Disclosure: I am LONG Athersys via common stock and various call options
Preface: This article is meant to be read with a bit of background on the company Athersys that is so readily available due to the efforts of the many well-informed SA contributors who have written on this company in the past
A recent Seeking Alpha article regarding the stem cell company Athersys (NASDAQ:ATHX) concluded that ATHX is overvalued at its current price. As sole justification for this conclusion the author cited the fact that the company had doubled in value since early December without any seeming reason. Comically, the author didn't even realize that the company was at a market cap 25% bigger than the number he cited … gosh talk about a shorting opportunity!!
A company that doubles in value without any change in the business (an assertion I'd also disagree with regarding ATHX) is only overvalued IF it was properly valued before the run. If the company was undervalued by a factor of ten before doubling it would still be an attractive investment. In fact, as a multi-year long with a basis of approx $1.80, I feel that ATHX is still currently trading far, far below its fair market value. I arrive at this conclusion by comparing the current valuation with its intrinsic value.
Methodology
The next question then is how do you determine the intrinsic value of a speculative biotech? Again, the logic of the author of the previous article. In the comment section Louis Dematteis asserted that "Sales potential is only relevant once there is an approval, not before." A particularly astute observer laid out the basis for the calculation of intrinsic value in responding that "valuing a pre-approval biotech is a function of probability of success multiplied by what the payout will be if success happens. That market size is irrelevant until approval is irrational." For the purposes of this exercise, I will assume that the end goal for the ATHX management team is a buy-out. Thus for fair value I will be using the bottom bound of the recent Onyx buyout (3-4 times projected peak sales). In projecting peak sales, I will multiply each outcome by its probability and subsequently discount the produced expected value backwards from the year 2020 to create a present expected value of peak sales. I use an aggressive 14% discount rate with a company like Athersys (and accept that there is a very real risk of loss of almost entire investment).
Of course, especially with a company like ATHX this can be taken to the nth degree as there are truly a hundred plausible outcomes from here. To keep it acceptably brief, I will evaluate ATHX's two furthest along usages for its flagship product Multistem, IBD and stroke. With each indication, I will keep the lines very broad and evaluate the expected value of Best case scenario, Middle-ground and abject failure. With the expected NPV of each indication's peak sales, I can apply recent buyout valuations (3-4 times peak sales) to arrive at the current FMV.
IBD
Evaluating IBD is less cut and dry than stroke will be. This indication's value will be split with Pfizer. In addition to not knowing the exact terms of the deal, the final structure is still possibly going to change as ATHX has the option to split development costs with Pfizer from Phase 3 onwards. I will assume that they will do that and will be entitled to 50% of profits from the IBD indication. Results from the Phase 2 trial for this indication should be made public for the first couple batches of primary endpoints in late April or May. Should the Phase 2 trial be successful, Athersys has said that they will expand the trial in Phase 3 to include Crohn's sufferers as well as Ulcerative Colitis sufferers. This means that there is, in the US, approx 2.4 million sufferers that ATHX would be going after. I've been unable to find the number of sufferers in the rest of the developed world, but I will guess that in total the market in the wealthy portion of the world is approximately 5 million people.
The best case scenario is that this drug becomes the standard of care. I encourage each reader to examine all of the available evidence as to the efficacy of multistem. If they achieve peak sales in 2020, 30% penetration as standard of care, and charge $5,000 ($2,500 to ATHX) for this indication.
I think the middle-ground for this indication is that multistem works but does not unseat the standard of care. These drugs don't work for everyone though and have significant side effects for many people too. For me the middle-ground is still charging $5,000 but only achieving 3% penetration.
Of course, abject failure is still very possible (perhaps even probable). In this event, obviously, penetration will be 0%.
Obviously assigning a probability to these events requires a great deal of qualitative analysis. At best it's informed speculation. To inform my speculation I point to the wealth of preclinical data. For IBD I'm assigning a 2% probability to the best case, 33% probability to middle-ground and 65% probability to abject failure.
Stroke
There are approximately 2 million strokes occurring in Japan, the US and Europe every year. I'm no expert but I would guess that as populations age, this number will at the very least be stable for the forseeable future and quite possibly increase. The current standard of care is only applicable for approx 5% of patients.
Best case scenario is the drug works within the timeframe, and something new does not come along that is more effective. In that case, in light of how debilitating stroke can be and how much money can be saved in long term care costs, I think 50% penetration with $25,000 dollar price is a very modest best case scenario.
The middle ground is that the drug works, but something comes along that also works but does not completely eliminate the need for multistem. If multistem can work in tandem with other new drugs, but is not the most important of the cocktail, I think they would likely be able to still achieve a fairly large degree of penetration but at a much lower price. Let's call it 35% penetration at a $3,000 price.
The worst case for multistem is either that it does not work at all, or something comes along which renders its application pointless. I feel comfortable assigning a 10% probability to the best case, 10% to the middle ground and 80% to total failure. Given the nature of stroke research up to this point, I have to believe that if multistem does produce significant results with stroke, it's fairly possible that they will become the standard of care.
Indication |
Mkt Size |
Pen. |
Price |
Peak Sls |
NPV @ 14% |
Prob. |
Ex. Val. |
IBD BEST |
5,000,000 |
0.3 |
2,500 |
3.75 bil |
1,708,449,554 |
0.02 |
34168991.1 |
IBD MID |
5,000,000 |
0.03 |
2,500 |
375 mil |
170,844,955 |
0.33 |
56378835.2 |
IBD NOPE |
5,000,000 |
0 |
2,500 |
0 |
0 |
0.65 |
0 |
ST BEST |
2,000,000 |
0.5 |
25,000 |
25 bil |
11,389,663,692 |
0.1 |
1138966369 |
ST MID |
2,000,000 |
0.35 |
3,000 |
2.1 bil |
956,731,750 |
0.1 |
95673175 |
ST NOPE |
2,000,000 |
0 |
0 |
0 |
0 |
0.75 |
0 |
1.325E+09 |
See the table for the NPV of the Expected value of peak sales in each indication. The sum of all of the EV's is 1.325 billion dollars. Using metrics from the recent buyout of Onyx, I feel comfortable saying that three times the NPV of peak sales is a fair multiple for today's fair-market value. I think though it is fair to assume if Multistem does make it to market, ATHX will likely dilute more so I assume 100 million shares outstanding. That means the intrinsic value, today, is $39.75 a share.
Of course the key question is what is the true probability of each outcome. I feel very comfortable being public with these numbers, but honestly in my personal modeling I feel more confident in the probability of success. Additionally keep in mind that Athersys likely has many other market opportunities for multistem if it proves efficacy in either of these indications
Perhaps as significant as how undervalued the company is today, is what the effect of a successful IBD Phase 2 results announcement. Consider how much I will have to modify the probabilities … Should Athersys meet primary endpoints in both IBD and Stroke … This could be the investment of a lifetime.
Disclosure: I am long ATHX.
Additional disclosure: Long via equity and options.