Marijuana drugmaker GW Pharmaceuticals Plc (GWPH) shares have returned an unbelievable 500% in the past year; trouncing the S&P 500 ETFs 23% return and handily outpacing the 37% return for the iShares Nasdaq Biotechnology ETF.
Given GW Pharma's meteoric rise, investors are right to wonder if there's more room left to run higher, or if the shares are ready to retreat, so let's take a closer look.
Source: GW Pharmaceuticals Plc.
Elusive earnings and rising expenses
Emerging biotechnology companies like GW Pharma spend the majority of their cash developing new products or conducting trials to expand labels on existing medication. As a result, emerging biotechnology companies rarely have earnings that shareholders can rely upon to justify their share price; and GW Pharma is no exception.
GW Pharma's only commercialized drug is its multiple sclerosis spasticity treatment Sativex, which is sold in 14 European countries. However, sales of that drug have been lackluster, totaling just $1.7 million last quarter.
That means that until GW Pharma wins more approvals, investors will have to rely on partnership revenue from Otsuka, a major Japanese drugmaker that's working with GW Pharma on Sativex' for use as a cancer pain treatment.
Although Otsuka pays Sativex's clinical trial bills, GW Pharma still expects to burn through $41 million in cash during the year ending September. That burn rate may give investors pause, but equity offerings added $233 million to the company's balance sheet earlier this year. That gives the company plenty of money to continue its epilepsy, ulcerative colitis, and diabetes trials.
Source: GW Pharmaceuticals.
Debating valuation
Valuing emerging biotechnology companies is tricky.
Since GW Pharma has little in the way of sales and is still losing money every quarter, traditional price to sales and price to earnings measures are of little use.
Instead, investors have to rely on research and a bit of guesswork to determine the potential future revenue that may come from GW Pharma's product pipeline. That means considering whether the drug will make its way past regulators, how much the drug will cost, whether doctors will prescribe it, and whether any revenue will be shared with partners.
Since 60% of drugs in phase 2 and another 30% to 40% of drugs in final phase 3 clinical trials typically fail, I typically like to focus on the potential of drugs that are currently in phase 3. At GW Pharma, that limits me to Sativex for cancer pain. However, I'm not willing to ignore the company's phase 2 programs for treating childhood epilepsy given that there are few treatment options; so let's consider potential sales from Epidiolex, too.
We'll know better whether Sativex for cancer pain has a good shot at making its way to market when data from the company's phase 3 study is released later this year. If those results are solid and the FDA approves the drug, it will compete for market share against currently approved opiates including Mallinckrodt's Xartemis and Insys Therapeutics Subsys.
To get a better feel for what that market opportunity may look like to GW Pharma, Mallinckrodt reported sales of oxycodone containing tablets, including Xartemis, of $54 million and Insys reported sales of subsys totaled $55 million in the second quarter.
That's a good starting point for Sativex, but investors should remember that Sativex approval would be for second line use in patients that have failed on opiates. That suggests that sales could prove smaller than they are for these two other drugs. Even if sales do exceed competitors, investors should also remember that it's Otsuka that stands to benefit most from Sativex approval, not GW Pharma. That's because Otsuka will only pay GW Pharma a royalty on sales that is in the mid 20% range.
Shifting gears...
A lot of investor interest is focused on Epidiolex -- for a very good reason. Childhood epilepsy has a significant unmet need.
But while trial results may or may not prove that Epidiolex can address that need, investors should recognize that the patient population for childhood epilepsy indications like Dravet Syndrome is small. GW Pharma estimates that there are just 5,400 patients in the U.S. and another 6,700 patients in Europe.
Source: Author's calculation.
Also, while there are no specifically approved treatments for Dravet in the U.S., Biocodex' stiripentol is approved in Europe. Stiripentol is used alongside anticonvulsants and as of last year carries a price tag of about $370 for 60 250mg tablets. So depending on dosing, that could work out to thousands of dollars in sales per patient per year. That prompted me to do a little back-of-napkin math. Assuming that every U.S. patient took stiripentol three times a day, its peak U.S. sales would still be less than $40 million per year.
Since GW Pharma's current market cap is roughly $1.2 billion and acquirers paid 10 times sales for Viropharma and seven times sales for Forrest Labs, GW Pharma investors would likely want to see between $120 million and $170 million in annual sales to justify GW Pharma's current valuation. Based on these assumptions for Sativex and Epidiolex, that may happen -- but it's far from a certainty.
Fool-worthy final thoughts
Investing in biotechnology stocks like GW Pharma is a risky proposition. There's no guarantee that clinical stage drugs will ever make it to market and if they do win over regulators, they may still fail to win market share.
GW Pharma has an advantage in having already won over EU regulators with Sativex for MS Spasticity and the company should have late stage data that could support a filing in the U.S. for cancer pain soon; however, valuing the company based on those potential approvals may suggest that investors are best suited looking elsewhere until either more data is released or share prices retreat.
