Description

United Therapeutics is a specialty pharma/biotech company trading at a valuation that presents an extremely compelling risk/reward tradeoff with immediate catalysts. UTHR already markets a drug called Remodulin and is worth $17/share on a conservative NPV analysis of this drug alone. The company is working on a new indication for Remodulin (IV Remodulin) that will dramatically expand UTHR's market opportunity. I believe the probability that UTHR gets IV Remodulin is very high (I discuss the reasons below) and that the stock is worth well over $43/share if IV Remodulin happens (to put it simply, UTHR could earn $6/share in EPS in 2006 if they get approval for IV Remodulin at the end of 2004).

Currently, Remodulin is only approved for subcutaneous administration (sub-Q) and is growing at a decent rate of about 40%. I expect sub-Q Remodulin to do $53mm in 2003 and $120mm in 2006. While nothing is certain when it comes to predicting the future, I feel the ramp from $53mm to $120mm is reasonably predictable based on the fact that the company has 600 patients currently on the drug (drug costs $90K/year) and is adding 40-50 patients per quarter on a steady basis. I can also look at the growth in the patient population at earlier stages of the disease and the predictable progression from the earlier state to the later stage where Remodulin is used to get comfort in my 2006 estimate.

A DCF of the free cash flow that UTHR will generate from sub-Q Remodulin alone from now to 2012 when the patent expires (burdened by all corporate expenses and R&D) yields an NPV of $17/share ($6 current net cash + $11 of FCF NPV).

Now, here's where things get really interesting. Remodulin competes with a drug called Flolan. Flolan is a $300mm drug. The reason, however, that Remodulin only garners a fraction of this number in sales is that the sub-Q form of administration has a big problem: a large percentage of patients suffer from very severe pain at the site of sub-Q administration. This is the key factor that stops doctors from prescribing Remodulin instead of Flolan.

The company is currently working on getting approval for an intravenous form of Remodulin (IV Remodulin). Based on some very involved survey work that I have done, I believe that approval of IV Remodulin will allow UTHR to get most of Flolan's $300mm market. If IV Remodulin happens, I expect UTHR's sales to ramp up to $230mm in 2006 and EPS to be $6.14 per share. The NPV of the free cash flow stream with IV Remodulin from now to 2012 would be $37 which when combined with the $6 of net cash would give a value of the firm of $43. If the stock were to be valued on a more typical 20-30x PE basis, the stock could go to $120 (I do not expect this, but it would be nice).

So, the basic idea is that cash + the NPV of the currently approved drug provides a foundation of support at $17 and approval for IV Remodulin gives tremendous upside.

The company has decided to pursue IV Remodulin by taking a "shortcut" that will either prove to be brilliant if it works or that will merely provide a temporary setback if it does not. UTHR is trying to get approval for IV Remodulin by showing bioequavalency to sub-Q Remodulin. This would normally be hard to do, but because sub-Q Remodulin is 100% bioavailable, there is a strong reason to think this is easily doable. Moreover, the bioequavalency trial is now complete and was done in 3 legs of 18 patients. The company on the last EPS conference call commented that the data from the first leg of 18 showed strong bioequavalency.

UTHR is expected to report the results of the bioequavalency trial in full detail in the next week or so. This is the first major catalyst. The second major catalyst will be when they announce that they are filing for approval based on the data and give some color on the guidance they have received from the FDA. If these things happen, IV Remodulin could be approved by the end of this year. If they don't, the company would have to run a full trial on IV Remodulin which hurt 2004 EPS but not really impact the economics.

I should point out that we know that IV Remodulin is currently being used on some patients by leading physicians in PAH (the condition that Remodulin treats) and they definitely think it works. We also know Remodulin is safe because it is approved in Sub-Q form. The only question is will the company get through the technical hurdles put up by the FDA to get approval this year, or will they have to wait another year.

While the beauty of this idea is in the incredible risk/reward it offers, the strength of my conviction comes from the underlying work that I have done to confirm that everything I said above is true. The best way to get more background on the details of UTHR and the bull thesis that I am advocating is to read the sell-side notes from Wachovia on UTHR. My value-added in this write-up is not trying to lay out this complicated situation more eloquently than the sell-side analysts have (I think they do a better job), but rather to share with you the insights that have come from my due diligence that confirm that the Wachovia thesis is on-target and that the risk/reward is compelling under rigorous DCF-based scenarios of underlying value.

The key things that my survey shows is 1) pain at the site of injection for sub-Q Remodulin is indeed responsible for holding back Remodulin adoption, 2) physicians would switch Flolan to IV Remodulin if it were available and would start a greater % of patients on Remodulin if it were available, 3) the results of the bioequivalency study should be positive, 4) the FDA should be amenable to approving IV Remodulin based on the bioequavalency without the need for a full trial, 5) even if the FDA is not amenable to the bioequavalency approach, IV Remodulin should still get approved.

I would like to make a couple of additional points-- UTHR has a couple of other items in its portfolio beyond IV Remodulin that could prove to be pretty nice additional boosts to the stock. I don't need ANY of them to get significant upside, but I think there is a decent chance some of these other shots on goal will provide additional upside. Second, I would like to point out that it is rare where you get a chance to get such a nice risk/reward payoff with so many key variables already known (such as is the drug safe, does it work, and how big is the potential market).

Catalyst

1) results of "bioequavalency trial" will be reported in 1-2 weeks, 2)company will give more color on their strategy for getting FDA approval based on this trial in 1-2 months, 3)FDA approval of IV remodulin in late 04