It was a wild week in the health care sector with a mind-numbing amount of merger and acquisition activity, a handful of key earnings reports, and even the occasional coverage initiation out of the blue as we got on Tuesday with GW Pharmaceuticals (GWPH).
The covering firm, Morgan Stanley, issued an "overweight" rating on the company as well as a substantial price target of $103, representing a 124% premium over its close on Monday prior to initiating coverage. It was also the first triple-digit price target bestowed on GW Pharmaceuticals by any Wall Street firm, let alone a widely recognized firm such as Morgan Stanley.
Morgan Stanley's stance on what it perceives to be an expected outperformance in GW Pharma's shares resides on success with Sativex for MS spasticity, as well as the potential upside of Epidiolex, its pediatric epilepsy therapy currently in mid-stage studies, and its novel research platform.
This is what sets GW Pharma apart
The real allure, and likely the big reason that GW Pharma's share price is up roughly sixfold over the past year, is the company's novel approach to drug discovery. Unlike your traditional pharmaceuticals, GW Pharma relies on the discovery of cannabinoids from the cannabis plants. To date it's discovered about five dozen such cannabinoids which it can used in conjunction with the naturally occurring cannabinoid receptor system in the body to effect biologic pathway changes that benefit a patient.
Source: GW Pharmaceuticals.
At the moment, GW Pharmaceuticals has one marketed therapy known as Sativex, which is licensed to Otsuka Pharmaceuticals. It's been launched in 11 countries and is approved in an additional 13. Sativex treats spasticity caused by multiple sclerosis and consists of two of the most common cannabinoids, CBD and THC. The product itself is an oromucosal spray which helps slow absorption into the body and reduce the "high" most often associated with THC and marijuana.
In addition to Sativex, which is also currently in three phase 3 studies in the U.S. with regard to cancer pain, it has five additional clinical and preclinical therapies being studied in everything from epilepsy and glioma to global chronic diseases such as type 2 diabetes and ulcerative colitis.
Given the changing public perception of marijuana in the U.S. and the possibility for more lax regulations domestically and throughout the world, investors are clearly looking for a way to get their hands on what could be a multi-billion dollar industry. With no other publicly traded "marijuana stock" having an approved therapy already on the market, Morgan Stanley sees what appears to be a clear comparative advantage for GW Pharma.
But, instead of making it rain green for shareholders, is it possible that this lofty assessment by Morgan Stanley could go up in smoke?
Let's have a closer look.
Source: GW Pharmaceuticals.
How Morgan Stanley's analysis could go up in smoke
One of the flaws I see with Morgan Stanley's analysis, which values GW Pharma at $1.5 billion based on its price target of $103, is that Sativex sales have been unimpressive.
It's actually a bit confusing on the surface why Sativex hasn't performed better. GW has a global pharmaceutical partner in Otsuka that's helping to cover clinical costs and is skilled in marketing a number of other therapies. However, in all of 2013 Sativex scrapped together just $3.7 million in revenue, a 14% drop from the previous year.
Partially to blame could be that one of the most commonly prescribed short-term spasticity relievers, Zanaflex, can be found in generic versions overseas where Sativex is currently approved. This isn't to say that Sativex is particularly pricey, but generic costs are usually going to be more attractive for physicians and patients.
The other portion of the blame could simply be a platform that physicians and patients are unsure of. Although GW Pharma has been through the process of approval in two dozen countries, divergent perceptions regarding marijuana could make cannabinoid-based therapies a tough sell. This is particularly worrisome with Sativex being tested as a treatment for cancer-related pain in the U.S. If the FDA determines there's too much risk of addiction or finds other concerns with the cannabinoid-based medication, a good portion of GW Pharma's valuation could go up in smoke.
Source: GW Pharmaceuticals.
With Sativex sales stalling and seemingly dependent on a U.S. approval to get jump-started it puts a lot of pressure on experimental pediatric epilepsy drug Epidiolex to get the job done. The drug has received an orphan drug designation for both Dravet syndrome and Lennox-Gastaut syndrome, both rare diseases, giving hope of a hefty price tag and a long period of patent exclusivity if approved.
On the other hand, we're also talking about an experimental mid-stage therapy that isn't even dosing until the second half of the year. It might be in shareholders' best interests to wait for more concrete data before breaking out the champagne.
Finally, I understand that Wall Street values the biopharmaceutical sector for its future potential, but exactly what sort of time machine was Morgan Stanley using to justify its valuation?
According to Wall Street's consensus estimates, GW's revenue is only expected to improve from $44.2 million in 2013 to $76.7 million in 2017, for a compound annual growth rate of nearly 15%. Loss per share, though, is expected to accelerate as it expands a number of early stage studies into more expensive and broader late-stage trials by 2016 and 2017. All told, Wall Street projections call for a cumulative loss of more than $10 per share over the next four years. Added up, that's in the neighborhood of $150 million in cash outflow, and the company only has $56.7 million in the bank as of the last quarter.
What this means is that GW Pharmaceuticals is either going to need to issue dilutive shares in order to raise cash for its ongoing studies that aren't covered by Otsuka, or it's going to need to partner up with additional pharmaceutical companies in order to rejuvenate its cash flow and give up sole control of its revenue stream.
We do have to keep in mind these revenue and EPS projections by Wall Street are fluid and could easily change, but I'm personally having a hard time seeing any scenario where GW Pharmaceuticals turns profitable before the end of the decade based on its clinical costs and disappointing Sativex launch in the EU.
With that being said, I would suggest keeping an eye on GW Pharmaceuticals for the sake of platform uniqueness, but as an investment I'd avoid it with a 10-foot pole.
