Sarepta Therapeutics Investment Thesis

Monday, 5-May-2014

A couple of weeks ago I wrote an investment thesis for a charity ideas contest.  The aim was to write about an investment that represents unusual value over the next twelve months.  The only rules were that you had to choose a company with a market cap of at least $1 billion, and the thesis had to be less than 1,500 words.  Since the contest has now passed, I thought I would publish mine here (it unfortunately didn't win).

 

I chose Sarepta Therapeutics (Nasdaq: SRPT) for my submission.  Biotech friends on twitter already know how I feel about this company, and I thought it fit perfectly given the parameters of the contest.  Keep in mind the submission was geared towards a general audience, so I tried to keep the science and valuation calculations very basic and approachable.  I hope you enjoy it.

 

One quick word about the charity, The Sohn Conference Foundation.  Each year they put on a great investment conference in New York that is definitely worth attending if you ever have the opportunity.  The format is that a dozen or so highly regarded investors (here is this year’s lineup) give a short presentation about a stock or bond they feel particularly strongly about.  It is a fantastic event because not only do you hear new investment ideas, but also the proceeds go to pediatric cancer initiatives.

 

In addition to the scheduled speakers, The Sohn Foundation holds a write-in contest where they allow anyone to submit an idea for a $100 donation.  One winner even gets picked to present his or her submission in front of the conference.  How cool would that be!  Here was my entry this year:

 

 

Sarepta Therapeutics Investment Thesis

By Brad Loncar

 

Introduction to Sarepta

 

Duchenne muscular dystrophy (DMD) is one of the most prevalent genetic-based orphan diseases in the world.  It is currently estimated to affect approximately 1 in 3,500 boys worldwide, with 35,000 patients in the United Sates and Europe alone.  According to the CDC, 82% of DMD boys aged 10-14 will progress to a wheelchair, and the average lifespan is sadly only about 25 years of age.  The only thing doctors can currently provide these kids with are steroids, which are palliative and do not slow the disease.

 

Duchenne is caused by a genetic mutation that renders DMD patients unable to create a protein called dystrophin, a shock absorber for the body’s muscles.  Without dystrophin, muscles slowly waste away and patients progress from losing the ability to walk, to requiring breathing assistance, to sadly culminating in death.  However, as science has gained a better understanding of the genetic basis of certain diseases, there is potentially new hope on the horizon for Duchenne.

 

For a large percentage of DMD kids (perhaps up to 80%), only a small piece of their DNA code, called an exon, contains the primary error that makes them unable to create dystrophin.  With this understanding, Sarepta Therapeutics has created an experimental therapy, called eteplirsen, which skips over the damaged section of DNA (technically a related molecule called messenger RNA in this case) to create a type of dystrophin without it. In layman’s terms, think of this as a recipe for a cake that you are missing one ingredient for.  Rather than getting stuck on the one ingredient, Sarepta helps the body skip over it and bake the cake anyway.

 

A small, mid-stage study Sarepta has been conducting with 12 kids has produced uncommonly encouraging results. At 48 weeks of treatment, kids on the highest dose showed an 89.4-meter walking benefit compared to kids who started out on placebo.  Biopsies from the treatment group also showed 47% of muscle fibers testing positive for the missing dystrophin protein.  Sarepta has now followed these kids for 120 weeks and has demonstrated continued stability on the walking test.  Below is a snapshot of the latest data.

Source:  Sarepta Therapeutics.  Click here to see their latest full presentation.

At this point in the kids’ lives, such stability would seem highly unlikely if the drug was not truly having an effect. Importantly, there have also been no material side effects or safety concerns.

 

Why the market under-appreciates this company, and why investors should pay attention to what happens to Sarepta on the regulatory front.

 

Sarepta consistently ranks as one of the top five shorted stocks in biotech.  In fact, over 13M of its roughly 40M shares outstanding were shorted as of April 15th.  I think it is a misunderstood stock, particularly by fund managers who have been jaded by FDA’s historical lack of flexibility.  The bull-bear argument for Sarepta is primarily about what timeframe the drug could be approved.  Because of the uncommon promise this small study has shown, Sarepta and the larger DMD community are interested in filing for an accelerated approval of the drug. This would allow eteplirsen to be marketed right away while the company conducts the requisite late-stage, long-term studies to confirm these early results.  If those studies succeed, the drug stays on the market forever.  Bears will tell you that an early approval is impossible given the small size of the data package.  However, I think they are overlooking these important facts:

  1. Congress passed legislation, called FDASIA, in 2012 that included a specific provision asking FDA to speed up the approval process for life-saving orphan drugs.  Eteplirsen’s story is tailor-made for that legislation, something many in congress have recently reminded FDA of publicly.  Elizabeth Warren has said she views a timely review as an important issue for her state (where the company and many patients are located).

