AVEO Pharmaceuticals (NASDAQ:AVEO) is at a unique time frame in their evolution. They are both past the extreme excitement surrounding them 5 or so years ago, as well as past the initial excitement leading up to their first FDA approved product, FOTIVDA. After FOTIVDA was approved in March 2021, the stock quickly jumped up, but then just as quick went back to lower than its pre-approval price. It also languished over the year following approval, minus a few short stints higher:
I'm getting a little ahead of myself though. FOTIVDA, or tivozanib, is a kinase inhibitor used to treat relapsed or refractory advanced renal cell carcinoma in a third line setting. Drugs approved in third line settings are not really blockbuster drugs. Usually they can only be expected to add tens of millions of dollars in revenue or maybe a few hundred million in some cases. It usually is just a good starting point though for getting other drugs to market, as well as expanding labels on their first drug and possibly getting up to a higher line therapy setting.
So I want to get back to the price action of AVEO and where I see it going forward, but first I want to talk about smaller biotechs in general a little more. Biotechs can be a tough sector to play correctly as many lose value very quickly. AVEO itself is a testament to this as they have done terribly if you held them since the start of 2018:
However, if caught at the right time, you can play the recovery of a stock that has dropped for half a decade. Some of the best examples of this that I have seen over the last 5 years were Vericel (VCEL), Exelixis (EXEL), and Catalyst (CPRX). All of these companies saw their share prices explode in a few years, usually either as they became profitable or it was obvious they would become profitable with continued growth.
Now you may notice that I certainly am cherry-picking those dates to make those look as good as possible. But that's kind of the point. Because of the extreme volatility of the sector, timing is everything when picking biotechs. Picking at the wrong time can lead to quick 80% losses or 95% losses over a few years, but picking at the right time can lead to 10 bagger returns in less than a couple of years. I don't try to time the market as a whole, but I do try to time my entry into individual biotechs especially.
The way I see it, most biotechs have a long, long way to fall when they are priced at their best case, blue sky scenario down to what reality is. Whether that means several rounds of dilution, failed trials, FDA rejection, or just lower sales than originally projected, there are a ton of ways for biotechs to fail. For this reason, I think it is extremely tough to make money buying biotechs that are newer companies. I have since tried to follow overhyped companies for long after they have lost their hype and see if I ever can find the right time to buy back in. I caught a little bit of the VCEL and CPRX trains higher, but missed most of the EXEL run up. I have since sold out of all 3, as I hardly ever plan on holding biotechs long-term anymore.
Since I'd much rather try to find a forgotten name of yesterday that finally had an FDA approval than try to guess which company will be next to get overhyped, that brings me back to AVEO. The ramp up FOTIVDA has seen in revenues has been very nice for a third line cancer therapy drug.
As is typically the case, bringing a new product to market makes for a lot of extra expenses in sales and marketing teams for a small biotech. Even with these extra costs that drove profits lower at first, you can start to see how the expenses are leveling out some while the revenues keep growing, leading to cash flows that are improving again (albeit still negative):
Though the pace of growth in FOTIVDA will surely slow down, I expect it will still see expanded adoption over the next 2-3 years. Analysts seem to think the same as you can see from the expected revenues:
The revenue estimates actually expanded back in March, based on AVEO's first quarter numbers and on the management team affirming their $100M-$110M guidance. Analysts are still a little more bullish than management, with the average of their estimates at $113M. This is of course beyond management's guidance, but it shows that the rates of adoption in the first quarter and other factors are leading analysts to be even more bullish than management.
