Discovery Laboratories (DSCO) offers upside reward over both the near and long-term. It is rare to see a biotech stock with two recently approved drugs (Afectair and Surfaxin) that is, in my opinion, trading at such a discount to fair value. The stock underperformed over several years as it took considerable time to get drugs approved and investors paid the price. Now the drugs are finally approved, launch is imminent and investors will likely see over a 100% increase in the stock price as per my analysis given below.
In valuating DSCO, I conservatively exclude its promising pipeline, which includes product solutions for Respiratory Distress Syndrome (RDS) such as Surfaxin LS, a lyophilized formulation of KL4 surfactant, as well as Aerosurf, an aerosolized KL4 surfactant. Aerosurf could represent a transformational change in neonatal respiratory critical care by providing practitioners the ability to administer surfactants using less evasive means. Leaving aside the value in the pipeline, I'll valuate DSCO solely on the "home run" drugs already cleared by the FDA:
Afectair: The commercial introduction of Afectair is coming soon. On February 8, 2012, DSCO signed a manufacturing agreement for Afectair in the U.S. As per the company's press release, US Annual Sales should range from $50-$75 million. Additionally, as per the company's press release, "According to national health statistics and market assessment data, it is estimated that each year more than 1.3 million patients in the United States and European Union receive aerosolized medications while requiring ventilator support." EU commercialization is expected late this year, from which the company can expect additional revenue.
Surfaxin- On March 6, 2012, DSCO announced FDA approval of Surfaxin for prevention of RDS in premature infants at high risk for RDS. Surfaxin is the first synthetic, peptide-containing surfactant approved for use in neonatal medicine. Discovery Labs anticipates that Surfaxin will be commercially available in the United States in late 2012 where, annually, approximately 90,000 premature infants are treated with currently available animal-derived surfactants. The company's surfactant franchise has the potential to achieve peak sales of over $1 billion worldwide in the infant RDS market, as noted to clients by Roth Capital analyst, David Moskowitz, who raised the price target on the company's stock to $10 from $6. He figures Surfaxin's initial formulation could take 40% share of the current infant respiratory distress syndrome market in the U.S. by 2016. Other formulations and line extensions of the technology "offer blockbuster potential and could attract suitors," he added. Furthermore, he stated "risks associated with non-U.S. approval and advancement of the company's aerosolized surfactant candidate, Aerosurf, are also lowered by the event."
DSCO is employing Dendreon's (DNDN) strategy of retaining rights to its drugs and is thus adding shareholder value because they are not sharing product revenues. (DNDN still holds global rights to its blockbuster drug, Provenge.) The downside is the company needs to rapidly expand its sales force and execute well on its sales plan. DSCO has $57 million in cash ($42 million from an offering of 16 million shares on March 21, 2012 plus $15 million on the prior balance sheet) which provides the necessary financial resources to commercialize its products. Assuming only $50 million for Afectair sales, which is the company's low-end projection for U.S. sales alone and the $1 billion estimate for Surfaxin, I estimate that DSCO will achieve approximately $1.05 billion in annual sales and I do not anticipate any future dilution. DNDN trades at a price/sales multiple of 4.36. Assuming that DSCO trades at the same multiple as DNDN and assuming 40 million shares outstanding, the target price per share is $6. Thus, I believe the upside potential is tremendous for DSCO and presents a bright future for its investors.