United Therapeutics: A Profitable Biotech With A Potentially Undervalued Pipeline

| About: United Therapeutics (UTHR)
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Fast historical growth threatened by patent expirations.

Aggressive, innovative pipeline products.

Diversification beyond core focus underway.

Background: The polymath entrepreneur Martine Rothblatt founded United Therapeutics (NASDAQ:UTHR) after her daughter contracted pulmonary arterial hypertension (PAH), a disease that is usually fatal. UTHR succeeded in bringing several drug products to treat PAH to FDA approval; each has the leading market share in its category, and the company has a multi-billion market capitalization. I am long large amounts of UTHR, and feel the bull case is strong despite meaningful headwinds. This stock may appeal both to growth investors as well as certain types of value investors.

Introduction: UTHR went public in the frenzied year of 1999. Going public in 1999 was a recipe for marked underperformance in the out years, and so it went for UTHR. The stock soared, then collapsed:

Chart forUnited Therapeutics Corporation

Splits: Sep 23, 2009 [2:1]

Yet since 1999, the stock has returned approximately 21% yearly.

If one takes the more realistic bottom in price seen around the beginning of 2002 around $5, one then sees that the stock is up 20X in 12 years, a compound annual return of 28% per year.

In any case, past performance is past. The question is whether an outsider such as myself can weigh the pros and cons of this company to make a reasonable judgment as to whether the market is valuing it properly.

My sense is that a background in cardiovascular medicine, pharmaceuticals, pharmaceutical patents, and FDA procedure allows me to make a reasonable assessment of this company's prospects. That assessment is strongly positive. I am long a substantial amount of the company's stock and may increase that position if I continue to like what I see. Let's start with some major negatives that (potential) investors should consider.

Negatives for UTHR:

Patent challenges and expirations, and insider sales:

Remodulin is an intravenous product, which contains the company's workhorse molecule treprostinil. This has been the lead sales product for UTHR for years, though an inhaled version of treprostinil, Tyvaso, roughly equaled it in Q4. Remodulin is the subject of a generic patent challenge by the generic giant Sandoz, with a trial scheduled for this spring. The most common dose of Remodulin could go generic this October. The company's other two marketed products, Tyvaso and Adcirca, may go generic in 2017.

Perhaps this existential risk explains why the company's president and COO, Roger Jeffs, exercises and sells almost as much stock in the form of options or similar vehicles as the company will grant him.

This is not a comprehensive list of risks to shareholders or negatives for the company, but it will do for now.

Basically, Dr. Rothblatt, Dr. Jeffs et al have built V 1.0 of a company treating this rare, generally fatal orphan disease known as pulmonary arterial hypertension. They are now building out a more broad-based company that is going to treat PAH in a much more sophisticated manner, but the company now has a broader focus that can allow it a much larger market value. Overall, I am emphasizing the positive as a shareholder of UTHR, though understanding this is a high risk situation.

The bull case for UTHR:

The company is preparing V 2.0 of new, better ways to treat PAH. This is because its way of mimicking prostacyclin with treprostinil is awkward. Remodulin is delivered via an intravenous line 24 X 7, which is awkward and inconvenient, and also is prone to infections, which may be fatal. Tyvaso requires numerous inhalations daily, and these are difficult to standardize and difficult to do.

Where the company is going with its new regime involves compelling improvement. Happily, for patients and the company, UTHR has developed an orally available sustained-release formulation of treprostinil. This has recovered from an initial rejection by the FDA and has now been approved for marketing. This product, named Orenitram, is slated to have marketing begin mid-year. CEO Rothblatt waxed ecstatic on this product's prospects on this week's conference call:

...the reason why I believe 2014 will be even better is because 2014 is the year in which we will launch oral treprostinil under the trade name, Orenitram, to the pulmonary hypertension market in the United States. And I can certainly assure everybody on the phone that there is not a prescriber of medicines for pulmonary hypertension who have say more than 30 or 40 patients, in other words a significant treater of people with pulmonary hypertension, all of those physicians are very excited about the advent of Orenitram oral prostacyclin analogue called treprostinil that we will launch towards the middle of this year.