Now the biggest reason I like AVEO is once again back to the fact that there is no real excitement around them anymore, in terms of how they are priced. It might sound like a bad thing to not have any excitement in the market, but I believe it is a positive for timing. They have been growing their FOTIVDA revenues and having their future guidance boosted, all while their share price has been dropping. Their market cap is even lower than their revenue estimates for next year, giving them a Forward P/S and EV/S of less than 1x:
Now these low multiples aren't ridiculous for biotechs that are either:
1) In financial trouble
2) Doesn't seem like they will make it to profitability any time soon
I don't see either of these as worries for AVEO. To tackle the first point, I do not see AVEO as being in any sort of financial trouble. They have done a great job raising funds over the last few years without diluting a huge amount. They seem to be in a very safe financial position due to this. Their ~$70M of cash on hand (and closer to $80M in cash and marketable securities) means they have a runway of around 7 or 8 quarters, even if they kept burning close to $10M per quarter, which I expect to go down. They also still have more cash on hand than debt:
As to the second worry that sometimes rightfully places biotechs at very low valuations, I see AVEO likely making it to cash breakeven within the next year. As we saw before, they have only had ~$60M in trailing revenues at the end of Q1 this year, yet they have guided for between $100M-$110M for 2022. Additionally they have guided for $50M in commercial expenses and $20M in administrative expenses for 2022, leaving them with $30M-$40M in excess cash flows if they were to cut all R&D spend immediately.
Now the reality is that they won't be free cash flow neutral in 2022, due to their R&D spend, which management has guided for $60M-$70M this year. However, I see this as growth CapEx and think it is an important distinction, since it shows that they could already be profitable if they just wanted to sell their drug and not invest anything into their future.
I believe it is the right move to keep putting money into R&D and trying out FOTIVDA in combination with other drugs, such as they are doing with Bristol Myer's OPDIVO, as well as several other drugs. This could help expand addressable market by a lot. Here a look at all of their pipeline efforts:
So all of that explains why I think AVEO trading at less than 1x Forward EV/S does not make much sense. They won't technically be free cash flow neutral in 2022, due to their R&D spend that should hopefully continue to help their future growth. If they get anywhere close to analyst estimates for $173M in revenues for 2023, they should be able to be free cash flow neutral that year. This leaves them in very good financial shape and allows us to start looking at comparisons to other companies of similar size and growth.
I think VCEL, which I mentioned before as a stock that took off over a few years as they reached a tipping point, is a very good comparable company to AVEO. VCEL is likely a couple years ahead of AVEO in terms of where their revenues are at, but if AVEO can keep expanding the way they have been and the way analysts expect them to, VCEL offers a very realistic scenario of just how much multiple expansion we could see from AVEO.
Here is how VCEL's EV/S expanded from a similar 1-2x that AVEO is currently at up to more in the 5-10x for most periods and even up over 20x for a short while.
This was happening to VCEL during the same period that AVEO seems to be in now. AVEO's revenues are expanding very quickly and they should hit cash breakeven pretty soon. There is not a guarantee that AVEO will follow the same path, but I do think all the ingredients are there for AVEO to bake up the same cake that VCEL did. Here is another way to look at the revenue progression from each of them and just how big AVEO's market cap could get if it reaches the same revenues and the same trading multiples:
As shown above, with the expected growth from FOTIVDA, as well as possible multiple expansion, it is entirely reasonable to see AVEO 5-10x higher than their current price in a couple of years. This isn't even my blue sky scenario where AVEO beats estimates and they soar to higher than a 10x EV/S, due to expected future growth. In this case, they could be 10-20x higher than their current price.
There is a lot to like about the trajectory AVEO is on with their FOTIVDA launch. I also like the steps management is taking in R&D to hopefully keep the growth going for many years. Lastly I like that AVEO seems to be a forgotten about name, with little excitement surrounding them at the moment. In my eyes, this is the perfect time to buy back in, being before they approach profitability and the excitement starts to build again.
I started buying back into AVEO around a year ago and have picked up the pace of my purchases as they dropped to under $4. I am still a buyer at these prices and will continue to rate them a Buy, unless terrible news comes out about their expected growth of FOTIVDA or perhaps if enough trials failed. That all being said, I hope everyone realizes just how risky investing in biotechs can be. The extreme volatility can lead to outstanding gains, but can also lead to very large losses. Only invest in AVEO if they fit your personal goals for risk appetite and volatility.
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Disclosure: I/we have a beneficial long position in the shares of AVEO either through stock ownership, options, or other derivatives. 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.