August 24, 2007

Now is the time for Vanda

Two weeks ago, I laid out the situation at Vanda Pharmaceuticals (VNDA). Since then, not much has changed, but I have continued to review the company and I am more confident with giving it a buy recommendation.

One reason is that a couple of institutional investors are betting big on the stock. In a regulatory filing, it was announced that Galleon Management LP has raised its stake in VNDA to 10.01%. That is up from a 6.9% stake in April. Galleon is the third big buyer of Vanda's shares. Westfield Capital Management also has a 10.01% stake as of August 9. Also, Oppenheimer Funds holds a 19.18% stake of the company. According to Yahoo! Finance, institutions own about 81% of Vanda. This number would worry me if Vanda was an established company with profits and positive cash flow, etc. Since Vanda is a small biotech, this number actually is pretty reassuring to me. I look at it as a vote of confidence for the company, especially with Galleon and Westfield increasing their stakes recently. With small biotechs, any sign of confidence that the company has a good chance of FDA approval should make investors happy.

My other reason for being more confident in Vanda is my fair value calculations. There are many factors that move a stocks, but I still like the idea of a theoretical fair value. For Vanda, I think the company is currently fairly valued based on its pipeline potential, but I think it is undervalued based on the good chances that iloperdione and VSF-173 are about to move to a new stage. I calculated a fair value for each drug in its pipeline using my rNPV Template (which you can download and try).
I try to be very conservative in my calculations, and in that I found Vanda's pipeline to be worth about $10.71 right now, with about $7 coming from iloperidone. You might be saying, "that's five dollars under the current price, how can you be confident about that!?!" Well, because if I'm not so overly conservative, I think the stock is worth right at $15, with iloperidone worth more like $11.50.
Furthermore, I think the stock is worth around $21 by the end of the year, based on the company's expectations for movement through the cycle with the new drug application of iloperidone, and potential movement to Phase III for VSF-173 in the treatment of excessive sleepiness. Once iloperidone moves to the NDA stage, I believe its worth to the company becomes about $16.50, which is based on the idea that the drug has a greater chance of FDA approval. (I explain the theory of rNPV further here)

To conclude today's post, I believe the timing is pretty good for Vanda. However, I do caution the risks involved, as with all small biotechs. VNDA has pulled back to nearly $15 and there are several catalysts out there that can move the stock in the fourth quarter. However, I still believe that the company needs to secure a partner for iloperidone. If that does not happen, the full value of Vanda's pipeline may never be realized. With that said, I do believe Vanda will eventually find a partner because the schizophrenia market is huge ($16 billion) and Vanda has a pretty viable candidate to compete in the space. Friedman Billings Ramsey analyst David Amsellem thinks that iloperidone can achieve $308 million in sales by 2012 and that would be a good pick up at a decent price for a bigger biotech looking to get into the area.
Based on Vanda's potential fourth quarter catalysts, the institutional buying, the idea that Vanda will find a partner, and my fair value estimates I am placing a speculative buy recommendation on VNDA, with a price target of $21 by the end of 2007.

Disclosure: I currently own shares of VNDA, however I did not at the time of writing this article



Theirs a time and place for everything.