Investment Thesis
Reviewing Paratek Pharmaceuticals (PRTK) – a commercial-stage biopharmaceutical company with 2 approved antibiotic products, Nuzyra and Seysara – I am inclined to believe that there is a reasonably strong case for investment.
The antibiotics market offers unfavourable market conditions at the present time, being overcrowded and not well-served by reimbursement opportunities. Developing and commercialising antibiotic treatments is generally considered to offer a poor return on investment owing to the end-products’ short shelf life.
Paratek’s current share price – $5.9 at the time of writing – reflects these conditions. But thanks to numerous factors – a lucrative collaboration deal with the Biomedical Advanced Research and Development Authority, an experienced management team and a well-thought-of drug in Nuzyra that can be administered both orally and intravenously – there are many reasons to believe that Paratek’s share price can climb back towards its July 2017 peak of $28.
At that time, the company traded on promise alone, having no commercialised treatments. The path to approval has been extremely challenging for Paratek, but having secured approval and access to significant funding, the company and its investors may be about to reap the benefits of the development process, launching 2 drugs that analysts believe can achieve peak sales >$400m.
In this article I will discuss Paratek in more detail and map out a scenario, using DCF analysis, that values the company’s shares at >$10-15, offering a chance for investors to make exceptional gains, whilst the current low price of Paratek stock offers downside protection.
Investing in a pure antibiotic play is investing against the grain, but in Paratek’s case, the unique circumstances make the company a speculative buy, based on my analysis, that would suit a risk-on biotech investor.
Investment Overview and Antibiotics Background
Nuzyra is an oral and intravenous antibiotic approved for treatment of community-acquired bacterial pneumonia (“CABP”), and acute skin and skin structure infections (“ABSSSI”), and Seysara is an oral therapy for the treatment of moderate to severe acne vulgaris.
Both products were approved by the FDA in October 2018. Paratek is responsible for the marketing and sales of Nuzyra and the drug has got off to a good start, earning revenues of $8.1m in Q220 (up 378% year on year). The company out-licenses the rights to market and sell Seysara in the US and China (where a license to sell the drug was submitted in early 2020) to Spanish biotech Almirall – earning royalties I estimate to be in the low double-digits.
Nuzyra in particular targets a vast market – estimated to be in the region of $4.5bn by Paratek’s CEO Evan Loh on the company’s Q220 earnings call, and split between hospital and community settings. One analyst has set a peak sales target for Nuzyra of $500m, whilst according to Grand View Market Research, the global antibiotic resistance market was worth $7.8bn in 2017, and is expected to grow at a CAGR of 5.6% until 2025.
Antibiotics are generally seen as an unattractive market by pharmaceuticals, however. Used sparingly owing to fears of patients building resistance, antibiotic treatments often struggle to secure reimbursement deals from insurers and have a short shelf life, hence they are viewed as providing a poor return on investment. Of the 15 antibiotic treatments to have been approved by the FDA since 2010, 5 have been effectively withdrawn from the market owing to their developers’ bankruptcy or sale.
This, alongside Paratek’s high cash burn, the company made losses of $89m, $112m, and $129m in 2017, 2018 and 2019. Paratek raised $50m in Jan 2018 via a share offering and $140m in April 2018 via a debt offering – explanation for the significant decline in Paratek’s share price from a high of $28 in August 2017, when the company had no approved products to speak of, to just $5.9 at the time of writing.
Paratek Pharmaceuticals 5-year share price performance. Source: TradingView.
The US Government is keen to support the development of new antibiotic treatments, and in December 2019 the Biomedical Advanced Research and Development Authority (“BARDA”) handed a lifeline to Paratek via the award of a contract to procure and stockpile Nuzyra on behalf of US troops who might become exposed to the bio weapon anthrax.
Paratek was the sole recipient of this funding – the first ever award for an antibiotic for the Strategic National Stockpile (“SNP”) – which could be worth up to $285m over a five-year period, with an option to extend for a further five years. The deal is structured to provide up to $77m in reimbursement for all of Paratek’s post-approval obligations around Nuzyra, up to $153m of procurement purchases of Nuzyra, and up to $54m to allow the company to onshore manufacturing – which is currently outsourced to companies across Europe.
As a result of the BARDA funding and its $186.6m of cash, cash equivalents and securities, Paratek management says that it has sufficient funding runway to last until 2023, by which time the company hopes to have achieved cash flow break-even.
Nuzyra – a clean label, IV & Oral Versions + Extra Funding Make For A Potential Winner
Paratek is essentially banking on Nuzyra bucking the trend of sluggish sales in the antibiotics market, and the early signs have been promising, as we can see from the chart below from the company’s Q220 earnings presentation.
