By Robert Lowy :
Nektar Therapeutics Company Analysis and Recommendation
Target Price: $19.42
Position: LONG (1-3 years)
Analyst: Robert Lowy
Recommendation And Investment Thesis
I recommend buying a LONG position in Nektar Therapeutics, currently trading at $12.31 per share as I believe it is currently undervalued by approximately 50%. It is my view that the current price fails to account for the following:
- A strong lineup of candidate drugs currently in Phase III trials.
- Strong liquidity with a reported $389 million in cash and equivalents at the end of 2016 ( NKTR JPM Healthcare Presentation ) as well as a Q3 2016 current ratio of 3.7x.
- A strong leadership team with an established record of bringing products to market and providing shareholder value in the past.
Additionally, recent political turbulence surrounding the Affordable Care Act ((ACA)) and particularly drug pricing has caused increased trepidation within the biotech sector, further depressing the price below intrinsic value.
The principal catalysts for the appreciation of per share value to an estimated target of $18-20 per share over the short to intermediate term (1-3 years) include the following:
- Topline data from Phase III trial of NKTR-181, an opioid with reduced penetration of the blood-brain barrier, expected in 1H 2017. Subsequent early NDA filing expected in 2H 2017.
- Topline data from Phase III trials of both Ciprofloxacin Dry Powder for treatment of Non-CF (cystic fibrosis) bronchiectasis and Amikacin Inhale for treatment of gram-negative pneumonia expected in 1H 2017.
- Further progression of the company's other pipelines currently in clinical development (Fovista, NKTR-214, Dapirolizumab Pegol) and expansion to include those currently in pre-clinical development (NKTR-358, NKTR-255, NKTR-119) in the intermediate-to-long term.
The risks involved with this investment, in addition to overall market sentiment and volatility include:
- Failure to pass regulatory hurdles: Each stage presents a binary outcome and failure to clear any phase or topline data questioning a drug candidate's safety or efficacy is always possible and would negatively affect share price.
- Failure to meet financing needs: While currently well positioned to cover liabilities, it is possible that the company could be unable to source sufficient financing in the future.
- Dilution of common shares: Currently the company has issued approximately half of the 300 million shares authorized and has none of the authorized 10 million preferred shares outstanding. Should the company issue any or all of these in the future at a price below current book value per share (BVPS), there is a risk of significant dilution of shares currently outstanding.
Nektar Therapeutics is a U.S.-based biopharmaceutical company that develops drug candidates using its PEGylation and advanced polymer conjugate technology to design new molecular compounds that target known mechanisms of action in a different manner to enhance efficacy or improve the side-effect profile. The company operates across a wide range of therapeutic areas including pain, oncology, infectious diseases, and immunology. The company has a current market capitalization of approximately $1.9 billion and had 2015 revenue of $230.8 million from existing product sales, royalty agreements, and licensing/collaboration agreements. While not yet achieving positive EPS to date, revenue has grown by a CAGR of 41.7% between 2012 and 2015. The company has approximately $250 million in debt at 7.75% scheduled to mature in 2020, and as of an investor presentation in January 2017, the company reports $389 million in cash and equivalents at the end of 2016.
Nektar Therapeutics Products and Pipelines
- Movantik (Partnership with AstraZeneca ( AZN )): Peripheral Mu-opioid receptor antagonist for treatment of opioid-induced constipation in adults with chronic, non-cancer related pain.
- Adynovate (Partnership with Baxalta): Recombinant Factor VIII for treatment of Hemophilia A.
Candidate Drugs in Phase III Trials
- NKTR-181: A novel opioid designed to reduce the euphoric and addictive properties inherent to opioids for the treatment of moderate to severe chronic low back pain.
- Amikacin Inhale (Partnership with Bayer (BAYRY)): Treatment of gram-negative pneumonia in patients on mechanical ventilation.
- Ciprofloxacin Dry Powder for inhalation (Partnership with Bayer): Treatment of non-cystic fibrosis bronchiectasis.
- PEGPH20 (Partnership with Halozyme ( HALO )): PEGylated hyaluronidase to be used in combination therapy for pancreatic cancer.
- Onzeald: Long-acting topoisomerase-I inhibitor for treatment of advanced breast cancer and brain metastases.
- Fovista (Partnership with Ophthotech ( OPHT )): Anti-platelet-derived growth factor (anti-PDGF) agent for the treatment of neovascular age-related macular degeneration.
Candidate Drugs in Phase II Trials
- Dapirolizumab Pegol (Partnership with UCB/Biogen ( BIIB )): Anti-CD40L antibody for the treatment of systemic lupus erythematosus (SLE).
