Misunderstood News Offers Opportunity for Deep Discount on Momenta Pharmaceuticals

For the last few days I’ve been meaning to write up a nice long article on why I think Momenta Pharmaceuticals (NASDAQ:MNTA) is good long-term investment for a certain type of risk-tolerant investor. I want to go over the scientific and regulatory developments that make me think that MNTA is likely (~85% is my estimated probability) to be worth $40/share (or more) in a few (0-5) years. But today there was a major piece of news that dropped the share price over 20% to $12.50/share, so I’m trying to get this analysis out as quickly as possible. So I hope you’ll forgive me if I gloss over some details.

Momenta is a biotechnology company specializing (primarily) in developing generic versions of complex biological drugs. They have one drug on the market, a generic version of the blood thinner Lovenox. This drug is manufactured and sold by Sandoz, the generic subsidiary of Novartis (NYSE:NVS), and as long as it is the only generic version on the market Momenta earns 45% of the operating profit. For now, it is the only generic, sales are running around $1.1 billion/year, and Momenta’s share of this works out to roughly $300 million/year. Since Momenta has over $200 million in net operating loss carry forwards, and only ~$80 million/year in operating expenses, I estimate that they will earn roughly $220 million over the next year. Not bad for a company with a current market cap of $627 million (based on a fully diluted share count of 50.2 million).

What collapsed Momenta’s share price yesterday was that Teva (NASDAQ:TEVA) announced they had received a response from the FDA on their application for a generic version of Lovenox. In the event of a second generic Lovenox approval from a competitor, Momenta only gets 10% of total sales. When that happens, I estimate that Momenta will have annual losses of roughly $24 million/year.

A brief quote from Teva’s announcement:

“The receipt of this action letter, called a Minor Deficiency letter, indicates that the FDA has completed its review of the ANDA including the Company's responses to key questions during the review process. Prior to potential final product approval, the Office of Generic Drugs requires responses to a short list of questions, which Teva intends to respond to in the near future.”

The market today took this to mean that the approval of Teva’s version of Lovenox is imminent and relatively certain. And it is that implication that led to Momenta’s steep share price drop today. But I did some digging on this “Minor Deficiency letter,” and it seems that this is equivalent to the “Approvable letter” from the FDA’s system up until 2008. And then I found this article outlining the difficulty of getting FDA approval after receiving an Approvable letter. The average delay to approval after receiving an Approval letter is 20 months, so approval is probably much farther off than most are assuming.

Just doing some very rough calculations, I estimate that if Momenta gets 20 additional months as the exclusive generic, they will earn a total of $325 million during that time (I’m guessing $220 million loss carry-forward, 35% tax rate). Add that to the $220 million of net cash, cash equivalents & receivables I estimate they had at the end of December 2010, and MNTA will have almost $11/share at the end of those 20 months.

A minor, but likely, variation on this scenario is that Momenta increases sales of Lovenox for these 20 months. As of their last conference call, Momenta’s Lovenox sales were limited by how much of the drug they could manufacture. It seems likely that they will be able to optimize manufacturing and increase production modestly (say, 10%). That would put their end-of-20-months cash at close to $12/share.

So let’s call that the baseline scenario. For the worst-case scenario, we’ll assume that TEVA gets approval at the end of April, roughly 3 months after they received their Minor Deficiencies letter. (Target time for FDA response to TEVA is 30 days after they receive TEVA’s answers.) I estimate that that leaves Momenta with roughly $270 million, or $5.35/share. That’s not a lot, but spending $24 million/year, it gives Momenta 11 years to reach one of the best case scenarios described below.

Now let’s look at the best case scenarios. Momenta has patents on the analytical methods they use to characterize Levonox and ensure that their product is effectively identical to the brand name drug. In December they sued Teva for infringement of those patents in their manufacture of Lovenox. I’m going to guess that there’s a low but significant probability (let’s say 20%) that Momenta’s patents will allow them to keep Teva out of the Lovenox market. In that case, Momenta’s Lovenox remains the sole generic on the market, and they maintain their favorable profit share rate. Using the same assumptions as the baseline scenario, after loss carry forwards are exhausted and assuming production increases 10%, Momenta will have a net profit of roughly $162 million/year. A 15x multiple on that puts their market cap at $2.4 billion, or $42/share.

Another, more likely best case scenario involves Momenta receiving FDA approval for their generic version of TEVA’s multiple sclerosis drug, Copaxone. Copaxone generates over $4 billion in sales for Teva, and Momenta filed their application for generic Copaxone with the FDA in July 2008. Momenta’s version could be approved tomorrow, but assuming it takes just under 5 years like their Lovenox application did, approval would come in early 2013. Momenta’s share of Copaxone sales (also partnered with Sandoz), will be 50% of operating profits, regardless of the number of generics on the market. If I estimate Sandoz/Momenta’s generic Copaxone sales at $1.6 billion, with 60% operating profit (same as Lovenox), Momenta will get $480 million/year in revenue from this program. Assuming the $24 million/year loss from the worst case scenario above has increased to $50 million/year, Momenta’s after-tax (35%) profit will be $280 billion. A 15X multiple here gives almost $4.2 billion, or $83/share. Let’s say there’s a 60% chance of this scenario playing out by the end of 2013.

The final best case scenario has Momenta developing generics to biologic drugs (e.g., Enbrel, Avastin) approved under the biological license application (BLA) process of the FDA. Lovenox and Copaxone are biological drugs, but they were approved under the traditional new drug application (NDA) system of the FDA (the one used for small molecule drugs). Because they went through the traditional pathway, the generics for these two biological drugs could be approved through the traditional pathway. Until recently, biologic drugs approved under the BLA process had no pathway for approval of generics. The 2010 health care reform legislation granted the FDA the authority to develop a pathway for approval of BLA generics.

The details of the process are still being worked out by the FDA, but the simple fact that this pathway is forthcoming has raised the interest of numerous pharmaceutical and generics companies in taking advantage of it. Momenta states that they are in negotiations with a number of companies to establish a collaboration for development of a pipeline of biogeneric drugs. As the only company with technology proven to meet FDA requirements for characterizing complex biological drugs, Momenta will be in a strong position in these partnership negotiations. Eventually I would anticipate that Momenta will have a number of these biogenerics approved and generating billions in sales. But let’s say they just get one by 2016, with economics similar to the Copaxone generic. We’ll just attach the same $4.2 billion market cap, $83/share valuation on this scenario, also with a 60% chance of success.

So I have to admit that some of these timelines are long and the profit and success probability estimates are gross approximations, but I have tried to be fairly conservative. Feel free to adjust my estimates to your taste. But assuming they’re approximately correct, they suggest a greater than 85% chance that one of these best case scenarios will occur over the next five years, with a stock price appreciation of over 200% to over 650%. Also, there is some possibility that two or even all three of these favorable scenarios will work out, with even greater upside to the stock price, but let’s not get greedy.

On the other hand, if the stock falls to its cash value in the baseline or worst case scenarios (overall, less than 15% probability) the loss will be between 5 and 60%. This seems like a very appealing risk-reward opportunity, as long as you can stomach the small possibility of that 60% loss.

Disclosure: I am long MNTA.