Nuzyra launch sales curve vs. competitors. Source: Q220 earnings presentation.
Sales of Nuzyra in the first 6 months of 2020 of $15.4m represents a 413% annual gain, but in truth, that is still a long way off where the company needs to get to if it wants to reach break-even and start turning profits.
It has been estimated that an antibiotic treatment needs to generate around $300m in annual sales in order to achieve a sustainable revenue model, yet research suggests that most antibiotics make sales of between $15-50m, with only a few exceeding $100m annually.
But with Nuzyra, Paratek has several circumstances in its favour. First of all, it has the BARDA funding to help keep the company solvent as it conducts the necessary post marketing studies agreed to upon Nuzyra’s approval (estimated to cost around $77m), and launches a major marketing push to try to win favour with hospitals and physicians and secure places on formulary lists and reimbursement from health insurers. 90% of Nuzyra’s sales come from hospitals and adjacent sites of care, but the company expects to branch into the community setting once it has established a foothold in the overall market.
Secondly, post marketing studies notwithstanding, Nuzyra was given an exceptionally “clean” label by the FDA – in other words, the agency saw no need to give the treatment a boxed warning and has not highlighted any safety concerns. These comments from a recent MOI Global investor communication are notable (as is the rest of the discussion which I would recommend prospective investors to read in full).
It was our clear sense from attending the FDA’s Advisory Committee hearing on NUZYRA in October 2018 that the FDA’s scientists and doctors thought highly of the drug.
This is probably down to the impressive work of Paratek’s original founders and its current management team. Together, Stuart Levy – an antibiotic-resistance research pioneer who conceived the idea of developing a tetracycline (one of the oldest forms of antibiotic) relative in pill form, and Walter Gilbert – a Harvard University molecular biologist associated with the 1980 Nobel Prize in Chemistry, founded Paratek in 1996.
The current management team is led by Evan Loh, who has held numerous positions of authority at the company since 2014 but has served as CEO since June 2019, and previously worked at Pfizer (PFE) and Wyeth Pharmaceuticals. At Wyeth, Loh worked alongside Paratek’s President and Chief Commercial Officer Adam Woodrow, and its Chief Development & Regulatory Officer Randy Brenner, developing Tygacil, a successful antibiotic treatment that made peak sales of $400m, and was later sold to Pfizer.
This vastly experienced trio have built the company to a staff of >100, having had to reduce it down to just 6 employees when the company was struggling for funding prior to listing, as several major Pharmaceuticals including Bayer (OTCPK:BAYZF), Merck (MRK) and Novartis (NYSE:NVS), decided not to pursue development partnerships.
Tygacil came with a boxed warning and was an intravenous-only antibiotic, but the third major advantage of Nuzyra is that it can be administered in both IV and pill form, giving it the potential to dramatically reduce patient hospitalisation duration, saving hospitals millions of dollars, clearing room for other patients, and also reducing insurance payouts.
Paratek – current pipeline. Source: Q220 earnings presentation.
As we can see in the table above, Paratek has secured approval for both an IV and oral, and oral-only version of Nuzyra for ABSSSI and an IV and oral for CABP, with an oral version at the registration stage.
And finally, also shown above, Paratek is pursuing approval for a third indication – in Nontuberculous Mycobacteria.
Nuzyra Nontuberculous Mycobacteria opportunity. Source: Q220 earnings presentation.
As we can see above, Paratek has done its research and concluded the opportunity could be worth $740m, owing to the current lack of effective treatments, and their inconvenience and longevity.
Seysara
The Seysara opportunity is more modest, given that Paratek earns royalties only, but it should not be discounted. The global acne drugs market was worth $4.1bn in 2017, according to Grand View Research, and is estimated to be growing at a CAGR of 4.2%. Almirall sounded upbeat about the drug when reporting its FY19 earnings
Seysara® finished the year with €23 MM of Net Sales and 6% volume market share in December 2019. Up to 6,200 dermatologists prescribed the drug and a total of 204,090 prescriptions were written in 2019. A revised co-pay card program has been implemented to optimize profitability from January 2020.
Given the challenges that antibiotic treatments face, any revenue stream will be welcomed by Paratek, plus the company retains rights to market the drug itself in territories outside the US or China.
Fair Value
Based on some relatively optimistic DCF analysis I find it quite easy to get to a present day fair value price of ~$14 for Paratek’s shares.
