A tiny country in Asia
Would you have found South Korea on this map?
( Source for all slides in this article)
The tiny country is obviously the red spot indicated by Orexigen's (NASDAQ:OREX) distributor Kwangdong that should start selling Contrave in Q3/16.
U.S. competitor Belviq was launched in South Korea in Q1/15 and sells about 40,000 scripts per quarter which is ~30% of its U.S. sales volume and, given similar pricing, roughly represents the same percentage of its U.S. revenues (from product sales).
Given that Contrave substantially outsells Belviq in the U.S. and the terms of the respective distribution agreements are similar ($7 million upfront payment to Orexigen, ~35-40% of net sales, potential sales-based milestone payments + other fees), a conservative estimate for Orexigen's potential in South Korea would see 2017 revenues at its competitor's 2015 level, i.e. at ~$4 million from where it should continue to grow.
While not very exciting in itself, at a second look this small country reveals a substantial charge of bitter needed calories. In fact, in 2015, Orexigen had total U.S. revenues of $24.5 million, of which only $10.6 million came from royalties on product sales. Hence, if Orexigen managed to equal its competitor, the tiny country of South Korea would represent ~27% of its 2015 revenues from product sales!
From 2016, this ratio will obviously change. Instead of receiving royalties on U.S. sales, Orexigen will receive the entire revenues and bear the entire cost of commercialization. As a result, the bottom line for the U.S. segment will likely stay negative for a few more years. This won't be the case with the company's foreign adventures. In fact, the South Korean revenues will be reduced only by very little COGS and other expenses, so that most of it will drop directly to the bottom line.
We can estimate South Korea to deliver between ~$3 and ~$3.5 million of net profits. Not bad for a company trading for a total market cap of ~$80 million - especially considering the tiny spot on the map South Korea represents.
Let this sink in: If Orexigen was sold only in South Korea without any opportunity outside of that tiny country, its current market valuation would be a bit on the high side, but still close to fair. - Doesn't that seem absurd?
At this point, probably the most urgent question is: Why, for heaven's sake, Orexigen insists on the complicated and expensive U.S. opportunity? Why not simply throw the towel and cash in nice and easy royalties from multiple cooperation agreements abroad?
How much would the business be worth as a royalty management company with little overhead costs and dozens of distribution partners around the world?
One thing is certain: Something is wrong with this company - or its share price.
In fact, if we presume that the current share price reflects an accurate valuation, it also says that Orexigen is run by idiots. With very little effort, the company could close its U.S. operations, reduce the number of its employees and operating expenses to the bone, avoid the costs of an own sales force and become, with all likelihood, profitable with very little risks. And the share price would rise. Moreover, there would have been no need for the recent dilution, as the company had already owned all current distribution rights outside of the U.S.
The international opportunity
So let's take a closer look at those foreign countries.
Korea is not even a country with high obesity rates. In fact, its obesity rate is only half as high as in the U.S., and overall obesity rates in Korea are among the lowest in the OECD. Yet, with a pretty good probability, it could still deliver $3-3.5 million of net profits per year.
Europe: What is most interesting about the region is the absence of generic phentermine. In the U.S., phentermine has ~80% of the total anti-obesity drug market. In the EU, it is not authorized. Moreover, neither of Orexigen's U.S. competitors in the pill segment, Belviq and Qsymia, are authorized. This means that there is only one anti-obesity pill on the menu - and that is Mysimba (EU name for Contrave).
Orexigen plans to conquer the continent via several, mostly non-exclusive distribution partnerships. The opportunity is huge: In Europe, there are even more potential patients than in the U.S. and, besides greater willingness to pay out-of-pocket, health insurance is mostly public. So coverage will be much better than in the U.S. from day one. Based on pricing for Bupropion and Naltrexone, the components of Contrave (that are available in Europe as generics in much higher dosages than those used in Contrave), prices should be similar to the U.S. in the most important countries. (I have researched Germany, the U.K., France, Italy, Spain, representing over half of the EU population and much more of its sales potential.) Last but not least, prescribers will be easier to address, as in many countries there is a concentrated community of obesity specialists. Hence, Europe is very attractive and Orexigen forecasts that about one-third of Contrave's overall value will be generated there (50% from the U.S., 17% from other countries). And this is obviously based on an optimistic long-term forecast for the U.S. - where at least until 2019 no value will be generated at all.
