Description

Investment Thesis

Siga Technologies (SIGA) is an extremely undervalued company due to misunderstandings over a controversial biodefense contract but with several looming catalysts that should lead to significant near-term appreciation of the stock.  Characterizing the company as undervalued may seem dubious to investors that have been around the block a few times as the company is currently losing money and the “undervalued” qualification is based on future earnings estimates.  My earnings forecast for SIGA should be reliable as the next couple of years of revenues are very easy to forecast since the company will start fulfilling a $435 million contract from the Biomedical Advanced Research and Development Authority (BARDA) to deliver 2 million courses of ST-246 smallpox antiviral into the Strategic National Stockpile over the next two years.  Using reasonably conservative cost assumptions, I estimate SIGA trading at a ridiculously low multiple of just 3 or 4 times its 2013 potential earnings.  I believe the downside is minimal and protected by a worst-case scenario of $2.85 in expected cash per share by mid-2015 following SIGA’s fulfillment of the $435 million BARDA contract.

The Smallpox Antiviral Contract and the Controversy Surrounding It

Investors may review the detailed history and background regarding the smallpox antiviral contract in SIGA’s most recent 10-Q filing.  The contract was controversial as some viewed smallpox antivirals as a waste of money because smallpox vaccines are already stored in the Strategic National Stockpile in the event of a smallpox outbreak unleashed by bioterrorists.  However, smallpox vaccinations cannot be given to certain people, including pregnant women, infants and people with compromised immune systems.  Smallpox vaccinations are also useless on victims already infected.

Because of the criticism, SIGA’s contract was overly vetted and withstood a congressional inquiry.  BARDA defended the contract and the risk of BARDA somehow backing out has passed.   The initial contract awarded to SIGA was for “up to $2.8 billion,” including follow up orders, an amount well beyond the current $435 million contract.  Any such follow up orders may cause the controversy regarding the need for a smallpox antiviral to resurface, but I do not consider the current contract to face any meaningful further criticism. 

In fact, in the 4^th quarter of 2011, SIGA received a nonrefundable advance payment on the contract from BARDA of  $41 million and in December 2012 SIGA received an additional nonrefundable $12.3 million milestone payment from BARDA following U.S. Food and Drug Administration (“FDA”) concurrence on the product labeling strategy.  The funding makes me very confident that the current contract is secure.

Catalysts

1)   Commercial shipments commence this quarter.  SIGA will show revenue and earnings.

2)   SIGA’s appeal of the Delaware verdict that awarded Pharmathene a 50% profit split on ST-246 could be successful.  Wedbush recently hosted a conference call with retired Delaware Judge Joseph Farnan Jr. to get his opinion of the case.  Judge Farnan explained that after a thorough review, he believed that the verdict was unlikely to be overturned but the damages could be greatly reduced.  Pharmathene’s 50% profit share could completely disappear.  This outcome would be a huge victory for SIGA and a huge catalyst for the stock to move higher.  A decision on the appeal should come in 2 or 3 months. 

Jet Capital Investors L.P. recently increased their stake in SIGA by 1 million shares becoming a 5.42% holder on 1/14/13. The fund is co-managed by Matthew Mark, who has a JD from Harvard and thus has a solid background for understanding the SIGA/Pharmathene appeal.

Valuation Targets

In the Low scenario, I apply a low multiple of 4.5 times this year’s average earnings estimate of $1.32.  In the Medium scenario, I assume the reduction in award leads to a 20% growth in this year’s earnings estimates and I increase the multiple to 6 times to reflect an increase in “valuation goodwill” that investors give the company given the positive development.  In the High scenario, I assume a 40% increase in earnings estimates and we increase the multiple to 7 times to reflect even more of an increase of “valuation goodwill” that investors give the company given the complete reversal of the award.   Under the Medium and High scenarios, it is important to note that not all of the reduction in Award flows back into profitability for SIGA as the ruling allowed SIGA to keep the first $40 million in profit and deduct some expenses.  

Alternatively, as a valuation measure and to give an idea of the margin of safety on the investment, I estimate that if SIGA completely loses the appeal that following the fulfillment of the $435 million contract at the end of Q2 2015, SIGA will have $150 million in cash balance, or 2.85 per share.

There are always disaster case scenarios that could lead to any investment turning into a zero.  Perhaps some devastating side effect could come to light that would cause the FDA to ban the drug.  However, I view this scenario as extremely unlikely given that the drug has always been found to be extremely safe. 

Longer term there is the risk that SIGA does not get any more contracts by 2015.  However, Israel has been rumored for quite a while as a potential customer and India and Pakistan also come to mind as potential customers for ST-246.  Any international orders would be a catalyst for the stock to mover higher.

There is also potential upside in the rest of SIGA’s pipeline.  Their antiviral technology is being applied to other viruses.  Their pipeline is preclinical but nevertheless interesting, especially the Dengue and Broad Spectrum antivirals, that address big potential markets and are attractive to big pharmaceutical companies following any successful Phase I results.  These compounds should also garner more enthusiasm from traditional biotech investors. 

Catalyst