Paratek 5-year financial projections. Source: my table and data (available exclusively to Haggerston BioHealth subscribers), using company historical data.
First of all, I am anticipating Paratek achieving peak revenues of $350m by 2025, breaking down as follows.
I see Paratek earning ~$45m per annum from the BARDA agreement overall, which assumes that earnings from the $285m contract will be split evenly over the five-year period. In FY20, Paratek is expecting to receive $38m based on procurement of 2,500 anthrax treatment courses, subject to pre-emergency use authorisation (“EUA”), and earned $1.2m in the first 6 months of the year, according to its Q220 10Q submission.
Therefore, it’s not unreasonable to assume that Paratek will receive ~$45m this year from Barda, and convenient for my purposes to assume this figure will stay roughly the same throughout the contact lifecycle, with a remaining $15m kept in reserve.
Regarding Seysara, prior to its approval Almirall reportedly viewed the peak sales opportunity to be in the region of $150-200m, whilst Allergan, which sold the rights to the asset to Almirall, had predicted peak sales of $250-500m. Almirall may have cause to revise its estimates upwards since it has submitted Seysara for approval in the Chinese market, with a decision expected in 2023. But based on US sales of $23m in 2019 and Almirall’s positive outlook, I am forecasting sales of $60m in 2020, and $150m by 2025 (a CAGR of 90%), with Paratek earning 10% of this in royalties.
Regarding Nuzyra, again I am opting for a more conservative figure of ~$35m of sales in 2020, which translates to ~$19.5 of sales across quarters 3 and 4, based on the $15.4m earned in Q1 and Q2, rising to $290m by 2025, at a CAGR of 53%. All told, these estimates see Paratek meeting the midpoint of its upwardly revised FY20 forecast revenues of $78-83m in FY20, and posting revenues of $350m in 2025 – growing sales by ~34% annually.
Paratek FY20 revenue and OPEX forecasts. Source: Q220 results presentation.
Regarding OPEX, I am forecasting Paratek to meet its target of $135m – approximately 167% of total sales – in 2020. I expect OPEX to increase in each year to 2025, but I am pulling down the percentage of total sales in each year, by ~10% in 2021, ~20% in 2022 and 2023, and then again by ~10% in 2024 and 2025. In this final year, I anticipate OPEX amounting to just 78% of total revenues, giving the company a net profit margin of 16%, EPS of $1, and a very low forward P/E ratio of 4.8x, which indicates that under such circumstances, Paratek’s share price is likely to grow significantly.
Paratek DCF analysis. Source: my table (exclusive to Haggerston BioHealth marketplace subscribers).
The income statement forecasts provide a 2025 EBIT of $76.1m, which translates to a FCF of $63.6m, based on a tax rate of 20%, relatively high depreciation add-back of $17.6m (5% of revenues), netted off by high working capital costs of $14.6m. The WACC I calculate as 9.0%. I am using a high (given there may be a recession coming) expected market return of 9% and beta of 1.53 (figure from Google Finance), and assuming a 5% cost of debt.
Paratek is heavily indebted – its long-term debt stood at $251m at the end of Q220, borrowed from several sources. This includes a borrowing arrangement with Hercules Capital, Inc., with variable rates of interest paying ~8% on average, $135m of convertible senior notes paying 4.75%, and a $32.5m royalty-backed loan agreement paying up to 12% interest.
In my income statement, I have Paratek recording interest expense of ~$13m per annum between 2020-25. In the first 6 months of 2020, the company recorded interest expense of $9.8m, but this ought to reduce over time as the debt is repaid, or even restructured.
My analysis ultimately delivers a present firm value of $641m – a 140% premium to Paratek’s current market cap, and 111% premium to estimated current enterprise value of $303.5. This translates to a fair value price of $14 for Paratek shares.
It is worth noting that Paratek also has a position of 17.4m of potentially dilutive securities owing to a shelf registration statement filed in 2017, to raise up to $250m, with ~$200m remaining. When applied, this could reduce my fair value estimate down to $10, although this assumes Paratek makes full use of the shelf, and raises at current share price of $6, which, as my thesis suggests, is unlikely given I expect the share price to gain significantly in the next 6-18 months.
Risks
Although my DCF analysis is highly speculative, and there are many possible permutations that I have not considered in the interest of presenting a simplified forecast, I believe it paints a realistic picture of what the company can achieve, and there are certainly areas where I could have been more optimistic. Nuzyra and Seysara sales could be significantly higher, the BARDA contract could be extended to 10 years, and I have not factored in the Nontuberculous Mycobacteria opportunity – which could potentially push Nuzyra sales beyond the $500m per annum mark.