  2. Eteplirsen has shown NO safety concerns to date, which makes the early approval decision much easier on regulators.  FDA officials are on record as saying they weigh risk vs. reward more heavily than the agency did in the past.  Given how risk seems to be minimized in this case, many argue that the kids deserve a better chance offered by eteplirsen than no drug at all (since the disease would be guaranteed to progress).

  3. FDA’s engagement with Sarepta has been unprecedented, something that bodes well for a positive regulatory outcome.  FDA Commissioner Hamburg personally describes in speeches how FDA has met with the company many times and that all levels of the agency are involved.  In fact, FDA recently told Sarepta the agency is willing to review an application for accelerated approval if the company files one. While that does not guarantee a positive outcome, it certainly provides strong clues about the likelihood of approval.

The overall story developing is that eteplirsen may represent a new, faster way of approving some drugs in the future. This would have important ramifications for investors.  First, investors should be aware of the story because it could signal a shift in the risk/reward paradigm for some drug development.  We have to figure out ways to lower healthcare costs in this country, and a faster regulatory path is one way to get there.  Second, it might mean Sarepta’s stock is undervalued because skeptics and short sellers are still largely discounting the company based on the longer route to approval that drugs have traditionally been put through.  While it is dangerous to say ‘this time is different’, the above arguments suggest there is legitimate reason to believe change is actually coming in this case.

 

Valuation commentary – There is significant upside in the stock.

 

Investors who are not well versed in biotechnology might be surprised to learn that therapies for rare diseases are some of the most financially lucrative.  This is because: 1) they provide unmistakable value since they tend to have the biggest impact on patients’ lives, 2) even though these therapies typically have high per-patient prices, small populations mean they do not take up big space in payers’ overall budgets, and 3) since patients typically stay on these drugs for life, they often represent an annuity for the companies who develop them.

 

Well-known examples of successful rare disease companies include Alexion Pharmaceuticals (Nasdaq: ALXN), a $30B company which currently markets only one drug that will be used by single-digit thousands of patients worldwide (it has another in the pipeline), Vertex (Nasdaq: VRTX), a company with a cystic fibrosis drug currently valued at over $15B, and ViroPharma, whose drug faced various commercial pressures yet still recently sold to Shire (Nasdaq: SHPG) for $4.2B.

 

Trading at a market cap of about $1.5B, Sarepta represents unusual value.  For the reasons described above, I believe Sarepta will in fact receive early approval for eteplirsen in approximately the next 12 months.  When it does, the stock should be worth well over $2.4B, and perhaps significantly more.  Here is my rationale:

 

There are roughly 2,000 applicable patients in the United States alone.  At an average treatment cost of $400K per year (the midpoint of current rare disease pricing), that roughly equals $800M in annual revenue.  At three times revenue, eteplirsen could be valued up to $2.4B.  However, significant hidden value comes from the fact that eteplirsen only applies to 13% of the DMD market.  If the drug works for those 13% (an accelerated approval by FDA would endorse a high probability of that) it is also likely that Sarepta’s technology will work for a large portion of the other 67% of DMD patients who are eligible for exon skipping.  The company is rapidly moving other follow-on drugs into the clinic and will start a study for two of them, representing 14% of the market, later this year.

 

If only 13% of the U.S. market is worth up to $2.4B, an approximate 80% of DMD patients ultimately eligible for exon skipping could mean many billions in revenue one day.  Addressable-market estimates are unlikely to come to fruition perfectly, but the numbers do put Sarepta’s relatively modest $1.5B valuation into perspective.  These figures also say nothing of the DMD opportunity throughout the rest of the world, or other genetic diseases Sarepta’s technology might work against.  Over time, I believe the stock realistically can increase by a multiple of ten.

 

A strong management team and well-respected biotech investors support the stock. This has the potential to pay off big for society as well.

 

I will conclude by making a few additional points.  First, Sarepta insiders have been buyers of the stock (there have only been a few sales), something that is unusual for a biotech company.  Second, even though the short interest is high, there are many well-respected biotech funds that believe in the story.  Joseph Edelman of Perceptive Life Sciences, who is well regarded in biotech, is the company’s largest investor.  Lastly, Sarepta is uniquely attractive not because of its stock market potential, but also because of how it might greatly benefit DMD patients, science, and society overall.  That makes it a highly worthy investment in more ways than one.

Who Am I?

I'm an individual investor from Kansas City.  My focus is on biotech stocks, but I enjoy investing in all industries. I'm an old-school, buy and hold investor who believes the best way to outperform and grow capital is to own innovative companies with good management teams over the long-term. more>>

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