Biomarin - Fair Value of $50+: A Step-by-Step Analysis

Jun. 8.11 | About: BioMarin Pharmaceutical (BMRN)

Biomarin (NASDAQ:BMRN) trades at a deep discount to fair value and the rationale for this long thesis is important to understanding investing as a whole – so it is my sincere hope you will get two things out of this, a good long idea and a good framework for approaching stocks.

There are 111 million shares of Biomarin outstanding, shares trade for about $27, so the entire business is worth $3 billion (market cap). The next thing I look at is what we call capital structure: how much cash and how much debt. In this case, $395 million in cash and $378 million in debt, for "net cash" of $18 million.

Biomarin sells a few products: Naglazyme, Aldurazyme, Kuvan and Firdapse. Total revenue is about $450 million for 2011 in my model. Biomarin does not report positive earnings and this is what can trip folks up. The best way to analyze biotech/pharmaceutical companies is to exclude R&D as an expense. Wall Street doesn't generally do this (at least the investment banks) and it is a big mistake. This is probably my biggest pet peeve at the moment with the Street (and a good reason I have cut down my commission levels!).

Companies endeavor to do R&D to make money. R&D is not an expense on any planet. You invest in R&D to get a positive return. R&D should be "capitalized" (in accounting speak), if not actually, at least mentally. If you include R&D as a cost, but do not include the future benefits from said R&D, you are double-costing. Now, as many analysts have told me, most companies do not spend R&D wisely. There is a way to estimate this mysterious idea (the technical term is "return on investment") but I'll try to do so in a future idea.

If one looks up the earnings estimate on Bloomberg for 2011 through 2015 for Biomarin, you will find -0.14, 0.21, 0.68, 1.32 and 1.92. These numbers are misleading as they cost R&D, which has nothing to do with the "earnings power" of the business. For comparison, my estimates are 2.06, 2.76, 3.73, 4.72 and 4.63. Big difference! In one case, Biomarin is trading at 14 times 2015 earnings. Seems pretty rich? In my "steady-state" or "run-off" model, Biomarin trades at just 6 times 2015 earnings.

The funny thing is I like that Biomarin invests in R&D. As the CEO of Genentech once told me, "If we could invest more in R&D we would. We simply can't find the projects that are worth it!" I think Biomarin does a decent job of providing good returns on capital. Not all of their decisions have been brilliant (Riquent), but in general they're approaching the biopharmaceutical world correctly.

The current portfolio of Biomarin drugs includes two biologics (Naglazyme and Aldurazyme) and two small molecules (Kuvan and Firdapse). I assume Kuvan disappears from the earnings model on 2014 due to generics. However, because Naglazyme and Aldurazyme are difficult-to-make and even more difficult-to-genericize drugs, I assume they last close to forever. This means they'll throw off enough cash flow to provide Biomarin with earnings for shareholders as well as capital to invest in R&D and find "the next Naglazyme". I think this business is worth $32 per share.

The real secret to the Biomarin trade is GALNS. GALNS is an enzyme replacement therapy that I believe will generate $500 million in high-margin sales. GALNS is a treatment for a disease called MPS-IVA, or Morquio Syndrome. Morquio is similar to the other devastating diseases Biomarin treats with Naglazyme and Aldurazyme. It's a rare disease. If you don't know the rare disease business, it is pretty simple — the drugs are very expensive but they're very meaningful life-changing drugs that the world agrees are worth the high price tag. I think with GALNS approval, Biomarin could be worth at least $50 per share and as much as $100 per share.

There is a risk that GALNS does not work. The good thing is the fair value of Biomarin without GALNS is higher than the current share price. The other good thing is management is bright and will find more GALNS-like opportunities. The recent acquisition of Zystor is a good example of Biomarin's intelligent capital deployment. Capital redeployment is the basis for capitalism (ask Warren Buffett). The more Biomarin spends, the better. I wouldn't say the same for all companies, however!

Finally, the error margin here is good (not as good as it was when Biomarin was trading in the teens). You have rare disease drugs where patients are Biomarin customers "for life." Biologics simply don't go away. Even the first biologic, insulin, still has no generic competitors. Making biotech drugs is very difficult (trust me, I own a small biotech company trying to do similar things). The complexity is simply orders of magnitude larger than small molecules. Contrast it with companies like Somaxon or Avanir, where the chemical identities of the drugs have been documented for quite some time and generics have little to no problems entering the markets. Most of the first biologics barely have competition. This gives you some error margin in case bad management shows up. One of my colleagues likes to quote Warren Buffett: "you want stocks that are a buy even if an idiot runs the company, because someday, one will".

Disclosure: I am long BMRN. I may change my position in Biomarin (BMRN) at any time.