Why You Should Be Bullish On Vertex Now

| About: Vertex Pharmaceuticals (VRTX)

Vertex Pharmaceuticals (VRTX) shares recently dropped 20% on the news that its VX-809/Kalydeco Cystic Fibrosis combination therapy data had been inflated. Instead of 46% of the patients in the Phase II studies showing an improvement in lung function of 5% or more, the actual figure was 35%. And though it had been reported that 30% of the patients showed a 10% improvement in the functioning of their lungs, the figure was later revised downwards to 19%. The error was attributed to the outside agency that had been engaged by Vertex misinterpreting the data. This leads us to the question, is Vertex a viable investment option?

The company insists that it is on track for its VX-809 drug to commence Phase III trials, and that it's revised data still shows statistical improvement in patients. The FDA has given the drug both orphan and fast track status, and this has not changed despite the mistakes in the data analysis. The Kalydeco/VX-809 combination therapy has the potential to cater to a much larger segment of the population, as nearly half the people in the world who suffer from cystic fibrosis have the specific condition that is targeted by this combination. The company will likely target the study toward a much larger sample to demonstrate their confidence in the drug.

Continuing our investigation, we need to look at the drug combination to understand a little bit more. The combination therapy consists of Vertex's already approved cystic fibrosis drug, Kalydeco, and its experimental VX-809 drug, which is believed to have the potential to become the most effective line of treatment for the majority of cystic fibrosis patients. Only a few months ago, Vertex was successful in obtaining FDA approval for Kalydeco, the first treatment for cystic fibrosis that addresses the underlying cause of the disease. Unfortunately, Kalydeco works only on a small percentage of Americans who have the specific genetic mutation that the drug has been created to combat. Yet, the company has been experimenting with different combinations of drugs to try and reach out to a larger percentage of patients.

Cystic fibrosis is a disease that causes the thickening of the mucus layer that lines the lungs, leading to blocked airways and to infections that can damage the lungs. Patients suffering from the disease often suffer a premature death due to the worsening of infections and breathing complications. The average life expectancy of a patient suffering from cystic fibrosis is 37 years. In addition to cystic fibrosis, Vertex is also involved in projects targeted at hepatitis C and rheumatoid arthritis.

Despite the data error, Vertex remains a profitable company with a promising drug pipeline and a bright future. Over the last 12 months, Vertex generated revenue of $1.78 billion. The company currently holds $980.87 million in cash, and $400 million in total debt. Vertex has a profit margin of 16.74%, and operating margin of 26.63%. Lets look at its hepatitis C medication, Incivek. $456.8 in revenues were generated through Incivek in Q4 2011. The company's total revenues for the same quarter were $563.3 million. Vertex expected revenues for Incivek somewhere between $1.5 and $1.7 billion in 2012. The company parterned with Johnson & Johnson (JNJ) subsidiary Janssen Pharmaceuticals, in Europe, which demonstrates the potential for future growth. In the first quarter of 2012, Incivek generated nearly $360 million in revenues, and the total revenues of this quarter at $430 million multiplied almost six fold from the same quarter of the previous year. With five drugs for diseases ranging from epilepsy to inflammation in Phase II trials, and 12 preclinical trials for diseases from cancer to multiple sclerosis, this company is far from being a one product wonder.

Revenues for the year 2012 are expected to be just under $2 billion, of which 75% will come from Incivek, the hepatitis drug. However, sales of the drug are showing signs of slowing down, and it is important for the company to find a replacement for the cystic fibrosis treatment. Much of the proposed expenditure of $800 million on research and development will probably be spent on cystic fibrosis and hepatitis though potentially promising drugs that are in the initial stages of being developed for epilepsy and rheumatoid arthritis. It is important for the company to develop new treatments for hepatitis C and cystic fibrosis as quickly as possible. The hepatitis C market is becoming crowded as Merck (MRK), Gilead Sciences (GILD), and Bristol-Myers Squibb (BMY) are all in the race to develop alternative treatments. In 2011, Merck released Victrelis, a drug which improves the cure rate for hepatitis C, while Bristol Myers Squibb and Gilead are examining the possibility of a joint testing venture for phase III treatments for the disease.

The S&P US BMI Health Care benchmark forward P/E ratio is 13. In comparison, competitor Spectrum Pharmaceuticals (SPPI) has a forward P/E of 8.5, while Valeant Pharmaceuticals (VRX) has a forward P/E of 11. Vertex had reached a forward P/E of 23 before the news about its data problems surfaced. However, I consider it important to be extremely careful when using P/E ratios in the evaluation of biotech investments because of the game changing nature of biotech drug development. Vertex, like other biotechnology companies, is a relatively high risk investment, but the sheer spread and success of its activity makes it an attractive investment candidate. Moreover, the successful development of the cystic fibrosis treatment cannot be ruled out really because of data problems. If you are looking for biotech exposure in your investment portfolio, I would certainly recommend buying Vertex.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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