Comparing PLX And Celgegen Corporation

Ticker: (PLX)
Country & Exchange: United States; NYSE
Recommendation: HOLD

Ticker: (CELG)
Country & Exchange: United States; Nasdaq
Recommendation: BUY

Finance Information System
Professor Zhang
Research Project

Overview of Biotechnology Sector

This equity research project will be dedicated to valuing Protalix BioTherapeutics Inc.(PLX), and Celgene Corp. (CELG). Both companies compete in the Biotechnology sector, within the healthcare industry. Both PLX and CELG are publicly traded on the NYSE and Nasdaq, respectively. Before sharing my due diligence on each company, I will first explain and examine the industry and sentiment of the Biotechnology sector. The Biotechnology industry emerged in the 1970’s; as a result of the enhancement in heal care technology, which could provide synthetic ingredients with extraordinary benefits for the healthcare industry. These advanced
companies combine living organisms or parts of living organisms, which seek to improve, modify or produce products for very specific application. There is a tremendous amount of controversy surrounding many biotechnology stocks, due to the application of their genetic engineering of products. These scientists working for these companies are effectively able to transfer genetic material from one organism to another, which poses many benefits and risks. A wide variety of living organisms are now being routinely altered to produce results, which have been described as nearly limitless. As a result, the industry is under intense scrutiny and regulation by the EPA and FDA. This particular sector is known to be highly volatile and tremendously unpredictable due to the experimental nature of these businesses. The Biotechnology industry serves industry’s including medical, environmental, industrial and agricultural. In respect to the medical industry, companies such as PLX and CELG operate through the creation of recombinant DNA, through combing DNA sequences that are artificial. Through these cellular alterations, biotechnology companies discover and create treatments for a range of diseases such as cancer, AIDS and diabetes. The profitability of the sector is contingent based on the commercial success of their products. Businesses that undertake this challenge are highly research intensive and demand large amounts of capital. Once a company is able to gain traction with its products, it mainly funds its growth and operations with cash flow. However, a company can easily exhaust is debt and equity funding and many times turns to external funding from large institutional investors. Many biotech companies will partner with large pharmaceutical companies or investment entities where a mutual arrangement is in accord based on the success of the products. The success of many of these companies is very contingent to economic conditions, where high economic stress can paralyze production and deal making. However, new discoveries of treatment for fatal diseases are able to foster great opportunities for growth a value for stakeholders. Investors must be willing to take steep risks and endure volatile results in the short term. Additionally, biotech firms remain unprofitable for a lengthy amount of time before a drug can yield any results in the market. This is also true in that the earning potential of innovative drugs once successful, can produce immense profits and remain successful for years to come. Companies can gain a strong competitive advantage through exclusive patents for as up to 12 years of protection, guaranteeing investors lucrative returns for an extensive period of time. Biotech companies must first be approved by the U.S. Food and Drug Administration (FDA), before a product can be commercially released. A staggering statistic show that out of 5,000 companies, only about 5 are given approval for release of a drug. Even after the approval and release of a drug, products are subject to ongoing studies to monitor side effects. Recalls are not uncommon and can tarnish a company’s reputation as well as shut down its business all together. Due to the risks of solvency for a firm, biotech managers must carefully design capital structure that puts their cash to best use. Their primary goal is to achieve out sized growth and success, in order to fully fund research and development as well as marketing. A large source of capital is also invested in order to gain approval for their drugs for optimal production. Marketing and distribution require substantial funding, as well as potential acquisitions for larger companies. As a result, debt retirements, stock buybacks, and dividends are the least desirable uses of capital. Due to the nature of the biotechnology firms, investments are generally undertaken through high risk, high reward investors, such as hedge funds, that are willing to remain patient in the event that a company produces significant returns.
Overview of Protalix BioTherapeutics Inc.(PLX) Protalix BioTherapeutics Inc. (PLX), is a pharmaceutical biotech company that is currently revolutionizing the development and production of recombinant therapeutic proteins, which is undertaken through its patented ProCellEx protein expression system. The company is headquartered in Carmiel, Israel and was founded in 1993. PLX primarily targets large established pharmaceutical companies and markets that are eager for innovative drugs for distribution. PLX’s commercial focus is gauged to the treatment of diseases such as Gaucher and Fabry disease. Gaucher disease is a genetic disorder where a fatty substance accumulates in certain organs causing bruising, fatigue, anemia and the enlargement of liver and spleen. Fabry disease is a dysfunctional disease that causes severe cataracts, strokes and heart failure. Their main product is called Elelyso/Upylso which treats Type 1 Gaucher disease.
Financial Ratio Summary & Market Performance: Turning to their business and finance, PLX become a public company in December of 2006 as the result of a reverse merger. The company sold over 10 million shares in their public offering, and is currently traded on the NYSE. The stock has had a very volatile performance since its inception. At its all time high in 2007, PLX was trading at over $50 a share and has now settled in a $4-$6 range. Here is a chart of PLX’s most current financial ratio’s from Barrons.com:
PLX Financial Ratio Summary: The valuation’s for PLX show that the company is not yet profitable, and is cash flow negative. PLX is still in its growth phase of reinvesting all capital back into research and development. The company has very high cost of goods sold, as well as selling and general administrative expenses in order to achieve its goals for creating successful products. PLx’s P/E multiple is negative because they have no earning as of yet. Turning to their efficiency ratio’s, PLX’s Total Asset Turnover is a more relevant measure for the company. Total asset turnover is equal to the revenue of a company, divided by the total assets. PLX’s total asset turnover is 0.12, a very low ratio for a company in biotechnology. This proves that in respect to their assets base such as their labs, factories and equity, that their revenue is far smaller when compared to them. PLX’s liquidity is difficult to quantity due to the distortion of capital structure and negative profitability. However, PLX’s current ratio indicates strong short-term liquidity, indicating that the business is able to operate to serve its current needs. The current ratio is calculated by company’s current assets, divided by their current liabilities. This assesses how well a company a company can pay back its short-term obligations. PLX employs very little short term debt, where the majority of its funding comes from equity issuance as well as long term debt. As such, their current ratio being at 3.67, represents that the company can continue their business cycle in waiting for revenue to come in. PLX’s profitability looks horrible to an investor, such that it’s nearly all in the red. This is common for many young biotech stocks that are working hard to gain traction for their products. A more important metric to analyze for a company such as this would be their gross margin. This is calculated by revenue minus cost of goods sold, divided by their revenue. PLX is at 52.85% gross margin, which is on the lower end of its industry peer average of about 70%. Most biotech companies should high a higher gross margin, indicating a higher retention rate on each dollar of sales. PLX’s capital structure is highly levered, indicated by a very high total debt to total capital ratio of 167.19. Debt-to-capital ratio is defined as a company’s debt, divided by shareholders’ equity plus debt. It is a measurement of a company’s financial leverage. Last year of 2013, PLX issued over $67 million of long-term bonds in order to fund operations for its business. Due to their already low stock price, the company chose to rather issue debt then equity, as such to not dilute their stock price further. As a result, PLX is highly levered, far more levered then most of its industry peers. If PLX is unable to achieve high revenue and profits, the company could very well become insolvent, and default on its long-term obligations. This shows how risky the company is from a long-term perspective.
PLX’s WACC, FCF Model and Valuation: In turning to my fundamental analysis of PLX, I had came to a target weighted average cost of capital (WACC), of 6%, nearly inline with Bloomberg’s estimate of 7%. PLX has a beta of 0.69. Beta is a measure of relative sensitivity of a stock to a benchmark index market, such as the Standard & Poor’s (S&P). Being that PLX’s beta is less then 1, it indicates that the company is less sensitive to overall market movements (this beta was taking from Bloomberg). I used the current 10-year risk free rate of 2.61% when calculating PLX’s WACC. I calculated the S&P’s expected return to be approximately 10%, with a required rate of return of 7.71%. PLX has over 93 million shares outstanding, and a current price-per-share of $4.04. Their market value is approximately $377.8 million and they have a total debt of $178 million. PLX’s cost of debt is roughly 4%, and has no effective tax rate since the company is yet to be profitable. Given this calculations represented by my data in excel, I arrived at a target WACC of 6%. When turning to my discounted cash flow analysis of PLX, I used $3 million for my free cash flow. This number is very abstract, due to my anticipation of when the company will finally become cash flow positive. As of year end 2013, PLX was cash flow negative of $32.5 million, but the prior year was only negative $1.4 million. The company went into more negative territory from its large long-term debt issuance and increased investment in R&D. I find the long-term bond issuance a positive sign, in that the company is projected a bright future ahead, and just needs the liquidity not to maintain its business. PLX is also very optimistic about the launch of their product Elelyso, due to patients switching brands to a lower cost and no co-payment through Pfizer. I feel with this signals that the company will become cash flow positive at a prudent rate of $3 million. My estimate for growth rate years 1-5 is 20%, with a growth rate of 6% after year 5. I am taking a more conservative approach, due to the volatility of the company and its early stages still. My recommendation for PLX is a HOLD.
Through my analysis of the FCF model, I have PLX valued at $5.52, nearly a dollar difference in its current price. I am not very optimistic of PLX due to its intense competition from companies like Vertex Pharmaceuticals, Celgene and Alexion Pharmaceuticals, who are more attractive investments are have a greater market share. PLX is also limited to only two products at this point, to which if one does not continue success it can prove further risk to the company. I feel that PLX is appropriately valued, and its current conditions are already reflected into its stock price. My future forecast for PLX is somewhat stable, to where the company will grow modestly over the long term and perhaps see reasonable profits based on their current situation. The company is extremely limited to capital as well as a diversity of products which make it difficult to invest in. Despite the company appearing to be very cheap, the equity seems to be somewhat stagnate in value, and future success of the company seems very
skeptical.

