Anacor (NASDAQ:ANAC) seemed expensive to me back in mid-January. I thought that the upside potential was limited and that just the uber-bullish scenario would yield significant returns for its shareholders. The stock is now down 30% and I am upgrading Anacor to buy with a 12-month base case price target of $80. The upside potential based on the bullish case is much higher.
Two reasons for the upgrade
Anacor performed poorly since I issued my bearish call on January 19. The stock was trading at $90 back then and is trading around $73 as of this writing. The two stocks that I thought to be better picks than Anacor have performed much better, as did the two major biotech ETFs.
|Symbol||Price on January 19||Current Price||Change %|
The second reason for the upgrade is the recent convertible note offering, which has removed the financing overhang. If underwriters use the over-allotment option, the company should raise around $270 million. The offering should bring the pro-forma cash balance to around $400 million which should be enough to cover the commercial launch of Crisaborole next year. Cash burn this year should not be higher than $100 million, assuming a ramp in Kerydin sales, but also a ramp in SG&A expenses related to the Crisaborole launch (the company burned around $60 million in 2015). Anacor has decided to do a capped call transaction with the notes, which should reduce the potential dilution. The cap price is $80.18, representing a premium of approximately 50% based on the closing price on March 31, 2016. Depending on the final size of the offering, the dilutive effect is in the range of 7% to 8%.The 30% correction has resulted in a significant change in the risk-reward ratio and is the first reason for my upgrade. Back in January, I thought that the upside under what I believed to be realistic circumstances was very limited and that the company could be worth $9 billion (or $180 per share) under the most bullish assumptions. The situation is much better now and I think that Anacor has solid upside potential based on both the conservative and bullish scenario. However, the fundamental situation has changed since I wrote the first article, and I will revisit the upside expectations later in the article.
Crisaborole is the most valuable asset
The FDA has accepted Anacor's NDA for Crisaborole and the PDUFA date is January 7, 2017. The timeline is somewhat shorter than I expected and a full commercial launch should occur during the first half of 2017. There were no major changes around Crisaborole since my January article and I think it has blockbuster potential. I have seen peak sales estimates of $2 billion and here is what Anacor's management had to say on the Q4 2015 call (emphasis mine):
Let me remind the review on the current market opportunity for Crisaborole if approved. As we've refreshed our market research with the data from the Phase 3 studies and the long-term safety study in hand, we continue to believe that this is a multi-billion dollar brand opportunity, driven by the prevalence of the disease and the interest from physicians and patients for a new first line non-steroidal topical anti-inflammatory PDE-4 inhibitor for the treatment of mild-to-moderate atopic dermatitis.
They also think that the early success of topical calcineurin inhibitors, or TCIs, is a good benchmark for Crisaborole. TCIs - Protopic and Elidel were approved in 2000 and 2001 and totaled approximately 5 million prescriptions by 2004, representing 14% of the topical anti-inflammatory market. Prescriptions were expected to continue to grow beyond 2004 had they not received a black box warning from the FDA. TCIs now comprise only 2% of 43 million prescriptions in the topical anti-inflammatory market.
Crisaborole's price is yet to be determined, but I assume that it will be close to Kerydin at around $1,400. Assuming a gross to net discount of around 35%, this translates into net sales per prescription of around $900. Getting prescriptions to half of what TCI's achieved in 2004 translates into annual net sales of around $2.25 billion and taking 10% of the total topical anti-inflammatory market translates into annual sales of around $4.5 billion to $5 billion. The company stands to generate almost $1 billion in annual sales with just 2% of the addressable market (the share that TCI's currently have even with a black box warning). Wedbush thinks that Crisaborole sales will reach $350 million in 2017 and $2 billion in 2020 and the firm estimates the price per prescription of $1,500. I am not that certain about $4 or $5 billion but think that $1.5 billion to $2 billion is achievable. Based on my projections, Crisaborole's present value per share is in the $61 and $95 range.
