January 12, 2014

Provectus Biopharmaceuticals: Worth of $150 per share

Worth. Provectus is worth $150 per share. At the time of an acquisition approximately 200 million fully diluted shares outstanding should imply a $30 billion worth.

Worth may not or may never be share price, or market capitalization.

Worth of $150 per share or a total of $30 billion is my estimate of the company’s intrinsic value on a net present value (“NPV”) basis, an amount I believe could accrue to Provectus shareholders upon an M&A transaction and over time through an earn out.

Yahoo! Finance currently uses a total number of common shares outstanding, about 140 million as of Provectus’ 2013 third quarter 10-Q, to calculate market capitalization. At a closing share price of $2.64 on January 10, 2014, the company’s market cap was about $370 million. Fully diluted shares outstanding is a comprehensive approach to assess/measure and project future extrinsic value or market cap, and for Provectus would include common stock, two kinds of convertible preferred stock, stock options and, warrants on common stock:
  • ~144 million common shares, including convertible preferred shares presumably now converted into common shares
  • ~44 million common shares that have resulted and would result from warrant exercises. I assume 25% of the total number of warrants have been/will be exercised for cash, and the balance of 75% have been/will be exercised on a cashless basis.
Click on the table to enlarge it.
Valuation Process. Worth does not necessarily translate into or equal enterprise value, firm value or market capitalization, and it may never do so. Provectus will not grow to a $30 billion market cap before Big Pharma or Big Biotech acquires it (at least I don't think so). Rather, as management wrote in the company’s November 2013 filed prospectus, worth should be achieved through a combination of upfront cash and an earn out upon and following an M&A transaction.

$30 billion ($150 per share) is a really big number. Amgen acquired Onyx Pharmaceuticals for $10 billion (2013). Celgene closed the year with a market capitalization of $67 billion, while Bristol-Myers Squibb was $87 billion. New biotech darling Intercept Pharmaceuticals (NASDAQ: ICPT) closed Friday with a market cap of nearly $9 billion (a share price of $445.83); although it may not last, BofA/Merrill Lynch raised its price target to $872 (note: Intercept has more than 19 million shares outstanding, while Provectus has about 140 million, both per Yahoo! Finance).

I’m mixing apples and oranges because my estimate of Provectus’ worth spans, say, 20 years and includes a terminal value, although $30 billion and $150 are represented in today’s dollars. My point is Provectus is worth a lot, as I previously have said.

Allow me to pursue a tangent for several paragraphs.

Valuation is the process of estimating what something is worth. I’m currently preparing a student team from the University of Nevada Las Vegas’ (“UNLV’s”) college of business, Lee Business School, for the 2013-2014 CFA Institute Research Challenge (the “IRC”). This year’s team is the third group of UNLV undergraduates I’ve prepared for the competition as a volunteer industry/faculty adviser. The IRC is an annual competition where graduate and undergraduate business and finance students reprise the role of a sell-side equity research analyst. Students prepare and present an investment recommendation of a publicly traded company from their geographic region. Industry and faculty advisors guide teams as they carry out their work and participate in three rounds of competition: local, regional and global. The 2012-2013 IRC comprised 3,500 students from 775 universities in 55 countries.

My first team reached the semis of the 2011-2012 Americas regional (North, Central and South Americas), and in my biased opinion were one badly framed judge’s question and a momentary falter in answering it/him from the four-team final. Covering MGM Resorts International (NYSE: MGM, Resorts and Casinos) and recommending a strong buy in January 2012 with ~30% upside in their 12-month price target compared to the then current price (their target was reached in April 2012), the students successfully wrapped their heads around MGM’s monstrous hybrid debt-equity capital structure, and honed their investment thesis driven by continued growth in China and a strengthening Las Vegas recovery. They identified the key risk to their thesis as MGM’s heavily leveraged balance sheet, which exposed the gaming company to any substantial tightening in the credit market.