It is one of the signalled (sic: "signal") iconic developments in the history of pulmonary hypertension that has an oral ability to help increase the prostacycline levels in people with pulmonary hypertension and that will become part of the prescribing reality in 2014, hugely positive fact in the history of our disease.

This is the experienced CEO of United Therapeutics, a lawyer and Ph.D., speaking. She is not given to hyperbole. She says that "all" heavy PAH treaters are "very excited" about this new drug product. She says this is an iconic development.

I believe her.

Now, this oral formulation is going to have a limited label and it remains to be seen whether the sicker PAH patients will obtain high and steady enough blood levels to benefit much from this. So there is a need for something better than Remodulin, the intravenous treatment that may succumb soon to generics. That product appears to be on the horizon. It is a Medtronic (NYSE:MDT) fully implantable pump that delivers treprostinil from within the body. This product has done well on the FDA-required safety study and is being reviewed by Medtronic for secondary endpoints. UTHR's treprostinil is the first molecule that Medtronic is using this novel device, their SynchroMed II pump with. Given the life and death nature of PAH, I think that Ms. Rothblatt is credible when she expresses a high degree of optimism that this product will receive FDA approval and will be a game-changer.

If and when UTHR achieves commercial success with the oral Orenitram and then it with MDT's assistance achieves commercial success with the SynchroMed II pump with treprostinil, it will have made the existing way of treating PAH almost antiquated.

Other PAH innovations: A third way of delivering treprostinil is moving toward clinical testing. This TransCon method involves polyethylene glycol modification ("PEG") to allow painless injection and a long duration of activity in the body. This formulation is approaching the initiation of clinical trials (IND filing), so we should not say much about it. The other product is beraprost, another orally available prostacycline analog that UTHR has in-licensed from a Japanese company. Beraprost is on the market in Japan. We shall see if a beraprost product can be brought to market in the U.S. by UTHR, and if so it could breathe new life into Tyvaso, as Ms. Rothblatt explains in the conference call.

PAH summary: UTHR's products are market leaders in the U.S. Not discussed herein, but international expansion is underway. As effective treatments are introduced into the PAH population, the addressable patient pool expands as people live longer. This can continue indefinitely. The company is developing and has FDA approval on one very innovative oral product for new and superior methods of treating PAH.

There is thus good reason to look beyond patent expirations to the next generation of PAH treatment from UTHR. I would expect this superior product line to generate higher net profits and thus strong share price appreciation.

Other initiatives: There is more, though, as the company's website describes. Nearest to market, perhaps this year, is an orphan biotech product. The company is preparing to market a treatment for childhood neuroblastoma, called Chimeric Monoclonal Antibody14.18 (Ch14.18). UTHR hopes to earn a manufacturing profit and will attempt to generate a marketing profit as well. The company has partnered the development of this product with the government's National Cancer Institute, which was the primary developer of this biotech drug product. I would nonetheless expect meaningful profits from it over time, given it will be marketed in Europe and the U.S., if all goes according to plan.

Finally, the company is working on an innovative anti-viral product or products, designed to treat untreatable conditions such as dengue. UTHR hopes that one molecule could in fact serve to treat more than one viral disease. We shall see, of course, but this is ambitious stuff and a testament to the CEO and to Dr. Jeffs, the president-COO and a chemist.

Financial results: Confusion regarding the company's Q4 profits, reported as a 60 cent per share loss under GAAP, may be helping to present a buy opportunity here. Here's some of the story.

