Using History to Make a Buck, or Save One
Almost exactly three years ago, we published our first article on Seeking Alpha. It was, at least in our view, an objective assessment of Sarepta Therapeutics (NASDAQ: SRPT) that concluded the small biotech was overvalued because so much of its valuation depended on its new-drug prospect getting "accelerated approval" on the basis of a tiny and controversial 12-patient Phase 2 clinical trial. Our efforts were not well-received, as underscored by the many comments that largely echoed the sentiments expressed by the first comment ever received by this author. It read as follows: "I just wonder who holds the other end of your leash. Not one ounce of compassion -- no thought of the boys and their families. The ONLY thing you are concerned with is decreasing the value of this stock." About two months later, we penned an article that suggested Arena Pharmaceuticals (NASDAQ: ARNA) didn't represent a good buyout candidate mainly (but not only) because that small biotech had a marketing and supply agreement with Japan-base Eisai Inc. (OTCPK: OTCPK:ESALY) that complicated and diminished its takeover prospects. For that horrendous transgression, many of Seeking Alpha's discerning readers called yours truly all sorts of vile names, names that would, perhaps, have even some Trump supporters blushing.
And so, it is with some trepidation and apprehension that we review the stock of another small biotechnology concern, which, in our view, is overvalued, inflated, once again, by the takeover rumors and speculation that seem to surface all too frequently in the already volatile healthcare subsector. The latest buyout story/rumor fueled a nearly 70% spike in the price of Relypsa, Inc. (NASDAQ: RLYP) stock two Thursdays ago (on April 7th). History makes us skeptical that the latest round of speculation will lead to anything more concrete than did the previous rounds of guessing and hoping. Indeed, the strong probability that regulators will soon approve a drug that may be superior to the company's only product makes a deal even less likely, certainly not anytime in the near future. Moreover, the history, which also involves the potential rival drug, strongly suggests that Relypsa's current valuation is not supported by its fundamentals. All that said, taking bearish positions can be riskier and trickier than assuming bullish positions, which explains, in part, the fact that we've recommended same only three or four times in our history - only Sarepta Therapeutics, Puma Biotechnology (NYSE:PBYI), and Great Northern Iron Ore come to mind. As such, we would advise extra caution here, and suggest using either put options or hedging short positions with call options. (Note: Hopefully the above disclosure will keep some readers from calling us bashers, tools of short sellers, or any other name that would further complicate our Herculean efforts to embrace the pumper, cheerleader, and other also less-than-flattering monikers that have come our way.)
Relypsa, Inc. is a biopharmaceutical company that's focused on the discovery, development, and commercialization of polymeric medicines for patients with conditions that are overlooked and undertreated and can be addressed in the gastrointestinal tract. It was technically a "development-stage" concern until December 21, 2015 when it launched its first (and only) FDA-approved drug, Veltassa (patiromer). Veltassa, which was approved on October 21st, is a non-absorbed potassium-binding polymer for the treatment of hyperkalemia. Relypsa was founded in 2007 and is headquartered in Redwood City, California. As of December 31, 2015, it had 406 full-time employees, with the total bulked up last year with the formation of a sales force. The company has few personnel with manufacturing experience, though, as it relies exclusively on third-party manufacturers to produce bulk drug substance and drug product.
Significantly, in August 2015, Relypsa entered into two agreements with respect to Veltassa. The first is a "License Agreement" with Vifor Fresenius Medical Care Renal Pharma (VFMCRP) to commercialize the hyperkalemia drug outside the United States and Japan. In return for that right, Relypsa received an upfront cash payment of $40 million and the potential of receiving up to $125 million in regulatory, commercial, and sales-based milestone payments. The California-based company also stands to earn tiered, double-digit royalties of up to 22% of annual net sales. Additionally, VFMCRP is to submit a marketing application for the product in Europe later this half. The second is a "Detailing Agreement" with Sanofi (NYSE:SNY) to "engage in face-to-face presentations, or details, in connection with Veltassa." The France-based pharmaceutical giant's nephrology sales force will essentially complement Relypsa's own sales representatives. In exchange for those detailing efforts, Sanofi will be paid a quarterly service fee "generally based on the number of details performed during the quarter." The Detailing Agreement commenced in August 2015 and expires on December 31, 2017, unless extended or earlier terminated.
As to the financials, Relypsa has a history of losing money, as is invariably the case with development-stage biotechs. As of December 31, 2015, it had an accumulated loss of $484.4 million, having lost $178.7 million, $79.9 million, and $81.2 million in 2015, 2014, and 2013, respectively. At the end of last year, the company had $240.6 million in cash and marketable securities, along with a capital loan of $15.6 million. Relypsa's market capitalization, meantime, approximates $804 million, based on 43.3 million shares outstanding and last Friday's closing price of $18.56.
