Last year was very good for Anacor (NASDAQ:ANAC). Kerydin sales have ramped up nicely and the company reported positive phase 3 trial results for Crisaborole. Shares are up substantially in the last two years and the company's current market cap implies a great future for its two products. I can see why the market is so excited about Kerydin and Crisaborole, but I am not a buyer at current levels. The current market cap is too rich for my taste and I would consider buying Anacor at a lower price. The only justification for the current market cap is the fact that Anacor is an attractive takeover target, but the risk/reward is not right and I would wait for a deeper pullback to initiate a position. There are much better opportunities in the biotech sector at the moment, but Anacor is certainly worth watching.
Kerydin sales picking up, could reach $1 billion in peak sales
Kerydin is doing rather well following last year's launch. Sandoz is responsible for Kerydin's commercialization and Anacor is entitled to 50% of gross profit (approximately 48% of net sales) and the company received $20 million in Q3 as Sandoz generated $40 million in sales. This represents an annual run rate of around $160 million and analysts are expecting peak sales around $1 billion (half of which should go to Anacor). Sandoz launched a direct-to-consumer (DTC) campaign this summer, including TV and print ads and prescriptions responded with a solid sequential increase, but this points to higher promotional sensitivity and Sandoz seems to be spending much more to generate an uptick in sales. The other negative part of this story, at least when it comes to media attention and the recent specialty pharmacy issues surrounding Valeant (NYSE:VRX), is the fact that 35% to 40% of Kerydin prescription go through specialty pharmacies. I see no issue with this fact, but the market has punished several companies which are using specialty pharmacies and Anacor is certainly one of them. The company addressed this issue in on the Q3 call and management stated that "the specialty pharmacy that Sandoz uses to distribute Kerydin is called RxCrossroads", which is not affiliated with Sandoz or Anacor. RxCrossroads is owned by CVS since mid-2015, and CVS' specialty pharmacy is one of the largest in the country. I expect no adverse impact on Kerydin sales due to the fact that a large part of prescriptions goes through specialty pharmacies, but investors should keep this in mind if other issues surface going forward.
Kerydin's growth trajectory since launch has been lower compared to Jublia's trajectory since launch (Jublia is marketed by Valeant) and the ramp up in marketing spending shows that Kerydin may be dependent on heavier promotion. Since I am not that optimistic about Anacor at current valuation levels, I am going to assume that Sandoz is able to get annual sales to $1 billion at peak (which is a bit optimistic in my view) in four to five years, of which around $500 million belongs to Anacor. Now, I will take a look at Crisaborole and provide an opinion on Anacor's valuation afterwards.
Crisaborole - the company's most important asset
Positive phase 3 trial results from Crisaborole were the most important share price driver for Anacor this year, driving the stock from low to mid-80's prior to the announcement to as high as $155 in the next few days. Anacor announced in mid-July that "Crisaborole Topical Ointment 2% for the treatment of mild-to-moderate atopic dermatitis met all primary and secondary endpoints." Anacor plans to submit an NDA to the FDA in the first half of 2016 and the product should reach the market by early 2017. Atopic dermatitis affects between 18 million and 25 million people in the U.S. and 80% to 90% of cases are mild to moderate. The company thinks that Crisaborole will benefit from broad market access in a large and growing market for topical prescription anti-inflammatories and it also expects to have first-mover advantage and limited branded competition, since Crisaborole is the leading product candidate in late-stage development. There are others that think that competition will increase going forward - fellow contributor Heterosis Research strongly believes that Crisaborole "will face a significant uphill battle against topical calcineurin inhibitors ((TCIs)), which have impressive efficacy." Prescriptions of TCI's have been in a strong downtrend since 2004 when they got a black box warning from the FDA regarding increased rates of cancer, but Heterosis Research points that "the newly published studies are clarifying misconceptions regarding their safety profile." On the other hand, SA author Dave Schneider points that Crisaborole was "barely better than the placebo."
Anacor expects to commercialize Crisaborole on its own and has already taken steps to build the sales team in anticipation of FDA approval in late 2016. The company and some analysts have high hopes for Crisaborole, and I saw peak sales estimates as high as $1.7 billion. This peak sales estimate came from Goldman in July, following the positive phase 3 trial results. The firm's analyst, Gary Nachman, believes that getting an 18% share of the AD market would result in peak sales of $1.7 billion and that off-label use "could be significant in other types of dermatitis."
Psoriasis is another potential large market for Crisaborole. Management did not talk much about psoriasis in recent quarters and the company has been focused on getting approval for AD and they stated that they will evaluate psoriasis (among other things) in 2016. The total addressable market for Crisaborole would expand substantially and peak sales could end up being above $1 billion just for psoriasis. I would not get too much excited about Crisaborole's potential in Psoriasis at this point, but positive developments here could unlock significant shareholder value in the following years.
