Vertex's Price Pop by the Numbers: Does It Fly?

U.S. stocks finished lower on Tuesday, with the benchmark S&P 500 closing down 0.6%, while the narrower Dow Jones Industrial Average lost 0.7%. The technology-heavy Nasdaq Composite Index fell 0.1%. One Nasdaq component had a banner day, however, as shares of Vertex Pharmaceuticals exploded higher, hitting a new 52-week high and closing up 40.4%, as the company announced that it will seek regulatory approval for an experimental cystic fibrosis drug later this year.

Source: Wikipedia.

Vertex Phamaceuticals' annoucement follows positive results in two studies that looked at the efficacy of Vertex's experimental drug lumacaftor in combination with its currently approved therapy ivacaftor (brand name: Kalydeco), in cystic-fibrosis patients with two copies of a rare genetic mutation.

Cystic fibrosis is a rare disease to begin with, but add to that this genetic mutation, and Vertex estimates that the target market for the combination therapy is just 22,000 across North America, Europe and Australia. (While there is no single definition of a rare disease, in the U.S., the Rare Diseases Act of 2002 as "any disease or condition that affects less than 200,000 people in the United States" - a rate of approximately 1 in 1,500.)


Nevertheless, while the target market is very narrow, the price of treatment is very high. In this case, analysts are forecasting a cost of roughly $150,000 per annum. As such, Citigroup analyst Yaron Werber expects peak sales of $3.1 billion in 2015.

Now consider that the market added some $6.4 billion to Vertex's market capitalization today. If this combination therapy had been kept entirely secret until today, instead of being highly anticipated, and its approval were now a certainty, today's increase in market value would amount to "paying" roughly two times forward revenue for the new therapy - an absolute bargain! (That $6.4 billion is approximately two times Citigroup's 2015 sales estimate of $3.1 billion.)

But not so fast. Werber wrote today that the new results only increase "the likelihood for approval from 65% to 80%" but concedes "that it might be conservative." Using those figures, the increase in Vertex's market value is now equivalent to paying nearly 14 times forward revenue (or 6.4/ (3.1*0.15)), which starts to look a bit pricey, even compared with the often optimistic valuations prevalent across the biotechnology sector. Note that as of yesterday's close, Vertex itself was trading at 11.2 times the consensus revenue estimate for 2015.

On the other hand, if we assume instead that the odds of regulatory approval just went from two-thirds to certainty, the revenue multiple is above 6 -- a relative bargain.

Bottom line: If you believe that Vertex was fairly valued yesterday, then today's jump in the share price looks like it's roughly in line with prevailing valuations. But those levels could well carry some risk, particularly since they are being goosed by furious merger-and-acquisition activity in the pharmaceutical sector. In valuing Vertex in the current environment, investors may well be drawing some of their inspiration from AbbVie's pursuit of Shire , for example, as Shire has a strong franchise in rare diseases.

Leaked: This coming blockbuster will make every biotech jealous
The best biotech investors consistently reap gigantic profits by recognizing true potential earlier, and more accurately, than anyone else. There is a product in development that will revolutionize not how we treat a common chronic illness, but potentially the entire health industry. Analysts are already licking their chops at the sales potential. To outsmart Wall Street and realize multibagger returns, see The Motley Fool's new free report on the dream team responsible for this game-changing blockbuster. Click here now.

The article Vertex's Price Pop by the Numbers: Does It Fly? originally appeared on Fool.com.

Alex Dumortier, CFA, has no position in any stocks mentioned. The Motley Fool recommends Vertex Pharmaceuticals. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Copyright © 1995 - 2014 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.


Increase your money and finance knowledge from home

Investing in Real Estate

Learn the basics of investing in real estate.

View Course »

Investing in Emerging Markets

Learn to invest in a globalized world.

View Course »

Add a Comment

*0 / 3000 Character Maximum