Fundamental Analysis Discussion Only (IXC Thread), page-18

@JabraD

I think you're a little mistaken in how clinical stage biotechnology stocks are valued with reference to TAM.

Biotechnology stocks are valued based on a risk adjusted DCF model, called a "RNPV" approach.

This means that the potential future FCF is being discounted first by a probability of success %, as its accounting for the risk of the drug clinical trial process, THEN by the cost of capital (discount rate),

The FCF is where the TAM and other drugs come in (aka, competition in the market). You then need to judge the TAM and see how much of that is taken by competing drugs in the space/estimate your drugs market penetration/peak sales.

For example: If you have a $1B TAM, with no existing drugs, and an expectation of a peak market penetration of 40%, then you have $400M in revenues per year. Say you're running at a 25% margins, after all other required capital for WC/CAPEX, thats ~$100M in FCF.

But youre in a clinical trial process with significant risk, and this future FCF of $100M isnt accounting for any of that risk of Phase III failure.

Therefore, you must risk adjust it at the probability of success. For Phase III, the peer neurology drug candidate is ~56% likely to pass phase III, and ~50% likely to from successful Phase II to FDA approval.

So you risk adjusted that $100M in FCF, through a 50% chance likelihood of success = accounts for $50M in FCF in fair value today.

If you have a close look at the MST equity research report for IXC, that is precisely how it is being done, resulting in a $3.38 fair value.

Now what happens if you have a secondary indication? Well, you calculate the TAM, the competitors, the potential market penetration and peak sales, the year of launch, the future FCF... then you risk adjust it by the probability of success. But it isnt a phase III, instead its a phase I, and the neurology peer phase I -> approval probability of success is just 8.4%.

So you account for just 8.4% of the future FCF from that indication to todays fair value.

So, fair value today based on MST financials report is $3.38, at 50% risk adjusted, now if the phase III is a success, there is a 100% likelihood of that future FCF, therefore the fair value goes from $3.38 to say, $6.76, over night.

Hope that helps.