Menlo Therapeutics (MNLO) is a biopharma focusing on the development and commercialization of dermatologic products. Its first product to market, Amzeeq, is a topical minocycline foam for the treatment of acne, and now Menlo has a second product, Zilxi for rosacea, that has received FDA approval. As Menlo ramps up efforts to initiate and grow sales of these products, the company looks extremely undervalued, trading with a current market cap around the combined low ends of peak sales estimates for just these 2 products and completely ignoring the third product with Phase 2 data expected soon. Boston Biotech Investor recently published an excellent relative valuation of Menlo based on past dermatology acquisitions, and in this article, I present a discounted cash flow model that similarly shows Menlo as undervalued.
Menlo Now Has 2 Approved Products Which Will Soon Generate Substantial Cash Flow
Amzeeq has been on the market since January and is already seeing good growth. Amzeeq represents a step forward in technology for the use of minocycline in acne treatment.
Figure 1: Chart Showing Amzeeq's Benefits Over Oral Minocycline (source: corporate presentation)
As you can see in Figure 1, Amzeeq is far more effective at getting the antibiotic minocycline to the skin and, perhaps more importantly, has a 750x lower plasma concentration versus orally delivered minocycline products. Given the concern these days about antibiotic-resistant bacteria and about chronic antibiotic use being bad for the microbiome, this is a substantial differentiator for Amzeeq over its competitors.
Menlo has said it expects greater than $200 million in peak sales for Amzeeq, but I've seen even higher estimates from other sources. For example, an analyst at Cowen has said up to $250+ million is reasonable for peak Amzeeq sales. At the current market cap of about $330 million, Menlo is only trading for roughly 1.32x to 1.65x Amzeeq's peak sales estimates. This is extremely cheap when we're talking about a product already out on the market with no more risks remaining as to its approval.
Menlo's second product, Zilxi (FMX103), just got approved a few days early this past Friday, May 29. Similar to Amzeeq, Zilxi is also a minocycline topical foam.
Figure 2: Chart Showing Before and After Pictures with Zilxi Use (source: corporate presentation)
As you can see from Figure 2, Zilxi has fairly noticeable results in at least certain patients with rosacea. I've seen estimates of peak sales ranging from $100 million up to $250 million for Zilxi. While Zilxi sales will probably be somewhat less than those for Amzeeq, the two products combined will still likely have peak sales greater than Menlo's current market cap.
FCD105 is a topical foam combination of minocycline and adapalene, a derivative of vitamin A. FCD105 is also a product designed for the acne market, like Amzeeq. FCD105 Phase 2 data could be coming potentially any day now which might provide an additional catalyst for upside in Menlo stock. Menlo has said to expect top-line results in mid-2020. If this data is positive, Menlo will likely initiate a Phase 3 trial, and FCD105 could hit the market by 2023, providing even more cash flow on top of what will likely be a significant amount by then from Amzeeq and Zilxi.
Lastly, although it doesn't factor into my discounted cash flow model, it's worth noting that Menlo is taking steps to get its products into foreign markets as well. Menlo recently reached a deal with Cutia Therapeutics for Cutia to market Amzeeq, and potentially Zilxi and FCD105, in China. Cutia paid Menlo $10 million upfront, and Menlo will receive another $1 million upon the Chinese approval of its first product and royalties thereafter. This is, ultimately, not a big deal in my view, but I like to see management taking opportunities to maximize cash flow from their products.
Menlo has Enough Cash to Support its Product Launches but More Will Likely be Needed
Menlo reported having $81.4 million in cash and short-term investments versus just $32.8 million in long-term debt at the end of the first quarter. The company's 2019 loss was about $74 million, suggesting the company can make it to the first half of 2021, consistent with management's guidance. Sales should start picking up significantly not long after that, with analyst estimates of 2021 and 2022 revenue at $67 million and $131 million respectively.
Figure 3: Chart Showing Shared Infrastructure for Menlo Product Sales (source: corporate presentation)
When considering launch costs for Menlo, it's worth noting that Amzeeq and Zilxi are generally prescribed by the same physicians, so there will be a lot of beneficial overlap in the company's sales and marketing efforts for both products. This will, hopefully, keep costs down to some extent and allow Menlo to get by on less cash than might ordinarily be required for launching 2 products almost simultaneously. An obvious downside risk for Menlo as with any early commercial-stage biopharma is that sales are slow to pick up which could lead to Menlo having to raise funds in a manner dilutive to current shareholders. With 2 products now having FDA approval, slow sales uptake is the only major risk I see remaining for Menlo.
Menlo Shares Look Far Undervalued Based on Estimated Discounted Future Cash Flows
I tried to build my discounted cash flow model to determine whether Menlo is undervalued even assuming fairly low estimates of product sales. My modeling suggests the company is likely undervalued at present.
Figure 4: Menlo Stock Chart (source: TradingView)
Menlo just got through a major catalyst, the approval of Zilxi, but as you can see from Figure 4, the company's share price actually dropped mid-day on May 29 after Zilxi was approved. I point this out to say that even though the company is likely undervalued, there is a substantial chance it could stay that way for a long while. Also worth noting is that a discounted cash flow model like what I used to estimate Menlo's value is best to show the extreme cases, meaning it will be better able to suggest that shares are undervalued or overvalued right now versus coming up with an exact estimate that we can feel confident about.
Because of that, I tried to use a very low case for total revenues for Menlo. I used the lowest peak sales estimates I saw for Amzeeq and Zilxi, $200 million and $100 million respectively. I didn't include any present value for FCD105, and I didn't factor in any royalties from foreign sales of Menlo's products. I also only valued sales for the next 10 years even though it's certainly possible both of these products will still be generating income beyond then.
I estimated SG&A expenses as 35% of revenue and marketing expenses at 5% of revenue, at the point where the company has substantial cash flow in a few years, and I scaled the numbers up fairly evenly from present values for the years in between. I factored in R&D for FCD105 despite not accounting for any revenue from the product. I also adjusted for future cash flow needs based on continuing cash burn for what will likely be the next couple of years before revenue is high enough to support the company's ongoing operations.
Figure 5: Discounted Cash Flow Analysis of Menlo Based on Amzeeq and Zilxi Sales Estimates (source: Menlo's 10-Q and my calculations based on it)
As you can see from Figure 5, my fair value estimate even off of the lowest sales estimates for Menlo's first 2 products is still over 30% above where the stock is currently trading. If you went with slightly higher estimates, like $250 million for Amzeeq and $150 million for Zilxi, the fair value estimate is significantly higher at $4.61. Based on this analysis, Menlo shares look substantially undervalued at present.
Conclusion
Menlo already offered a lot of value to shareholders with just Amzeeq on the market, but Zilxi's approval adds even more potential upside. With the stock dropping on Zilxi's approval, investors with a long-term perspective have an opportunity to scoop up shares with a wide margin of safety to the value of likely future cash flows. I had a half position in the stock prior to Zilxi's approval, and I added enough shares to bring it up to a full position during the afternoon post-approval dip. I intend to hold long-term for either an acquisition or a significant market repricing as cash flow builds.