Still, there are also many risks to consider that may prevent investors from doubling or even tripling an investment into Paratek at a price of $6.
Although the BARDA contract could be extended, it can also be withdrawn at any time at the discretion of the agency. At a less extreme level, BARDA could object to certain reimbursement payments, reduce its stockpiling operations, withhold funding at a crucial time, insist upon an in-process review of Paratek’s operations, or Paratek could breach the terms of the contract and default.
Paratek is heavily reliant on the BARDA funding as it navigates through the costly commercialisation process and conducts its post-marketing reviews – it is BARDA that gives Paratek a major competitive advantage in this respect.
If the funding stops for any reason, Paratek could find itself unable to successfully bring Nuzyra to market, and headed for bankruptcy or sale, as has happened to 4 other antibiotic developers in recent years: Achaogen (NASDAQ:AKAO), Aradigm (ARDM), Melinta Therapeutics (NASDAQ:MLNT) and Tetraphase Pharmaceuticals (NASDAQ:TTPH).
Funding concerns aside, Paratek is entering a competitive market. Although its clean label, oral/IV versatility and strong current backing mark Nuzyra out as a potential market leader, nevertheless the company faces a huge task persuading physicians and hospitals to choose Nuzyra over its current preferred treatment.
There are a host of antibiotic treatments addressing both the CAPB and ABSSSI markets, being marketed by the likes of Pfizer, Johnson & Johnson (JNJ), Abbott (ABT), Merck and many other smaller biotechs. As a consequence, no matter the efficacy or safety profile of Nuzyra, a massive marketing investment will be required by Paratek if it is to successfully make a dent in these markets.
Although sales have been growing, there is an argument to suggest that this is actually due to COVID-19. Nuzyra may be being oversubscribed due to its perceived usefulness as a treatment for coronavirus. Whilst this is good news in the short term, in a post-pandemic environment sales could drop off – there is no way of knowing at the present time if the current sales growth trajectory can be maintained.
Most drug developers cultivate a diverse pipeline of candidates, but Paratek is solely focused on antibiotics, and does not have any treatments in the pipeline capable of making up sales should Nuzyra, and to a lesser extent, Seysara, fail to deliver the expected revenues. And then there is the antibiotics market itself. Despite initiatives such as the GAIN Act legislation, which is attempting to raise the prices of commercially available antibiotics in order to stimulate development, the overall risk-reward profile of this market remains unattractive.
Conclusion
The gist of many of the articles and research notes I have read relating to Paratek can be summed up as follows: “if you only pick only one developer to back in the current depressed antibiotics market – and one is most probably the limit – make sure it’s Paratek.”
I am not going to disagree with this thesis, because most of the evidence I have come across supports the argument. Big Pharma concerns do not want to prioritise antibiotic drug development because of the short shelf life, low sales, and difficulties in securing reimbursement, whilst biotechs that have tried have often run out of funds before bringing a product to market. Even those that succeed find that they cannot sell enough product to remain solvent.
What’s needed to succeed is expertise, versatility, financial support, and most importantly of all, an effective product. Paratek has all four of these competitive advantages.
Its management team knows how to develop and commercialise a successful antibiotic having done so previously at Wyeth, and subsequently Pfizer, with Tygacil – which achieved peak sales of >$400m. Out of hundreds of applicants, the team secured the BARDA funding contract that covers the costs of its post-marketing studies and commercialisation. Nuzyra is proven to be safe, effective, and versatile – its oral formulation could save hospitals and insurers hundreds of millions of dollars by allowing patients to return home earlier than if they were using another treatment.
As such, despite the numerous risks, it seems not only realistic, but likely that Nuzyra will continue to grow sales, and once it has been proven to be successful at a cluster of hospitals, the sales growth may increase exponentially.
It takes a leap of faith to imagine such a scenario, given that Nuzyra will make ~$35m of sales only in FY20, but from an investor’s perspective, Paratek has one final significant advantage – its stock is exceptionally cheap at the current time, trading at $6, when once it traded at $28 on future promise alone.
In a moderately successful scenario, based on my analysis, investors could double their money by backing Paratek at this time. Even if Nuzyra struggles to make an impact, catalysts such as BARDA, the Nontuberculous Mycobacteria opportunity, the company’s access to funding that is not excessively dilutive, and even Seysara – which the company could attempt to bring to, say, the European market – all protect against downside.
Hence, I take a bullish stance on Paratek, and will set a modest price target of $10-15. The investment opportunity, however, appears to be anything but modest.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in PRTK over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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