Candidate Drugs in Phase I Trials
- NKTR-214 (Collaboration for combination therapy study with Bristol-Myers Squibb ( BMY )): Immuno-oncology therapy targeting CD122 on immune cells.
- NKTR-358: Treatment for autoimmune disease targeting the IL-2 pathway.
- NKTR-255: Immuno-oncology treatment targeting the IL-15 pathway involved in long-term T-cell memory to treat cancer.
- NKTR-119 (Partnership with AstraZeneca): Co-formulation of Movantik and opioid pain medication for treatment of pain.
Cara Therapeutics (CARA): Clinical stage developer of novel pain therapies currently focused around selectivity for the Kappa opioid receptor to reduce the GI, psychoactive, and addictive properties as compared to standard opioids. Its main competitive product is CR845, currently in Phase III trial for post-operative pain and Phase II for chronic pain, and will likely compete directly with NKTR-181. CARA is currently trading at $11.19 per share with a market capitalization of $305.3 million.
Biogen, Inc.: Diversified developer of therapies for neurological, auto-immune, and rare/orphan diseases. The main competitive product within Biogen's pipeline is BIIB059 (anti-BDCA2) for SLE which could compete directly with Dapirolizumab Pegol, for which Biogen is also a development partner with UCB. BIIB is currently trading at $283.01 per share with a $60.9 billion market capitalization.
Novo Nordisk (NVO): A large developer of therapies focused on diabetes, obesity, growth disorders, and hemophilia. The main competitive products with Nektar are N9-GP (filed for approval), N8-GP (Phase III), and Concizumab (Phase I), all treatments for hemophilia that will compete with the existing Adynovate product line. NVO is currently trading at $36.20 per share with an $88.9 billion market valuation.
It is my belief that Nektar Therapeutics' share price will appreciate approximately 50% from current levels to a price target of $19.42 per share calculated via DCF analysis. Driving this appreciation in value over the next 1-3 years are the following principle catalysts:
Topline data from Phase III trial of NKTR-181 expected in 2017
- Topline results from the SUMMIT-07 Phase III study of NKTR-181 in opioid naïve patients with chronic low back pain expected in March 2017.
- Topline data from the Human Abuse Liability study (SUMMIT-HAL) expected mid-2017.
- Expectation of early NDA filing 2H 2017, pending results of SUMMIT trials.
- Pending trial results and NDA, expected to market in 2019-2020 contributing approximately 60-70% of revenue from product sales as projected by this analysis.
Topline data from Phase III trials of Ciprofloxacin DPI and Amikacin Inhale expected 1H 2017
- Topline data from Amikacin Inhale Phase III trial for treatment of mechanically ventilated patients with gram-negative pneumonia expected mid-2017.
- Topline data from Ciprofloxacin DPI Phase III trial for treatment of non-CF bronchiectasis expected 1H 2017.
- Pending trial results and NDA, expected to market in 2019-2020 contributing approximately 10-15% of annual royalty revenue going forward as projected by this analysis.
Further progression of the company's other pipelines currently in clinical trials or advancement of those in pre-clinical development
- The company has a strong lineup of candidate drugs in early-stage or pre-clinical development, suggesting strong potential for continued long-term growth.
- Preliminary data from Phase I trial for NKTR-214 in combination with Opdivo expected in 2017.
- Plan to initiate Phase I clinical trial of NKT-358 in March 2017.
I have valued Nektar Therapeutics using a DCF analysis. The following are the main assumptions used in this calculation.
Revenue: Revenue streams were divided between existing product lines already producing revenue from sales or royalties and risk-adjusted revenues from pipelines in later stages of development (Phase III clinical trials).
- Existing Product Lines : Revenues from existing product line sales were projected in a straight line at 14.14% for the period forecast, representing the average percentage of annual revenue growth from product sales for the period 2013-2015. Royalty revenue from existing products were projected on a rolling basis as the average of the values from the previous three years; this method was chosen as historically this revenue stream has been variable from year to year without a demonstrable pattern of growth or recession over time.
- Pipelines in Development : Revenues were estimated for each of the three pipelines projected to come to market within the forecasted period of five years. The potential market for each product line was estimated based on published data on incidence of specific conditions ( Grosso et al , Polverino et al , Freburger et al ). Where ranges were used to estimate incidence, best judgments based on trend and medical knowledge were made. Similarly, annual cost of each drug was estimated using publicly available data for the cost of existing drugs on the market ( Falagas, et al ). Target market share was estimated conservatively as 5% of total potential market for most product lines (except for GNB pneumonia, estimated as 16%, given incidence data already recognized a select subset of the treatable population) to reflect competition and the targeting of specific subgroups of the total patient population, with a straight line ramp up over five years. Royalty revenue was estimated at 20% where applicable ( Zaharoff ).