In Q4 of 2013, the stock soared primarily on the basis of FDA approval of oral treprostinil, i.e. Orenitram. The much higher price benefited any shareholder who sold high, but the accounting treatment of stock options, tracking stock grants and the like meant that the company reported a loss under GAAP. Operating results were fine, however:

(in millions) Q4 2013 Q4 2012 FY 2013 FY 2012
General and Administrative $38,112 $31,118 $140,235 $116,889
Sales & Marketing $21,038 $15,788 $73,871 $67,220
Share-based compensation expense (benefit) $98,028 ($6,833) $179,904 $17,627
Total selling, general, and administrative expense $157,178 $40,073 $394,010 $201,746

Quite a difference between Q4 2012 and Q4 2013, all because the stock price went down in that quarter in 2012 and rose sharply last quarter. Of course, this does not reflect the economic reality of producing and marketing drug products.

Given the above info, it is not surprising to see the following strong results for the last quarter and all of 2013 under the company's specific definition of non-GAAP results:

(in millions) FY 2013 FY 2012 FY 2011 FY 2010 Q4 2013 Q4 2012
Net income (loss), as reported $174,560 $304,442 $217,868 $105,916 ($30,314) $83,255
Interest expense $18,058 $16,639 $21,732 $19,714 $4,562 $4,490
Non-cash license fees $37,049
Depreciation Amortization $31,259 $27,145 $20,535 $17,919 $7,753 $7,290
Impairment charges $4,839 $7,688
Share-based compensation $320,786 $30,115 ($15,715) $113,942 $178,202 ($10,453)
Non-GAAP Earnings $544,683 $383,180 $281,109 $265,179 $160,203 $84,582
Non-GAAP Diluted EPS $10.23 $7.19 $4.73 $4.46 $2.88 $1.62

Certainly, given rapidly rising annual sales and relatively stable operating margins, the non-GAAP earnings trend makes more sense than the GAAP earnings trend. Yet these particular non-GAAP earnings are not what the analysts normally use. For comparability between different companies, I would emphasize the following measure of profits, which likely has the advantage of consistent accounting treatment between companies and from quarter to quarter for UTHR. From Yahoo Finance:

EPS Trends Current Qtr.
Mar 14
Next Qtr.
Jun 14
Current Year
Dec 14
Next Year
Dec 15
Current Estimate 1.58 1.68 7.20 8.43
7 Days Ago 1.62 1.72 7.20 8.06
30 Days Ago 1.62 1.72 7.20 8.06
60 Days Ago 1.65 1.75 7.20 8.29
90 Days Ago 1.67 1.74 6.96 7.72

Given my belief that the future is quite bright for UTHR's PAH franchise and quite promising for its other foci, I find these projected (non-GAAP) earnings attractive with the stock at $102.

Because of retained earnings over the years, UTHR has built real value. Over the past twelve months, shareholder equity has grown, as has net cash:

Selected Balance Sheet Data

(In millions) FY 2013 FY 2012
Cash, cash equivalents and marketable securities (excluding restricted amounts of $5.4M) $1,136.7 $784.9
Total assets $2,087,6 $1,626.6
Total liabilities $828.3 $542.6
Total stockholders' equity $1,259.3 $1,084.0

With this has beneficially come the 2 million decline in primary shares outstanding and the slight decline in fully diluted shares.

In other words, the company has a solid book value of about $25/share. It argues that under one non-GAAP measure of cash flows, it is ramping value by $10/share per year, and that this measure is moving higher.

Given all the uncertainties about patents and success or not of Orenitram, the various R&D programs, competitors' actions, reimbursement levels, foreign sales and margins on said sales, etc., I find it impossible to go to a spreadsheet and provide a present value analysis of UTHR's worth.

How will investors value UTHR should it have the success I envision with its next-generation PAH product line plus some degree of success with its non-PAH product efforts? That answer is part of the uncertainty of investing. I am optimistic that the restrained valuations we have seen for UTHR in the past few years could give way to higher ones, but I cannot prove it.

An objective review of United Therapeutics is found in Value Line.

