Description

I believe SIGA Technologies at the current price offers a very low risk double digit IRR with a free option on a significantly higher return.

SIGA was last written up on VIC in February 2017 by conway968 at $2.98/share, and while this has been an excellent result since that time, I believe the risk/reward is better now than it was then (mostly because I believe downside risk is minimal today).  I will try to avoid repeating much of what was said by conway968 so please take a look if you would like to see more information about the history.

SIGA is a biodefense company with a single revenue generating product, TPOXX, which is an FDA approved antiviral for smallpox.  Smallpox is the most deadly disease in human history and, although having been declared eradicated in the late 1970s, it can be synthetically created in a lab.  I personally believe that a bioterrorism attack involving smallpox is a greater threat than any form of nuclear attack (mostly because it is cheaper and would be far easier to pull off while potentially being more deadly).  The fact that anyone born in the US after 1972 has not been vaccinated for smallpox means there is a very large percentage of the population susceptible to this disease.  It is also speculated that the smallpox vaccine does not provide life long immunization so those that were vaccinated as children may also be susceptible.

I first got involved in SIGA in early 2016 while the company was in bankruptcy and have been following very closely ever since.  A lot has occurred since then but much of that history is not relevant to the company today (I’m happy to go over or describe any prior milestones in the comments if there are any questions).

As the company stands today, it has $180mm of cash and an $80mm TL (with a $4mm exit fee upon repayments so effectively $84mm) so net cash of $96mm.  The TL matures on 11/30/2020 but can be repaid on 5/30/2020 which is when I expect the company to pay it off with cash.  At the current price, it has a fully diluted market cap of $441mm.

SIGA currently receives revenues by selling TPOXX to a division of the US government called BARDA (Biomedical Advanced Research and Development Authority) which stores the drug in the SNS (Strategic National Stockpile).  SIGA first signed a procurement contract with BARDA in March 2011 (more than 7 years before the drug received FDA approval).  The original contract was valued at $2.8 billion for 14mm courses ($200 / course), 2mm of which were fixed with the remaining 12mm as options. 

To slightly digress, there is some logic behind 14mm courses (or more) being the appropriate amount for the stockpile.  Vaccine contraindication (either the vaccine doesn’t work or cannot be taken) is estimated to be 5-15% for the smallpox vaccine in the US.  With a 330mm population, 5% on the low end is 16.5mm people.  This doesn’t even include those that get infected before they are able to get vaccinated (the predominant use case for this drug in my opinion).  Separately, those that have been vaccinated know that it is not the “friendliest” vaccine.  There have even been adverse cases associated with reactions to the vaccinia virus (the virus used in the smallpox vaccine) which have required TPOXX to be used.  Considering TPOXX had no MAEs in clinical safety studies, I believe TPOXX would be the prophylactic of choice upon a bioterror attack.  Below is how the FDA describes the vaccine (“ACAM200”):

ACAM2000 is administered differently than the typical "shot" associated with most vaccinations. A two-pronged stainless steel (or bifurcated) needle is dipped into the vaccine solution and the skin is pricked several times in the upper arm with a droplet of the vaccine. The virus begins growing at the injection site causing a localized infection or "pock" to form. A red, itchy sore spot at the site of the vaccination within 3-4 days is an indicator that the vaccination was successful; that is, there is "a take." A blister develops at the vaccination site and then dries up forming a scab that falls off in the third week, leaving a small scar.   

SIGA’s sole competitor, Chimerix, disputed this 2011 contract as it believed BARDA was allocating all of its smallpox antiviral procurement dollars to SIGA while it was working on an antiviral itself.  Even dating back to 2011, BARDA stated it was desirous of two mechanisms of action for a smallpox infection so it did not want to discourage Chimerix of its development.  At the end of July 2011, CMRX and BARDA reached an agreement to strike the 12mm courses associated with the original SIGA contract.  This lowered the contract value down to approximately $500mm for the 2mm courses ($250/course).  Technically, the contract was for 1.7mm courses, with 300k to be delivered for free.  SIGA fulfilled the 2mm course contract in mid 2017 (mostly front end loaded). 

In September 2018, BARDA granted SIGA a replenishment contract for the 1.7mm courses valued at $600mm.  Due to the current US government budget mechanism (it is only funded on an annual basis rather than on a multi-year basis as was the case during the 2011 contract), this contract was predominantly option based as BARDA technically could not commit to funding in future years.  Given where the stock is trading, we believe there may be some confusion on this.  In BARDA’s RFP, it stated clearly that the purpose of the contract was to maintain its current stockpile of 1.7mm courses.  Below is the exact language:

The USG is seeking to procure and maintain up to 1.7 million treatment courses of an antiviral(s) therapeutic against smallpox. Under past procurement contracts, the USG has established a stockpile of over 1.7 million treatment courses of a smallpox antiviral therapeutic MCM against smallpox. The USG will utilize this anticipated procurement to maintain the level of preparedness achieved in the stockpile.

While it’s correct that it’s within the government’s contractual rights to choose not to exercise its options for the full 1.7mm courses, we believe this risk is close to nil.  We think there would need to be some sort of unpredictable exogenous shock that would prevent the USG from following through on this contract. 

Valuation

We believe SIGA should be valued in two parts:

i)        Value of the company based on BARDA only maintaining 1.7mm courses of TPOXX in the SNS until SIGA’s patents expire (1 more cycle beyond the current) and

ii)       All other sources of value (of which we believe there are plenty but more difficult to quantify)

As for i), we run a DCF extending to 2030 (1 more replenishment contract) using a 7% discount rate, 22% tax rate, and I assume the same price for the follow-on contract (despite the price increasing by ~20% from the first contract).  The drug has a 7 year shelf life so product that is delivered in 2020 (I expect the “base period” of the contract of 36k courses to be delivered in 2019, 23k of which were delivered in 1Q) so this drug will need to be replaced in 2027.  This gets me to a present value in the low $6/share context.  I believe this is conservative predominantly because I burden the DCF with ~$20mm of SG&A and net R&D cash burn per year.  A company that exists solely to supply the SNS with externally manufactured TPOXX while it is under patent does not need to be spending much money at the corporate level.  This burden’s the DCF by nearly $1.50 per share.

