Why "Sell the News" on Seattle Genetics (SGEN)

There is an old rule of thumb from biotech investors and traders… SELL FDA APPROVALS.  This is very counter-intuitive on the surface but we wanted to explain in more detail why this is the case here.  Today marks the first drug approval from Seattle Genetics Inc. (NASDAQ: SGEN) for its Adcetris (brentuximab), which also happens to be the first approval of a new drug to treat Hodgkin lymphoma in over 30 years.

The drug treats a less common form of the cancer known called systemic ALCL (anaplastic large cell lymphoma).  The ‘more rare’ and ‘rarer’ wording is the key here.  Also, the figure for the treatment used is now being set at $13,500.00.  It is going to take many treatments before the company recaptures what was called more than $500 million in R&D expenses per CNBC data during a company interview this morning.

Seattle Genetics is apparently going to make the drug, again its first commercially available drug, available next week.  The long and short of this is that brentuximab combines an antibody to target the cancer along with the effects of chemotherapy.

We looked for analyst opinion and Bloomberg showed an RBC comment noting that a conservative estimates is that the drug may reach $200 million in two years.  RBC did note that it could be larger.  Canaccord Genuity sent us some data that was much more cautious and it maintained a “Sell” rating and $10 target.

What is going to drive the sentiment here is rather simple… Dollars in versus dollars out against valuations.  The $500 million price tag and the $1.7 billion market capitalization play a part for a drug that could be a $200 million a year drug.  If the drug generates more in sales, then the caution on valuation is going to be less warranted.  Still, this values the one-product company at close to 8.5-times sales and the straight-line math puts a 2-year or 3-year cost recapture period in place.  Then will come the real profits.

The good news is that Seattle Genetics has more than $400 million in cash and liquidity on the books.  That will bolster the company for a while.  Before the effects of this approval, which was mostly expected, Thomson Reuters had estimates of $55.31 million for 2011 sales and $151.76 million for 2012 sales.

In the case of a biotech, we cannot back out a penny of the cash to derive a raw value for the company.  The cash burn and cash cushion is just too deeply required by the investment community to discount the cash from the market capitalization analysis.

If the drug generates even a 50% upside to the RBC target and manages $300 million after a couple or few years on the market without any news of prohibitive side-effects (an unsafe automatic assumption) then the company as it stands today for commercialized product will trade at more than 5-times annual peak sales and that is before the cost recapture time.

While no new treatment has been approved in more than 30 years for this indication, imagine what happens if another drug approval is granted or even if another drug approval looks possible.  The forward value comes under fire.

Here is what else the company has in its pipeline.  Brentuximab has more Phase I to Phase III trials underway for broader aspects in Hodgkin Lymphoma.  More is a s follows:

• SGN-75 for Renal cell carcinoma and non-Hodgkin lymphoma is in Phase I;
• ASG-5ME    for Pancreatic and for Prostate cancers is in Phase I;
• ASG-22ME for Solid tumors is in Phase I;
• SGN-19A    for CD19+ hematologic malignancies is in pre-clinical studies,

The company shows that 11 clinical-stage ADC programs in hematologic malignancies and solid tumors are in pre-clinical to Phase II studies under ADC Collaboration.

Now you know why we refuse to value the cash and liquidity as a discounting mechanism against the market capitalization.  That cash may all be spoken for in current R&D and clinical studies as far as monetary commitments.  The good news is that this will begin to assure much-needed revenues for the company.

Before you consider that this is a bash against Seattle Genetics, it is not.  The problem that exists is that there is only so much a single drug approval can do for the total value of a company.  Shares were up after the news initially, but at 1:00 PM EST the stock is down about 2% and around the $14.70 level.  The 52-week trading range is $11.36 to $21.41.

The old trading adage is “buy the rumor and sell the news.”  This was mostly an expected outcome for approval, so investors and traders are currently following the textbook trade.  No more, no less.

JON C. OGG