Why Gilead's Hepatitis C Vaccine Is So Hard to Value
In today's Clear & Present Markets column, Tom Clancy opines on Gilead, corporate management, and the end of Microsoft Windows.
There are a few random things on my mind today, namely Gilead's (NASDAQ:GILD) hepatitis C vaccine, the market's confidence in corporate management (is it warranted?), and the decision at Microsoft (NASDAQ:MSFT) to scrap Windows.
1. I have a position in Gilead, and this is a stock that could go up or down 50% depending on how the market for its new hepatitis C vaccine plays out. I have been modeling health-care companies for over a decade, and I have never seen a drug so difficult to value.
Cash-flow models depend on the size of the cash flows, the duration of the cash flows, and the discount rate that reflects the required return for taking the risk. We are talking about a patient population of 10 million and a drug priced at $66,000 for an 8-week regimen that will cure more than 90% of the patients treated. I understand that Gilead does not expect a long life for this vaccine because as you cure people, the patient population and demand decreases, but the exorbitant sticker price could backfire and erode Gilead's first-mover advantage (competitors have competing drugs expected to be approved shortly).
Probability ranges for each of the major inputs are extremely wide as investors estimate market share, reimbursement rates, years of sales growth, and changes in these dynamics as sales begin to decline. My best guess is that the stock has about 20-25% upside to a fair discounted cash-flow valuation plus about $8 in pipeline value. The thing is, prior to Gilead's $12 billion acquisition of Pharmasset, which brought the hepatitis C franchise, management flushed billions of dollars down the toilet on failed acquisitions, and the market's current perception that management will destroy value by misallocating the hepatitis C vaccine cash flows may be accurate. However, when dealing with this much uncertainty, profits can be made, and I have recently placed my chips down on the long side with the expectation that the stock can run to new highs as investors gain greater clarity on near-term cash flows.
2. Peter Atwater highlighted (subscription required) the waning credibility of corporate management in the headlines, but the market is showing tremendous confidence in management. Facebook (NASDAQ:FB) has recovered the losses that followed Mark Zuckerberg diluting shareholders to the tune of $20 billion, and Google (NASDAQ:GOOG) (and Google Class A (NASDAQ:GOOGL)) is trading higher after diluting shareholder voting rights today. These types of intangible assets (credibility and voting rights) don't mean much when markets are peaking, but the lack of them can have a significant impact on valuations as markets decline.
3. After competitors have already done so, Microsoft is finally killing Windows. The future of Microsoft is its cloud services. While it attempts to hold on to the cash flows from its flagship products, it is revealing that the first two actions of its new CEO have been to go mobile and to go free. Apple (NASDAQ:AAPL) has won mobile share with a great integrated software and hardware mobile platform, which it convinced telecom service providers to subsidize and distribute. Google won mobile share by providing a common software platform to every non-Apple smartphone developer, allowing it to capture margin through its hardware while using mobile data to expand its competitive moat in mobile search. Microsoft still owns the enterprise and should be able to leverage that into market share gains in mobile if it plays its cards right. For the first time in a long time, it appears as though Microsoft "gets it." Strategically, this could make BlackBerry (NASDAQ:BBRY) a more valuable asset.
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