As the EU population is 10 times the South Korean population, with a much higher obesity rate, and there is no competitor in the pill segment, we can presume that the EU could deliver 10-15 times our projected South Korean annual script number. This is probably too conservative, as our projection for Korea is based on Belviq's results in its very first year on the market. But it's better to err on the side of caution. With similar pricing and a similar net profit per script to the Korean arrangement, net of COGS and (little) operating expenses, Orexigen's EBIT from EU sales should reach ~$40-50 million pretty soon. (Being a one-time event and non recurring, I exclude the already financed CVOT trial expenses from my projections.)
Not much additional sales outside of the EU would be needed to cover interest expenses (~$7.5 million in 2015) and taxes. Probably not more than South Korea and Turkey will be needed for this. (Turkey has a population of 75 million, 37% of which are overweight and 24% are obese, a sales agreement with Valeant (NYSE:VRX) is already concluded.)
Hence, if it had simply shut down its U.S. operations, within a few years Orexigen could have made annual net profits of ~$40-50 million or ~$0.30 per share. No dilution, little risks, monopoly in Europe, low tax rate (foreign operations are based in Ireland) - what's not to like?
This is why I wrote in my first article on Orexigen that the recent, second Baupost transaction represented a long-term bet on Contrave's U.S. potential. This highly dilutive financing would not have been necessary for the sole international opportunity. Which, by the way, is probably far larger than my projection (based on little more than sales in the EU and South Korea).
The recent Valeant agreement already includes several countries that are not part of the EU (the largest being Turkey).
Several other countries are already close to an agreement:
A rough indication of their potential size is given by the following table:
While already interesting, investors need to take into account that many of these markets have never seen a drug like Contrave (which explains the ridiculous China peak sales in the table). So chances are excellent for much higher peak sales. In fact, the table doesn't even include New Zealand (population: 4.5 million; term sheets with multiple distribution partners already in place):
Or let's take Canada (which is included in the table with a very low peak sales estimate of $36 million). Canada has a population of 35 million people and obesity is "expected to surpass smoking as the leading cause of preventable morbidity and mortality" (Source). Canada ranks 33 on a 2007 list of fattest countries, with 61.1% of its citizens having a body mass index (BMI) of at least 25. (Source) That doesn't seem to justify a low-ball peak sales estimate of $36 million for this country (for all competing anti-obesity drugs together).
I could go on like this for a while. Just check out this page with international statistics and draw your own conclusions.
However, keep in mind that all these huge international opportunities come with an important caveat: Each country has its own culture. An Italian woman seen as in perfect shape in the U.S. might consider herself to be overweight in Venice. In Germany and in the U.K., there has recently been an increasing number of offers for oversized clothes, indicating that people might feel good about their extra-large shape. (Or maybe the fashion industry has just discovered an attractive growth segment. Keep in mind that overweight people frequently need new clothes as their size changes.) In Korea, obesity seems to affect mostly undereducated women.
So there can't be a one-size-fits-all approach - and no extrapolation of market potentials. That's why I have deliberately chosen to stay extremely cautious. However, while Europe might deliver less sales than projected, Turkey, Russia, Latin America, Canada, China, etc., could surprise to the upside. Each country will be different, each country can be disappointing, but each country can also be a huge success. Orexigen has dozens of shots and, as I have shown with South Korea, each and every shot has the potential to justify the current market cap. And this totally excludes the U.S.
So let's return to my first, conservative estimates that largely excluded opportunities beyond the EU, South Korea and Turkey. With a very high probability they allow us to project that, at the latest 5 years from now and without its U.S. operations, Orexigen could have been worth $6 per share (20 times EPS of $0.30).
It currently trades for $0.56. Quite a margin of safety.
Even if the EU, Korea, Turkey and the entire rest of the world delivered only half of the estimated sales, investors would still do great.
That said, the path to $6 is still open. Orexigen could exit the difficult and expensive U.S. market tomorrow. But would it really be worth more at that point? Baupost and the company itself apparently think differently.
Stay tuned. I will take a closer look at the U.S. opportunity in another article.
Disclosure: I am/we are long OREX.
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.
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