The Company's One (and only) Product
Veltassa was approved by the FDA on October 21, 2015, making it the first new medicine approved for the treatment of hyperkalemia, or elevated blood potassium levels, in more than 50 years. Made in powder form consisting of smooth, spherical beads, the potassium binder is mixed with water and taken once-a-day with food. The new medicine is not absorbed and acts within the gastrointestinal tract, binding to potassium in exchange for calcium, primarily in the colon. The potassium is then excreted from the body through the normal excretion process.
Veltassa is not be used as an emergency treatment for life-threatening hyperkalemia, though, because of its delayed onset of action. Very important, too, the prescribing information for Veltassa includes a Boxed Warning that the drug binds to many other orally administered medications, which could decrease their absorption and reduce their effectiveness. As such, the instructions call for other oral medications to be administered at least 6 hours before or 6 hours after Veltassa. Doctors are to choose between Veltassa and the other oral medication if adequate dosing separation is not possible.
As noted above, Veltassa was launched late last December. In the out-patient setting, it's provided to patients as a 30-day supply, consisting of 30 single-use packets. The wholesale acquisition cost is $595 and this price is the same for each of the three dosage strengths. The wholesale acquisition cost for hospitals is $119 for a pack holding four single-use packets of the 8.4 g dose.
Wall Street's consensus mean revenue estimate for 2016 is $39.4 million, derived from 12 data points, which range from a low of $23.6 million and a high of $66.5 million. The consensus figure for 2017 is $86.1 million, with a low and high of $27.6 million and $127.6 million, respectively. Wall Street's bottom-line expectations also vary greatly for both years. Significantly, though, not a single analyst - out of 12 for 2016 and 14 for 2017 - expects Relypsa to be profitable in either year. The consensus is for losses of $5.23 a share this year and $3.82 next year.
Market and Competitive Considerations
Hyperkalemia, which can be life-threatening, occurs most frequently in patients with chronic kidney disease (CKD), where the ability of the patient's kidney to excrete potassium has been compromised. Patients with heart failure (HF) are also at increased risk for developing hyperkalemia. According to Relypsa, there are approximately three million patients with CKD stage 3 or 4 and/or HF - the market opportunity for Veltassa. On the other hand, Ardelyx, Inc. (NASDAQ; ARDX), another California-based company that's developing two potential rivals to Veltassa, sees a far smaller target market. In that company's filings with the Securities & Exchange Commission, it details a market that might consist of about 900,000 individuals with CKD stage 3 or 4, another 900,000 patients with HF, and about 200,000 patients with ESRD (End Stage Renal Disease), for a total target population of two million. All that said, our research shows that few studies have determined the frequency of hyperkalemia in a large CKD population, nor the extent to which this metabolic disturbance is associated with adverse outcomes. Indeed, a finding by one study that the prevalence of hyperkalemia in hospital patients is between one and 10 percent underscores the wide range in analysts' estimates and long-term revenue projections.
The early adoption data for Veltassa are encouraging, but the outlook is necessarily obscured by myriad variables, including insurance reimbursement, free sampling programs, early education, and possibly warehousing. The outlook for Relypsa's sole product is further muddied by the fact that AstraZeneca's (NYSE:AZN) ZS-9, a zirconium silicate particle to treat hyperkalemia, could be approved by the FDA in about six weeks and commercialized very soon thereafter; the PDUFA (Prescription Drug User Fee Act), or decision date is May 26, 2016. The clinical data suggests ZS-9 is faster-acting than Veltassa and an approval without the Boxed Warning may well make it the standard-of-care in treating hyperkalemia. It should be noted, too, that the MAA (or marketing application in Europe) for ZS-9 was submitted last December, meaning that AstraZeneca's drug will most likely get at least a six-month head start in that market. The aforementioned Ardelyx, meanwhile, expects to begin a Phase 3 clinical study with RDX022 in the second half of the year, putting a possible market introduction at least two years away.
Like the estimates for 2016 and 2017, peak revenue projections for Veltassa are all over the place, going up as high as $920 million, in the year 2027. Predicting the performance of a new drug (or class of drugs) is almost always more art than science, with many moving parts - actual number of potential patients, penetration rate, price, entry of rival products, their labeling advantages and disadvantages, etc. But Wall Street analysts are paid to generate numbers, so that's what they do, over and over again, with each using his or her own set of invariably arbitrary assumptions. It should also be noted that they tend to be an optimistic lot.
