mstar:
We're maintaining our fair value estimate for Chiron CHIR even though U.K. regulatory authorities have extended the suspension of production at the company's Liverpool flu vaccine facility for an additional three months. While the extension is not great news, the suspension is still set to expire before the start of next year's production of Fluvirin vaccine. Should Chiron fail to receive authorization to resume production at this facility in time to develop vaccine for the 2005-06 flu season, however, our fair value estimate could fall by as much as $3 per share.
Thesis 10-05-2004
A mix of business lines steadies Chiron's trajectory, but it can also cause management to take its eye off the ball.
Chiron's roots trace back to developing vaccines and testing for infectious diseases such as hepatitis and HIV. Unlike most biotech firms that have chosen to focus on developing drugs, Chiron maintains its diversified product platform. While this strategy can shield the firm from idiosyncratic events in any one business, it also poses the problem of potentially spreading talent and resources too thin. For example, the firm couldn't mobilize enough resources to fix Fluvirin production problems, resulting in the loss for the 2004-05 flu vaccine season of $415 million in revenue, according to our estimates.
At first blush, Chiron's blood testing, vaccines, and biopharmaceuticals businesses have delivered solid results. Sales have increased an average of 19% annually since 1998 and generated enough cash to fund development costs. However, growth has come from acquisitions and one-time payments rather than from breakthrough drug development. Sales of the once-top-producing cancer drug Proleukin have been flat, and strong competition from Serono's Rebif SRA and Biogen IDEC's BIIB Avonex are eating into multiple sclerosis drug Betaseron.
Chiron's inability to develop profitable drugs isn't for lack of trying. As a percentage of sales, the firm spends more than twice what other established biotech firms do on research and development. The biopharmaceutical segment now spends 56% of its product sales on R&D, down from 80% in 2001; its five closest rivals spend 25% on average. Given these statistics and Chiron's lab failures, we would like better proof of the firm's drug-development capabilities before we put our money at stake.
Chiron's blood-testing and vaccine businesses are picking up the slack and providing a decent return. Thanks to Procleix, blood-testing products (with 51% operating margins) account for more than 65% of the firm's operating income, up from 40% in 2001. With the PowderJect acquisition, Chiron is now one of two injectable flu vaccine manufacturers. Despite the Fluvirin production setback for the 2004-05 flu season, Fluvirin should be a major contributor to the company's bottom line in the future, given the strong demand for flu vaccines and limited suppliers.
While the Procleix and Fluvirin franchises should drive decent future sales growth, the biopharmaceutical business continues to absorb investment without providing significant returns. We'd want a large margin of safety before investing in this diversified biotech.
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