Barron’s Analyst Ratings of PLX:

Celgene Corp. Overview: Celgene Corp.(CELG), is a global biotechnology company that engages in the development and commercialization of cutting edge treatments for cancer and immune-inflammatory diseases. The company is headquartered nearby in Summit, NJ. Their major products are Thalmid, which treats Erythema nodosum, a disease that cures lumps and nodules on skin. Another main product they produce is called Revlimid, which treats mantle cell lymphoma, which is an aggressive rare cancer of the lymph nodes.

Financial Ratio Summary & Market Performance: Celgene(CELG) had its initial public offering in 1987. An interesting statistic provided by Barron’s indicates that if you invested $5,000 in CELG in its IPO in 1987, your investment would be worth $881,582. The company is a blue chip biotech stock, that has achieved tremendous success since its inception, and generated considerable earnings to share holders. Here is a current chart of their financial ratios:

Turning to their valuation metrics, CELG has a P/E multiple of 44.14x, indicating that the market is anticipating very high earning to come. A P/E multiple is the price of the stock, divided by its earning per share (EPS). In CELG case, their P/E is at a premium to their peers, where most of them trade in an average range of 12x. Their enterprise value to EBITDA is also very at 24.21x. Enterprise value to EBITDA or EV/EBITDA is a metric that looks at the total value of a company compared to their profitability or cash flow, in which EBITDA is a proxy for cash flow. The market is valuing CELG at a premium, suggesting that the stock is highly valued. In reference to their efficiency ratios, CELG total asset turnover is higher then PLX’s, at 0.52, indicating more a higher percentage of revenue to assets. When analyzing CELG’s liquid, we see that both PLX and CELG are highly liquid companies. CELG has a slightly higher current ratio of 3.88. Again the current ratio is a company’s current assets divided by its current liabilities, CELG represents a company with strong short-term liquidity, to where its current assets far more out way its current liabilities. Profitability is CELG’s strongest and most important category. CELG has a gross margin of 90.70, indicating that it retains 90 cents for every dollar of revenue generated. CELG has one of the highest gross margins of any kind of company. It has a very comfortable return on equity of 25.7. Return on equity or (ROE) is a measure of net income divided by shareholders equity. In this case, shareholders see that they are getting a strong return on equity in comparison to what a company brings in, and to what it owns. When analyzing CELG capital structure, we see that their total debt to total capital is reasonable at 45.89. CELG is also very levered, indicating a capital structure that operates around debt funding, however no near as levered as PLX. CELG has also been using its cash flow to repurchase common and preferred shares, which indicates also why their P/E multiple is much higher. The leverage ratio is not scary for investors, since the company has such high and predictable revenue streams to cover obligations. The fewer shares there are outstanding, the higher the value of the shares owned by equity holders. Because the cost of debt is so cheap right now, CELG can take advantage of this cheaper funding, while also driving up the price of their stock. Here is a chart of their 5-year trending cash flow statement showing the buybacks:

Celgene’s WACC, FCF and Valuation: In turning to the fundamental analysis of CELG, I arrived at a target WACC of 10%, nearly inline with Bloomberg’s estimate of 11%. CELG has an equity beta of 1.08, indicating a slightly higher correlation to sensitivity in the market. Any number over 1 for beta would indicate much higher sensitivity to market swings then companies under a value of 1(CELG’s beta was taking from Bloomberg database). I also used the 10-year US risk free rate, which was currently trading at 2.61%, a benchmark for all risk free assessment. I calculated an expected 10% return in the S&P, with a required rate of return at 10.59%. CELG has over 400 million shares outstanding, which at the current time of valuation were trading at $148.80 a share. CELG has a market value of over 59 billion, one of the largest biotech companies in the world. Their total debt stands at roughly $5 billion, with a low cost of debt at 2.65%. CELG effective tax rate, as represented by Bloomberg is 13.21%. As represented by my calculations in the provided excel spread sheet, my target WACC arrived at 10%. When turning to my discounted cash flow analysis of CELG, I used the current free cash flow of CELG of $2.27 billion, as indicated by Bloomberg. CELG is highly cash flow positive and is generated a tremendous amount of capital for a global company. I factored in a 15% growth rate for their years 1-5, by averaging growth rates historically, as well as using my own intuition for the company. I used a 5% growth rate anticipated after year 5, which valued CELG at $168.97 a share. This price is about 12% more then what it was currently trading at when valued. Due to this discovery, I am initiating a buy on the company. Shares have also fallen about 6% in the recent month, due to lowered earnings release for the company’s expenses in R&D. I find feel situations like this are a perfect buying opportunity. I am very bullish on the future of CELG, due to the success of their numerous products, as well as global market share. CELG has also had numerous recent news reports on approval of many of its drugs from the FDA. In March, CELG won approval for Otezla, which treats arthritis associated with skin condition psoriasis. This condition appears in about 30% of the 125 million people worldwide who have psoriasis. Due to the nature of an aging population as well as recent healthcare reform, I feel strongly that this is a recipe for success for CELG for distribution of its product. Analysts expect Otezla to produce about $1.1 billion in sales in in 2017(according to Bloomberg). More support for my buy would also be from the recent sell-off on the Nasdaq, particularly in the biotechnology sector. I am the type of investor that looks for things that are on sale, or at as much of a discount as possible. The Nasdaq Biotechnology Index is down a little more then 20% as of the end of April, within a category like this, many great values can be made, as opposed to buying into a rally. When there is fear in the market, it usually always corresponds to opportunity. Here is also a graph of analysts rating provided by Barron’s and Market Watch on CELG:

Conclusions: The intent of my research was to be able to compare a very large and well-established biotechnology company, to a relatively newer and less well known one that is in its development stage. Both companies are in the same industry; however trade at extremely different prices. PLX trades at $4 a share, while CELG trades at over $140 a share. I wanted to make a more unique comparison of two companies that wouldn’t relativity be compared by size and revenue, and conclude if there are better values in more small cap, unknown companies to large cap established companies. I found the biotechnology industry very interesting because of how volatile it is as well as being more difficult to understand when it comes to the products many of these companies make. Investors have made incredible profits off biotech as well as loosing fortunes in the matter of a few days. These companies are very interesting because of their consumer-addicted market, as well as the swings in stock prices due to good or bad press. They are always subject to clinical studies, so even when a biotech company has success, it can be taken away from reports of severe side effects and fatal problems from drug prescription. In the end I would definitely invest my money into Celgene Corp., due to their proven business model and global presence. However, investments in companies such as theses are not set it and forget it companies, they must constantly be monitored to protect your investment.