One of the currently intriguing evaluations of a biotech firm is that of Array Pharmaceuticals (ARRY). Its stock has been incapable of luring investors regardless of how large the number of its cancer products, how encouraging the news about clinical trial results, or how generous the upfront and promised milestone payments and royalties by the collaborating pharmaceutical companies. Array is a biotech firm that created an extraordinarily effective small molecule dug discovery and design technologies. Its technologies are state-of-the-art, built over advanced biochemistry and molecular biology. They include high throughput screening, virtual screening, protein x-ray crystallography, structural databases and computational modeling – all assembled around a chemoinformatic databases and a library that has all sorts of molecules to pick from. The selection of molecules is made possible through its wide electronic laboratory notebook that enables scientists to generate novel predictive databases suitable for designing novel drugs out of existing molecules. This drug discovery capability, which was seen by many as the most defining criterion in Array’s value, does not seem to considered by the evaluators of biotech firms.
Critics’ believe that Array’s partnered and proprietary totally owned drugs are still in early clinical trials; most are still in Phase II trials, when the devils are known to surface in Phase III, where most failures occur even with drugs that might have demonstrated excellent results in earlier trials. The critics also resent Array’s exaggerated spending, especially when considering the fact that the collaborators are taking care of the heavy expenses. Among other negatives, some critics voiced their concern that the small molecule nature of Array’s cancer products are not what the pharmaceutical companies are striving for, in addition to the potential grave side effects, especially when the therapeutic small molecules aim at multiple targets!
For the firm’s supporters, the critics’ claim that large pharmaceutical companies are unmoved by small molecule drugs is offset by the fact that Array has already amassed a large number of collaborators among mostly large pharmaceutical companies, including AstraZeneca (AZN), Amgen (AMGN), Novartis (NVS), Genentech, Roche (RHHBY.PK), Celgene (CELG) and, recently, ASLAN Pharmaceuticals. Oncologists are fervent about using small molecule chemotherapeutic agents in the treatment of most cancers. These drugs do not discriminate, but kill the healthy cells together with cancer cells. If these drugs are still the bread and butter of pharmaceutical companies, how then can anybody believe that these companies will be unmoved by small molecule drugs that are accurately and specifically designed to target proteins, which are features of malignancies only, not of normal cells? Also contrary to critics’ claims, the firm’s fans believe that targeting multiple proteins has demonstrated great advantages in counteracting cancer resistance of conventional chemotherapy and biological treatments. Array’s friends have expressed enthusiasm for the news, announcing that Array is cutting spending. With this enthusiasm the fans might have indirectly admitted that the firm’s spending has been unnecessary and out of order?
The question is: At Array’s current market capitalization, is its stock undervalued, overvalued, or fairly valued?
To reach an answer to this question one has to see how the market is evaluating similar firms when they were at the same stages of their drug development and how their evaluations proceeded when these firms reached beyond Array‘s drug development stage. Selecting Ariad (ARIA) for this comparison task, we could see that both firms have small molecule drug design technologies, both have more than three products in clinical trials, both have heavyweight alliances and both have promising early clinical trial results. The only thing that Array does not yet have is promising Phase III results and final results. Final Phase results of Ariad’s drug ridaforolimus were positive, which led its partner, Merck (MRK), to submit a marketing authorization application (MAA) to the European authorities. Ridaforolimus’ positive results are what triggered ARIA’s rally. Prior to this milestone, Ariad’s stock price was stagnant and the firm’s market value was as low as Array’s current market value. Ariad’s rallying momentum picked up as Merck filed for approval in Europe and announced its intention to follow on filing in the US and several other countries. That’s why Ariad’s market capitalization has reached over $1.3 Billion, while Array’s market cap is as low as $125 million.
History taught investors that many drugs, which have shown promising results in early-phase trials, have failed to demonstrate the same in larger and lengthier Phase 3 trials, or extended final phase trials. Until they became aware of this phenomenon, many investors saw their investments perish overnight - a relevant reason for developing an overly cautious approach to investing in mid-stage biotech firms. In cases when the odds were obviously in favor of drugs’ success, based on the firms’ technological capability and the drugs’ highly promising early and mid-stage results, the firms’ market capitalization barely reflected their future promises before Phase III results were announced. Bottom line, during mid-stage drug development, the proven, or unproven firms’ values have almost always been held hostage by either the firms’ overspending, or lack of future programs, or exaggerated future programs, which, for many analysts, mean nothing but lack of good management and negative financial results, both worth punishing through downgrades. That’s why, in most cases, before Phase III trial results, a biotech stock value is a feather in the wind.
The reality that we have to take, or leave, is that Array’s current stock price, undervalued as it might be, is the fixed price of what could be predicted as an excellent future biotech firm. Having great technologies, excellent products that are attracting the largest pharmaceutical companies, and early-phase positive clinical trial results, do not change the fixed price. With regard to Array, this firm has around 14 products in various phases of experimentation. We do not believe that 14 devils are waiting for them to fail Phase III clinical trials. Drivers of the stock price in the next few months will be the results coming from several Phase II clinical trials that we believe will be positive.
Array is well financed. Its current stock price could be representing a great investment opportunity. The only catch is that those who would buy the stock now might have to wait for another couple of years to turn the huge opportunity into a mere reality. As for now, during the period when the stock is a feather in an uncontrollable violent wind, some would prefer to buy when ARRY goes south and sell when it goes north, while others would prefer buy the stock for a long-term investment. ARRY is expected to keep yo-yoing until the end of 2013. From that time on, those who will not have the stock among their investment portfolios might tell stories about regret.
Disclosure: Long ARRY