An Undervalued Biotech

Last week, I wrote about my valuation system for biotech stocks, so I thought it would be a good idea to follow up with an example of how I usually go about it. First, I put on my chimp suit, get a dartboard...Oh wait, that's the Wall Street Journal. Or maybe Jacko. Yeah, cheap shot, I know. Anyway, on to finding good biotech values...

Step 1: Get an idea
The first question I often get is, "How do you actually FIND a stock?" With retail stocks, finding one isn't that hard -- you can walk down to the mall and take a look inside. With biotech stocks, you're much more likely to read about them in a scientific or medical journal, like the New England Journal of Medicine, a news site (several of which specialize in biotech news) or through friends or family who are being treated by a biotech product. A great place to fish for ideas and links is the Fool's own Biotechnology discussion board.

Step 2: Winnow the field
After reading a clinical update, or a Fool's fervent recommendation, you're intrigued. As with any other stock, if you're intrigued, you should start doing some research. With a retail stock, you're going to want to get a feel for the customer, market space, same-store sales, and the like. In biotech, you need to get a similar feel for the company's pipeline and products -- whom they are going to treat, how many patients there are, how much they can charge.

I've been a sideline observer of Lilly's (NYSE: LLY  ) attempt to enter the sepsis market with its costly biotech drug, Xigris, and it was through monitoring this that I discovered a little stock called Nabi Biopharmaceuticals (Nasdaq: NABI  ) . I noticed lead product StaphVax was in phase III trials and decided to dig deeper into the company. StaphVax is a vaccine candidate designed to prevent Staphylococcusaureus infections, a bug that causes about 30% of blood infections.

Step 3: What's the market?
I'm often asked, "How do you figure out if it's a billion dollar drug?" This question is more difficult to answer. If the drug has similar competitors, you can hunt down the price of the competition to make a ballpark estimate. If the drug doesn't have much competition, or if the competition is very different (Lilly's Xigris operates by a unique mechanism), it can be more difficult to "price" the pipeline.

Sepsis is a very large market, with over two million cases per year in the U.S. alone. And more than 10 million people are at "high-risk" -- they are having surgery or are on dialysis, for example. It also happens to be a condition with few treatment options, hence few competitors for Nabi's lead product. Staph infections cost about $20,000 per patient to treat, and the current treatment, again, isn't always effective. About 10% to 30% of infected patients die, and for those who survive, hospital stays are typically extended.

Furthermore, Staph bacteria are rapidly gaining resistance to traditional antibiotics. Slightly more than 1/3 of the Staph infections in the U.S. are resistant, as are slightly more than a quarter of infections in Europe. The resistance rates continue to grow rapidly, increasing the need for alternatives to antibiotics.

So, using just a rough calculation, the accessible patient population for StaphVax numbers around 10 million just in the U.S., and double that when European markets are added. At $100 a shot, that's a $2 billion drug globally.

Without a comparable drug to check that estimate against, one has to wonder whether insurance companies and governments pay $100 per treatment. Since U.S. hospitals spend about $4.5 billion fighting serious Staph infections, a reduction of infections by 50% (the FDA's standard that would ensure approval) would still cut costs by over $1 billion after taking the drug's cost into account, with better patient outcomes. A clinical trial of StaphVax in dialysis patients showed a 57% reduction in infections. So I believe that StaphVax would be cost-effective even at a higher price, especially when compared to a drug like Xigris.

Step 4: Valuation
As I mentioned in last week's column, my rule of thumb is to assign each phase III trial for a billion dollar drug about $400 million in enterprise value. Using this standard, Nabi Biopharmaceuticals should be worth at least $400 million in enterprise value. There are a couple earlier stage trials that I won't go into today, but you can apply similar evaluations to them.

But what really sold me on the stock is that besides a potential blockbuster in StaphVax, Nabi is a rare biotech company with real revenues. The company had about $125 million in revenues for the past nine months and uses this to fund much of its research and development. Although a recent stock offering will dilute the share base 20%, it's still trading around 3 times sales and has a potential blockbuster in phase III trials, all at the relative bargain enterprise value of $600 million, counting the share dilution.

And that's not even counting the rest of the pipeline. Put it together and Nabi Biopharmaceuticals looks undervalued to me.

Step 5: Have a happy New Year

David Nierengarten, Ph.D., works with a biotechnology venture capital fund. He often contributes to Fool.com and is an active member of the TMF Community as DavidMN. He owns shares of Nabi Biopharmaceuticals. He appreciates your comments at davidnierengarten@mac.com and on the Biotechnology discussion board. He wishes all his readers, and even non-readers, investing success in 2004.


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