Is Incyte Corporation Overvalued?

One of the secrets to successful stockpicking in the biotech sector is adequately valuing and pricing the risk/reward profile of a company's pipeline. Almost every biotech looks cheap if an investor just assumes that everything will work as planned, but the reality is that only a small percentage of pipeline prospects live up to their potential. In the case of Incyte (NASDAQ: INCY  ) , this company does have a solid product in Jakafi, but it seems as though the Street is already factoring in a fair bit of success for the company's early stage pipeline.

Jakafi's prospects should soon double
Jakafi is Incyte's JAK1/2 inhibitor and its first drug to reach the market. Incyte secured FDA approval for Jakafi in myelofibrosis and markets the drug on its own in the U.S., while Novartis (NYSE: NVS  ) pays a double-digit royalty for EU rights. Myelofibrosis, a disease characterized by abnormal bone marrow stem cells that produce scar tissue instead of marrow leading to anemia and spleen enlargement, affects close to 50,000 in the U.S. and EU.

While this market could be worth as much as $4 billion in total, Jakafi is unlikely to get 100% of the market as some will opt instead for stem cell transplants, and there are tolerability issues with the drug for some patients. Though there was some disappointment and angst over the initial commercial launch, Jakafi is annualizing around $275 million on an adjusted basis and seems on its way toward becoming a $1 billion drug, with some of the more bullish analysts projecting $1.4 billion in peak sales. While Incyte could potentially see competition from Gilead or Lilly (NYSE: LLY  ) , that's likely several years away.

There could still be meaningful upside in Jakafi outside of myelofibrosis. The company recently revealed very limited data on the company's Phase III study in polycythemia vera, indicating that the study met the primary endpoint of phlebotomy independence and reduced spleen size by about one third. Seeing as the traits that limit Jakafi in myelofibrosis (anemia, namely) are actually a plus in this indication, the Street had been bullish on its prospects.

The company should be able to get FDA approval and with a potential patient population of 25,000 or so in the U.S. alone (25% of the 100,000 PV patients who are resistant to hydroxyurea), this indication could roughly double Jakafi's myelofibrosis sales. Better still, as the targeted physicians are the same, that incremental revenue will be quite profitable.

Can JAK inhibition play a role in oncology?
Evidence is building that JAK inhibition reduces cancer-induced inflammation, and that such inflammation plays a meaningful role in at least some types of cancer. Incyte has seen encouraging early stage results from administering Jakafi to pancreatic cancer patients, and the company is now pursuing pivotal studies. The company is also looking to study Jakafi in other cancer types like breast, colon, and NSCLC.

Jakafi isn't Incyte's only JAK shot on goal in oncology. The drug '110 is a JAK1 inhibitor that the company is now prioritizing for its potential cancer indications.

IDO-1 could be a valuable complement in immuno-oncology
Incyte is also developing its IDO-1 inhibitor '360 as a potential combo therapy partner with new immuno-oncology compounds (particularly checkpoint inhibitors). IDO-1 inhibitors appear to cause less tryptophan to be converted to kynurenine and T cells do not proliferate as easily in the absence of trypotophan. Given that potential mechanism of action, IDO-1 inhibitors could increase the efficacy of other cancer-fighting compounds.

Incyte put '360 into a study in melanoma with Bristol-Myers Squibb's Yervoy, but this was meant more as a proof of concept study. Incyte has subsequently partnered with Merck (NYSE: MRK  ) to study the combination potential of '360 and Merck's PD-1 inhibitor MK-3475 (or lambrolizumab). Merck and Incyte will co-fund studies, with Incyte running the studies. The first study will be in non-small cell lung cancer (NSCLC), and the potential of this drug could stretch into the billions if it proves capable of improving survival (as it seems to do in combination with Yervoy).

Multiple shots on goal
Incyte has a lot going on in the clinic. The company licensed its oral JAK1/2 inhibitor baricitinib to Lilly for development in inflammatory diseases like rheumatoid arthritis and psoriasis. The Phase II data in RA were positive and Lilly should have Phase III data in 2015. Incyte has another anti-inflammatory JAK inhibitor program of its own, having chosen to focus '110 on its oncology applications and pursue development of JAK1 inhibitor '986 in rheumatoid arthritis. Incyte also has '060, a c-MET kinase inhibitor licensed out to Novartis for oncology, and '093, a PI3K-delta inhibitor for oncology.

If all of these programs were certain to make it, Incyte would be a $90 stock today on the discounted value of the revenue and cash flow streams. While Incyte's pipeline could generate $6 billion or more in revenue in 2023, there is still ample risk to the story. Only about $1.5 billion of that $6 billion seems relatively certain (Jakafi in myelofibrosis and PV), and the lack of robust data on '110 and '360 argue for significant haircuts (remembering that fewer than two-thirds of oncology drugs in Phase III studies make it, let alone those that have not completed Phase II studies).

Using a discounted, risked, revenue-multiple approach, Jakafi is likely worth about $37 today for its applications in myelofibrosis and PV. Adding a 50/50 chance of approval in pancreatic cancer adds another $11. The Lilly partnership on baricitinib adds another $3, while '110 contributes around $4.50. The IDO-1 inhibitor '360 contributes nearly $5. In the case of '110 and '360, the potential peak sales are measured in the billions, but oncology drugs at this stage of development only have about a 20% chance of making it through to approval.

The bottom line
Adding up all of the component parts, Incyte appears to be worth about $60 today, not a particularly compelling target relative to the current price. Reasonable people can certainly disagree about the proper odds of approval for each compound (as well as peak sales targets and fair multiples to that revenue), but it would seem that bullishness on Incyte today is predicated on above-average expectations for success. Clinical trials may well validate that optimism over the next few years, but investors considering Incyte should understand that risk-reward trade-off before buying.

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  • Report this Comment On March 25, 2014, at 9:57 AM, newoncomeds wrote:

    IDO is over-expressed in cancers as a strategy to starve the T-cells that would normally surveil and kill the cancer. IDO inhibitors prevent this tryptophan starvation syndrome thereby allowing the immune system to work to help kill the tumor.

  • Report this Comment On April 26, 2014, at 10:29 AM, dlhnj wrote:

    Nice article with good insights on the potential of Jakafi and the pipeline. It would have been nice to provide more context on the valuation. For example, how do you come up with a $37 value for Jakafi as well as the other assets? When you start talking about earnings, Jakafi and the pipeline assets are not independent variables. INCY can become profitable based on Jakafi, and revenue from other drugs currently in the pipeline can increase earnings substantially as the cost basis remains relatively fixed.

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