In this edition of Investing chronicles, Lockstep CEO Paul Farah delves into a key future-proofing strategy: valuing businesses for their future potential, not just current earnings.
“At current levels, we believe the company’s shares predominantly reflect the value of the royalty portfolio, based on the relatively uncontroversial outlook for the company to achieve current and projected future royalty streams from end-market sales of the respiratory products by GSK.”
Goldman Sachs Analyst, July 2022
That was the last published comment I found from a reputable analysis on Innoviva (INVA).
The comment was from July 2022, when the analyst had a target price of $16.00 per share.
But this is what has happened to the company since then:
As you can see, INVA has been busy, yet with all that activity, its share price is still below Goldman’s target price of $16.00 per share.
Why?
Because people aren’t paying attention!
Today, we look at the case study of Innoviva (INVA) and the importance of valuing a business based on its future earnings without the need for complex calculations.
How to value a business: the INVA case study
Investing is laying out money today with the expectation that you will get more back in the future. Therefore, it is essential not to value a business based on its past earnings in isolation, but intsead look to its potential to grow earnings going forward.
A brief history of INVA
INVA was founded in 1996 as Theravance Inc. Its main focus was discovering and developing drugs to combat several diseases, including respiratory diseases.
In 2002, Theravance and GSK collaborated to develop and commercialise respiratory drugs, which led to the successful development of Relvar/Breo Ellipta, Anoro Ellipta and later, Trelegy Ellipta (FDA approved in 2020). Under the agreement, Theravance received royalties for these products.
In 2014, Theravance split into two businesses, with one arm, Theravance Biopharma, focused on research and development, while the other, Theravance Inc., became the royalty management company, later changing its name to Innoviva (INVA) in 2016.
The problem with the past
If, when I first analysed INVA in 2022, I had based my decision purely on the company’s revenue, I would have quickly skipped over the business.
As mentioned, in 2022, INVA’s only revenue came from royalty fees from GSK. This revenue stream is about as simple as it gets to forecast because it is based on established products with a knowable lifespan.
Based on the company’s assumptions, analysts’ expectations, the royalty business is worth about $1100 million after subtracting all the company’s operating expenses.
Source: Innoviva Corporate Presentation
Of course, we mustn’t forget that the company has liabilities, and we need to exclude those from the valuation of the business. See The Liquidation Value of a Company as a Margin of Safety for more details on why we do this.
INVA has roughly $520 million in debt, but it also has $400 million in liquid assets. So, based on the royalty revenue alone, INVA should be worth approximately $1,000 million. INVA has a current market cap of $992 million, so we are not far off where it should be valued.
But INVA is so much more than a royalty business!
Enter Sarissa Capital
Activist investor Sarissa Capital Management first appeared on INVA’s shareholder registrar in 2017. The highly regarded Alex Denner, a former senior managing director at Carl Icahn’s activist fund, Icahn Capital, owns Sarissa.
As things stand today, Sarissa is one of the largest shareholders of INVA, with more than 10% ownership, while Pavel Raifeld, a former Sarissa employee, is the company’s current CEO.
Sarissa’s involvement has resulted in a fundamental shift in the company and, as a result, it is no longer just a royalty business.
The opportunity
Royalty business
The primary source of revenue remains the royalty business. Relvar and Anoro earned the company $238.8 million in revenue for the Financial Year (FY) 2023, and, as mentioned, based on my analysis, I value this line of the business between $550 million and $1100 million.
The actual value depends on the patent expiration and whether or not there is a market for the products when generic options become available. The CEO has commented on the difficulty of manufacturing these products and believes they have a longer shelf life, past the patent expiration date.
So it could be worth more than $1,100 million, but, as always, let’s be conservative.
Giapreza and Xerava
In 2022, INVA acquired La Jolla Pharmaceutical for around $210 million. La Jolla Pharmaceutical’s portfolio of products included Giapreza, a treatment to raise blood pressure for adults with septic and other distributive shocks, and Xerava, a therapy for complicated intra-abdominal infections.
Both of these products generate revenue for the company, and sales are growing. Below is a breakdown of the revenue growth since INVA took ownership of La Jolla.
As you can see, these two products currently generate close to $17 million in sales per quarter, which will likely continue to grow. While it is difficult to predict the exact market size, we can safely value this business based on current revenue of approximately $80 million a year, and apply a few simple assumptions.