The second team covered Kona Grill (NASDAQ:KONA, Full-service Restaurants), ending as runners-up in the 2012-2013 Global Final. They placed a very strong buy on their target company in January, and later revised it upward in April 2013 before the final competition, with a 50% 12-month price upside (which the share price reached in October). The team’s investment thesis centered on a company strategy of substantial new store growth and improving U.S. economic conditions. They identified food costs and new store persistency as key risks to Kona’s profitability and their thesis.

The target company for the 2013-2014 team is Meritage Homes (NYSE:MTH, Residential Construction). The students currently have a sell recommendation on Meritage, choosing to decouple an improving U.S. economy from a homebuilding industry they believe is past its peak in the current business cycle, and a middle-of-the-pack company that has missed opportunities and should have its margins squeezed. The core of their investment thesis is investor capital can achieve better risk-adjusted returns outside the sector, and only with the best performing companies in the sector (of which Meritage is not one) if such exposure is sought. They have highlighted a rising-tide-raises-all-boats scenario as the key risk to their thesis. Using Friday’s close their sell recommendation came with a 12-month price downside of 15%.

Most people think valuation is a process of estimating worth where practitioners conducting the same exercise of the same company all should arrive at or around the same answer. Far from it; valuation is valuable (pardon the pun), but it’s a game that can be gamed or manipulated to serve the practitioner’s purpose(s) or reinforce his or her bias or opinion. Put simply, if I’m long I’m more likely to think and say a higher value. If I’m short I’m more likely to think and say a lower one. This is obvious, I know, yet I need to say it as I write this post.

The singular message to my teams has been and is to think like an investment management (or hedge fund) analyst, not a sell-side equity research or investment banking one.

Although both groups (let’s assume just two groups, buy-side and sell-side) diligence, measure and analyze, the essence of the difference is the latter (the sell-side analyst) typically decides without consequence, rendering the opinion, however bold he or she may think it is, often without conviction. The buy-side analyst (the latter), and his or her firm and fund, potentially and more often than not has to live with the loss associated with being wrong, and possibly longer-term damage to reputation.

The IRC local bracket’s organizing committee (in this case CFA Society Phoenix) chooses the students’ target companies for them. While the situation mostly is out of the students’ control, their ability to deliver a clear, cogent and compelling investment message (buy, sell or hold notwithstanding) is not. In thinking like the investment management analyst, I implore my students to be memorable, which I believe is underpinned by an intelligent, thoughtful, nuanced and comprehensive view of valuation (worth). One other note: MGM, KONA and MTH, while potentially having a priori some or a lot of risk-adjusted return opportunity to either the up or downside, have in my view limited absolute (as in absolute value) up/downside relative to the upside I believe Provectus possesses. +30%, +50% and -17% are not >+8,000% (again, remember I’m temporally mixing apples and oranges). The message, however, is the same. What were/are MGM, KONA and MTH worth, and tell the judges why you think so.

Even though worth may not or may never be equal to share price or market capitalization, understanding the "what and why" of worth undoubtedly helps you determine when to monetize worth (i.e., when/why to sell if you’re long or buy-to-cover if you’re short).

Provectus’ Worth. A paradigm shift in the treatment of cancer, a very high potential gross margin (98-99.5% depending on treatment cost of $5,000-20,000, potentially varying by geography), and a relatively low deficit accumulated during development stage ($130 million overall as at 9/30/13 for a drug having demonstrated multi-indication viability), with potentially a fraction of additional spend to go before initial approval, I contend the valuation process for Provectus is both simple and complex. It is simple (very quantitative) to arrive at a baseline valuation – a share price, and a market capitalization (an apple) – for the company. It is more complex (qualitative judgement influences quantitative measurement) to postulate and project Provectus’ worth above and beyond its market cap today or what that figure might be at end-game transaction. Orange equals apple (upfront payment) plus earn-out.