A recent Value Line review of UTHR projects that it will have about $6/share in free cash flow in 2014. Operating margin is projected at 50%, up from 30% in 2010. Long-term debt is projected to be zero, down from $205 MM in 2012, with cash up $200 million from the same year with similar shares outstanding. Book value is projected to be in the mid-$30s per share, though as noted, share price surges cost the company book value at the time. The "value line" of 16x cash flow would put the stock's "fair value" at $128 per share at mid-year. These are mainstream assumptions, and I think they are reasonable and support investing in UTHR for this year and beyond.

Often, the best investment opportunities are the ones that are least clearly defined. Once one can define them in a public company, upside has been sacrificed. In this case, the world is UTHR's oyster regarding new and improved methods of treating the terrible disease of PAH. Patent challenges come and go, but Dr. Rothblatt's therapeutic goals are being realized and exceeded by the company she founded. Much higher UTHR prices beckon from this evolution alone if successful. The ambition of Ms. Rothblatt, Dr. Jeffs et al to expand the company beyond treatment of PAH in ambitious ways makes me simply want to hold on tight to the shares.

Technical comments: The stock has a 15-year trading history. This limited history shows long, strong vertical up-moves and then periods of consolidation. Currently, the stock is digesting another such move, which was capped by the surprising news that the FDA reversed itself on Orenitram and approved it for marketing. I am looking at the "negative earnings surprise" from Q4 as a buying opportunity, and the stock is currently above its relevant moving averages. However, it could stagnate again. While momentum traders may still be attracted to UTHR, and while I am not an investment adviser, I would suggest that any readers who are interested in joining the UTHR team as a shareholder consider doing so from an intermediate-to-long term perspective. To do otherwise risks the real possibility that some scary trial or other news could cause a sale of stock at just the wrong time. Focus on the vision that caused the company to be formed may be just what the shareholder doctor ordered.

Competition: The company is threatened not only by expiration of its patents, but by numerous other products. For example, Adcirca is a version of the erectile dysfunction drug product, Cialis (tadalafil). Cialis is expected to go generic in July 2016, and to date Cialis has not had much negative effect on Adcirca sales. Also, the first ED product, Viagra (sildenafil) is also approved to treat PAH under the brand name Revatio, and both Viagra and Revatio have had generics approved by the FDA. To date, an inconvenient dosage regimen for Revatio has not made it a strong competitor to Adcirca, but the possibility that cost containment could drive some Rx'es from Adcirca to sildenafil could exist.

Regarding treprostinil, recall that it is a follow-on product to the innovator Flolan, which is now also marketed as the generic product epoprostenol (a prostaglandin). Epoprostenol is said to have superior clinical outcome data to treprostinil regarding mortality, which could in certain scenarios be harmful to UTHR's treprostinil franchise.

Numerous other competitive threats to UTHR's current and future marketed products exist.

Summary: United Therapeutics is a difficult company to value. It has a substantial book value and significant unencumbered cash on the balance sheet. The existing products are highly profitable and are growing. A large amount of stock awards to senior management work against shareholders' interests. Generic competition and risks of new product development and introduction are difficult to provide accurate probabilities of success and failure to.

Overall, my own judgment is that the company has a strong chance to lead, or at least be in the front ranks of, transformation of the treatment of PAH. If so, its products will be treating more people for longer periods of time, in the U.S. and globally, than ever before. Patients living longer will in that scenario provide a virtuous feedback mechanism to UTHR's financial results. This happy scenario could ultimately occur even if there is a period of disruption to the company and the stock due to an unfavorable patent ruling or "at risk" product introduction this year.

The company could have a positive surprise for investors regarding its neuroblastoma treatment, and through other diversification efforts as described above and on its website.

Risk-taking investors may wish to look closely at this company and its shares given its explosive success to date, strong finances, experienced management, and potential for strong growth for the rest of this decade.

Disclosure: I am long UTHR. 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.

Additional disclosure: Not investment advice. I am not an investment adviser.