Long-Term (Sustainable) Growth Rate : The long-term growth rate was estimated at 4% annually to reflect the average annual U.S. GDP growth rates over the past 20 years ( St. Louis Federal Reserve - GDP ).
Weighted Average Cost of Capital ((WACC)) :
- The company currently has a capital structure of approximately 40% debt and 60% equity. It is expected that the company will continue to maintain a similar capital structure beyond the forecasted period to enhance the overall cost of capital, so this structure was used for both the short-term forecasted period as well as to discount terminal value.
- At present, the company's debt has a cost of 7.75% and matures in 2020. This rate of 7.75% was used for the forecasted period (through 2021), after which the long-term pre-tax cost of debt used in calculation of terminal value was estimated at 5.5% to reflect reduced risk due to maturity of the company as well as likely increasing interest rates. The current nominal tax rate of 33% percent reported by the company was used for the calculation of after-tax cost of debt.
- The cost of equity was calculated via the CAPM using the 10-year arithmetic mean of returns on the Russell 2000 to estimate expected market return (E(R m)) of 8.85%. Short-term risk free rate (Rfr) is the current yield on the 10-year U.S. Treasury of 2.398% with a long-term rate of 4.050% used for calculation of terminal value to reflect the 20-year historical average of 10-year Treasury yields ( St. Louis Federal Reserve - Rfr ). Beta (ß) of 1.86 was obtained from Google Finance and found to be consistent with other sources.
The risks involved with this investment are substantial due to its speculative nature given the developmental stage of its pipelines. The following represent some of the key risk considerations:
Failure to pass any step in the regulatory process for any or all drugs under development
- As with any biopharmaceutical company, future success if dependent on successful progression through clinical trials and FDA approval. Each stage in the process presents a binary scenario with clearance/advancement leading to likely outsized appreciation in perceived valuation and conversely failure of any stage leading to a precipitous drop in valuation.
- Each of the three pipelines factored into the revenue model for this analysis are in Phase III clinical trials. While this reduces the perceived risk of failure to bring these drugs to market, it is still possible for the failure of either the current Phase III trials or rejection of the NDAs by the FDA.
- While not directly factored into this valuation analysis due to their early stage of development, disappointing topline data from any one of the products currently in Phase II or Phase I trials would likely result in some depression of stock price.
Failure to Meet Financing Needs
- While the company has a strong balance sheet with a sizable cash balance of ~$56 million at the end of 2015 and recently reported in an investor presentation that it ended 2016 with a cash and equivalents balance of $389 million, there is always a risk that obligations may outpace financing at some point in the future.
- Additionally, the current long-term debt of ~$242 million will mature in 2020. Should the company experience a delay or fail to gain approval of its candidate drugs or experience any event causing realized revenue to be inadequate to cover these costs, it will be necessary for the company to find other sources or debt financing possibly with unfavorable terms or potentially offer additional equity. While unlikely, should the company be unable to source adequate financing, the viability of the company would be at risk with an obvious resultant drop in share price.
Dilution of Common Shares
- The company is authorized to issue up to 300 million shares of common stock with 132,458,000 outstanding as of the end of 2015. Should the company issue the remaining 167,542,000 shares, it presents the possibility of substantial dilution should they be sold for less than book value per share.
Contingencies And Worst-Case Scenario
It is possible that these estimates are wrong due to the unlikely event of fraudulent or misleading claims, misrepresentation of financial statements by the company, macroeconomic factors, unforeseen events, and inherent error in estimating values for calculations. In this section, I present a few contingencies assuming the assertions on the performance of the company inherent to my valuation are incorrect.
Assuming a dramatically lower rate of growth in the short and long term as keeping pace with GDP growth, estimated at 2%, the stock would be valued at an estimated price of approximately $14.23 per share.
Should the company fail to secure approval for its products currently under development, particularly its wholly-owned NKTR-181 pipeline, the value based on DCF analysis would be estimated at $0.00 per share.
In the case of liquidation of the company at present, the price could be estimated by Net Assets/Shares Outstanding (non-diluted), which would equate to a price at current balance sheet values of $0.05 per share and a value of $0.00 when adjusted for intangible assets (goodwill).
See also Prospect Capital: Big Dividend, Big Risks on seekingalpha.com
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.