Summary
Geron's shares have shrugged off a torrent of recent good
news.
The stagnation of the shares has created a buying opportunity
for patient investors.
This article provides a view of how the author believes Geron's
shares could be priced, based on this value gap.
There is an old trial lawyer trick where the following question
is asked of a witness: "Were you lying then, or are you lying now?"
Once a jury hears that question, the damage is done, even though an
objection will prevent any response. A similar question could be
asked of Geron's shares: "Were you overvalued before all this good
news, or are you undervalued now?" Unlike in the lawyer example,
the answer to this question is important to investors who have, in
some cases, been waiting on Geron's (NASDAQ:
GERN) candidate, imetelstat (IMET), for a
decade.
I will spare you the suspense. I believe the answer is that
Geron is currently undervalued, perhaps very significantly so, and
that the shares' muted reaction to numerous instances of good news
has created a value gap. In this article, I will try to quantify
just how undervalued it could be, based on the analysis I describe
below.
ASH2013, and the Clinical Hold is Imposed/Lifted
Things were finally looking up for a company that, for two
decades, had struggled to develop any viable pipeline candidate and
engaged in numerous secondary offerings to keep the ship afloat. It
was so bleak when the current CEO, Dr. Scarlett, took over, that he
was forced by circumstance to divest the company's stem cell
development unit and focus the company's paltry remaining resources
on an "all or nothing" bet on IMET. When Dr. Scarlett was named CEO
at the end of 2011, the shares were worth 2 bucks. Just a year
prior, the shares traded above $5.
But things now appeared to be changing. The American Society of
Hematology's 2013 Annual Meeting (ASH2013) was a high-water mark
for Geron. In November 2013, an
ASH2013 abstractwas published
that announced something unprecedented: In a small trial run by the
Mayo Clinic, IMET had achieved reversal of bone marrow fibrosis in
several myelofibrosis (MF) cancer sufferers. MF was, and still is,
considered a terminal illness where only the symptoms (i.e., an
enlarged spleen) can be treated. But the abstract detailed the
properties IMET had displayed that lead the Mayo Clinic to describe
it as "
tantamount to a cure." The stock
responded by surging from $3.40 to almost $7 after the abstract was
leaked. It bounced around in the $4-5 range for four months, until
the unthinkable happened.
In March 2014, the FDA issued a
clinical holdon further
development of IMET due to liver function test abnormalities (since
described as being of the "low-grade" and "reversible" variety).
There are many theories as to how and why this hold was issued, and
whether someone else (like a potential competitor) was behind it. I
have an opinion on that, but it is not relevant to this article.
What I am focused on is the price reaction to catalysts. When the
hold was announced, the share price cratered from $4.15 into the
mid-$1 range. Incidentally, that was also the day I first heard
about Geron. But what is more interesting than what happened to the
stock the day of the hold is what happened to the stock on the days
the hold was lifted.
It gave all those gains back, and then some, so when the
full clinical hold was liftedon
November 3, 2014, the stock bounced from $2.22 to $2.80, which it
gave back almost immediately and settled around $2.30.
So by the end of November 2014, a stock that had been worth
$4.15 the day before the FDA hold in March was now worth only $2.30
to the market, despite that hold being lifted. There is still an
intrinsic value gap of at least $1.85 left on the table regarding
the hold alone - a conservative figure considering the stock almost
touched $7 immediately after ASH2013. Perhaps one could argue that
the delay imposed by the hold strained Geron's cash position such
that now, additional dilutive financing would be necessary to
develop IMET, which may explain why the share price did not bounce
back to pre-hold levels. However, what happened ten days after the
hold was lifted defeats that otherwise sound argument.
Global Collaboration with Janssen
In November 2014, ten days after the FDA clinical hold was
completely removed from IMET, Geron announced a global
IMET development
collaborationwith Janssen - a subsidiary of Johnson &
Johnson (NYSE:
JNJ). There have been many great articles
covering the specifics of this agreement, so I will not rehash it
here. Rather, I will summarize briefly:
This collaboration covers all potential human indications for
IMET.