Assessing a Potential Takeover
Early last September, the shares of ZS Pharma (NASDAQ:ZSPH) soared 28% after Bloomberg News reported that Actelion Ltd. (OTCPK:ALIOY) had made a preliminary offer of $2.5 billion for the developer of ZS-9. By contrast, the Swiss drugmaker's stock fell the most in almost eight months, as its investors reacted adversely to the rationale (and price) for the potential deal; the price was approximately four-times the IPO price of ZS Pharma just a year earlier. About two months later, Britain's AstraZeneca announced that it had agreed to buy ZS Pharma for $2.7 billion, outbidding Actelion. AstraZeneca is since on record predicting both that ZS-9 will be the best-in-class drug for hyperkalemia and would generate peak sales of at least $1 billion.
In the deal's aftermath, analysts of all stripes, including the professionals on Wall Street and the amateurs who have a plethora of venues on the web to publish their thoughts, have speculated that Relypsa represents an obvious next acquisition target. The names of just about every large drugmaker has been tossed out as a possible buyer, and, like almost everything else about small biotechs, the possible price tags are only limited by each individual "analyst's" imagination.
With that said, we would note the following:
- Actelion tried to buy ZS Pharma, not Relypsa.
- AstraZeneca thought it better to outbid Actelion for ZS Pharma, rather than pursue Relypsa, which would have been a far cheaper alternative.
- In the roughly six months since losing ZS Pharma to AstraZeneca, Actelion hasn't made an offer for Relypsa, as far as we know, even though its shares had plummeted dramatically earlier this year.
- Sanofi, which knows the hyperkalemia market intimately, since it sells phosphate-binders Renagel and Renvela (both of which use the sevelamer polymer as the active ingredient), not only didn't try to acquire Relypsa last summer, it didn't even agree to a marketing partnership with the California concern. Rather, the large France-based drugmaker simply signed a risk-free "Detailing Agreement," whereby its sales reps get paid for calling on potential customers.
- Likewise, Vifor Fresenius didn't look to acquire Relypsa last summer. In lieu, it paid a relatively paltry sum for non-U.S./Japan rights to market Veltassa.
So, it would seem that at least four potential acquirers of Relypsa essentially kicked the tires and decided to pass. While it's certainly possible that Sanofi could always change its mind, speculators should bear in mind that Relypsa is clearly less attractive now than it was last summer, for at least three reasons. One, the aforementioned Boxed Warning makes Veltassa a less valuable commodity, and this reality gets even worse if ZS-9 gets approved without the same warning. Two, given the deal with Vifor Fresenius, an acquisition of Relypsa would now come without the rights to market Veltassa in a large part of the world. Three, ZS-9 represents a far more serious competitive threat in the hands of AstraZeneca than under the control of a relative start-up in ZS Pharma.
As to a potential takeout price, many prognosticators use the ZS Pharma deal as a benchmark. One of the problems with this approach is that so much has changed since then that its value as a meaningful comparator is highly questionable. Beyond the fact that Relypsa's intrinsic value has undoubtedly diminished over the past six months or so, as detailed above, investor sentiment towards the biotech sector has deteriorated dramatically. At the time Actelion and ZS Pharma were talking, the sector was at what proved to be the tail end of a five-year-long bull-run that saw prices soar almost 400%; the discussions between these two companies, meantime, set the starting point for the price negotiations between ZS Pharma and AstraZeneca. The environment is certainly far different now. Indeed, iShares Nasdaq Biotechnology (NASDAQ:IBB), which can be viewed as a reasonable proxy for the sector, plunged 40.1% from its all-time high in mid-July, 2015 to a 52-week low in mid-February, before staging a modest rebound.
Assessing the Fundamentals
No head-to-head trials comparing ZS-9 to Valtessa have been done. Ultimately, it's going to depend largely on what their prescribing label or package insert looks like. That said, we do know that Veltassa has a Boxed Warning for drug-to-drug interactions, whereas the clinical studies for ZS-9 give it a good chance of clearing the FDA without that complicating factor. Significantly, too, while the financial analysts on Wall Street, and the laymen elsewhere, can argue endlessly about which of the two is the superior product, one can reasonably surmise from the actions taken by Actelion, AstraZeneca, Sanofi, and Vifor Fresenius what the science-based experts have concluded. As things stand presently, ZS-9 will probably have the benefits of a superior label - i.e., rapid onset of action and no drug interaction warning - and a seamless retail distribution model and manufacturing cost advantages, keeping in mind that Relyspa has no manufacturing capabilities in-house.
