Should a Soaring Market Cap Worry Repligen Corporation Investors?

While the biotech sector has failed to keep last year's momentum rolling in 2014, bioprocess products supplier Repligen Corporation (RGEN 0.46%) has remained immune to the woes of the broader peer group. And the comparison isn't even close. The most widely regarded biotechnology index has remained flat this year, while Repligen has soared 33%.

RGEN data by YCharts

Investors sure aren't complaining, but the march to a nearly $600 million valuation should raise an eyebrow for those following the company closely. This year marks the first time Repligen won't record revenue from a royalty stream from rheumatoid arthritis drug Orencia from Bristol-Myers Squibb (BMY +0.56%), which contributed mightily to net income and total revenue in 2013. Consider that 2014 guidance calls for as little as half of the $16 million in net income recorded last year despite growing product sales and improving margins. Should investors worry about a swelling price-to-earnings ratio being fueled by a growing market cap?

Digging into 2014 guidance
The last time I wrote about Repligen, I attempted to model the company's top and bottom lines in 2014 accounting for the loss of the virtually cost-free royalties captured from Bristol-Myers Squibb and before the company's guidance. I wasn't too far off (I narrowly underestimated revenue and operating income), but management's latest guidance from the first quarter earnings conference call is as follows:

• Total revenue of $54-$57 million.
• Product revenue of $52-$55 million.
• Product gross margin of 53%.
• Total operating income of $11 million to $13 million.
• Total net income of $8-$10 million, or $0.24 to $0.30 earnings per share.
• Cash balance of $84-$87 million.

The guidance doesn't include potential milestone payments from two companies developing Repligen's previously owned assets or the effects of a potential acquisition (how the company obtained its current product offerings). Additionally, while total revenue will shrink because of the loss of Orencia royalties, product revenue may grow 10%-15% on the heels of growing industrywide investment in monoclonal antibodies.

Still, it's important for investors to remember that Repligen's current P/E ratio reflects three quarters of royalty payments from Bristol-Myers Squibb and just one quarter without it. In other words, the company's P/E ratio won't reflect current operations until the end of 2014, when four quarters of post-Orencia revenue is reflected in the trailing EPS figure displayed on various financial dashboards. How can investors determine a more realistic P/E ratio, and what should they do with the information?

What's a fair market value?
The company's trailing 12-month P/E ratio (the one displayed on financial dashboards) of 32.7 at $18 per share can be pretty deceiving. Luckily for investors, it's simple to determine Repligen's end-of-year P/E using (1) management's latest full-year EPS guidance and (2) the current share price. The company's P/E ratio would look something as follows at various price points (we aren't claiming to predict share price) assuming an EPS range of $0.24-$0.30 remains intact for the remainder of the year.

*Using figure of 32.8 million shares outstanding as of March 31. Source: author calculations.

The current share price would reflect a P/E ratio of 75 at the low end of the EPS range and 60 at the high end of the EPS range. That seems a bit expensive to me, although Repligen would also finish the year with approximately 15% of its market cap in cash, or up to $87 million. That alone is quite advantageous -- and I wouldn't rule out a strategic acquisition by management to help solidify its position in the bioprocessing industry and make high P/E ratios seem more reasonable. However, to keep its current trailing 12-month P/E ratio at the end of the year, shares would have to fall to $10 and the company would need to hit the high-end of its EPS guidance. I'm not saying shares will end the year at $10, but you can see how the current P/E ratio is misleading.

Foolish bottom line
Is Repligen overvalued? I suppose it depends on how individual investors define "value." Does your definition account for double-digit growth in product sales for the foreseeable future? Does it account for a strongly profitable business growing its cash position? Investing solely on P/E ratios is probably not the best way to secure long-term gains, but performing experiments similar to the one detailed here can provide useful information that will help you answer that question based on your investing goals. I would be surprised if investors see $18 per share at the end of 2014 if the scenario discussed here plays out -- even if unexpected milestone payments are triggered. However, a strategic acquisition could destroy my model. Until that occurs, I'll be sticking to my current thinking.