Geron has received $35M in upfront payments (but has not booked
the revenue, more on that later).
Up to $900M in additional payments can be made if IMET hits
certain milestones.
The funds paid under the agreement are expected to equal or
exceed Geron's cost share of IMET development going forward.
If IMET is commercialized and the agreement remains in effect,
Geron will have the option to either: (1) opt out and receive
royalty checks equivalent to a "mid-teens" percentage of IMET
sales, while Janssen markets the medicine; or (2) opt in and
receive a royalty percentage of sales in the "low twenties," in
exchange for being actively involved in marketing.
We have already gone over the mess that Dr. Scarlett inherited.
And one could be forgiven for pointing out that since his arrival,
Dr. Scarlett has presided over a 75% increase in share price (18.8%
annualized), so all must be good in GERN-land. However, consider
that during that same time period, the iShares Nasdaq Biotechnology
ETF (NASDAQ:
IBB) has experienced a 275% increase and has
exposed its holders to infinitely less risk and volatility in the
process. If you had bought IBB at almost any time during the last
four years, you are in the black. To hold a profit in Geron, you
would've had to time your purchases well.
Given this tortured history, one would think a collaboration
with Janssen - erasing the need for further dilution and putting
IMET into the hands of those who know how to push molecules to
market - would be rewarded handsomely by the market. Unfortunately,
that was not the case. The day after the announcement, shares of
Geron gapped up 40% ($2.31 to 3.21), before fading throughout the
day to close up a mere 20% at $2.74. The stock then traded sideways
for the next 110 days, hovering around $3, until a bidding war
broke out over Pharmacyclics (NASDAQ:
PCYC) and buyout fever gripped the sector and
sent Geron's shares higher.
Finding a potential value gap for the hold was much easier, as
all one has to do is compare Geron to Geron. To find a value gap
here is trickier. What I present for your consideration (rightly or
wrongly) is a comparison between the performance of Geron and the
aforementioned PCYC 110 days after their respective collaborations
with Janssen were signed (PCYC entered its
own agreement with Janssenin
December 2011). The results are polar opposites of each other.
Return of GERN vs. PCYC 30, 60, 90, 110 days after respective
Janssen collaboration
As mentioned above, PCYC was famously
bought outfour years after its
deal for $262 by AbbVie (NYSE:
ABBV) (return of over 2,000% from December
2011). It is important to note that PCYC's deal was not identical
to Geron's. It allowed a 50/50 profit/loss split, while Geron's
deal is a straight-up mid-teens to low-twenties sales royalty. PCYC
also received more cash up-front. Given these differences, how do
we use the PCYC example to determine a potential value gap in the
shares of Geron related to the Janssen deal? By being conservative,
of course. The 110-day delta between Geron and PCYC performance
after their collaboration was signed was 72%. PCYC received 4.3
times more cash up-front than Geron. Some bears have suggested that
this shows a relative lack of confidence in IMET on behalf of
Janssen. So, using a conservative model, let's divide that
performance delta by half of the 4.3 cash differential (2.15). We
are left with a figure of 33.5%, which translates to 77 cents of
potential value gap, based on Geron's deal with Janssen in this
(very) conservative model.
Orphan Drug Designation for IMET
On June 11, 2015, Geron announced that the FDA had
granted IMET orphan drug
designation. The stock was flat. While this is obviously great
news from a development perspective, some research has shown that
such designations do not usually cause a large price spike. For an
excellent read on the subject, check out
this articleby Jason Napodano.
Mr. Napodano concludes that the expected share price return after
90 days of receiving an orphan drug designation is only 4%.
However, I'm going to differentiate Geron a bit from the
research.
