I have to admit, when I first started work on Tonix Pharmaceuticals (TNXP), I didn't like what I saw at all. But the more I worked on it, the more I realized that the issues I have with it are ones that are either not as bad as I originally thought or ones that won't become an issue for the market for a while. The fact that the Phase IIb data is likely to be positive and the valuation is as low as it is, especially compared to the company's intrinsic value, also help matters. After I ran several valuation scenarios, I was convinced that going short TNXP is way more risky than going long.
So let me start by addressing my original concerns and how they became at least partly mitigated. My big issues were:
- IP - I'm a big fan of simple, straightforward intellectual property. Think composition of matter patents with a decade or decade and a half left before expiration. You don't have that here. The active ingredient of their lead product, TNX-102 SL, cyclobenzaprine, is a muscle relaxant first approved in 1977! Their current patents go to around 2020 and their IP strategy is creative, depending on pending patents for "PK Technology" and "Eutectic Technology." They also will only have 3 years of Hatch Waxman exclusivity, which will expire around the time of their current patents.
- Market potential - TNX-102 SL is going to have a difficult time while on the market. Cymbalta, the market leader in Fibromyalgia, just recently went generic. Lyrica, the #2 branded product, will be going generic in 2018, approximately when TNX-102 SL will be launched. Then of course there will be all those generic versions of itself it will have to compete with. Will the sublingual formulation be able to differentiate the product enough from the generics? If not, why would people ever pay the higher co-pay?
- Related-party transactions - I don't like it when companies do anything shady and especially when the company buys assets from the CEO. In 2014, Tonix had 2 transactions with companies controlled by the CEO, Seth Lederman, for assets like a novel smallpox vaccine. It paid out $250,000 and issued 50,000 shares to them/him. Do we have any way of telling if these were fair? How did the negotiations go? Was the CEO negotiating with the CFO? How do you think the CFO felt in those? I remember Enron being involved in such shenanigans though to a far, far greater scale. I'm sure the company has a fairness opinion from some bank saying they paid fair value but I know personally that managements will put pressure on banks to make sure they say it was fair (I've been on the receiving end of such pressure from a CEO in a similar kind of situation).
- MGMT pay - Given the stock has a market cap of $100 million, should the CEO really be paid over $1 million a year? Isn't that a bit too much given the stage of the company? I think it is more appropriate for him to be paid half that. And why is the CEO making consulting fees amounting to a quarter of a million a year every year?
So let me go through these and why I worry less about them (well at least the first two, can't really do anything about management pay & other shenanigans, but watch management really closely or go activist).
On IP, if the pending patents are issued (which they probably will be, the patent office views that its job is to grant patents not to not grant patents) then TNX-102 SL will have patent protection until 2034, which gives them quite a bit of runway. And even if the "PK Technology" and "Eutectic Technology" patents do end up being busts, generic competitors can be kept at bay for years and years.
One of the most ludicrous patents I had heard of was the food interaction patent on Skelaxin, another muscle relaxant, which was marketed by King Pharmaceuticals. Skelaxin was approved in 1962 yet there was a patent issued in 2002 that said that you should take it with food, which was actually well known at the time. The first Paragraph IV filing from a generic came in 2003, but actual generic competition didn't come until 2010! That delay greatly benefited King Pharmaceuticals and its shareholders and I don't think that the justice system has become any swifter since then.
On the market size, it really is difficult to peg this far out. Is it going to be $100 million in peak sales or $300 million in peak sales? I can make arguments for both. On the one hand, payors and pharmacies will try to push people to either generic Cymbalta or generic Lyrica or generic cyclobenzaprine. But on the other hand, 50 million doses of cyclobenzaprine are already prescribed for Fibromyalgia annually without any marketing and with a suboptimal formulation, so is $300 million that unreasonable? We really won't know for another 5-10 years and by then the stock will have gyrated between exuberance and despair. And based on my valuation work, exuberance is pretty damn high and despair isn't really that far lower than the current price (it helps when a company is trading a little over 2x net cash).
NPV valuation work is often pretty difficult with small companies with little history like this one so it helps to look at different scenarios so you have a good sense of what is priced in at what level. Are you paying for perfection or better than perfection? Or is there much more upside than downside. My first batch of valuation scenarios did have a few assumptions in common, namely:
- Launch in 2018 for TNX-102 SL
- 95% gross margin
- 200 sales and marketing personnel (costing $250k each)
- $10m in corporate expenses
- no value to other indications/pipeline candidates as they are too early
- NOLs that cover taxes until 2020 to 2024, depending on the scenario
- A 12% discount rate
I then did another batch of scenarios, this time assuming a takeout so that incremental sales and marketing expenses are near zero (this is how a potential acquirer with an existing sales in the area will look at the company and I have found out it's a great tool to understand the real potential upside of a company). Here is what I got, with scenarios with the highest associated valuations on top:
|Scenario||NPV per Share|
|$300m in peak sales, full patent protection, takeout||$82|
|$300m in peak sales, full patent protection, no takeout||$62|
|$100m in peak sales, full patent protection, takeout||$23|
|$300m in peak sales, 2021 protection, takeout||$17|
|$300m in peak sales, 2021 protection, no takeout||$10|
|$100m in peak sales, 2021 protection, takeout||$3|
|$100m in peak sales, full patent protection, no takeout||$1|
|$100m in peak sales, 2021 protection, no takeout||(-$7), effectively 0|
As you can see, in the most bullish of scenarios, it is a 7 bagger, while your downside is limited effectively down to its cash level (a bit more than 50% lower than the current share price). What should give longs some comfort is that we won't really have clarity on either the date of generic competition or whether this will be a dud launch for a while. Generics won't file until after this drug has positive Phase III trials and FDA approval so that downside risk is really a long-term worry, with no short-term catalyst to bring the issue to the fore. Ditto for the peak sales.
What there is a catalyst for is clinical data, which will help bring investor attention to this company and validate their strategy. So why am I confident that the Phase IIb data scheduled to be released later this year will be positive? First, we know the active ingredient works based on previous clinical data. Cyclobenzaprine has a modest but statistically significant impact on pain in Fibromyalgia patients and an even better impact on their sleep. Also, 50 million doses of an off label generic with no marketing behind it has to be a sign that it actually WORKS in patients. This means that the risk in the trial is entirely on the formulation and it's not so hard to know early whether your formulation is decent or not. Given the CEO is a scientist and even the CFO is an MD/PhD who is listed as an inventor of a marketed drug, I don't think they would mess up something so simple. Once the Phase IIb data is out, I think it is far more likely that the stock trades closer to euphoric levels than ones filled with despair.
Once shares start taking off, there isn't much to stop them. There aren't that many shares outstanding and so even those valuations at the top of my list aren't so high in the grand scheme of things. $82 per share would simply mean that TNXP is a $720 million company. Is that so outrageous for something that will likely be on the market for a large indication? TNXP also doesn't have the issue that other companies have which is that once they have good news, they run back to the market because they are low on cash, capping shares. TNXP has almost $50 million in cash so there is no "roadshow risk."
I think being short TNXP right now is a great way to go to the poorhouse. Does it have issues? Sure, but they won't be bringing TNXP down anytime soon. Not that I think it will NEVER be a short, but let's talk when it is closer to $60-80 per share.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.