As many of my readers know, I have been closely following several of the biotechs that are developing new antibiotics. Over the past few years, I have written several articles on Paratek (PRTK), Nabriva (NBRV) and Achaogen (AKAO), while also taking a look at Melinta (MLNT) and Iterum (ITRM) for members of my subscription service Stability & Opportunity. After over 100 pages of analysis and notes, several detailed models and discussions with many of you, management and fellow investors, one thing is crystal-clear: There is a huge disconnect between market prices and the projections that have been made either by the sell-side or by the companies themselves, even the most bearish ones.
So who is right? As Howard Marks says, the market's intelligence and knowledge is average at best - hence the experts and specialists (analysts, commercial officers) should have a good chance to prevail, at least in theory.
The market's reasons
The reasons for the stocks' bad performance are probably:
- Disappointing private market valuations, as seen in the MedCo (NASDAQ:MDCO) - Melinta transaction or not seen in the probably busted Allergan (NYSE:AGN) - Paratek transaction (which failed, so the chatter goes, due to a disagreement on price).
- A perceived relatively high likelihood for ugly surprises in the sector (Cempra's non-approval of solithromycin, Tetraphase's (NASDAQ:TTPH) bad luck with eravacycline, Achaogen's non-approval for BSI).
- Repeated disappointments for big pharma acquirers of just-approved antibiotics, as sales expectations could not be met.
- The decision of those companies deemed to be likely acquirers of antibiotics to completely exit the space (the last one was Allergan).
- As a consequence, the high likelihood of substantial dilution at the small biotechs developing antibiotics, as they will probably need to "go it alone" and build their own sales organizations. (As confirmed by the convert sale at Paratek, projections made by Achaogen.)
- The extreme inefficiency of companies selling only one drug each will weigh on P&L statements for a long time. (One exception: Melinta actually has a small portfolio of antibiotics.)
- Reimbursement challenges. It's hard to get an antibiotic on hospital formularies and before that there is no way it sells in the community.
- Given rising resistance rates to older antibiotics and a perceived lack of new drug candidates in the pipeline, doctors may be hesitant to use the new drugs immediately, as they tend to preserve these options for only those cases where older drugs have been proven inefficient.
Well, that really doesn't sound good, does it?
On the other hand, while everywhere else the pressure to reduce drug pricing is enormous, in the antibiotics sector there are actually several ongoing attempts to increase prices. One law wants to create some kind of licensing model for antibiotics, where hospitals have to buy a minimum stock of each antibiotic, regardless of their effective use rates. And another law wants to grant certain developers of anti-infectives the possibility to extend patent exclusivity of a different drug by one year, an advantage that could easily be worth $1B or more when applied to the "right" blockbuster drug.
However, it is unlikely that these laws will produce immediate benefits for those companies that already have done their work.
An incredible valuation
The result is that we now have a portfolio composed of
- two approved excellent antibiotics against gram-negative bugs (Vabomere and Zemdri),
- three approved antibiotics which cover predominantly gram-positive bugs: one long acting lipoglycopeptide against ABSSSI, one fluoroquinolone against ABSSSI, one tetracycline against various infections,
- two antibiotics with IV and oral formulations that will likely be approved soon: one pleuromutilin (new class) against CABP and one tetracycline against ABSSSI, CABP and maybe also UTI and/or cUTI,
- a robust pipeline of further indications and antibiotics,
- which is trading for a total market cap of roughly $1.2B (AKAO + MLNT + NBRV + PRTK). Assuming some of the substantial combined cash reserves are used for debt repayment, there would even be some net cash left, so that the total combined EV of the four is around $1B.
That's pretty crazy, isn't it?
The way out of the doghouse
There are a few potential catalysts that might propel these biotechs to higher valuations:
- A takeover at a decent valuation in the space.
- An international partnership with decent conditions for one of the pack.
- A U.S. sales partnership with a large pharmaceutical company and decent conditions for one of the pack.
A takeover would hit the market as a total surprise, while any sales partnership would be seen as a double-edged sword: On the one hand, it would confirm the drug's value, but on the other hand it would mean that an outright sale of the company is unlikely. So the market reaction would certainly depend on the precise terms of the partnership. Given the absurdly low valuations, any decent upfront payment would likely provide a boost.
Another possibility is consolidation. If two or more of these companies decided to merge and to build only one common sales organization, the synergies would be enormous.
The problem is obviously that some of these drugs compete with one another, but overall this is probably the only and most realistic way out of the doghouse. Once Paratek's omadacycline and Nabriva's lefamulin have been approved, we should see some movement in the space.
Who will be the most likely participants?
Vabomere and Zemdri target largely the same patient population, so a combination might be difficult. In addition, the sales reps for gram-negative antibiotics of last resort like Vabomere and Zemdri call on ID specialists, while gram-positive and broad-spectrum antibiotics have largely different promotional targets. So I'm not sure where Achaogen might fit in this consolidation game.
Nabriva, which is clearly targeting first and second-line therapy of CABP, might be a nice fit for Melinta or Paratek.
Finally, given the two large indications of omadacycline and its potential third, even larger indication, any attempt to consolidate the space will likely have to involve Paratek.
This is one of the reasons why I am long Nabriva and Paratek.
...management and investor interviews, sales projections and dozens of pages of in-depth analysis of the antibiotics space can be found in Early Retiree's subscription service Stability & Opportunity.
In addition, subscribers get frequent alerts to short-term investment opportunities arising from carefully identified market inefficiencies. Stability & Opportunity provides full entry-to-exit coverage for all positions that have been initiated.
Disclosure: I am/we are long NBRV, PRTK. 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 microcap stocks. Please be aware of the risks associated with these stocks.