Vernalis Plc - Reading Between the Lines
Vernalis PLC - LON:VER
July Market Update Analysis
Simpvestor previously published an in-depth report on Vernalis Plc in advance of the company's previous interim report. To read the Simpvestor Report on Vernalis please click here:
Vernalis Plc - Company Report, February 2017
Vernalis Plc recently released an upbeat market update ahead of its Annual Report in September. VER has made several assertions as to sales volume growth and smaller operating loss. The update, however, raises more questions than it answers:
- If revenues are ahead of “current market expectations”, what are the market expectations?
- What is the “consensus” if operating loss is meant to be “smaller than consensus”?
- Why has the Tuzistra US sales force been brought in house when less than six months previous in its interim report VER stated the sales team was performing “strongly”?
- Given Moxatag faces material patent expiry in 2020, why is there not greater urgency in bringing the drug back to production? Does VER think investors should be content with the lack of progress on this?
- CCP-07 was refused FDA approval in May. More than two months on, why has VER not formulated a path forward for the drug? Again, why does Vernalis think investors should be content with the lack of progress?
The latter three questions are only answerable by Vernalis itself and it will be telling to see what the Annual Report has to say on these matters. The first two questions on the other hand, relate to sales and operating loss which investors are able to analyse to a degree.
Vernalis Plc Revenues
Revenues are expected to be ahead of current market expectations. This of course leads to the question of: what are the market expectations?
VER generates revenue from two sources: milestone receipts derived from developing new products and sales of those products once approved. According to the 27 July RNS, the majority of revenue for FY 2017 is attributable to milestone receipts. Vernalis should receive $5 million in milestone receipts from Corvus and Servier.
VER asserts there has been a 200% increase since the interim period in Tuzistra sales with a total of 35,000 prescriptions in the second half of the year. This sales volume may generate up to £2 million revenue. No revenue was derived from Moxatag as Vernalis continues its search for a manufacturer. Interestingly the update made no mention of Frovatriptan which had generated £1.5 million revenue in the first half of FY 2017 – one may infer the patent expiry in December 2016 has had a material and detrimental impact on sales. Put all this together with the interim revenue of £5.6 million, revenues for FY 2017 may well fall short of the £12 million VER achieved the previous financial year.
Vernalis Plc Operating Loss
VER states the operating loss is expected to be “smaller than consensus”. So, what is the consensus? Or even, whose consensus? In FY 2016, VER posted a £26.2 million loss, it also forecasted a £27.2 million loss for FY 2017. So will the operating loss be less than the forecast or less than another measure now referred to as “the consensus”?
Vernalis Cash Position
The company’s cash position is expected to be £61 million, down from £84 million at June 2016 and £74 million at December 2016. VER has drawn down £23 million pounds cash reserves in the 2017 financial year.
Vernalis Costs
There are other contributing factors, including the huge marketing budget. Marketing expenses made up the single largest cost on VER’s P&L for 2016. An outlay £20.5 million resulted in less than £4 million in sales revenue – for every £5 spent on marketing, VER generated £1 in sales. There was no noticeable improvement in this ratio at the interim stage: VER spent £13.3 million on marketing products for what looks to be about £2.4 million sales revenue. Should the interim trend continue through the full year, marketing costs will be in excess of £25 million generating sales revenue of what looks to be less than £5 million. It seems obvious Vernalis needs to address this issue, marketing costs running so far ahead of revenue will quickly eat up what cash reserves Vernalis is sat on.
With R&D and administrative expenses on track to be similar to last financial year, two other main contributing factors to the operating loss will be cost of sales – which VER asserts are lower this financial year – and the favourable USD:GBP exchange rate.
Add all this together with £11 million interim loss and £23 million draw down on cash reserves, it is entirely possible Vernalis will post a greater loss than the £27 million forecasted – perhaps even in excess of £30 million. One wonders whether even at this level, the operating loss would still be “smaller than consensus”.
A Note on Vernalis Plc Brokers Ratings
More than half a dozen brokers have weighed in with their opinions in the past several months. Most of them have quoted VER as a “Buy”, “Add” or “Hold” with targets ranging 40p to 138p. At the time of writing, the share price was at 18p. Below is a table showing some of the ratings history on Vernalis from Panmure Gordon and Cantor Fitzgerald.
Had you heeded Panmure Gordon and Cantor Fitzgerald in February 2016 and invested say £1000 when both issued “Buy” ratings your investment would now be worth only £300.
Vernalis seems to be one of those equities where, for whatever reason, brokers have called it completely wrong. Perhaps it is understandable, after all this is a Plc which has a good history, patents in place, projects in the pipeline and a foreign exchange bonus – on the surface Vernalis Plc seems ripe for success. Perhaps the brokers need to dig under the surface to better understand why the market has downgraded the stock despite their collective thumbs ups.
Panmure and Cantor (amongst others) have already been made to look a bit silly. Perhaps VER will deliver share price growth in the future, though that will be scant consolation for long time holders. Perhaps recently initiated Numis will be more thorough in their research and come to more rational ratings and targets.
No doubt we will find out in the coming weeks as brokers release their updated ratings.
Thoughts on September’s Final Results
The cause for concern is Vernalis' operating loss may widen to unexpected levels forcing the company to deplete cash reserves at an alarming rate.
The fundamental problem Vernalis faces will be laid bare in the results: this time last year Tuzistra XR was going to be Vernalis Plc’s flagship product, the biggest amongst a portfolio of products. Fast forward to now and there is zero revenue from Moxatag and negligible revenue from Frovatriptan while CCP-07 has been refused FDA approval leaving Tuzistra XR as VER's' only revenue generating product – for now and the foreseeable future. Vernalis has over £40 million of costs annually, for it to rely on one product generating barely £3 million annually and a handful of milestone receipts is not a healthy situation.
Vernalis has also delayed a $3 million payment to Tris Pharma, citing the collaborative CCP-07 project’s failure to gain FDA approval. Similar to the recent and ill-fated transaction with Pragma Pharma over Moxatag, it is not unreasonable to assume the $3 million owed to Tris will be paid in full through the course of the following financial year.
CCP-08 is still under review by the FDA, another refusal from the agency would not be catastrophic but certainly damaging. On the other hand, an FDA approval would not be "transformational" either. However, should CCP-08 receive approval it would be unsurprising to see the Vernalis Annual Report lean heavily on the product's future potential. Word of caution: it would take considerable time to bring CCP-08 to market, let alone generate profits. Should the current revenues and losses continue unabated, Vernalis risks burning through its considerable cash reserves before any new product is brought to market.