Current market cap leaves little room for error
Anacor's current market cap is around $4.1 billion. If we consider Kerydin's and Crisaborole's combined optimistic peak sales potential of $2.2 billion ($500 million for Kerydin and $1.7 billion for Crisaborole), the company is trading at 1.9x peak sales of its two most important assets and both Kerydin and Crisaborole have a long way to go to reach those levels. Since Sandoz is responsible for Kerydin's commercialization, Anacor receives pure profits and does not incur any costs, so the $500 million in expected peak sales (or roughly half of $1 billion) is actually a pre-tax profit, and deserves a much higher multiple. Since the company's accumulated deficit is already around $260 million (and should be north of $300 million by the end of 2016, which could be the last year of operating losses), the company stands to pay little or no taxes in the following years. Applying a profit multiple of 15 gets us to $7.5 billion, but this needs to be discounted back and the value of Kerydin is in the $4 billion to $5 billion range under the most optimistic circumstances, but likely less is we take a more conservative approach.
On the other hand, the company intends to commercialize Crisaborole on its own, and given the valuations of recent deals (Shire (NASDAQ:SHPG) acquired Dyax (NASDAQ:DYAX) for $5.9 billion with $2 billion peak sales estimates for DX-2930 and Astra Zeneca (NYSE:AZN) acquired ZS Pharma (NASDAQ:ZSPH) for $2.7 billion with peak sales estimates of around $1 billion for ZS-9), a price to peak sales ratio around 3 is realistic, which means that Crisaborole's value for a potential acquirer is around $5.1 billion if we take the peak sales estimate of $1.7 billion. On a net income basis, I think that a net margin in the 30% to 35% range is realistic, which results in net income in the $510 million to $600 million range at peak. Applying a P/E ratio of 15 gets us to $9 billion based on the upper end of the net margin range, but since this will happen in around 7 years, it needs to be discounted back, which yields a present value of around $4.5 billion. If we add Kerydin, we get a market cap of around $9 billion. This translates into upside of more than 100% and is the most bullish scenario with the mentioned set of circumstances.
The above-mentioned math for a valuation of around $9 billion is the best case scenario for Anacor in my opinion. Taking a more conservative approach for Kerydin (peak sales in the range of $500 million to $700 million, of which half would go to Anacor) and Crisaborole (around $1 billion) results in a market cap that is very close to the company's current market cap. Both calculations assume a 10% discount rate and 5 years for Kerydin to reach peak sales and 7 years for Crisaborole.
I think that the current valuation is a bit stretched and the only justification is the fact that the company might be an attractive takeover target.
On the other hand, the downside risks are considerable since both Kerydin and Crisaborole have a lot of work to do to justify the current valuation. Anacor as a standalone company is too expensive at the current price in my opinion. Insiders also seem to support my view on current valuation, since they have sold 2.7 million shares (on a net basis) in the last three months and have been the major source of supply of shares.
I would consider buying Anacor at $60 or lower all else being equal, but I think that there are better opportunities in the biotech sector with a much more favorable risk/reward ratio. These are some examples:
- Omeros (NASDAQ:OMER) - with a market cap of around $380 million, the company is trading in the range of 0.9x to 1.3x Omidria U.S. peak sales, without considering international sales and the rest of the pipeline with potential peak sales close to $1 billion (OMS721) and above $1 billion (OMS824). You can read more about my opinion on Omeros here.
- Otonomy (NASDAQ:OTIC) - trading at less than 1x combined peak sales of Otiprio and OTO-104 without any value assigned to the rest of the pipeline. Otonomy's current market cap is just north of $600 million and with the latest $115 million offering, the company should have around $300 million in cash as of December 31, 2015. You can read more about my opinion on Otonomy here.
Off course, these companies are not directly comparable to Anacor, but Omeros and Otonomy are at similar stages of development with each having one approved product and each having a stage 3 candidate, though Anacor's Crisaborole has successfully completed phase 3 trials, so Anacor's product portfolio is somewhat more advanced than Omeros' and Otonomy's. On the other hand, we should consider that both Omeros' Omidria and Otonomy's Otiprio have no FDA-approved competitors, which cannot be said for Crisaborole and Kerydin, which I think is enough to eliminate Anacor's development stage advantages. Omeros and Otonomy are better biotech picks with more favorable risk/reward ratios in my view.
Anacor's valuation is too rich for my taste and I although I think that it is a great company with a solid product portfolio and pipeline, I have other companies like Omeros and Otonomy in my portfolio, which (in my opinion) have a more favorable risk/reward ratio. A lot of the future success of Kerydin and Crisaborole is already priced in and insiders seem to feel the same way given the strong selling pressure on their behalf in the last few months. I am waiting for a deeper pullback to initiate a position and if shares fall to around $60, I might consider buying a few shares.
Disclosure: I am/we are long OMER.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: This article reflects the author's personal opinion and should not be regarded as a buy or sell recommendation or investment advice in any way. I may initiate a long position in OTIC over the next 72 hours.