Back in November, I tried to guess Seth Klarman's (Trades, Portfolio) motives for investing in Keryx Biopharmaceuticals (KERX, Financial), an unusual biotech position for the renowned value investor. In his latest letter to shareholder, the secretive guru has finally commented on this company. In November I wrote:
Keryx has only one product that is FDA approved. Given Klarman’s background, I believe he will pay a lot of attention to that product but not ascribe as much value to its pipeline products, although these often play a central role in biotechnology investment theses. At his heart Klarman is very much a value investor, and he wants to see cash flows, not air castles.
This single product the company has on the market is Auryxia (ferric citrate), which is an oral, ferric iron-based phospate binder. It was approved in September 2014. Auryxia is meant to help with the control of serum phosphorous levels in patients with chronic kidney disease (CKD) on dialysis. Because the product is new on the market, sales are still ramping up and the company is not free cash flow positive yet. It does look like it has a clear path to positive cash flow, though.
As it turns out, Auryxia's sales are exactly what Klarman is after from the get-go, buying shares at as much as $14.50 per share. Shares are now priced at $3.36.
In the case of Keryx, we purchased our initial position at an average price of $14.50 per share based on what turned out to be an overestimation of initial prescriptions for Auryxia, the company’s approved drug to control phosphorous levels in dialysis patients.
Klarman admits it was a mistake that they overestimated Auryxia sales, but thinks the market is now making a bigger mistake by driving the stock down 70% (emphasis mine):
While we remain confident in the long-term potential of Auryxia, and, thereby, our investment in Keryx, the slower sales ramp through 2015 did have a modestly negative impact on our estimate of intrinsic value. The market, however, took a much harsher view and punished the stock, driving it down to almost 70% in less than three months from about $10 to almost $3 a share. Although this certainly was not good news for our mark-to-market P&L, we believe it was a significant overreaction, and we were able to take advantage of the opportunity by investing additional capital on a private basis at what we believe is an incredibly attractive valuation. This, of course, is a great illustration of the fact that even in circumstances when we reduce our own expectations, price declines can far exceed what we judge to be warranted.
Although Klarman and his team may have been too optimistic on initial sales, there are good reasons to be confident. Auryxia has been prescribed nearly 50% more in the third quarter as compared to the second quarter (we have to compare quarters in chronological order instead of year-over-year, because it is a new product). The number of physicians who prescribe Auryxia increased by 120% from the first quarter to the third. It appears to be fairly easy to convince physicans of the benefits of the produc as it has a high conversion rate (from the Q3 earnings call):
One tactic to driving increased adoption in utilization of Auryxia is to get more physician experience with the drug through samples. We did this with starter kits, which we delivered throughout the summer primarily to high potential nonprescribing target physicians. Notably, in this group of physicians, these observed a rapid 26% conversion rate to revenue generating prescribers in the third quarter.
In addition, as I also wrote last time I covered the company, the company is increasing its sales force by 50%. Unless physicians suddenly decide they don't like the product or the company did a terrible job in hiring, this should result in materially higher sales going forward. Analysts covering the company, as per Reuters, estimate the mean sales per share will exceed $10 in mid-2016. Even the most bearish among them expects a 100% year over year increase by mid-2016. Keryx is not free cash flow positive yet, but it appears very likely it will be much closer by mid-2016. Perhaps the market will recognize the transformation of its sales by that time and adjust its future expectations, resulting in a re-rate and a meaningful appreciation of the stock.
Disclosure: Long KERX.
