Long Undervalued, Is Alkermes Still A Bargain?

| About: Alkermes plc (ALKS)
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For a large part of its history, Alkermes (ALKS) never quite seemed to get its due from the Street. Given its business plan of helping other pharmaceutical/biotech companies develop drugs in exchange for modest royalties, perhaps that's not so surprising. After all, other drug development names like Nektar (NKTR), PDL BioPharma (PDLI), and Flamel (FLML) really haven't worked out to early expectations.

Things are different now. Not only does the company have a mature portfolio of proven drugs and established technology, but the merger with Elan Drug Technologies has diversified that base in a meaningful way. Better still, the company has an intriguing mix of emerging drugs and a strong pipeline that includes several promising wholly-owned compounds.

A Toll Collector On A Multi-Lane Highway

With the EDT merger done, Alkermes collects royalties from a veritable who's who of Big Pharma. Johnson & Johnson (JNJ) is unquestionably the biggest partner, with the anti-psychotic franchise chipping in about 40% of revenue, but well-known names like Abbott Labs (ABT), Novartis (NVS), Pfizer (PFE) and Merck (MRK) also feature in the mix.

While Alkermes admittedly doesn't collect huge royalties on its partnerships, they're not peanuts either. JNJ pays a very high single-digit royalty rate, as will Amylin (AMLN) on sales of its potential blockbuster Bydureon. High single-digit royalties are admittedly lower than the double-digit rates that companies routinely get for partnering their drugs, but investors should remember that these royalties are based on established technology and know-how, offer excellent incremental margins, and require little incremental effort from Alkermes.

Solid Growth Opportunities On The Way

In addition to an existing business that already delivers hundreds of millions in revenue, Alkermes shareholders can look forward to some meaningful launches and ramps in the next couple of years.

First and foremost is the Amylin Bydureon launch. GLP-1 drugs are already proven success stories in treating diabetes, despite the inconvenience of the once-daily or twice-daily injections that the treatment requires. Alkermes' technology allows Bydureon to work as a long-acting drug that requires just one injection a week. Clinical data firmly supports the efficacy and safety of the drug in controlling diabetes, but it also helps body weight and cardiovcasular outcomes. Although the initial launch has been short of expectations (due in part to Amylin's need to build out its salesforce), Bydureon should be a blockbuster on the order of $1 billion to $2 billion (or more) in sales.

After Bydureon, Alkermes longs can also look forward to Zohydro and Lyxumia, though neither are FDA approved at this time. Zohydro is an effective, albeit controversial painkiller (an extended release version of hydrocodone), that Zogenix (ZGNX) intends to file with the FDA in the second quarter of 2012. Lyxumia is another GLP-1 drug, this one a once-daily formulation, that will be marketed by Sanofi (SNY) if approved by the FDA.

A Deep And Interesting Pipeline

Alkermes has at least three interesting shots on goal in its pipeline where it has retained full ownership.

ALKS-37 is an opioid antagonist in a Phase 2b study for opioid-induced constipation. While this is a promising and under-served market at present, numerous other companies are working on OIC drugs - including Nektar (partnered with AstaZeneca (AZN)), Cubist (CBST), Theravance (THRX), and Salix Pharmaceuticals (SLXP) (through a partnership with Progenics (PGNX)).

ALKS-5461 is a combination of ALKS-33 (a novel opioid receptor modulator) and buprenorphine that is in a Phase 1 study for cocaine addiction, but also a Phase 2 study for depression. The recent record with new depression drugs has been poor (perhaps best seen in the Targacept (TRGT)-AstraZeneca partnership), but an effective drug with a novel mechanism of action could easily be a true blockbuster in the market.

Last and not least is ALKS-9070. This drug is basically a long-acting formulation of Otsuka's Abilify, a blockbuster anti-psychotic that is co-marketed by Bristol-Myers Squibb (BMY) in the U.S. Phase 3 data is expected in the first half of 2013 and a successful outcome could position this drug as another blockbuster.

These are not the only drugs Alkermes is developing, but they are the furthest along. One project further back in the pipeline worth a mention is a monthly formulation of exenatide that Amylin is developing with Alkermes' technology.

Valuation - Fair Today, But What About That Pipeline?

On the assumption that Alkermes can produce over half a billion in revenue in 2015 and start producing pharma-level free cash flow margins, the stock is arguably fairly priced today. Likewise, looking at probable revenue of $650 million to $750 million in 2016, a revenue-based price formula suggests that Alkermes should trade at around $17.

The trouble is that neither of these estimates factor in much success for those three pipeline drugs mentioned above. Now, I'm not all that sold on the blockbuster potential of ALKS-37, so I'd only add about $1 for its 2018 sales potential.

The other two drugs (ALKS-5461, ALKS-9070) are different stories. If each of these turn into billion-dollar drugs before the end of the decade, that could throw in another $10 or more in per-share value. It doesn't look as though any analyst is building these drugs into their ALKS model at this point, and while I understand that from the standpoint of conservatism, it does represent some real potential upside.

With the average sell-side price target on Alkermes at around $22, it looks to me that the Street is giving about $4 to $7 per share in pipeline value. For a company with Alkermes' track record, that seems a little light to me. This stock has had a strong run from 2009 and may be vulnerable to disappointments tied to Vivitrol, Bydureon and Zohydro, but on balance this looks like a mature biotech that is still worth considering at prices below $20.

Disclosure: I am long AMLN.