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How to Play the Immediate Uncertainty of this Promising Biotech Stock

Sunday - 4/7/2013, 1:13pm  ET

Sarepta Therapeutics has been one of the best performing stocks of the last year, and has among the greatest level of promise in the biotechnology industry. However, it faces immediate uncertainty, and because of that uncertainty I am exploring the best way to play the stock.

A 50/50 Chance is a Gamble

Sarepta Therapeutics has been volatile over the last few sessions, but saw a 5.17% gain on Friday after Piper Jaffray reiterated its “Overweight” rating on the stock following updated Eterplirsen data. The firm is highly optimistic for the company’s future, but is giving a $35 price target based on a 50/50 chance that its drug will receive an accelerated approval. If the drug is granted an accelerated approval for the treatment of Duchenne muscular dystrophy (DMD) then Jaffray explained that they will revisit its price target.

Last month I named Sarepta Therapeutics my “Value of the Month” and it has since rallied 25%. The company is one of my favorite in biotechnology, as I believe it along with Acadia Pharmaceuticals, is the most sure thing in the space. However, a 50/50 chance is not “great” but is a fair assessment. The company’s study produced unprecedented results yet the study was small. Therefore, I think it may have been bad timing for the firm to reiterate its call.

Expecting Positive Results But Uncertainty Lurks

Currently, the market is expecting an accelerated approval due to their being no treatment options for DMD, and because the results for its small study were incredible to say the least. After 74 weeks, patients saw a 62.4 meter improvement in walking distance in the six-minute walk. This may not sound like much, but for those who suffer from the disease, it is a glimmer of hope. As a result, the market wants an approval, but with less than 20 patients tested, and no clear manufacturing strategy, there is a good chance that the FDA will want more data. In the event of this decision, it is almost logical to suggest that Sarepta could see short-term downside between 15% and 30%, making it a very high-risk investment at this point.

Regardless of the FDA’s immediate decision, there will no doubt be positive remarks from the committee and the drug will almost certainly be FDA approved at some point in time. In a market that wants and seeks immediate results, this will not be encouraging to all if the FDA requires more testing. However, if the drug is granted an accelerated approval, then Sarepta will most likely see a 10% to 20% increase in valuation. Therefore, the question of whether or not to invest is both a decision based on your time horizon and also your risk tolerance.

Looking at Sarepta as a long-term investment, there are almost no reasons to believe that it will not eventually be approved. Once again, clinical results and no treatment options for the disease weigh in the company’s favor. However, my advice, as the best way to play the decision is to simply wait. The company is currently valued at $1.15 billion and Eterplirsen has peak sales potential in the neighborhood of $700 million. In biotechnology, this is a combination to create significant upside from this point forward, and then there is the final emphasis of valuation, which is the Orphan status and its technology.

Long-Term Upside is Great (Relative to Others in the Space)

Sarepta has a great clinical team with an encouraging pipeline; it is not just a one-hit wonder. In biotechnology, most companies trade at 3-5 times sales (following an approval), but then there are a class of stocks that trade at much higher multiples, those with Orphan designations. An Orphan designation indicates to the market that a company is innovating, transcendent, and that its product will have more time of exclusivity on the market. A couple prime examples are BioMarin Pharmaceuticals and Alexion Pharmaceuticals .

BioMarin is a company with just $500 million in sales over the last 12 months that trades with a market cap of $7.78 billion. Therefore, it trades with a price/sales of more than 15.0 (far times greater than the industry average). The company has a large pipeline and there are many reasons for this valuation, specifically its clinical drug GALNS, a drug that could double its revenue.

Alexion is a near $20 billion company with revenue of $1.13 billion, therefore having a price/sales of 17.00. Much like BioMarin, the company’s upside is in its exclusivity, its technology, and its pipeline. The point is if two companies with revenue between $500 million and $1.1 billion trade with market caps between $7.78 billion and $20 billion, then eventually, Sarepta Therapeutics is worth the same with its peak sales potential of $700 million and the same Orphan statuses and technology that makes these two companies valued so high.

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