Onyx’s International Liver Opportunity Does Not Support Current Valuation
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Onyx Pharmaceuticals (ONXX) has a volatile history, and it may be hard for investors to take a dispassionate look at what is essentially a simple question. How successful will Onyx (and their partner, Bayer AG) be in their international rollout of Nexavar as a therapy for liver cancer? The answer to that question determines Onyx’s fair value.
The Risk-Reward for Onyx Seems Poor at $35
The result of my analysis is in the table below. I note that the stock seems to be pricing in $1.1 billion in 2012 international Nexavar sales for liver cancer, while consensus revenue estimates and management guidance would lead me to expect $750 million in 2012 international Nexavar sales for liver cancer.
| International Sales of Nexavar in 2012 - Net Present Value of ONXX | ||
|---|---|---|
| 2012 Int’l Liver Cancer Sales | Current NPV | Comment |
| $250 mm | $13 | |
| $500 mm | $19 | |
| $750 mm | $26 | < — Consensus estimates and management guidance |
| $1,000 mm | $32 | < — This is where the stock is priced in the market. |
| $1,250 mm | $39 | |
| $1,500 mm | $46 | |
| $1,750 mm | $53 | |
| $2,000 mm | $60 | |
You can see what I consider a poor risk-reward tradeoff in the table above. If consensus revenue numbers are wrong and Onyx delivers a little better than expected, I think the stock is fully priced here at $35. If the company delivers in line with consensus and managment guidance, the stock is overpriced. Nexavar sales would need to be a lot better than expected to make Onyx attractive.
The Story of Onyx Pharmaceuticals
As you can see from the five year chart to the right, Onyx has had a tumultuous history. Why has the Onyx story come down to the prospect of Nexavar’s international sales as a liver cancer treatment?
The original opportunity for Onyx was seen as far larger. The move from $5 to $60 in 2003-2004 was driven by Nexavar’s promise as the leader of a new class of cancer drugs. Investors did not know which cancers Nexavar would eventually be effective against, and as a result Onyx’s valuation soared.
Nexavar was approved by the FDA in December of 2005 for advanced kidney cancer, and the European Union granted approval in July of 2006. Although sales of Nexavar for kidney cancer proceeded to come through in line with expectations, the story was hampered by strong competition from Pfizer’s Sutent - another small molecule kinase inhibitor that received FDA approval for kidney cancer in January of 2006. Onyx traded lower throughout 2005 and 2006.
Nexavar’s failure to meet their primary endpoint of progression-free survival as a treatment for skin cancer was a painful blow, dropping the stock to $11 in December of 2006. At that price, I assume investors were valuing Onyx solely on Nexavar’s future sales as a treatment for kidney cancer.
Then, great news in February of 2007 — Nexavar’s trial as a treatment for liver cancer was stopped early due to efficacy, and Onyx popped to $26. European Union approval of Nexavar as a treatment for liver cancer was granted in October of 2007, and the FDA granted approval for liver cancer in November of 2007. Onyx ran once again to $60, driven by excitement over prospects of Nexavar as a liver cancer treatment.
Or perhaps not — Onyx was smacked down from $45 to $26 in February of 2008, when they announced a halt to their Phase III trial for lung cancer patients. Some portion of the run during 2007 was surely due to anticipation of Nexavar’s approval for lung cancer.
There is still a chance of approvals of Nexavar for additional cancers. The trials of Nexavar for breast cancer are still ongoing, for example.
The two abstracts accepted by ASCO from Onyx this year, however, both related to Nexavar’s effectiveness against liver cancer. Onyx’s research efforts seem to be focused on extending and supporting Nexavar as a treatment for liver cancer.
Maximizing International Sales for Liver Cancer
In their March quarterly conference call, Onyx’s management was clearly focused on maximizing sales for liver cancer. Management said:
- “Given the priority that Tony mentioned to maximize our in-line business, we are pleased that first quarter sales performance was driven by worldwide uptake in liver cancer, most notably in Europe [Internationl sales of Nexavar increased $19 million (+23%) sequentially in the March 2008 quarter. Domestic sales were flat after accounting for a price increase and a medical trial sale].
- Bayer has launched this indication [liver cancer] in Germany and France and just recently in Spain, and they anticipate launching in Italy over the next few months. In Asia, Nexavar has been approved for this indication in South Korea. Additionally, we look for approval in Taiwan later this year. Based upon what we’ve observed historically with regulatory approvals, we anticipate Bayer will launch the liver cancer indication in China in the second half of this year and in Japan in 2009.
