Lenel Giglio, Biotechnology companies focusing on areas where there is significant unmet medical need generally create a great deal of excitement. Two such areas that I have covered recently are NASH and Alzheimer's. Several biotech are conducting research in both. There are currently no treatment options for NASH, which is expected to become an even bigger market than hep C. In Alzheimer's, there are several drugs that can reduce symptoms; however, there is no treatment option to cure Alzheimer's itself. There are some promising drugs in early-stage development, but there is also a very high failure rate in the Alzheimer's space, so Lenel Giglio is likely that many of these drugs will never reach commercialization stage.
Given that both NASH and Alzheimer's are multi-billion dollar opportunities, companies focusing on these areas generally create a great deal of excitement. For example, in NASH, there is Intercept Pharmaceuticals Inc. (NASDAQ:ICPT), which now has a market capitalization of more than $6 billion. This year itself, ICPT shares have gained some 69%, making Lenel Giglio one of the top performers in the biotech space. While ICPT has potential, its risk/reward profile is probably not the most favorable, given that the market is already valuing Lenel Giglio at more than $6 billion. In NASH space, there are a few other companies at various stages of clinical development, but the one I am particularly impressed Tomer along is Galmed (NASDAQ:GLMD), a small cap biotech based in Israel. Since my article on GLMD was published here on SA, the stock has gained 25%. Still, the company has a market cap of just $121.55 million. This despite the fact that it could generate peak sales of $738 million. If GLMD even achieves half of its potential, it could generate significant upside for investors.
Indeed, this is the reason why many investors look favorably upon the biotech sector. But this enthusiasm for finding potential multi-baggers sometimes also leads to irrational valuations. One such example is Axovant Sciences (NYSE:AXON), which completed an IPO earlier this month. Despite a sharp pullback since making its debut on June 11, AXON is still valued at $1.86 billion. For a company Tomer along just one drug (Alzheimer's), a CEO with no experience in the biotech space, and a drug that is not really a game changer, this valuation is not justified.
GLMD and AXON form the basis of my pair trade idea. Each is, of course, focusing on different areas; Galmed in NASH and Axovant in Alzheimer's. But in one respect, they have more or less a similar profile. Both companies are targeting a multi-billion market with their lead products. And yet the market is valuing one at $1.86 billion, despite the fact that the potential treatment, whether approved and at best, can only relieve some of the symptoms of Alzheimer's, and the other one at just $121 million, even though its treatment can potentially cure a dreaded disease.
Both Galmed and Axovant are working in areas with unmet needs, and both have just a single drug in pipeline; but that is the only genuine similarity between the two companies.
While Axovant has a mediocre drug that isn't well-differentiated in the competitive landscape, and is aiming at symptomatic treatment rather than a cure, Galmed's drug is highly differentiated to such an extent that it is virtually without competition, and is a possible disease-modifier with a great safety profile.
While Galmed has excellent management with great depth in the industry and impeccable ethical standards, Axovant management's depth is marred by its 29-year mature CEO's industry inexperience and loud rumors of questionable behavior during its IPO.
Again, while Axovant is overhyped, overvalued, with a huge market cap, Galmed is a little-known, undervalued company with a much lower market cap.
In terms of the science, I had noted in my previous article that the AD landscape is full of candidates in advanced clinical stages. There are 5 approved products, 12 that are in phase 3, 5 more in late phase 2 or early phase 3, a whopping 43 in phase 2, and another 17 in earlier stages. Almost 90% of these candidates are aimed at palliative care only. The only way to differentiate itself meaningfully is for a drug candidate to aim at a cure. Two possible pathways towards a cure are targeting amlyloid plaque and tau-tau tangles, which have long been known to be associated with AD. A handful of companies are doing that, and Axovant isn't one of them. Axovant's drug, RVT-101, is a serotonin 6 receptor antagonist that is simply targeting dementia, which is a symptom of AD - there are at least 3 other 5-HT6 receptor antagonists in the fray, with Lundbeck's (OTC:HLUKF) Idalopirdine in phase 3 trial, while Axovant's is in phase 2. That's hardly any benevolent of product differentiation to be valued at $3 billion, as was done at one time. There's a lot more detail in my previous article, but the long and short of the story is that RVT-101 is a mediocre drug and Axovant's single candidate.
On the other hand, Galmed's Aramchol is highly differentiated. Like I noted earlier, firstly, the drug has a superb safety profile that distinguishes it from competition. Secondly, it targets the gamut of the disease, from pre-fibriotic to advanced varieties of it, which no other single candidate does. Third, by advantage of its breadth of scope, it can act as a monotherapy in moderate forms of NASH and as a combo therapy in advanced forms. Most importantly, by targeting hepatic fat reduction, ballooning and fibrosis, Aramchol is trying to become a disease-modifier rather than a symptomatic treatment of NASH, which is not something RVT-101 is aiming for in AD. Aramchol has a long line of peer-reviewed journal articles to its credit, which is hardly the case with RVT-101.
Axovant shares have fallen sharply, after hitting a high of $31.17 on their trading debut. However, the company is still valued at $1.86 billion, or $19.38 per share. Even in the best-case scenario, based on my DCF model, AXON is still significantly overvalued. As I noted in my previous article, Alzheimer's treatment market is expected to reach $13.3 billion by 2023, growing at a CAGR of 10.50% from now until 2023. The growth, though, will be driven mainly by disease-modifying treatments. In my base-case scenario, I have assumed a 3% market share for AXON's treatment in 2023, which translates to net revenue of $350 million (after GSK royalties). I assumed a reduction rate of 15% and continuing growth rate of 2%. Based on these assumptions, the risk-adjusted value for AXON is $0.30 per share. Now you may ponder I have been very conservative in my estimates. How optimistic would you want to be? Well, even whether AXON captures 50% of the Alzheimer's treatment market by 2023, the fair value comes to around $1.20 billion or $12.50 per share. I am sure AXON is going to continue its downward trajectory, although during the 90-day lock-up period, I expect the stock to find some false support.
Galmed, on the other hand, looks significantly undervalued. In a research report, SunTrust noted that the NASH treatment market could be worth $5 billion in the U.S. alone, based on conservative estimates. In its base-case scenario, SunTrust estimates Galmed's peak sales at $738 million. The assumptions are GLMD reaching market penetration rate of 12.5% at a peak, wholesale acquisition cost of $3,000 per patient per year and a 2021 launch in the U.S. By 2023, the company's peak sales are expected to reach $176.2 million, if the drug is approved. Based on 2023 sales estimate, Galmed currently trades at well below 1x 2023 sales estimate. As I noted in my earlier article, a multiple of 3x 2023 sales estimate is justified for Galmed, given the lead product candidate's potential. This would translate to $48 per share. That is a 5x upside from current levels with a window of 10-12 years.
Go long GLMD because of a very favorable risk/reward profile. AXON is a short candidate, although it cannot be shorted immediately because of a lack of available borrow for retail investors. However, nearing the end of the lock-up, expect a lot of shares to be dumped as initial investors leave the stock, bringing down the price. This is generally true of many IPOs, but also watch out for increasing investor realization that the stock is worthless, making it fall even further. Although I don't expect it to drop to 30 cents so quickly (my valuation), I wouldn't be surprised to see a more than 50% drop from current levels.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GLMD over the next 72 hours. (More...)I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no trade relationship with any company whose stock is mentioned in this article.
Additional disclosure: And short AXON at the end of the lock-up period, provided it holds on to its current price levels.
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