on $350M with any sales increases rewarding shareholders. Otherwise there is no reason to speculate on the stock.
  • Cost of goods sold and expenses will run about 70% of gross revenues and taxes at 35% of net income. These numbers are fairly standard industry wide.
  • A PE multiplier needs to be applied. In the first scenario we will apply a PE ratio of 21 which represents an average for biotechnology companies.

Using the criteria above resulted in an initial valuation of $15.25/share. This is in line with some of the recent price targets I have seen from analysts.

Revenue

$350,000,000

Expenses

$245,000,000

Income

$105,000,000

Taxes

$36,750,000

Net Income

$68,250,000

Common Shares

93,968,532

EPS

$0.73

PE Multiplier

21

Value per Share

$15.25

So why is the stock trading so much lower? The first problem I see is the PE multiplier. Avanir is no longer a small biotech company; it has a product and approval and it’s time to start manufacturing. As such it should be valued more in line with the major drug manufacturers which would represent a PE ratio of 11. Plug this multiplier into the equation and we get a valuation of about $8.00/share, very close to many of the pre-approval price estimates of $8-$9.

Revenue

$350,000,000

Expenses

$245,000,000

Income

$105,000,000

Taxes

$36,750,000

Net Income

$68,250,000

Common Shares

93,968,532

EPS

$0.73

PE Multiplier

11

Value per Share

$7.99

So I found the pre-approval valuation, but still need to explain the stock’s current price. For that we go to the latest 10-Q and dig to find two things most analysts missed:

  • There is an additional 20.5M in options, warrants and restricted stock not accounted for. These would increase the common shares outstanding to about 114.5M.
  • Way deep down in the 10-Q came this little notation under Commitments & Contingencies:

In addition, the Company is obligated to pay CNS a royalty ranging from approximately 5% to 8% of net GAAP revenues.

That second factor has a big influence on the valuation. Notice how it was not income but revenues, pulling 8% off the top before even starting. Adjusting our calculations for the above changes results in the following:

Revenue

$350,000,000

Royalty

$28,000,000

Adjusted Revenue

$322,000,000

Expenses

$245,000,000

Income

$77,000,000

Taxes

$26,950,000

Net Income

$50,050,000

Common Shares

114,516,700

EPS

$0.44

PE Multiplier

11

Per Share Value

$4.81

And there you have it, $4.81/share, almost identical to Friday’s closing price of $4.79/share. But don’t despair, longs. Withstanding a market turn or sales under $350M this valuation is conservative and should mark the bottom. You already know the drug works, now the game is banking on management. So here’s a final thought. If management can reach sales of $475M, keep COGS & expenses at 60%, and in this upward market garner a PE ratio of 15, you have a $13 stock on your hands. Not a bad return.

Disclosure: No position

Source: What Is Avanir Pharmaceuticals Really Worth?