Amarin Has Upside Potential With Drug

Nov. 8.12 | About: Amarin Corporation (AMRN)

By: Ishtiaq Ahmed

Amarin Corporation (NASDAQ:AMRN) stock has become sluggish in recent weeks due to a delay in the decision about NCE status of Vascepa. The company has been able to amass an impressive portfolio of patents for Vascepa. However, it seems that the market has put all of its focus on the NCE status of Vascepa. The stock has been through a lot of ups and downs on the news of a rumored acquisition. However, currently, a delay in the decision about NCE status is also deterring the potential acquirers.

It is quite clear that the NCE status is important for Vascepa. However, I believe the stock can still be a success even if the company does not receive NCE status for Vascepa. I decided to perform a fair value analysis based solely on the potential of the drug. Let's assume that Amarin fails in its efforts to get NCE status and decides to enter the market without a partner. How much Amarin should be worth then? In my analysis, I have kept my assumptions a little conservative and a high discount rate. Even with conservative assumptions and a high discount rate, the results were extremely encouraging. Let's go through the model assumptions and ProForma earnings.

Model Assumptions:

The Street expects Vascepa to generate $1.8 billion in sales by 2018. At the moment, Amarin does not have any drug in the market. As a result, the firm has recorded losses like other development stage pharmaceutical companies. In my model, I have assumed that Amarin gets NME status instead of NCE status. As a result, the firm decides to go into the market alone and launches the drug in the fourth quarter of 2012. Let's assume the company generates $5 million in sales during the first quarter of its launch. However, in the following quarters, the sales pick up and Amarin achieves over $1.6 billion in sales in 2018. My sales estimates are still below $1.8 billion the Street expects the company to generate in 2018. In the U.S. gross margin for the firm can be around 90%, but I have assumed a gross margin of 70%.

A reason for keeping my assumptions on the conservative side is to test how bad it can go for Amarin. I believe a disadvantage of 20% in Gross margin is significant for the company. In addition, the company will have to increase its R&D expenses for ongoing studies. Further, the marketing and administrative expenses will increase substantially as the firm will have to hire a sales team. For the model, I have assumed a yearly increase of 20% in marketing and administrative expenses. At present, Amarin has around 175 million fully diluted shares. For my model, I have used a diluted share count. In addition, I have assumed a secondary offering of 35 million shares in 2013 to fund the expansion of marketing activities.

ProForma Earnings:

2012 2013 2014 2015 2016 2017 2018
Revenues $5,000,000 $450,000,000 $585,000,000 $760,500,000 $988,650,000 $1,285,245,000 $1,670,818,500
Cost of Sales $1,500,000 $135,000,000 $175,500,000 $228,150,000 $296,595,000 $385,573,500 $501,245,550
Gross Margin $3,500,000 $315,000,000 $409,500,000 $532,350,000 $692,055,000 $899,671,500 $1,169,572,950
Operating Expenses:
Research and Development $18,250,000 $18,615,000 $18,987,300 $19,367,046 $19,754,387 $20,149,475 $20,552,464
Marketing, general and administrative $27,000,000 $32,400,000 $38,880,000 $46,656,000 $55,987,200 $67,184,640 $80,621,568
Total Operating Expenses $45,250,000 $51,015,000 $57,867,300 $66,023,046 $75,741,587 $87,334,115 $101,174,032
Operating Income (loss) -$41,750,000 $263,985,000 $351,632,700 $466,326,954 $616,313,413 $812,337,385 $1,068,398,918
interest Income (expense), net $5,260,000 $5,286,300 $5,312,732 $5,339,295 $5,365,992 $5,392,822 $5,419,786
Other Income (Expense), net $89,000 $89,445 $89,892 $90,342 $90,793 $91,247 $91,704
Income (Loss) before Taxes -$36,401,000 $269,360,745 $357,035,324 $471,756,591 $621,770,198 $817,821,454 $1,073,910,407
Provision for Taxes -$7,280,200 $53,872,149 $71,407,065 $94,351,318 $124,354,040 $163,564,291 $214,782,081
Net Income (Loss) -$29,120,800 $215,488,596 $285,628,259 $377,405,273 $497,416,158 $654,257,163 $859,128,326
Earnings (loss) per share -$0.17 $1.03 $1.36 $1.80 $2.37 $3.12 $4.09
Click to enlarge

According to my earnings estimate, Amarin should be able to maintain healthy margins. I expect Amarin to post EPS of $4.09 by the end of 2018. Beyond 2018, I have assumed that the earnings will grow at 2% annually.

Valuation:

For the valuation purposes, I have assumed a rather high discount rate of 12%. I have not used such a high discount rate in any of my previous valuation models. Amarin has massive growth potential, but the firm has no history of revenues, hence a high discount rate.

Valuation

2012

2013

2014

2015

2016

2017

2018

Earnings

$-0.17

$1.03

$1.36

$1.80

$2.37

$3.12

$4.09

Discount rate

12.00%

12.00%

12.00%

12.00%

12.00%

12.00%

12.00%

Present Value Factors

0.97

0.89

0.80

0.71

0.64

0.57

0.51

Discounted Earnings

($0.16)

$0.92

$1.08

$1.28

$1.51

$1.77

$2.07

Terminal year Value @2% constant growth

$34.75

Discounted Terminal Value

$17.61

True Value

$26.07

Click to enlarge

There are two conventional methods to calculate the terminal year value - multiple of terminal year earnings and a constant growth model. I have used the latter, and assumed a 2% constant growth rate after the high growth period of five years. Furthermore, the terminal year earnings of $4.09 are discounted using the single stage growth model, where the earnings are first adjusted for constant growth and then discounted by the discount rate of 12%. The single stage growth model also adjusts the discount rate for growth by deducting the terminal growth rate from the discount rate. Once the terminal year value is calculated, it is then discounted to reach at the present value. On the other hand, earnings before the terminal year are simply discounted to reach at the present value. Finally, the discounted earnings are added to the discounted terminal value to reach at the true value/fair value of the stock. According to my valuation model, Amarin should reach $26.07 based on the potential of Vascepa. The stock is currently trading at a significant discount to its fair value.

Summary:

My valuation model has strengthened my belief that the market has been extremely harsh to the stock. I understand that NCE status is important for Vascepa. However, the world will not end for Amarin if it fails to get NCE status. The drug has remarkable potential, and even with such restrictive assumptions, the stock looks cheap. According to the analyst estimates, Vascepa has NPV of $5.4 billion. At present, the company is valued at $1.6 billion, substantially lower than the potential Vascepa sales. It is my belief that Amarin will remain an attractive takeover target even if it fails to get NCE status. However, if the company decides to go solo. Vascepa has the profile to do wonders for Amarin.

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

Business relationship disclosure: EfsInvestment is a team of analysts. This article was written by Ishtiaq Ahmed, one of our equity researchers. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.