CASSAVA SCIENCES: A CASE STUDY IN VALUATION

By Owen Marino, Technical Analyst

While the recent groundbreaking news with pharma giant Biogen – the approval of its novel Alzheimer’s Disease treatment adumanucab – is hopeful, there are a number of hurdles that need to be overcome before it can effectively come into use. Besides the issue that there may be a number of negative side effects, many private insurance companies are not likely to cover the treatment for patients who take the drug, which is an issue because initial estimates put the cost of taking the drug at around $56,000 per dose. Because of these factors, the market for a treatment that may be more suitable for the general population is still wide open.

Biogen’s treatment, as well as a number of other Alzheimer’s treatments that have been recently developed, have been developed around using what is known as the “Amyloid Plaque Theory.” From brain scans and other tests, researchers have figured out that patients with Alzheimer’s are characterized by a buildup of amyloid plaques in their brains as a result of the breakdown of amyloid precursor proteins. The plaques disrupt connections in the brain and get in the way of normal cellular function, and destroying them has commonly been thought of as the solution for the disease. However, while aducanumab and other treatments like it are specifically programmed for doing just this, there is currently no conclusive proof that destroying these proteins in fact improves cognition. 

Recently, some companies are taking a different route trying to find a cure through other methods. Cassava Sciences, an Austin, Texas based clinical-stage development company founded in 1998, is approaching the Alzheimer’s crisis not through focusing on destroying amyloid plaques, but misfolded proteins in the brain, specifically trying to correct one known as filamin A. So far, the results have been extremely promising. Earlier this year, the company announced that phase II trials of its promising candidate, known as simufilam, improved cognition by 50% over a 6 month period. The company is set later this year to release data related to 12-month cognition trials, where positive results would be a huge milestone in terms of Alzheimer’s research, since little to no other companies have been able to show notable restorative improvements in cognition over a year-long span. 

There are still so many variables still in play and a long time for things to change before simufilam passes trials and is potentially approved for use in the US. The company is only set to begin phase 3 trials later this year at the earliest, and after that it may still be another few years before the treatment is given the green light to hit the market. Hypothetically speaking, however, what could a potential approval look like for the company in terms of revenue? The company’s market capitalization, which is its stock price times the number of shares outstanding, currently sits at around $3.35 billion, and its shares have gone from trading at $7 to over $80 each in the last few months, after the aducanumab announcement. However, could projections show that the company may still be undervalued?

A discounted cash flow model, or DCF, is one way analysts project the total enterprise value of a company. DCFs project estimates of the company’s future cash flows over a defined period of time, and account for the change in dollar value from year to year as a result of the Time Value of Money, or TVM. In order to run some calculations for $SAVA and value the company after a potential successful approval of simufilam for the treatment of Alzheimer’s, we need to make some assumptions about a number of different quantitative variables. 

The first thing that needs to be determined to make an evaluation is what the peak sales of the drug would be if it were to hit the open market. This can be determined by finding an estimate on sales price multiplied by the approximate number of people that would take the drug, which requires establishing a total patient pool as well as the percentage of that group that would choose Cassava’s treatment. This is known in the industry as the drug’s Total Addressable Market. The DCF model in this analysis assumes the following about the information above:

The total pool of Alzheimer’s patients was set at 7.5 million, which is a figure based on the total estimated number of AD patients in the US by 2030, which is just over one million people higher than the current total in the US. While this number is close to 14 million patients for all of the Developed World, there is currently only a clear path to approval in the United States. While European and Japanese approval boards remain open to the possibility of approving aducanumab, for example, they have yet to give the treatment clearance.

The second assumption made was that the treatment will cost an average of $28,000 per patient annually, half of the cost for Biogen’s novel treatment. This figure was obtained based on an average of reports by B Riley, Jones Trading, and Maxim Group, 3 capital markets companies that release periodic information reports on current financial developments. The lower figure compared to Biogen’s treatment can largely be attributed to the fact that simufilam is being designed to be taken orally, whereas two of the other major treatments are injections, which have to use more costly equipment. Additionally, if the treatment ends up costing more than this, the cost assumption on the lower side may help account for patients whose treatments may be subsidized or covered by insurance, and thus who thus the drug’s full price may not be paid.

