Synta Pharmaceuticals (NASDAQ:SNTA) – A Heavily Discounted Biotech Investment

Synta Pharmaceuticals (NASDAQ:SNTA) is a yet-to-succeed firm in the Biotech space with a Phase 3 candidate drug designed to treat cancer. Synta’s lead anti-cancer drug candidate, Ganetespib, has been studied in over 800 patients in more than 25 clinical trials. In preclinical models, Ganetespib inhibits a molecular chaperone called Hsp90, essential to the function of many of the most fundamental drivers of cancer cell growth and proliferation. Ganetespib is currently in Phase IIb/III FDA trials.Ganetespib utilizes a proprietary HDC delivery platform to deliver drugs to cancer cells. The company bills it as “Targeting the molecular chaperon in cancer”.

 

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Synta represents a unique opportunity because of its history. It’s initial HSP90 candidate failed in Phase III trials, burning shareholders and forcing the company to reformulate. Shareholders have seriously discounted the company’s potential in relation to other Biotech firms. The recent departure of a lackluster CEO prompted a recent sell-off as well.

Timeline of Drug Phases
Timeline of Company-Sponsored Drug Phases

 

 

Competing Hsp90 Candidates

Pharmaceutical Company Anti-Cancer Therapy Last Known Therapy Status
Astex Pharmaceuticals (ASTX) AT13387 Phase 2
Biogen (BIIB) BIIB021, BIIB028 Suspended
Debiopharm/Curis (CRIS) Debio 0932 Phase 1/2
Esanex SNX-5422 Restarted
Exelixis (EXEL) XL888 Suspended
Infinity Pharmaceuticals (INFI) Retaspimycin HCI Terminated after failed trial studying NSCLC
Kyowa Hakko Kirin (OTC:KYKOF) KW2478 Phase 1/2
Myrexis (OTCPK:MYRX) MPC-3100, MPC-0767 Suspended
Novartis/Vernalis (NVS) AUY922 Phase 2
Samus Therapeutics PU-H71 Phase 1
Synta Pharmaceuticals Ganetespib Phase 2b/3

Major Fully-Funded StudiesIndustry professionals are feeling confident about Synta’s drug as well. Multiple health-care organizations are funding their own studies of Ganetespib Most recently the EU, has decided to fund a $100M trial. In total, Ganetespib has the largest clinical study group ever assembled in the space (over 700 patients). Clearly the firm does not want to take chances with another Phase III failure. The amount of partnered organizations signals a clear interest from academia.

Partnered Institutions
Partnered Institutions

Interestingly, the heaps of data being provided are scaring investors away, leading them to the wrong conclusions about the drug and it’s efficacy. Seeking a blockbuster wonder-drug, investors are hesitant to invest in a firm which has accepted the reality that Ganetespib will do best when paired with other drugs. This is only an incrementally better cancer treatment than what is currently on the market, because of this the market is substantially discounting the sales potential. The stock has approximately a 40% short interest, with no clear thesis I have been able to discern other than momentum.

Short Interest
Short Interest

On the flip-side, insiders have been major purchasers, accumulating over $40M worth of shares in the past 6 months.

Note the miniscule sales to purchases
Note the miniscule sales (invisible here due to tiny size) to purchases

Here are some conservative sales estimates. We assume that Ganetespib only succeeds with androcarcinoma patients, a tiny subsect of the total addressable cancer market.

2013 2014 2015 2016 2017 2018
Ganetsib Sales 0.00 0.00 55.00 75.00 495.00 650.25
    Growth % 0.00 0.00 5,500.00 36.36 560.00 31.36
International Royalties 0.00 0.00 0.00 5.00 10.00 15.00
Collaboration Revenues 0.00 0.00 5.00 10.00 15.00 10.00
Grant Revenues 0.00 0.00 0.50 0.50 0.50 0.00
Total 0.00 0.00 60.50 90.50 520.50 675.25
New Cases Cancer per Year % NSCL % Androcarcinomas Market Share Est Customers Price Per Customer Revenue Per Year Est
500000 0.85 0.3 0.15 19125  $     34,000  $                            650

Now we turn to one of the more interesting sides of Biotech valuation. Because these companies are generally unprofitable, we derive the likely probability of drug approval and multiply that probability by the total potential cash flow to yield what is considered to be a fair value for the company.

Here are the generally prescribed probabilities of FDA drug approval at various phases.

Pre-Clinical Phase I

 Phase II

 Phase III

 Final

 1%15%35%60%90%

I have assigned much lower probabilities than the generally used examples. I feel Synta merits a more conservative estimate because of its past failures. Additionally, cancer treatments generally have a tougher time getting FDA approved. Even with the lower probabilities, sub-GDP terminal growth rates, and a WACC of 14%, SNTA appears to be significantly undervalued.

