Biotech Stock Mailbag: Myriad Genetics

BOSTON (TheStreet) -- In a landmark ruling this week, a federal judge invalidated patents on two genes linked to breast and ovarian cancer held by Myriad Genetics(MYGN). The company relies on exclusive access to these genes for the basis of its profitable breast cancer testing business, so the judge's decision immediately threw into question Myriad Genetics' long-term value.

Tyler R. asks, "Thoughts on Myriad Genetics' stock in the low $20s in the wake of this decision?"

Myriad's breast cancer testing business was already rife with problems before this week's patent ruling. Revenue growth has slowed significantly because Myriad's penetration into the oncology market has peaked and the company is having trouble convincing OB/GYNs to offer the breast cancer test to women who don't have breast cancer. [About 85% of Myriad's revenue comes from its breast cancer test.] To boost sales, Myriad has to ratchet up marketing costs, which is going to squeeze operating margins. Lastly, Myriad will start paying income taxes next year, which is going to take a bite out of net income and earnings per share.

Despite these operational challenges, Myriad trades a premium valuation compared to other diagnostic companies, which seems unjustified to me. I realize most of the analysts covering Myriad have buys and higher price targets on the stock. I just think they're being blindly bullish.

At $24, Myriad trades at five times fiscal year 2011 sales, compared to a price-to-sales ratio of just under 3 for the diagnostic testing group. Assuming Myriad can meet expectations for fiscal year 2011 revenue (not an entirely safe bet) and valuing the stock at 3.5 times sales (still a premium, but smaller), Myriad Genetic is worth about $19-20 a share.

You can get a similar valuation by applying a reasonable price-to-earnings ratio of 12-14 on taxed earnings of $1.20 to $1.30 a share.

Note that I'm arguing that Myriad is over-valued today (not by a lot, but still a bit pricey) before the uncertainty created by this week's patent ruling. Now, investors need to be concerned that Myriad might lose its key patents, which would allow other companies to introduce competitive -- and possibly cheaper -- breast cancer tests.