IMET is life or death for Geron. It is more important to the
company than the iPhone is to Apple (NASDAQ:
AAPL) or web-based advertising is to Google
(NASDAQ:
GOOG). If IMET fails, Geron shuts its doors. In
his article, Mr. Napodano also discusses how oncological Phase II
orphan-designated drugs reach approval 35% of the time. For
non-orphan drugs, the number is closer to 5%.
Consider that JNJ has already presented to the market that it
estimates that IMET will reach commercialization in as early as
2018 and
become a blockbuster($1B sales
annually) in very short order. If you assume Geron opts in and is
entitled to a low-twenties sales percentage royalty, JNJ's forecast
represents $200M-250M of annual revenue to Geron, which currently
has no revenues beyond collaboration payments from JNJ. Yet, the
market did not react when the probability of approval increased
from 5% to 35%? That is a textbook value gap.
So, what is it worth? There are two ways to consider that
question. The first is more holistic and utilizes the net present
value of expected revenues to arrive at a reasonable valuation. As
always, I will be conservative in demonstrating that approach. I
will assume $150M annual revenue to GERN (75% of JNJ's forecast).
If you multiply that amount by 35% likelihood of approval, you are
left with $52.5M. Assuming an annual return of 2.5% on money
between now and 2018, the approximate net present value of annual
IMET sales starting in 2018 is $50M, which translates to almost
pure profit. With a conservative future P/E of 20, an enterprise
value of $1B ($6.32/share) could easily be supported right now.
However, I disfavor this approach, because it only accounts for one
indication: MF. For example, we already know JNJ is launching a
Phase II trial for myelodysplastic syndromes (MDS) later this year,
and that IMET has already shown efficacy in treating essential
thrombocythemia (ET). For this reason, I have focused on the share
price reaction (or lack thereof) to recent news to determine the
potential value gap.
The other method is to try to figure out what the news alone is
worth on the day it was received. Maybe a global pharmaceutical
company can expect a 4% return from an orphan drug designation, but
for a company like Geron, that number is higher by several orders
of magnitude. Determining the right amount is tricky, and forgive
me for engaging in a bit of fuzzy math. I'm going to suggest that
the orphan drug designation for IMET could have conservatively
supported an upside move of 40%. How did I get that number? Because
IMET is, at a minimum, 10 times more important to Geron and its
share price than the average drug is to the average company. Even
this figure is probably too low, since IMET's failure is the end of
the company.
On the day of the orphan drug designation, its shares were
trading at $3.86. In my very humble opinion, the value gap
represented by the shares' non-reaction to the orphan drug
designation is a whopping $1.54 (40% of $3.86).
New England Journal of Medicine Publishes 2 IMET
Articles
Confirming Durability of Complete Responses
I am not going to go very deep into this topic, because I do not
have a methodology to determine a value gap based on Geron shares'
non-reaction to this news. But when the finest medical journal in
the world that has a reputation even with laymen (ask 10 random
people on the street, at least 4 of them have heard of NEJM)
highlightsa company's only
potential product and the stock does nothing, there might be a
value gap there.
Some critics point out that the articles are a mere "rehash" of
the old ASH2013 data. Even were that true, Geron still has a value
gap dated from the clinical trials holds, so any buzz about this
"old" data remains a positive event. I will also add that the
critics have made two big mistakes in interpreting this article.
First, the article is yet more evidence of the durability of
patients' response to IMET. Second, the power players in the
medical world are lining up solidly behind the drug:
The Mayo Clinic called IMET "tantamount to a cure."
The FDA lifted its capricious (in my opinion) clinical trial
hold, and corrected its mistake by granting IMET orphan drug
status.
The biggest pharma company in the world committed up to $935M
plus 50% of the development costs to license IMET.
And now, the New England Journal of Medicine is on board.
What's the Total Value Gap?
Let me first say that I will be the first to admit that this
analysis is very conservative. That is how I always approach
investing. It is a personal choice. I prefer upside surprise to
downside, and if an investment stills looks good after I impose all
of my hyper-conservative conditions upon it, then I know I have
found a winner. I believe Geron is that winner.