My process. Once again, a paradigm shift in the treatment of cancer (i.e., treat the tumor), pervasive use and substantial pricing flexibility allows for top-down valuation modeling essentially to be a percentage of revenues of potential total oncology sales over some period of time (e.g., 20 years) plus a terminal value similarly calculated. To bound valuation, a bottom-up approach would sum potential sales by indication using assumptions for addressable market, market share and penetration timelines, etc. and a discount factor applied to each indication reflecting approval probability. Both approaches above utilize NPV. You also can, for biotech, utilize peak sales in your valuation process. More broadly, you can include precedent transactions and comparable company multiples. How do you measure irrational exuberance, market and industry dynamics, a paradigm shift (if you reasonably objectively believe it), etc.? You don’t. You assess it to allow your valuation to better serve you when/if it comes time to sell. To understand the “what and why.”

Provectus is worth $150 per share. At the time of an acquisition 200 million fully diluted shares outstanding implies a $30 billion worth. Depending on assumptions, tweaks we could make by pushing the buttons, turning the dials and pulling the knobs in the valuation process, the range would be $125-175. Through my use of conveniently round numbers I’m trying to be accurately right and not precisely wrong. Provectus is worth, probably, much more than you think and, probably, much more than most pundits and professionals in the biotech space also think at this time.

Some life sciences investment professionals and generalist investors grasp the magnitude of the change others and I think PV-10 will portend for oncology (and PH-10 for dermatology). People reading this blog today are early adopters if they own shares, early to this game if they are aware of or know the company, or early to the debate if they’re arguing the pros and cons of the drug.

A $125-175 per share range does not reflect the lowest nor the highest figure my valuation work spat out, but rather the bulk (a “one sigma” around a mean or middle of sorts) of where I think Provectus’ worth lies. The more conservative (restrained) one is in their assessment and potential proliferation of the company’s innovation and technology and thus its prospects, the lower the number, which could be much lower than $125 low-end of the range. The more willing one is to consider PV-10 a paradigm shift in the treatment of cancer (a primary treatment, “before, during and after,” the first tool out of the physician’s tool bag, not a/the cure for the disease but a fundamental change in treatment) – and also accommodate or include the possibility of positive-for-the-drug,-company-and-stock unintended consequences – the higher the number than the $175 high-end of the range.

A $30 billion worth for Provectus is a considerable amount, but I think it may be conservative (to me, mind you). Some explanation follows, in no particular order.

$150 per share is not a near- (obviously), short- (obviously) or medium-term price target; it’s a long-term one. While it includes baseline and traditional valuation thinking and approaches (in and outside of biotech industry as it pertains to valuation), it comprises assessment, projection and estimate of the impact of PV-10 as a paradigm shift in the treatment of cancer. It also includes comparable thinking as it relates to PH-10 and its very likely high impact factor.

Worth, or the share price doesn’t contemplate deal structure. What management eventually consummates with Provectus’ eventual acquirer will be what it will be. "You take what the market gives you," whether that is the public market or the pharmaceutical M&A one. Worth, market capitalization for a publicly traded company, M&A transaction value, etc. need not or never converge. Monetizing some, most or all of this worth lies in the hand of management and their financial advisers, and may be additionally negatively or positively impacted by macroeconomic, geopolitical and broader market factors as well as pharmaceutical industry specific themes and dynamics.

My view of worth was crafted with management’s view of worth in mind. There are pros and cons to the thoughts and beliefs of worth of founding managers, as there are pros and cons to those of professional managers. These views can be exacerbated or magnified as the technology in question varies from run-of-the-mill to competitive to sustainably competitive to paradigm shifting.

Guessing the worth of a paradigm shift may be fool’s errand. Guesses, calculations and determinations of worth for high impact innovation, let along groundbreaking or industry changing ones, become more and more difficult as the impact factor increases. There only is so much we can surmise and hypothesize about intended consequences before our thoughts become swamped by the error term of the potential result of unintended consequences.

Worth is collectively influenced, not individually determined. If the market can stay irrational longer than we can stay solvent on the downside, it also can be much more irrationally exuberant on the upside than we might ever contemplate.