|Low estimate||High estimate|
|Crisaborole peak sales||1500||2000|
|Present value per share||53.06||82.54|
|Value per share in 12 months||61.02||94.92|
Source: author's calculations
Kerydin is facing significant headwinds
Kerydin's trajectory has slowed significantly in Q4. The underlying prescription trends were solid in 2H 2015, but Sandoz has taken a more aggressive approach to driving prescriptions, which has resulted in a lower share of gross profits for Anacor. This was the main reason for the significant Q4 revenue miss. The increased sales efforts have resulted in the prescription growth of 57% in 2H 2015 compared to 1H 2015 and unique prescribers have almost doubled from Q1 2015 to Q4 2015.
The negative side of these efforts is visible in revenues - Anacor's revenues increased just 20% in 2H 2015 compared to 1H 2015 due to lower gross profits from Kerydin sales.
Sandoz has made some changes in January 2016 which should lead to a decrease in costs per prescription of Kerydin this year but there are no changes for unrestricted patients, which represent the majority of prescriptions. The second largest group of patients are restricted and Sandoz has decided to fill their prescriptions under their commercial plan rather than the patient access program, which should reduce costs per prescription. Sandoz will also focus on driving prescriptions through increased promotion, but Anacor expects that its gross profits should increase in 2016 compared to Q4 2015.
Given the increased competitive pressure and higher spending, it seems that I was generous with estimating peak sales in the $500 million to $1 billion range and I am reducing it to a range of $300 million to $600 million. Anacor is entitled to half of the gross profit, which translates into around 47% of Kerydin sales and a pre-tax profit of $145 million to $290 million. Based on these projections, Kerydin's present value is between $16.5 and $33 per share.
|Low estimate||High estimate|
|Kerydin peak sales||300||600|
|Present value per share||16.61||33.22|
|Value per share in 12 months||19.10||38.20|
Source: Author's estimates
However, the lower growth trajectory for Kerydin is not the only negative development here. The Patent Trial and Appeal Board has instituted inter partes review proceedings on Kerydin patents based on a petition from hedge fund manager Kyle Bass, who claims that these patents are invalid because they are obvious. Anacor believes in the strength of its IP and the company claims to "have a number of strategies in place to expand and enhance our IP and regulatory exclusivity, and fully intend to vigorously defend and enforce our Kerydin IP." The institution of the IPR is certainly bad news since the invalidity rate is very high - 82% of challenged claims were ultimately invalidated in the PTAB's written decision, however, the percentage of patents that were completely invalidated is 22% and the number is dropping (it was 29% in 2014% and 15% in 2015).
I am not an expert on this issue but think that there is a reasonable chance for the company to retain exclusivity. The final determination by the Board will be issued within one year.
Upside potential over the next 12 months
The combined present value for Crisaborole and Kerydin is in a range of $69 and $114. Extending the time horizon to 12 months results in a price target range is $80 to $133. The upside based on the low end of the range is around 10% and is 80% based on the bullish case. I am still more conservative than Wall Street analysts - their price targets are between $95 and $173. The valuation is more attractive now, but the downside risks are still present. Crisaborole is yet to receive FDA approval and its commercial success is yet to be determined which poses a significant risk for Anacor since most of the value is based on it. Kerydin's patent exclusivity also presents a risk, but I think that there is a reasonable chance for the company to retain exclusivity. The risk of dilution is now off the table, and even moderate success with Crisaborole in the following years should enable the company to reach cash flow breakeven. Assuming a strong ramp in 2017, this should happen in early 2018.
I still like Omeros (NASDAQ:OMER) and Otonomy (NASDAQ:OTIC) more than Anacor, but I think that the situation has changed for the better. I am upgrading Anacor to buy with a 12-month price target range of $80 to $133, which translates into 10% to 80% upside from the current price. The main risks to the thesis are Crisaborole's uptake in the following years and Kerydin losing patent exclusivity.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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.