Is Bristol-Myers' Fall Justified?

| About: Bristol-Myers Squibb (BMY)


BMY lost $20 billion in market capitalization.

This seems unjustified.

BMY's valuation has gone down and the dividend yield has gone up.

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Bristol-Myers Squibb (NYSE:BMY) fell 15% on Friday in reaction to one of its drug candidates not reaching the primary endpoint during a phase III study. I'll try to examine whether this huge price drop is justified.

Bristol-Myers trades at $64 right now, down 15% from Thursday's closing price, and has traded even lower earlier on Friday. The 15% share price drop has wiped out $20 billion of the company's market capitalization.

The sell-off was based on the company's announcement that its drug Opdivo had failed to reach the endpoint of a phase III study where it was tested for treating advanced non-small cell lung cancer.

Opdivo, an immuno-oncology med, is on the market and is used to treat other diseases, such as melanoma and Hodgkin lymphoma. There are also a lot of other indications where Opdivo will be used in the future, such as bladder cancer and Squamous cell carcinoma of the head and neck. The drug saw sales of $840 million in this year's second quarter, an increase of several hundred percent over last year's Q2 sales of $120 million. It is easy to see that the drug is already the biggest contributor to Bristol-Myers' top line, and with the growth rate the drug is experiencing the importance of Opdivo for Bristol-Myers will only increase.

The drug is investigated in a couple of studies right now, and in June, at ASCO, Bristol-Myers has announced results from eight studies investigating Opdivo (or the combination of Opdivo and Yervoy), among them a phase III study for the treatment of melanoma, a phase I and a phase II study for the treatment of renal cell carcinoma, a phase II study for the treatment of colorectal cancers, and many more. The drug's recent very strong growth and the future expected growth rates thus do not depend on one single indication, but rather Opdivo will become a drug that can be used to treat many different kinds of cancers. The fact that Bristol-Myers did not reach the endpoint with the Checkmate-026 study is thus a negative, but this will not mean the end for Opdivo at all -- even if the drug would never be used to treat non-small cell lung cancers, the drugs' revenues will continue to grow over the next quarters and years.

The fact that Bristol-Myers sold off 15% based on this setback thus looks unjustified, I believe: If Bristol-Myers was a small biotech company relying on one drug and that drug did not meet the primary endpoint in one study, a sell-off would be justified. But since Opdivo is responsible for just 20% of Bristol-Myers' revenues -- and those revenues will not disappear, they will just grow at a slower pace -- the sell-off seems overdone to me.

Bristol-Myers has lost more than $20 billion of its market capitalization from the peak we have seen a couple of days ago. Since a company's valuation (and thereby its market capitalization) depends on the future earnings and cash flows the company will generate, this sell-off would be justified if this news would mean that Bristol-Myers future earnings will drop by $20 billion if Opdivo can never be used for the treatment of non-small cell lung cancers.

Bristol-Myers has a net profit margin of 17%, in order to have lost $20 billion in future earnings the company would thus have to lose $118 billion in future sales (the actual lost sales would have to be even higher since the future earnings would have to be discounted). In order to be conservative let's calculate with a higher profit margin of 20% and disregard any discounting of future earnings, in that case the failed phase III study would still have to mean $100 billion in lost revenues for Friday's price decline to be justified.

Leerink analyst Seamus Fernandez believes the failed phase III study could mean $4 billion in lost sales (annually) in a worst case scenario. Losing $4 billion a year at the peak sales level (in the worst case scenario) would mean that Opdivo would have to be in the market for roughly three decades in order to justify today's price drop. Opdivo is patent protected through 2027 in the US, thus for roughly ten years from the present -- it is very unlikely that the failed drug trial will lead to $100 billion in lost sales (or even anything close to that number) before the patent expires. A more likely guesstimate would be $30 billion in lost sales over the next years, which equals about $6 billion in lost profits when using a net profit margin of 20% (slightly higher than Bristol-Myers' current margin). The sell-off thus seems overdone, although we have to say that a portion of the share price decline was justified.

After the sell-off Bristol-Myers now trades at a forward earnings multiple of below 20, which is not a low valuation per se, but which is a lot cheaper than the company's valuation over the last three years (roughly in line with Bristol-Myers' valuation for a short time earlier this year). The company's dividend yield has risen sharply as well, investors can now buy Bristol-Myers' shares with a yield of 2.4%, which is a higher income yield than what investors get from the broad market (2.1%) and even 30 year treasuries (2.3%).


The failed study hurts Bristol-Myers, and some share price declines were justified, but a market cap decline of $20 billion looks overblown: Opdivo will still be a very profitable drug for the company, and the failed study will not lead to lost earnings anywhere close to $20 billion.

Bristol-Myers is still not trading for a cheap valuation on an absolute basis, but shares look more attractive than they did a couple of weeks ago. For income investors the same holds true, Bristol-Myers now trades with an above average dividend yield again.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BMY over 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.