Less meaningful, I don’t optimize the capital structure at all.  The company currently has $100mm of net cash which gets ascribed no value (beyond its cash value) and I don’t assume any debt is used.  I think this company with a USG contract could support a modest amount of debt. 

Lastly, I don’t assume any value from supplying the SNS with TPOXX after one more replenishment cycle.  This is because the drug will have patents that have expired by that time.  With that said, just because SIGA will no longer be able to earn its ~90% gross margins on the drug does not mean there will be no value.  The original smallpox vaccine (which was used for eradication) was licensed by the FDA in 1931.  Emergent Biosolutions bought this vaccine (technically the “second generation” of the original vaccine) from Sanofi in late 2017 for $125mm.  It is entirely dependent on the amount of TPOXX the USG is procuring at the time, but I believe TPOXX value could be well in excess of this amount, even beyond its patent life (despite assuming $0 in the DCF).

Thus, I believe the current stock price is approximately 20% below a conservatively calculated DCF value of BARDA’s current mandate of maintaining only a 1.7mm stockpile.  This is the “low risk” part of the investment thesis.

Considering I believe the market isn’t even ascribing full value to my part i) of the valuation, it means I believe I am also getting part ii) for free.   The following are what I consider the major possibilities for additional value:

1)      Sales of TPOXX to Foreign Governments: The World Health Organization, Israel, South Korea, Britain, France, Germany, Japan, New Zealand, Australia, and I suspect many other countries stockpile (or have stockpiled) a smallpox vaccine.  We believe it is not an “if” but a “when” and “how much” in terms of other countries and organizations stockpiling TPOXX.  SIGA announced a promotion agreement with Meridian Medical, a Pfizer company, to promote the sale of TPOXX in all countries (excluding the US and South Korea) a couple weeks ago.  While the stock did not react, we felt this was a meaningfully positive development and a great partnership to form.  We believe the ROW market could be even greater than the US in terms of revenues, which we think is a multi-billion dollar market itself.

2)      US Stockpile Expansion: As you probably expect, we believe 1.7mm courses of TPOXX is not a sufficiently sized stockpile.  We don’t think this would even protect a major US city.  The USG demonstrated in 2011 that it believed 14mm courses was the right number.  SIGA is currently working on getting TPOXX label expansion approval for Post Exposure Prophylaxis (“PEP”).  SIGA believes this alternative “use case” will free up additional funding for an increase in the stockpile.  Clinical trials are currently underway being funded by the government (predominantly the DoD).

3)      2^nd Mechanism of Action: As previously mentioned, BARDA has stated it would like to stockpile two smallpox antivirals, each with a different mechanism of action.  In 2015, BARDA awarded CMRX a sole source contract to stockpile their smallpox antiviral, brincidofovir, however brinci was unable to achieve the efficacy milestones to secure the contract.  SIGA believes it has a 2^nd mechanism of action, which it calls ST-357, which is currently in pre-clinical phase.

4)      Oncology: This is the true lottery ticket upside (with the least likelihood of occurring).  The vaccinia virus (the virus used in the smallpox vaccine, a live smallpox virus is not used) has been gaining traction in immunotherapy oncology treatment with over 50 vaccinia clinical trials done last year.  The problem with vaccinia virus is that it can be dangerous if too much is used.  TPOXX prevents pox viruses (including vaccinia) from spreading to other parts of the body and can thus be used in conjunction with higher doses of vaccinia which has demonstrated increased efficacy. 

We do not bother precisely calculating what we feel the value of numbers 1-4 in our part ii) of the valuation of SIGA because we believe each one, if achieved, would represent multiples in terms of the current stock price.  We listed them in order of most likely to add value to least likely (but not highest expected value).  We believe that both number 1 and 2 above are quite likely to occur but do not have a good sense on the value they could provide.  They could be anywhere from the low $100s of millions of value to multi-billions.

Competition

TPOXX is currently the only FDA licensed smallpox antiviral in the world (note, the FDA is a US organization and drugs only need FDA approval to be sold in the US but I do not know of any global competitors).  Emergent Biosolutions owns ACAM2000 and sells it into the SNS and Bavarian Nordic also has multiple vaccines (generally for those that are immunocompromised) which it also sells into the SNS, but TPOXX is the only antiviral. 

As previously mentioned, Chimerix has also been working on a smallpox antiviral for a long time now.  This is the only competitor we know of that is actively working on this.  While CMRX would obviously disagree, we see a low likelihood that BARDA would procure brincidofovir.  To start, the efficacy is simply not very strong (see CMRX’s latest presentation).  Just as important, it has generally caused negative side effects such as migraines and nausea.  This is particularly important as it relates to dosing because, due to the fact that efficacy trials are only done on animals (for obvious reasons), it is not certain the proper amount of dosing that would be needed in humans.  BARDA can procure a drug for the SNS prior to FDA approval, as it did with TPOXX and as it planned to do with brinci in 2015, but there are clearly reasons why it has chosen not to. 

Lastly, it took SIGA over 12 years to get TPOXX across the FDA finish line.  So even if a new competitor popped up out of nowhere, we think it would be a long road for them.

Catalyst

1) Foreign contract announcement

2) Expansion of US stockpile

3) Share buyback (upon repayment of Oaktree TL in May 2020)