Biota Holdings Limited (BTA.AX) Part 2
Part One of my Biota analysis was an example of how I initially approach investigating a biotech. In short read the filings and company website to get a base idea of products, pipeline, management, cash and cash flow. Then determine a rough value to see if there is any point in digging deeper. As I concluded I saw a lot of assets and existing cash flow going for a bargain price. I initiated a position in a personal account on Friday. This is part two in my Biota series.
I have written before about how management is an important key to success in biotech. Biota appear to have a strong management [Ed: 2/11 called into question on hot copper BTA board] with the ability to grow their pipeline, develop their assets and most importantly for a company this size partner. With Relenza Biota have developed and a partnered a successful product. RSV and LANI are two more examples of their ability to secure partnerships. Management also appear to control costs and the board awards appropriate salaries and options.
My product and pipeline summary highlights a good mix of the cash flow producing Relenza and three other drugs in the pipeline. [Ed: See part 4 in this series for a graphical pipeline.]
The Downside
As I’ve just started reading Seth Klarman’s Margin of Safety, it’s appropriate that I consider the downside risk before looking at the rewards. In part 1 I suggested the downside limit is the cash horde of around $60M and with a current market cap of around $88M the downside was $28M. However, as said I have seen biotech companies trade below their cash as investors see no hope in the pipeline and concentrate solely on cash burn. The recent discussion on Graham style net nets on TMF’s Liquid Lounge highlights that at times like this companies do trade for less than their tangible assets. The downside could also be worse if future Relenza royalties do not materialise, RSV fails in P1 trials and/or LANI and HRV fail to progress. That is the worst case scenario and with cash burn of X and a discount to cash, BTA.AX could trade at less than half its current market cap. I’ll assign 10% chance of worst case scenario and 30% chance of likely downside of $60M market cap.
The Upside
I highlighted in Part 1 that the enterprise value (market cap – minus cash + debt) of Biota was around $28M. This means you get all their assets and future cash flow for $28M. I very roughly valued those assets and NPV of cash flow at $137-$228M. I’ll assign 30% likelihood to each of those. I believe that is conservative, as Relenza royalties probably have a 90% chance of at least being worth my low estimate.
The Calculation
| Probability | Return |
| 10% | 50% loss |
| 30% | 30% loss |
| 30% | 60% gain |
| 30% | 160% gain |
Another way to look at the probabilities is to boil it down to one number and compare that to the current price or market cap.
| Market Cap* | Probability | Value | |
| Worst | 40 | 0.1 | 4 |
| Low | 60 | 0.3 | 18 |
| Medium | 137 | 0.3 | 41 |
| High | 228 | 0.3 | 68 |
| *($AUD millions) | $131 | ||
| Current Market Cap. | $88 | ||
| Discount | 33% |
I believe I have emphasised the downside and conservatively estimated the upside. A 160% gain would still have Biota trading below its year high and below most analysts lowered estimates of fair value. Using worst case to best conservative case Biota provides $3 in return for every dollar risked. Likely bad to best case is $5 return for every $1 risked.
Considering the experienced and capable management who appear honest and aligned with shareholders, I am comfortable with the risk to reward profile. The actual returns will be based on:
- Relenza Royalties, which are likely to be lumpy over the six years remaining patent life.
- Progress of pipeline. The most tangible element in the pipeline is RSV, with possible $107.5M in milestone payments over the development life.
- and of course the market’s willingness to pay higher multiples for the future cash flows.
Of those numbers one and three are closely linked. The market currently places a low value on Biota’s future cash flows due to the uncertainty on Relenza. The market has in effect completely discounted any future royalties. If future Relenza royalties materialise then the uncertainty will be removed, cash flow will increase and the market will be prepared to pay higher multiples, or viewed differently be prepared to pay closer to what the future cash flows are worth.
Catalyst(s)
- Relenza royalties starting to flow.
- New partnering on either HRV or LANI.
- New products into pipeline.
Two: Biota Analysis and Valuation Part 2 Closer at the down and upside with probabilities and catalysts.
Three: Biota 2008 AGM
Four: Biota under the microscope A closer look at the pipeline and management.
[Edit 3 Nov 08 - On top of the usual disclaimers I will soon list another disclaimer that could easily be misconstrued or claimed to be a conflict of interest and should have been declared. I am not yet at liberty to list the extra disclaimer. The to be announced disclaimer has only influenced my analysis in that it increased the priority and to a degree the depth of the analysis. Though the current analysis of four posts is an average level for any company I invest in. ]
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