Discount Rates
Terminal Growth Rate 15.00% 16.00% 17.00%
2.50% 12.50% 13.50% 14.50%
2.00% 13.00% 14.00% 15.00%
1.50% 13.50% 14.50% 15.50%
Fair Value          
  Approval Probability Terminal  Enterprise Fair Value Per Share Gain
Bear Case 0.25 3,172.21 1,613.75 1,649.28  $ 4 -1%
Base Case 0.4 3,301.68 1,749.82 1,785.35  $ 7 71%
Bull Case 0.5 3,440.75 1,900.09 1,935.62  $ 10 132%

Most analyst estimates are around $14/share. The investor willing to take on the substantial risks of this stock could triple their money. The risks are substantial and should not be downplayed.

  • Lack of partnerships signal may signal that drug companies are not thrilled by drug prospects
  • Previous formulations of HSP90 treatment failed in Phase III trials – Management is mitigating this risk with large-scale randomized trials designed to better target sub-segments of patients which yield greatest efficacy. Previous trials have already provided scads of patient data points.
  • Company may need to issue more shares to continue to fund operations, resulting in shareholder dilution (modeled into DCF)
  • As a drug class, HSP90 inhibitors have yet to achieve regulatory approval. Furthermore, the development history of competitor HSP90 inhibitors includes the emergence of hepatic, cardiac, and ocular toxicities as a result of formulation issues, but also presumably, in part, as a consequence of the on-target mechanism of action. If Ganetespib is unable to maintain an acceptable safety profile and/or demonstrate meaningful enough efficacy in clinical trials, the drug may not receive the regulatory approval necessary to become marketable.
  • Change of focus from mono-therapy to combination treatments are a bad sign for orphan status, but risk is priced in already
  • There are several companies with clinical stage Hsp90 inhibitors, many of which have lead development programs in advanced lung cancer. Additionally, multiple companies are developing drugs in NSCLC that may compete with HSP90, or alter the standard of care before Ganetespib reaches the market. Some of the companies competing with Synta have substantially greater resources and development capabilities.

The best way to hedge this risk is to diversify it away. I remain long in SNTA, PETX, EPZM, and BIND. At least one of these companies will likely fail. One or two others will probably do OK. One of them may go to the moon. I feel that SNTA may in fact be one of the safer plays, because the market has severely discounted past failures. I regard the CEO leaving as a potentially good thing. He displayed a tendency to zealously exaggerate drug potentials, and Glassdoor.com reviews were largely negative towards him in particular. Positive clinical results by the end of 2014 could propel this stock upwards over the next couple years.

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Lessons for the Stock Market from Snowboarding

Having just returned from a trip to Vail, Colorado for some beginner snowboarding lessons, I can’t help but make a few comparisons to another interest of mine: investing.

In snowboarding you fall a lot, and it hurts. All it takes is one downslope tumble and suddenly you are on your back with what feels like a keg of TNT exploding inside your skull. Having the wherewithal and grit to hop back up is important. Nobody wants to fall, but you have to go out expecting it to happen, and do what you can to minimize the probability of such occurrences.

Doing what seems contrary often works best. It can be scary to be rocketing down a hill, but losing control of your faculties is the real concern. As you point the board downhill you pick up speed. Your body instinctively leans back onto your back leg, your body thinks that this will slow you down, but that is patently false. All leaning back does is surrender any control you had to the slope, and now you really are in danger. When things seem scariest, your first plan is often the wrong one. What you really should be doing is leaning forward, into the speed, to retain control of your snowboard. This is the only way you can eventually turn the board and slow down, but it also runs contrary to what our body is telling us.

Our instincts are sometimes irrelevant to modern-day situations. The world has changed quite a bit in the last 10,000 years, yet our primal fears have not kept pace. Things like snowboarding and investing did not exist then. Hence what seems mechanically counter-intuitive on an emotional level is the intellectually correct choice.

It does make sense to quit at some point, to pump the brakes and unstrap our feet from the board. The big questions investors should ask are:

  1. How long is our slope?
  2. Where are we?

Most importantly, be prepared to fall and to get back up.

Trimming Corning (NYSE:GLW) adding to Smith & Wesson (NASDAQ:SWHC)

The past year has been good to Corning shareholders, with the stock appreciating over 45%. While I believe the company has great long-term potential, with a well-known and enduring brand name over 100 years old, I have decided to trim my position by 2/3rd in order to increase my cash holdings. The initial undervaluation thesis appears to have largely played out, and I do not see any big catalysts on the horizon. I am keeping about 3.5% of my total portfolio invested in the stock for the long-term. I believe the trend towards a touch-screen world still has a lot of room to run, but after a 65% gain in my initial investment in the firm at $10.70/share in mid-2012, I believe it may be time to take some gains and reallocate capital.

I have also increased my position in Smith & Wesson (NASDAQ:SWHC). SWHC currently represents 6% of total holdings. The story of an under-appreciated management team continues to play out. Recently, a poor earnings release by competitor Ruger made shareholders nervous enough to sell this great company before its own earnings report a few weeks later. The stock rocketed up over 10% when SWHC’s most recent report came out. I believe SWHC possesses a superior management team, is materially undervalued, and will continue to yield superior cash flow over the next few years.

Anytime the market starts hitting new highs, I tend to get a bit nervous and increase what I perceive to be undervalued stocks such as SWHC and BP. I have been watching a few Biotech companies with some interest, and believe that as the shine comes off the sector, a few good investment opportunities are presenting themselves.