For a case study in coverage feeding fantasy, look no further than
Investors moving the stock price have been swayed more by media coverage than by the tiny Rockville, Md., biotech's accomplishments. What's been lost in the press, however, has been any attempt to determine what the company is actually worth.
Back in May,
The New York Times
published a piece suggesting the company was on the verge of a cancer cure, and the stock exploded from 12 1/16 to a high of 85 in a day. Never mind that the
had reported the same results from the same study -- by famed
researcher Judah Folkman's lab -- in late 1997. The stock was moved not by the study, but by the coverage of the study.
Last week, it appeared as if developments at EntreMed, rather than in the coverage of EntreMed, would finally affect the stock's value.
pulled out of a partnership on an EntreMed drug and the stock was cut in half. But the very next day,
The Boston Globe
reported that the
National Cancer Institute
had indeed replicated some of the data (sort of) on EntreMed's other drug. The stock more than made up its day-earlier drop. The
-inspired press coverage drowned out the more material event.
All these events have conspired to give the company, at Tuesday's close of 21, a value of about $272 million, pretty close to where it was before Bristol-Myers pulled out. Biotech observers widely view the valuation as ludicrous. Echoing many of his colleagues, Craig Parker, an industry analyst for
Donaldson Lufkin & Jenrette
, says: "I think it's several-fold overvalued." (DLJ doesn't cover the company.)
Why is it that the biotech establishment believes something that the retail crowd doesn't? How do these analysts do their financial analyses, anyway?
Step One: Define the Company
What is EntreMed? It's a company that is primarily attempting to develop two anticancer compounds in the fledging field of antiangiogenesis. The drugs aim to starve tumors of the blood they need to grow. Both of the compounds,
, are in early stages of development. The company was formed in 1991 and has been public since June 1996, but it has yet to put either drug into clinical, or human, trials. To put that into perspective, it's close to impossible to bring a company public these days at such an early stage of development. The company didn't return repeated calls for comment.
EntreMed originally hoped to be in clinical trials by now with at least one of the compounds. Now, the company has said that it aims to bring endostatin into the clinic by the end of this year.
EntreMed, like most biotech companies, has only limited resources. And without Bristol, which canceled its agreement on angiostatin, the little company lacks a partner to lend it credibility.
Worse, few analysts or seasoned biotech investors on Wall Street feel anything but deep skepticism toward the company's drugs and its management. The compounds are controversial. For Wall Street, when a bigger company walks away from a partnership with a smaller company, it can cast a pall over the small firm for years. That, in turn, makes it difficult to raise capital on anything but onerous terms.
Step Two: Determine How Much the Products Could Sell
Cancer is an immense potential market, but EntreMed's compounds are not going to be
, the billion-dollar blockbuster from Bristol, says DLJ's Parker. The EntreMed drugs aren't cytotoxic: They don't kill cancer cells. The most recent NCI data suggest that endostatin only slowed or halted tumor growth -- but didn't eliminate tumors as had been expected.
Further, antiangiogenesis is a hotly contested field. Many companies that are either smarter, bigger, richer or better liked on Wall Street, including
, are ahead of EntreMed on antiangiogenesis compounds.
So, make some extremely generous assumptions. The clinical trials, if EntreMed moves quickly and has good luck, will probably take at least three years from today. Keeping the competition in mind, Parker thinks that the drugs together -- and the talk has been for the drugs to be used in combination -- could sell as much as $300 million to $500 million annually at their peak if they turn out to be as effective as hoped. Analysts generally estimate that a drug will reach its peak in four years.
EntreMed likely will not sell the drugs itself, but will make a deal with a big pharmaceuticals company and get a royalty on those sales. EntreMed's royalty rate from Bristol on angiostatin was never disclosed, but under its revamped agreement, the big company gets another look. Bristol has an option to re-up for angiostatin if EntreMed is able to prove it works in preliminary human studies. (In other words, Bristol reaps the rewards after EntreMed shareholders take the risks.) According to the revamped agreement with Bristol, the big drug company must pay $1 million and "substantially" increase the royalty to regain rights to the drug.
Most royalty rates on preclinical compounds are in the high single digits. Assume, however, due to the "substantial" increase clause, that the company gets a 25% royalty on the two drugs' sales -- again, a lavish estimate. Seven years from now, then, EntreMed would get $125 million at peak.
Step Three: Value the Company, Accounting for Promise and Risk
trades at about 13 times revenue. Parker, working on the back of his envelope, suggests -- tongue moved slightly to the cheek -- to apply that multiple to EntreMed. (Royalties tend to get higher multiples than sales, because more falls to the bottom line. But to assume a company will be valued equally to the class of the group is -- to use that word again -- generous.) That would mean the company would be worth, under these assumptions, $1.63 billion seven years from now.
Now comes the attempt to figure how much it's worth today. Analysts use a discounting method to get the present value, which could represent the most arbitrary aspect of financial analysis. The absolute minimum discount rate is what a pharmaceutical company's cost of capital is, around 11% annually. Parker says his methodology is to apply a 15% to 18% annual discount rate to sales of a marketed product with a highly variable growth rate. If a company has a drug in Phase II, with some human data, but not much, he applies a 25% to 30% discount rate per year. For a company with no human data, he applies a 35% to 50% rate. For EntreMed, with its controversy and the recent partnership collapse, he says he would apply a rate at the high end of that range.
Applying a 50% discount rate over seven years to a value of $1.63 billion gets a present value of $95 million.
At Sept. 30, EntreMed had $41 million in total assets, including $38.7 million. It reported a net loss of $4 million for the third quarter, which ended Sept. 30. Assume that the company also spent $4 million in the fourth quarter and now has $37 million in assets.
Add the cash and assets to the $95 million that the two drugs are worth, that gives a total of $132 million. The company has 12.9 million shares outstanding.
That means its shares should be worth $10.23 each.