On the charts, Arrowhead Pharmaceuticals (NASDAQ: ARWR) showed a “double top,” touching around $20 twice between September and October, before crashing down more than 30% in the last week. As value investors will ask after such a drop…what happened?
On Oct. 4, Arrowhead announced that it entered into a license and collaboration with Janssen Pharmaceuticals, a unit of Johnson & Johnson (NYSE: JNJ). The total deal is worth up to $3.7 billion. But up front, Arrowhead gets $175 million and a $75 million equity investment from Janssen. The other $3.5 billion would come through potential milestone payments, royalties on commercial sales and collaboration on up to three additional RNA interference (RNAi) therapeutics .
Janssen gets a worldwide exclusive license to the ARO-HBV program, Arrowhead’s RNAi candidate for treating hepatitis B virus infection. ARO-HBV is still in early stage clinical trials.
Despite the equity investment worth around $23 a share, ARWR stock is down to 13.36 as of this writing. Shareholders are clearly disappointed, even though the deal involves the purchase of 3.26 million shares. ARWR’s drop signals investors believe the deal undervalues Arrowhead.
But the market is often irrational when you least expect it. Arrowhead struck a favorable deal with a strong partner. Markets may have expected a strong response from the stock but when that did not happen, selling pressure accelerated.
The Janssen Deal Is a Positive for Arrowhead
Investors should treat Arrowhead’s partnership with the JNJ unit as a positive development.
As a counter example, Synergy Pharmaceuticals (NASDAQ: SGYP) decided to commercialize its TRULANCE drug on its own… SGYP is currently down almost 60% from its 52-week highs, with a market capitalization of just $363 million. Or look at Dynavax Technologies (NASDAQ: DVAX). DVAX is launching HEPLISAV-B, a hepatitis B vaccine, but is losing money so far. The company reported just $1.3 million in net product revenue for the quarter ended June 30, 2018. HEPLISAV-B product sales are included in the totals. Cost of sales totaled $5.2 million in the same period.
Yes, Arrowhead’s agreement will limit the unlimited possibilities in revenue growth for ARO-HBV. But along with the upfront cash and clinical research support, the company will have fewer risks moving forward.
As ARWR proceeds to commercialize its RNAi therapeutics, it will have a strong partner that can more easily handle the challenges of launching a new drug. (A disastrous launch could sink a small drug manufacturer, but Johnson & Johnson is not going anywhere.) Had Arrowhead continued alone, it could have faced the same cash flow challenges as Dynavax and Synergy.
ARWR Stock’s Third-Quarter Loss Is Not an Issue
In the third quarter, Arrowhead reported a loss of $0.18 a share. Revenue fell 92.3% to $720,000. But since all of the company’s drugs are currently in clinical or pre-clincal stages, revenues are not very important right now. Developmental-phase biotech stocks like ARWR trade on the possibility of future earnings, not their current ones.
What’s more important in ARWR’s last earnings report is that during Q3, Arrowhead presented its preclinical data on ARO-ATT, ARO-HBV, and ARC-520. It also completed enrollment and dosing for its ongoing Phase 1/2 study of ARO-HBV. These are the sorts of results that matter for an early-stage biotech.
ARWR Valuation
Six of the analysts on Wall Street are extremely bullish on Arrowhead stock. The average price target is $23.75, implying the stock has upside of 61% (according to tipranks.com). Modeling a fair value for the stock is a big guess. One may still assume revenue of around $300 million by FY 2023 will lead to a small profit. By the 10th year, Arrowhead could have revenue approaching at least $800 million.
With these input assumptions, a 10-Year DCF Growth Exit Model suggests the stock’s fair value is $17.5. This gives ARWR stock upside of 21% from current levels.
The Bottom Line for ARWR Stock
Biotech investments are notoriously risky investments. If you’re a more conservative investor, buying Regeneron Pharmaceuticals (NASDAQ: REGN), a company with clear and proven growth, would be a better way to play the space than ARWR. But for those who can handle some risk, the deal with Janssen is good for Arrowhead in the long term — and actually decreases the company’s risk overall.
And as a bonus, you can now buy ARWR on a sizable dip.
Those who bet on Arrowhead will need to ride out the near-term bumpiness. But I believe the reward will come eventually.
Disclosure: The author does not own shares in any of the companies mentioned.