The math looks like this:
So let’s value these two products between $80 million (1x current revenue) and $200 million.
Xacduro
Xacduro is an essential treatment as Acinetobacter infections result in high mortality rates and financial burdens on hospitals/patients. Until Xacduro, there was no effective treatment. It was made available only in September 2023.
Given the current lack of effective treatment on the market, it is difficult to determine the exact market size. However, the US and Europe have up to 100,000 cases yearly, while less developed countries in Asia, South America and the Middle East have a far higher case rate.
Xacduro has just been approved in China, and, in collaboration with Zai Lab, it should start selling in the country in the coming month. China could be a much bigger market than the US. INVA will earn royalties only from sales, but we know how lucrative those royalties can be!
Although challenging to value accurately, given that it is so new to the market, I have applied ultra-conservative assumptions. Xacduro could be worth between $100 million and $400 million, potentially significantly higher.
Zoliflodacin
Zoliflodacin is an oral treatment for uncomplicated gonorrhoea that has recently completed successful phase 3 testing.
The current treatment for gonorrhoea is an injection where one doesn’t want an injection. It is excruciating, and the current treatment is less effective as the bacteria builds resistance. Therefore, a less painful, less embarrassing and, most importantly, more effective treatment is required. Zoliflodacin is that treatment.
About 1 million cases are reported yearly in the US, and far more globally. Unfortunately, I have no idea what this treatment could cost, but current treatments are around $20. For now, let’s be ultra-conservative and value the product at between $50 million and $200 million.
INVA will be filing for FDA approval early in 2025.
Other investments
INVA has invested in many other businesses, including Armata Pharmaceuticals, Gate Neurosciences, InCarda Therapeutics, ImaginAB and Nanolive. These are all clinic-stage companies and, therefore, don’t earn any money.
They are currently sitting on the balance sheet for over $220 million. There is a chance all these businesses will fail and be worth $0, but there is also the possibility that they will produce products with massive potential.
Being conservative again, let’s value these investments between $0 and $220 million.
The ISP Fund
Finally, there is the ISP Fund.
INVA invested $300 million in a fund that invests in listed pharmaceutical and biotech companies. Sarissa Capital manages this fund, and, given Sarissa has to file quarterly holdings reports, we can see what the fund is invested in.
A competent team of investors runs Sarissa, so the ISP Fund should be in good hands. As of March 2024, it was valued at $287 million, and, given it is invested in listed companies, it should be reasonably liquid.
So let’s value this asset between $200 million (30% discount to March 2024 value) and $287 million (March 2024 value). Of course, there is the possibility this fund will do well over time, but for now, let’s be conservative.
Note: This is the one negative about INVA – I don’t like that the main shareholder is paid a 1% annual fee to manage $300 million of the company’s assets to invest in other listed pharmaceuticals. The company should be able to do this themselves.
What is Innoviva worth?
We have been through its assets and their potential, and it owns $520 million in liabilities.
So, let’s see what the business is worth:
Conclusion
Recall that INVA’s share price is currently $15.90 per share, implying a potential downside of -37.5% while the upside is +100%.
I like those odds!
Especially because I know I have been very conservative in my valuation. I am likely overstating the downside while the upside potential is far greater.
But the real point I am trying to make is that if you invest in INVA based on its past or current earnings, you would miss out on its true potential. As you can see from the exercise above, INVA is far more than a royalty business, so it is absurd that it is being valued as such.
The lesson
When we invest in a business, we buy the sum of all its future cash flows to understand what the company is doing and its potential.
And …
Invest in that company when you have a high degree of confidence that it will be worth more in the future than it is today!
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Paul Farah has worked in financial markets since 2006, holding positions at prestigious firms from New York to South Africa. Now, he manages his own money and provides access to his entire portfolio through his company Lockstep Investing. The views and opinions shared are his own and are for informational purposes only, they are not intended to serve as investment advice and do not represent the views or opinions of Standard Bank. This information should be used as a starting point for generating investment ideas, and should not be relied upon as the sole basis for making investment decisions. Lockstep Investing (PTY) LTD and the Standard Bank of South Africa Limited will not be responsible for the results of any investment decisions made based on the views provided.
