OSI Requires Leap of Faith
By Marc Lichtenfeld
Senior Columnist
8/21/2006 10:49 AM EDT
URL: thestreet.com
A valuable lesson in biotech investing is not to confuse a drug and the stock of the company behind it.
You can believe that a therapy will do wonders, both for patients' health and in terms of sales, but still not like the stock of the entity that created or markets it. Such was the case in my recent column on Elan (ELN) .
A stock in a similar or perhaps even more precarious situation is OSI Pharmaceuticals (OSIP) . The Melville, N.Y., company is the maker of Tarceva, a treatment for lung and pancreatic cancer that's sold with the help of biotech giant Genentech (DNA) . With Genentech's considerable marketing muscle, Tarceva is expected to rack up sales of more than $400 million this year.
Tarceva isn't the problem. The major concern of some on Wall Street is management's damaged reputation. The November acquisition of Eyetech for $650 million now looks like a disaster. OSI purchased Eyetech to gain access to Macugen, a treatment for wet age-related macular degeneration, a condition that affects the retina. Macugen garnered $51 million in revenue in the first quarter, but sales fell to $37 million in the second quarter.
Due to deteriorating market share, OSI is winding down its eye-business operations. Macugen will still be available for the time being, and management stated that as long as the drug achieves $100 million to $110 million in sales for the year, the product will still be profitable.
OSI's management estimates that Avastin, a Genentech product, has captured 35% of the market, up from 17% in January. That's a remarkable figure considering the use of Avastin for wet AMD is off label -- meaning it hasn't been approved by the Food and Drug Administration for that purpose.
Another Genentech drug, Lucentis, was cleared for treating wet AMD on June 30, so it's too early to determine its market share figures. But obviously, OSI realizes its eye-disease franchise is in trouble as the company looks to slash costs rather than focus on growing the business.
Lack of Clarity
The Eyetech deal also calls in to question management's vision. Why would a company acquire a costly drug when a giant competitor has a product that performs as well, if not better? A more important question is why they would go head to head with Genentech, their partner on Tarceva?
John McCamant, editor of the Medical Technology Stock Letter, thinks Tarceva is a terrific growth story, but he's not as bullish on OSI's management. The Eyetech acquisition "reflects management does not know how to manage relationships," he stated.
Furthermore, he was disturbed that the deal didn't require OSI shareholder approval. McCamant believes if it had been put to a vote, management wouldn't have received the green light from shareholders. (McCamant doesn't have a position in OSI.)
"We have a 20-year history of working with partners," counters Dr. Colin Goddard, OSI Pharmaceuticals' CEO. "It's not unusual to have competition in one area and collaboration in other."
Another who was miffed that the company didn't ask for shareholder approval is Carmen Tang, analyst with Montreal-based Sectoral Asset Management, which owned more than 2.7 million shares of OSI as of March 31.
"Eyetech was a very bad move," she said. "The intention was good but the execution was terrible."
Nevertheless, Tang remains bullish on the stock because of what she sees as an enormous opportunity for Tarceva. Including royalties from foreign sales, she believes Tarceva could be a billion-dollar drug -- and that's assuming only approved uses. There are currently phase III trials that are testing Tarceva in conjunction with Avastin in both first- and second-line regimens. Approval for a first-line use should increase the number of patients and the duration of time on the drug.
What's significant, though, is that Genentech is essentially the driver of the Tarceva bus. Tang believes that the reason Tarceva is being combined with Avastin is to ensure that Avastin takes part in both first- and second-line treatments. That would increase sales for Avastin, meaning Tarceva's growth trajectory is heavily influenced by what works best for Genentech, not necessarily OSI.
You Want Me to Pay What?
OSI's shares are pricey. The company is expected to lose 33 cents a share in 2006 before swinging to profitability next year. For 2007 and 2008, the consensus earnings estimates are 56 cents and $1.08, respectively.
According to my model, I believe 56 cents next year is ambitious. However, the $1.08 number in 2008 is achievable. Nevertheless, do you want to pay 34 times 2008 earnings, especially for a company with just one noteworthy product?
The historic average two-year forward price-to-earnings ratio for the biotech sector is 27 times earnings, according to HSBC. If OSI receives the average multiple, as I believe it deserves, the price target is about $29 -- a 20% haircut from current levels.
The saving grace would be if Tarceva sales exceed expectations or if the company is able to find a partner for its diabetes franchise, which is in development. However, McCamant says there's "nothing exciting" in the pipeline. Cowen analyst Joshua Schimmer, a trained medical doctor, recently issued a research report in which he called OSI's clinical development programs "questionable."
OSI created a terrific drug in Tarceva. Unfortunately, investors who buy shares of the company don't own Tarceva futures. Instead, they own the skills and vision of management and its ability to execute its strategy. So far, management hasn't proven that it deserves a premium on those criteria. |
