A recent study suggests that up to 61% of women would be interested in taking a drug to boost libido, and they would be willing to pay almost $10 per pill. The investor in me immediately started looking for a way to profit from this information, and it wasn't long before I found Palatin Technologies (NYSEMKT:PTN).
Palatin, if Rekynda is approved, will be selling a drug that helps people fulfill one of their most basic human desires: intimacy. Sex is a way for people to become closer to each other, and Rekynda will perform the invaluable task of bringing sex drives into parity - something that can save marriages.
We must put to rest the notion that Female Sexual Dysfunction, or FSD, is a weak market, and evaluate the drugs that treat the condition: Palatin's Renkynda and Valeant's (NYSE:VRX) Addyi, based on their actual potential.
The FSD market, despite Addyi's approval, is still untapped. 43% of women between the age of 18-59 are believed to be affected by some form of sexual dysfunction, and the market is worth around $6 billion. Rekynda, with the proper marketing and support, may be able to capture up to 30% of this market. However, the equity market is not confident in the Rekynda's value due to the commercial failure of Addyi.
Valeant's Addyi costs $800 per month and doctors write around 1,000 prescriptions per year, giving it sales of $10 million annually. Valeant's overall EBITDA margin is around 30%. Addyi, as part of the company's 'cash cow' division, can be assumed to lack both R&D reinvestment, a normal amount of sales force, and have streamlined overhead (most of Sprout's executives quit or were fired). Addyi can be assumed to have an EBITDA margin of around 80% - the same as Valeant's non-gap operating margin for U.S diversified products.
Addyi's annual EBITDA is probably around $8 million - a respectable number for a drug with a black box warning and practically zero promotional activity and a weak sales force. Using an high-growth biotech EV/EBITDA of 15, Addyi, as a standalone company with all other things held constant, would have an acquisition price of around $100-120 million.
When we divide $100 million by Palatin's fully diluted share count of around 250 million we get exactly $0.40 per share - the current price. Remarkable, isn't it? Notice PTN stock always faces stiff resistence when it tests this number. We believe the market is making the mistake of valuing Rekynda as another Addyi.
Palatin's Fully Diluted Shares: Page 41
The market is essentially valuing Palatin Technologies has a proxy for Addyi at current sales on a 15 EV/EBITDA. Retail investors should understand this concept carefully because, not only does it explain PTNs stock price behavior, but it is the crucial piece of information we can use to ask relevant questions and make financially sound decisions about Palatin as an investment.
It is not enough to buy Palatin Tech because you think Rekynda will be approved, we all think it will be approved. But what is the stock worth? It's not as simple as 'as much as people will pay for it'.
It doesn't matter how good a news event is, PTN's stock will be quickly shorted (or diluted) back to a price the professionals think it is worth. The company's price chart demonstrates this. So how does the little guy profit from stocks like PTN? We have distilled our research into five assumptions retail investors can use to make rational bets on this stock.
The Markets Bullish Assumptions:
The goal of investing is to uncover market inefficiency. If the market's negative assumptions about PTN are incorrect, there is significant upside in the stock. By valuing PTN at essentially the same as Addyi, the market has priced in a worst case scenario, assuming all other things remain constant.
- Rekynda will be approved and commercialized successfully or bought out by a larger firm for a fair value.
- Rekynda will not suffer much from competition with Addyi.
- Due to the partnership deal with AMAG, Palatin will not need to raise dilutive equity financing in the future.
We agree with all three of the bullish assumptions about Palatin Technologies. The drug has passed all three clinical trials with similar or greater efficacy than Addyi - the current first line treatment for FSD. It would not make sense for the FDA to reject Rekynda without contradicting its decision on Addyi.
Rekynda and Addyi are differentiated because, while Addyi is a daily treatment, Rekynda only needs to be taken before sexual activity. The drugs serve fundamentally different niches, and competition should not be an issue.
AMAG's agreement to pay Palatin $60 million upfront along with $80 million upon FDA approval ensures that Palatin should be able to take Rekynda to the finish line without needing to issue more shares. Also, all development costs for 2017 will be reimbursed by AMAG.
The Market's Bearish Assumptions
We believe these assumptions are what is being used to justify PTN's current value. If you disagree with these assumptions (and agree with our methodology), you think the stock price will go up from $0.41 per share.
- Every single warrant outstanding will be exercised and exert massively dilutive effects on the stock price.
- As an acquisition, Addyi is worth $120 million at a high-growth 15 EV/EBITDA. And Palatin Technology should be valued similarly to Addyi.
- Addyi's commercial failure is due to lackluster interest among women with FSD. The market is much weaker than people expected, and Palatin Tech will suffer the same fate as Addyi because it has no competitive advantage.
As for the market's bearish assumptions, we disagree with all of them except the first: PTN's warrants will most likely be exercised with the effect of diluting the stock price. This factor has already been taken into account when valuing the stock. However, we fundamentally disagree with the other factors, and here is why:
- Even if Addyi is worth $100-120 million on a 15 EV/EBITDA multiple on current sales, this is an artificially suppressed sales figure because of the FDA's restrictions on advertising, a black box warning, and mandatory physician education programs. With the proper infrastructure, Addyi can easily be expected to hit sales of at least double in the next few years. At $25 million in sales, and an 80% EBITDA margin, the drug would be worth around $300 million if we keep it's multiple the same.
Rekynda does not have the side effects of Addyi, and it will probably not have the same FDA restrictions. $50-$100 million in annual sales seem like a reasonable five-year estimate for Rekynda. Rekynda has a strong competitive advantage over Addyi. Read about Addyi's problems here.
- Rekynda is being developed for new indications, so EBITDA margin should be around 50% or lower. At $50 million in sales with a 50% EBITDA margin, Rekynda would be worth around $375 million as an acquisition. $375 million translates to around $2.8 per common stock outstanding, but due to dilution from the warrants (and new share creation), this sum will probably be closer to $1.00-$1.50 assuming FDA approval of the drug.
Rekynda's value is being artificially suppressed by weak Addyi sales, and Palatin Technologies is undervalued for this reason - even despite the large dilutive share count.
While, we feel that Rekynda's approval is very likely, nothing is guaranteed. In the worse case scenario, FDA delays are possible, but we find this unlikely due to the drugs improved safety over Addyi.
Cash burn is one of the biggest concerns for Palatin. The company spends around $10 million for operations per quarter, and this translates to around $40 million per year.
The company had around $14 million in cash at the end of 2016, and recently received an additional $60 million from AMAG as per the partnership. AMAG will also reimburse certain costs associated with bringing the drug to the finish line. Palatin should be able to finance operations until the NDA of Rekynda.
There is unconfirmed chatter about Valeant hiring more sales reps for Addyi to drive up sales of the drug before Rekynda hits the market. If this is the case, we could expect to see Addyi's sales begin to increase exponentially. It takes around $15 million in quarterly sales for a drug to be listed under Valeant's top 10 in U.S Diversified. If Addyi makes it here in the next few quarters, expect Palatin to surge.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PTN, VRX 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.
Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.