Assumptions for the purpose of calculating valuation are just that, assumptions. Because our forecasts are almost always wrong, what’s more important in determining value, valuation and worth is a very good understanding of customer value propositions and value drivers (in Provectus’ case clinical for patients and business for the acquirer) and key risks. If the former are robustly, sustainably defensible, we’re in no better a place to start. If the latter can be reasonably or tightly bound, we would’ve gone a long way in knowing what we don’t know (it also helps taking a swing at “we don’t know what we don’t know”).

My approach to valuation is straightforward, and similar to what any practitioner reasonably would do. I have beliefs and made assumptions about cancer types (solid tumors, blood cancers, soft tissue cancers) and indications, market shares and penetrations, geographies of use (the U.S., the Americas ex-U.S., EMEA, China, Asia Pacific ex-China), valuation methodologies (discounted cash flow or net present value, multiples, precedent transactions, comparable companies), methodology inputs (terminal values, discount rates, growth rates, etc.), and probabilities and discount factors, and... My beliefs, however, influenced subsequent scenario and sensitivity analyses. As I incorporate my contention and others, including management, that PV-10 is a paradigm shift in the treatment of cancer, I am aware one has to tread carefully and thoughtfully with respect to the impact on and likelihood of the upper end of the valuation range. There are quantitative metrics. There are qualitative features one can successfully and/or try to quantify. And then there are factors and outcomes that cannot be readily or effectively measured, but need to be considered, such as the impact of potentially increasing market share of Provectus’ versus the potentially decreasing share of non-acquirers (how do shareholders in the latter react, and what if any benefits accrue to the acquirer of the former). 

$150 is a floor. It represents what I think the minimum worth of the innovation Craig, Tim and Eric have created, and that Peter will endeavor to fully monetize. While there is a ceiling (nothing in the capital markets is infinitely high or finitely very large, unless we’re talking bubbles), the higher end of the range, over time, indeed could be surprisingly high.

I do not arrive at my estimate of worth using a weighted average of valuations derived using different methodologies, as is common among sell-side analysts. The analyst can use a mix of methodologies to triangulate or bound valuation of an asset. Alternatively, the analyst can apply a weighting to each method, and then sum the resultant products. While the weighting approach can provide more preciseness than the range, the weightings are arbitrary at best, spurious at worst (because there can be a tendency to construct weightings to arrive at the answer he or she wants). You can also similarly criticize me; however, my answer is high to very high.

The price has downside to it. I previously wrote there are miles to go before management sleeps. Although it would seem we are on or nearing the precipice of the approval of PV-10 for melanoma, there still remains more work (liver, other indications, PH-10) and more communication of work (compassionate use program, Moffitt, Rockefeller) that further broadens and deepens the clinical value proposition of the drug. Expectations of outcome by management execution are high; they may not or never be met. I think they will. The drug is very safe, very effective (both loco-regionally (local-regionally) and systemically), highly applicable to solid tumor cancers (and, with time to more fully demonstrate, very likely applicable to soft tissue and blood cancers too), and, beyond safety and efficacy, highly useful as a cancer treatment because of its tissue sparing benefit (with time to more fully demonstrate, use before, instead of, and after surgery, as well as in combination with other therapies to further enhance effectiveness).

Worth is not worth to me until and unless you monetize it. How many shareholders cashed out as the stock soared above $2, and while it is/was in the $2-3 share price range? When the price increases to, say, $5-10, $20 or more on the back of more regulatory clarity and a regional transaction or two, how many more will close out positions? $150 is a long way from today. Who has the discipline to hold out? It’s easy to become an investor, retail, institutional or professional. It is easy to buy (to initiate a position; to sell if you are shorting). It’s much harder to sell (when you’re long; buy, when you’re short), closing out your position and achieving true success with your investment thesis. How many of us claim success on the back of a 30%, 50%, etc. return, leaving 2x, 3x, 5x, etc. more return on the table because we really didn’t understand the what and why of when to sell?

Numbers in 2014. I plan to post my full valuation, scenario and sensitivity analyses (with commentary) as this year unfolds for Provectus, the drug and the company’s share price.

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