Potential Value Gap in Geron's shares created by non-reaction
to positive news
I know the instinct here is to add the value gap ($4.16) to the
current market price ($3.55 at the time of this writing) and say
the stock should be $7.71 right now. I am not saying that the share
price is going to more than double tomorrow. What I am submitting
for your consideration is that a conservatively-estimated value gap
of $4.16 currently exists in Geron's shares. Value gaps rarely
close explosively, but rather, tend to narrow with time. I will
discuss what the company can do to expedite this process below.
Is a Short Squeeze Ever Going to Happen, or What?
I'm not going to give you an answer to the question, because I
do not have one. What I can do, however, is offer my opinion on how
Geron, and all longs, can maximize the chances that it does
occur.
Let's be honest: the company has some work to do to
substantially close the value gap discussed above. There is a lot
of uncertainty in the market right now. Geron has not been
communicative as to what is happening in the trial, when patients
will begin infusing IMET, what its plans and timing for any
acquisitions are, whether the recent shelf financing filing was
just a renewal of an old agreement or indicative of an imminent
secondary, when will it book milestone revenue from Janssen, etc.
For this value gap to close, it needs to first close the
communication gap and remove uncertainty. Part of this means that
despite JNJ running IMET's development, the market wants to see a
fully engaged CEO. That means hosting quarterly earnings conference
calls and doing other "boring," but necessary, CEO-type stuff. To
those who may respond that it was not a big deal that Geron did not
have a conference call two quarters in a row, because there was
nothing to report, I would argue there were plenty of things Dr.
Scarlett could have discussed, if he chose to (see the list at the
beginning of this paragraph). Perception does matter here. When
dealing with a company with as painful a history as Geron's,
uncertainty is uniformly bad for the stock price.
As far as what longs can do, the best thing is to stay informed
and act as proxy communicators for Geron. If the company does not,
or cannot, be communicative at this time (be it on the terms of the
Janssen deal, lawsuits, whatever), retail investors can help close
that knowledge gap.
This leads me to my last point, which has been contentious on
the SA discussion threads: dilution and an acquisition. For
context, Dr. Scarlett has expressed interest in
acquiring or in-licensingone or
more new molecules. I am not going to belabor this point, except to
express my own view and then leave it to commentators to have the
floor. Now is not the time for Geron to make an acquisition. If the
company were to dilute to fund an early-stage molecule, I believe
the odds are much greater than not that the market will react very
poorly to this news and will punish Geron unfairly due to its past
missteps. An acquisition/secondary will offer the shorts (
30 million shares!) a clean
getaway and almost certainly send the likelihood of a near- to
intermediate-term squeeze to almost 0%. If there is going to be a
squeeze before commercialization, it will likely occur when and if
positive data from the Phase II trial is released. I do not want
Geron to remove fuel from the fire with a secondary offering before
that time, at the earliest.
The road has been too long and too painful to add another
unpredictable variable into the equation at this moment. We are so
close to learning exactly what we have in IMET. The Phase II trial
should give preliminary data readouts in a matter of a few short
months. When you have your best hitter at the plate, you do not try
to steal home. If IMET hits a home run, a secondary would be much
more lucrative after Phase II data.
Most of the risks are what you would expect of similarly
situated clinical-stage biotech companies:
IMET fails to meet clinical endpoints in MF Phase II trial
(unlikely, as Mayo Clinic has already found efficacy, and JNJ has
designed the study conservatively). However, as IMET is Geron's
only pipeline candidate, this risk is multiplied.
Severe safety signals are found in the trials (also unlikely,
as the FDA has released the clinical hold, and IMET treats very
serious conditions for which some safety issues would be an
acceptable trade-off).
Janssen withdraws from the collaboration agreement (highly
unlikely unless IMET fails to meet endpoints, in which case it's a
wipeout anyway).
Negative market forces.
Dilution and acquisitions (discussed above). These could, of
course, also represent upside over the longer term.
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