Weighing Out The Seattle Genetics Barbell

| About: Seattle Genetics, (SGEN)
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Looking at Seattle Genetics' (NASDAQ:SGEN) value makes me think of a barbell, as the valuation is split between the near-term potential of the approved oncology drug Adcetris in maintenance and salvage indications in Hodgkins, anaplastic large cell, and cutaneous T cell lymphomas, and the longer-term potential of extending Adcetris into front-line therapy and the company's pipeline. As is, I think there's enough value in the existing Adcetris business to support a price in the mid-$20's, but it is clear that the real value lies in the longer-term opportunities.

I think Seattle Genetics deserves to trade in the mid-$40's today, but this could well be a frustrating stock to own. With most of the company's pipeline in early stages of development and partnered programs offering only modest royalties, I suspect investors may get impatient with the years-long wait for data from the front-line ECHELON trials and the Street's fixation on the quarter-to-quarter wobbles in Adcetris sales.

ADCs Are Real, But It's Still Early

Antibody drug conjugates (ADCS)have emerged as a real and viable platform technology for addressing cancer, and Seattle Genetics has a well-established IP estate in this area. ADCs allow for more effective oncology antibody treatments by taking an antibody and linking it to a cancer-killing compound like a chemotherapy or radiological agent. Adcetris and Roche's (OTCQX:RHHBY) Kadcyla (developed with technology from ImmunoGen (NASDAQ:IMGN)) are probably the best-known ADCs (and both are approved), but there are dozens of ADCs in various stages of development around the pharmaceutical and biotech sectors.

Seattle Genetics has chosen to approach the ADC market with a hybrid model. While the company does have its own proprietary pipeline, the company has partnered with or licensed its technology to numerous other drug companies, including Pfizer (NYSE:PFE), Bayer, Roche, Takeda, and AbbVie (NYSE:ABBV). The downside to this agreements is that there is not much value in early-stage licensing in biotech, and these programs are generally only going to pay a mid-single digit royalty to Seattle Genetics in the event they reach the market. The next decade should see several Seattle Genetics-licensed ADCs reach the market, but it is still very much an early-stage/developing opportunity today.

Adcetris Has Real Growth Potential

Seattle Genetics has managed to get its own proprietary ADC to market in the U.S., and Adcetris has shown exceptional efficacy as a treatment for relapsed or refractory lymphomas. As is, I believe that the Adcetris label is good for over $500 million in U.S. peak sales and over $20 a share in fair value. The real question is whether or not Adcetris has significant additional label/use extension opportunity. I believe it does, but it will take time for that to come to fruition.

The biggest opportunity for Seattle Genetics is to get approval to market Adcetris as a front-line therapy for Hodgkins lymphoma, diffuse large B-cell lymphoma, and other lymphoma types. I believe that such approvals would open up at least $800 million in revenue potential and add at least $12 to the fair value of the company. Prior studies of Adcetris have shown strong efficacy in relapsed/refractory lymphoma patients, and small early-stage studies have likewise shown very encouraging efficacy as a front-line agent.

The efficacy of Adcetris seems solid enough, but safety concerns remain. In particular, investors and analysts have become concerned with elevated rates of pancreatitis in patients receiving Adcetris and the potential risk of progressive multifocal leukoencephalopathy. While I do not expect these issues to derail the drug, it could impact the commercial acceptance of the drug and the problems that Ariad (NASDAQ:ARIA) has had with its leukemia drug Iclusig show that it doesn't pay to just ignore safety worries. At any rate, it's going to be years before investors have the full results of the pivotal ECHELON studies (the ones supporting front-line use) in hand, and the Street is not a famously patient place.

The Pipeline Is Very Early-Stage

Past Adcetris, investors are looking at a long wait for any of Seattle Genetics' proprietary programs to reach market. SGN-CD19A, SGN-CD33A, and SGN-LIV1A may well prove to be powerful drugs for hematological and breast cancer, but they're not even in Phase II testing yet and looking at many years of clinical development.

Given the long development timelines of drugs and the poor odds of eventual approval for drugs that have not yet even reported positive Phase II data, the risk-adjusted value of Seattle Genetics' proprietary pipeline only looks to be on the order of $7 per share to me. This figure should grow in time as programs mature (earning them a lower risk weighting), but there is of course the risk that some programs will disappear altogether due to disappointing/unacceptable trial data.

Outside of its proprietary programs, Seattle Genetics also has ties to numerous collaborator ADC drug trials. Roche has eight identified compounds in clinical trials, while Pfizer, AbbVie, Takeda, Agensys, and Progenics have one apiece. Celldex (NASDAQ:CLDX), too, has a drug using Seattle Genetics technology in trials, with its very promising CDX-011 at the pivotal development stage.

Once again, though, the downside to all of these programs is that they do not mean a lot to Seattle Genetics in terms of revenue, as the company is only entitled to a small royalty on sales. It's certainly true that 5% or so of billions of dollars of revenue would still add up to something meaningful to Seattle Genetics, but on a risk- and time-adjusted basis, the total value of these collaborations today is about $2 to $3 per share.

The Bottom Line

I'm basically bullish on Seattle Genetics' technology, as well as the probability that clinical trials will support label extensions for Adcetris that could add $1 billion or more to the revenue base. Likewise, I'm encouraged that Roche has characterized ADCs as a potential backbone in the future standard of care for oncology, and I am curious to see whether some signs of toxicity issues in multiple ADCs licensed from ImmunoGen amount to anything (thus making Seattle Genetics a stronger partner).

Adding up the risk-adjusted values today, I come up with a target of $44 today, with upside to $50 or more if the addressable market for Adcetris as a front-line therapy approaches $1 billion and/or the pipeline matures as hoped. That may not be remarkable undervaluation for a biotech given the risks involved, but I think it does at least make Seattle Genetics worth a closer look and a spot on investor watch lists.

Disclosure: I am long OTCQX:RHHBY. 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.