The next thing that must be estimated is the drug’s market capture, which is the percentage of AD patients in the US that would take simufilam once it is introduced to the market. Currently, there are 28 other drugs for the treatment of Alzheimer’s in phase II/III, at the same stage in the approval process as Cassava’s product. The success rate for treatments once they get to this stage, as later accounted for in the model, is around 52%. In order to simulate this competition, the model assumes that each company will capture an equal 6.7% sales share during the 5 years of peak sales in the forecast. For the first five years, the market capture percentage increases twofold from 0.41% of the market to the full 6.7%, accounting for the fact that the drug will need to be marketed when it first comes out and will have to steadily incline to its full potential as a result of people being unaware of or slightly hesitant to undergo a brand new treatment. During the peak sales period, this comes out to a total of $14 billion in sales annually for a period of five years. 

To get from sales to cash flows, a number of steps need to be taken. First, the model needs to account for all the various expenses the company will incur throughout the development of the drug. This includes things such as lab equipment, facilities costs, and other general operating expenses. The biggest portion of expenses will come from the R&D costs the company incurs to produce the drug. On average, biotech companies producing a novel treatment will spend around 25% of revenues earned on the sale of a drug on R&D alone. While it is difficult and unpredictable to forecast estimates for individual expense factors, analysts should assume that at least 30% of total sales will be expenses the company needs to pay during the process of developing the drug, which is shown in the model. Next, the model accounts for the percentage of profits that the company will actually keep after royalty considerations. This accounts for things such as marketing, distribution, and maintenance costs, as well as deals with other companies for various other tasks. For a big project such as simufilam, the company can expect to keep around 30% of the total profits, with the rest obligated to various other groups. The last thing before taxes that needs to be accounted for is the industry-specific adjustment for risk. As we know, clinical-stage biotech companies are massive gambles that often rely on one single drug or product as the lifeblood of the organization. If a drug fails, the value of the company can often go straight to zero. Therefore, it is necessary to quantify the chances that these high revenues as a result of a successful project will actually come to fruition. As stated earlier, the probability of end success for a drug moving from phase II to phase III of clinical testing is around 52%. By multiplying our calculated revenues by this percentage, we account for the fact that the company’s product could fail during one of the final stages of testing and totally tank the firm’s value. The chances of failure are statistically reduced with each checkpoint the company passes, but this always remains a possibility and thus is needed to be factored into the model. 

At this point, the future cash flows to the firm, or FCFF, are established, but there is still a final step that needs to be performed in order to adjust the projections for the future to the current day, which is to discount all future cash flows back to the present day, accounting for the time value of money. This is done by dividing the cash flow for each year by 1 plus the appropriate discount rate, or the required return on the investment for the company, to a factor of the year. The weighted average cost of capital used in this assessment was 7.2%, the midpoint figure offered by finbox.com. WACC combines factors such as a company’s cost of debt and equity to find the appropriate rate at which a company should expect a return. The model uses a ten year forecast and no terminal value, because pharma companies usually enjoy only a 10 year window of profits before patents on their developments expire. 

In the end, the model values Cassava Sciences should simufilam be successful at around $4.58 billion. This is more than a 25% increase of the company’s current market cap, and one could argue that the assumptions made by the model were even a bit conservative. It could reasonably be estimated that Cassava could capture a bigger market share than 6.7% if current expectations hold that it appears to be more effective than previous treatments, and approval in places outside the US could help the company address even more of the market for the almost 50 million AD patients worldwide. The company is currently in a good position to continue its development, with over $282 million in cash currently on its balance sheet, and a cash burn rate far lower than that number. Should positive news continue to come out through the end of this year, SAVA could prove to be a steal for those who invest in the coming weeks.