NEW YORK (TheStreet) -- Within the biotechnology sector, there are many different niches that investors can look at to generate significant returns. However, one space that has routinely been mentioned as a potential breakthrough area is stem cells. When looking at this space, investors must be careful to identify companies that not only have a strong platform, but also have the financial discipline necessary to survive and prosper in the future.
One company that is really standing out as a potential player within this space is NeoStem . Based on some recent research, it has become apparent that NeoStem has the potential to derive significant revenue from its platform.
NeoStem is a stem-cell company with three technologies for the treatment of diseases with major unmet medical needs. Investors have enjoyed a 54% return over the past two months after two important decisions were made by management.
First, on July 11, the company announced a 1:10 reverse split. Typically, investors frown upon reverse splits, but that decision appears to have created a significant momentum upswing for NeoStem.
Second, on July 23, the company issued a press release that it would begin trading on the Nasdaq on August 5. Although the company had been trading on the NYSE, the move to the NASD allows the company to gain enhanced exposure and potentially receive additional institutional investments. Plus, a Nasdaq listing appeals to investors as it allows for lower-cost trades and faster execution speeds.
With the recent 50%+ appreciation in shares, investors are likely wondering if the shares can continue heading higher. After examining the pipeline potential through a sum-of-the-parts valuation analysis, the answer appears to be "yes".
The company is pursuing three technologies that include AMR-001 (from NeoStem's subsidiary, Amorcyte), T-cell or Treg therapy (from the subsidiary, Athelos) and VSEL (very small embryonic-like stem cells) technology. The one that appears to have the most potential is Amorcyte's AMR-001 for the treatment of acute myocardial infarction.
The company has been enrolling patients in the PreSERVE AMI Phase II trial since January 2012. The goal is to complete enrollment of 160 patients by the end of 2013 and announce the final results during the summer of 2014.
Aegis Capital estimates a Net Present Value for AMR-001 to be about $250 million. I believe that the value could be even higher. The company estimates the annual market value for AMR-001 to be in the ballpark of $1.2 billion. So the $250 million is most likely on the conservative side (as it should be). That being said, NeoStem's current market capitalization is $160 million. Based on the potential of AMR-001 for acute myocardial infarction alone, the market appears to be undervaluing the company.
NeoStem is also pursuing a secondary indication. NeoStem plans to begin a Phase Ib/IIa study with regards to AMR-001 for the treatment of coronary heart failure within the next six months. Because it is in a much earlier stage, the valuation that can be placed upon this program is naturally smaller than for the above (PreSERVE) program. That being said, this indication is likely to generate at least $500 million in annual sales, if approved. I will assign a conservative probability of success at 20%, which places the valuation at about $100 million.
Another component of NeoStem's business, that needs to be taken into account, is the value of Progenitor Cell Therapy, a wholly owned subsidiary. Progenitor Cell Therapy generated about $10 million in sales for 2011 and about $14 million in sales for 2012.
I'm certainly not expecting 40% growth each year, but I believe it is reasonable to expect 10% growth. If we extrapolate that out five years, investors should expect annual revenue of about $22.5 million in 2017. By taking a 6x multiple of sales, the valuation for PCT should be at about $135 million.
One last important note: Aegis Capital assigned a value of $200 million to NeoStem's other two technologies, Athelos' Treg therapy and the VSELs. Both of these programs have immense potential but are still early on. The $200 million value could rise or fall significantly depending on the future announcements.
If we add up all the valuations for each business, the total value appears to be in the neighborhood of $685 million. Based on the current share amount, this would mean a share price of around $37. Am I expecting the share price to reach that number soon? No. But I certainly expect a more accurate valuation than $160 million. A few reasons for the mispriced value appear to be related to the risks of the stem-cell industry. This particular niche within the biotechnology world is still in its infancy. There is a lot of promise, but investors are still waiting for that proof.
With regards to NeoStem, the company still faces several trials and studies. As with all biotechs, the risk of failure is high. Even after a successful trial, the company still faces the hurdle of attaining regulatory approval.
NeoStem will also likely need to raise additional funds in the future in order to continue funding trials. As of June 30, the company had about $14.7 million in available cash. Based on the company's current monthly burn rate of about $2.7 million, this cash balance should be enough to take the company into the late spring of 2014. Hopefully the share price will continue to appreciate, so the company won't have to issue as many shares.
Despite the risks facing NeoStem, there appears to be a mispricing by the market. Even with the recent run-up, a sum-of-the-parts valuation analysis indicates that the company should be trading much higher than it currently is. I believe that by the end of the year, the gap between the real value and the current value will narrow. Investors looking for a promising biotech stock in an exciting niche may want to keep NeoStem on their radar.
At the time of publication, Meyer held no positions in stocks mentioned, although positions may change at any time.
--Written by Tom Meyer in New York
This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.