With respect to earnings, Wall Street has Relypsa losing a total of more than $390 million over the next two years, including $225 million in just 2016 alone. Given a cash balance of $240.6 million at the beginning of this year, the company will have to access the capital (debt and/or equity) markets reasonably soon to keep its operations running - absent an extraordinary M&A transaction before the need arises. Beyond 2017, the competitive field could get a little more crowded, with negative implications for prices and profit margins; Ardelyx expects to initiate a Phase 3 study for RDX022 in the second half of 2016 and is planning an expedited (505b2) regulatory pathway to market. Needless to say, any further developments concerning RDX022 would undoubtedly have analysts running to adjust their long-term projections for Veltassa.
What's RLYP Stock Worth?
Relypsa has been a publicly traded entity for a little more than two years, having conducted its IPO (Initial Public Offering) on November 15, 2013. The shares opened for trading that day at $12.57. Within a mere two months, the shares had moved beyond the $40 mark, on its way to an all-time high of $52.74 on March 18, 2014. The stock slumped to an all-time low of $10.26 last October, before bouncing back up to $30.26 in early December. Then back down to the $11s in March. RLYP shares were trading in the $13s and $14s early this month, until April 7th when a Reuters report stated that the maker of treatments for hyperkalemia "is exploring a sale following a number of overtures from potential buyers, according to people familiar with the matter." The report further noted: "Relypsa is working with investment bank Centerview Partners Holdings LLC to review offers, the people said. The discussions are in their early stages and may not lead to a sale, the people added, asking not to be identified because the talks are private."
The stock's erratic price movements since public trading commenced mirrors our view that it's almost anyone's guess what the shares are actually worth. In the absence of positive earnings, the shares have been driven largely by news about the relevant drugs - Veltassa and ZS-9 - and takeover speculation, which have been based on nothing concrete or confirmable. Positive earnings aren't likely anytime soon, so this reality won't change for some time. So, what are the shares worth? In answering this question, one needs to keep in mind that Relypsa is truly a one-trick pony. Absent any additional favorable developments on the takeover front, the stock may well gradually return back to where they were before the Reuters story. A positive FDA review of ZS-9 in late May could accelerate the retreat. Looking out a little further, again assuming no takeover news, Relyspa will have to raise more money, and this could undermine investor enthusiasm even more. The net cash on hand, meantime, does provide some price support (of around $5.15), but the magnitude diminishes with each passing money-losing day.
The Final Word
A number of Wall Street analysts have lofty price targets (some well north of $50) for Relypsa stock and talk up the possibility of a takeover, even as they look for steep bottom-line losses this year and next that may well force a dilutive stock offering. Their words are echoed, if not amplified, by largely unaccountable bloggers on the Internet, including many who acknowledge having bullish positions in the company. On the flip side, there is a very large (14.1 million shares, as of March 31st) short interest in the stock, indicating that some sophisticated investors have made substantial bets that largely reflect our assessment that Relypsa has limited appeal as a takeover target and modest, highly uncertain value on a stand-alone basis.
The Final Final Word
RLYP stock slumped 15.9% (or $3.52) in last week's final trading session as investors reacted to news from a web-based financial media outlet named Benzinga. According to Benzinga, "A source familiar with the matter told Benzinga on Thursday that at this time, Relypsa no longer has Centerview Partners as an advisor. The source added that due to the expense of such expertise, Centerview's presence in ongoing M&A evaluation at Relypsa can only occur over a limited period. They did not mention the possibility of a sale over the longer-term. Relypsa declined to comment on its current relationship with Centerview Partners, while the latter could not be reached."
It's impossible to know how reliable Reuter's April 7th report was in the first place. The veracity of Benzinga's story is certainly a question mark, too, given the reliance of both on unnamed sources and the lack of a comment from any of the relevant parties. What is certainly true, though, is that RLYP's roughly $6 retreat over the past several days have complicated the decision making process for investors looking to act upon the view that the company is overvalued. All that said, our assessment of Relypsa's takeover appeal and its underlying fundamentals remains unchanged. Indeed, we would not be tempted to buy the stock even if it were to fall into the single digits. As noted above, any subscriber looking to short the stock would probably be well advised to protect that position with call options. An alternative strategy might be to buy put options. Yet others might prefer to wait for the stock to reflate again before initiating a position, thus getting both more room for error and increasing the profit potential.
As a final, final, final comment, we would note, for whatever it's worth: Sarepta's drug never received Accelerated Approval; Arena remains independent to this date; the price of Puma has fallen an astounding $200.12 (or 86.3%); and Great Northern no longer exists.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in RLYP over the next 72 hours.
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.