- In these countries, the annual deaths due to liver cancer are over 300,000 [China] and 30,000 [Japan] respectively. Together with the other Asian markets, these countries represent significant areas of unmet need and important growth opportunities for the brand. We see the market opportunity in liver cancer as quite large [over 600,000 cases per year globally] with a potential to grow significantly over time.”
So management at Onyx is focused on growing their international sales of Nexavar as a treatment for liver cancer. US sales are less of an opportunity — I note that the American Cancer Society estimates that the US had less than 20,000 cases of liver cancer in 2007. Liver cancer is a small catagory of cancer in the US, less than one tenth of the estimate of cases for lung cancer, for example.
Liver cancer is less prevalent in the US mostly because we have less hepatitis here in the US than the rest of the world. Chronic Hepatitis B infection can cause liver cirrhosis and liver cancer. Infection levels around the world track hot spots of liver cancer pretty closely: The US and Europe have less than 2% infection; Eastern Europe, Russia, and Japan have 2-7% infected; China, Southeast Asia and Africa have over 8% infected. Hepatitis B can be prevented by vaccination.
As an aside, it seems less than credible that an individual infected by a disease preventable by vaccination will be able to shell out the $4,300 per month it costs to take Nexavar. This high cost of treatment is one reason I believe investors should be cautious about the size of the international target market of Nexavar for liver cancer.
Potential Competition From Sutent
Another reason I am cautious about Nexavar sales looking out to 2012 is Pfizer Inc.’s (PFE) cancer drug, Sutent.
As you can see in the chart to the right, Sutent has consistently outperformed Nexavar in sales revenues for kidney cancer. This March, 2008 quarter is the first time Nexavar grew faster than Sutent since the two drugs were approved for kidney cancer at the end of 2005. This recent outperformance is because of Nexavar’s approval as a liver cancer treatement in November of last year.
Right now, Nexavar is alone in having been approved for liver cancer both here and abroad. I note however that Pfizer has had an abstract accepted for the upcoming ASCO meeting that examines Sutent’s effectiveness as a treatment for liver cancer.
The Sutent abstract actually doesn’t look that compelling, but I fear Pfizer’s strength and resolve in this matter. I expect Sutent will eventually join Nexavar as an approved treatment for liver cancer.
How I Developed Those Net Present Values
View the spreadsheet used for this valuation analysis.
You can click the spreadsheet above to see the details, but basically I have developed a December, 2012 target price for Onyx of $49. The stock is trading for $35 right now, which would imply a 6.9% annualized return over the next five years. I require a 15% annualized return to buy Onyx, so the stock is not a buy for me at greater than $26.
I’ve made several assumptions in developing this five year target value of $49.
- $750 million in international sales by 2012 of Nexavar as a liver cancer treatment. This brings total sales of Nexavar to $1.3 billion by 2012, up from $635 million estimated in 2008. That $1.3 billion includes global sales for kidney cancer and US sales for liver cancer in addition to the $750 million in international liver cancer sales.
- Operating expenses at both the Bayer and Onyx level are projected to grow at half the rate of growth of revenues over the next five years. This reflects Onyx management’s comment in their last conference call, that coming “from the very top of both organizations is the desire to manage the spend for the brand and to be very thoughtful about the expense base.”
- A small 1% increase in shares outstanding each year for the next five years. Onyx’s options program is a reasonable 9% of outstanding shares, and I expect them to be cash flow positive going forward. Onyx also has $407 million in cash on their balance sheet ($8.07 per share).
- I project a 20 multiple on 2012 estimated earnings and a 2.25 multiple on 2012 estimated sales. The Nexavar revenues are reported by Bayer rather than Onyx.
I calculated the net present values shown in the table at the beginning of this report by fluttering the 2012 international revenue value from $250 million to $2 billion. The NPV prices were a result of the different revenue figures combined with the assumptions listed above.
Taking an opposing view, Nexavar sales could be more successful than the $750 million I am projecting. It is possible to imagine Nexavar selling $2 billion into the non-US liver cancer market, particularly if the drug is covered by national health programs or NGO efforts of various kinds. If Nexavar outperforms to that extent, Onyx has tremendous upside. $2 billion in international liver cancer revenues would translate into an current fair market price of $60 and a five year target of $115. I find it difficult to become enthusiastic about this scenario, however, for the reasons outlined above.
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