Aspreva Pharmaceuticals ASPV
July 19, 2006 - 11:19am EST by
2006 2007
Price: 19.90 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 710 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Aspreva Pharmaceuticals, a pharmaceutical company with a very unique business model, sells for less than 5x 2006 earnings, has phenomenal growth (and growth potential) and a very high ROIC.  The stock has had a significant pullback recently driven by investor impatience and sloppy selling by venture capital investors. 
ASPV’s strategy is to find existing drugs and seek new indications for them.  In other words, ASPV seeks to find drugs that have already been approved for a particular indication (disease) but may in fact be used to treat an additional disease.  Once ASPV has identified such an opportunity for a new indication for the drug, it approaches the pharmaceutical company which owns the drug (typically a major) and ASPV agrees to fund the research and trial for the new indication in exchange for a royalty on any “off-label” prescriptions (“scripts”) written on the drug.  These new indications are typically for rare diseases or diseases where it doesn’t make sense for the major pharmaceutical to devote time and attention to them.
Some history of the company and its current partnership will help explain the strategy better.  In 2003, ASPV signed an agreement with Roche to develop and commercialize CellCept in all autoimmune diseases (e.g., lupus nephritis).  Roche’s CellCept is currently approved for and used in organ transplants.  ASPV undertook an extensive research effort and is currently conducting three clinical trials.  Meanwhile, information was published in a medical journal which indicated that CellCept might be effective in the treatment of autoimmune diseases.  As a result of this, scripts for CellCept for use on autoimmune diseases began increasing significantly.   
Pursuant to its partnership agreement with Roche, APSV began receiving royalties on the off-label scripts written on CellCept in the second quarter of 2005 (which was one year after ASPV began clinical trials on CellCept for autoimmune diseases).  The progression of royalties earned by ASPV is as follows:
As Reported
As Adjusted
Note that the “Adjusted” amounts show the royalties in the period in which they were economically earned.  The timing of the revenue recognition is changed to account for “true-ups” which were received and reported in subsequent quarters.  ASPV records royalties based on an initial estimate agreed upon by them and Roche.  A true-up payment is made two quarters later once the actual royalty due has been determined and agreed upon.  Roche and ASPV have recently refined their methodology such that future true-ups should be nominal.  Note that the cumulative reported and adjusted royalties agree in total. 
ASPV has about $10mm of G&A and $11mm of R&D per quarter and a tax rate below 20%.  ASPV has reported revenues for 2Q06 in a positive pre-announcement but reports 2Q earnings next week.  I estimate that ASPV will report $.74 for 2Q06 vs. consensus of $.64.  For the year, ASPV should earn north of $3 (consensus is $3.32). 
As of 6/30/06, I estimate that ASPV had $174mm in cash, or $5/share.  At the current price, you are paying 4.5x consensus 2006 EPS estimates, net of cash.
So the obvious question is “why is the stock so cheap?”, especially considering that ASPV’s revenue and earnings have continued to outperform investor (and company expectations).  First, ASPV has disappointed investors in another sense.  Currently, Roche is ASPV’s only partnership and the patents on CellCept begin to expire in 2009.  Thus it’s likely that the royalty stream from Roche will begin to taper off beginning in 2009.  Second, ASPV foolishly built expectations that it would announcement a new partnership by the end of 2005.  As most are aware, 2005 has come and gone.  ASPV still hasn’t announced another partnership.  As mid-year hit, investors seem to be giving up hope for another partnership, or at least have lost patience.  If the Roche partnership is all there is and all there ever will be, then stock is fairly priced.  A DCF analysis supports a mid-$20s stock price in a “run-down” scenario.
However, I think this is an opportunity to “arbitrage” the short-term nature of investors.  Given given the success of ASPV's innovative business model and the enormous world of pharmaceuticals, it doesn’t seem to stretch the imagination that ASPV will sign similar deals.  Think of all the drugs and diseases out there—it’s huge playing field.  Granted, the CellCept deal has been a homerun but we don’t need ASPV to sign deals that will add $3-4 of EPS in the future to make this a wonderful company to own.  My understanding is that the company is still very close to signing two new partnerships but I don’t have a firm view on when those deals may be announced.  The deals could be single product or a pipeline of products and may include additional deals with Roche.
The stock ran from $18 to $30+ earlier this year as revenue and earnings were well above expectations and the thinking was that ASPV was close to announcing a new partnership.  Further compounding the stock’s recent woes was the distribution of about 700K shares from a venture capital fund.  Sloppy selling ensued and the stock hasn’t looked back (or, rather, up) since then.  The market in general hasn’t helped, of course, and biotech stocks have been especially hammered.
The primary risks to the stock are (1) no additional partnerships are signed and (2) CellCept is not effective in treating autoimmune diseases (or that CellCept is the next Vioxx).  Given that there is over a year of history of increasing CellCept scripts for autoimmune diseases, the latter risk seems unlikely and the first risk has presented the opportunity.


--Announcement of new partnerhips
--Continued strong performance by the company
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