Vertex Pharmaceuticals’ Valuations Suffer from Continued Losses

Vertex Pharmaceuticals valuation

Vertex Pharmaceuticals (VRTX) has traded at EV-to-EBIT (enterprise value to earnings before interest and tax) multiples of 11.7x–47.6x, a significantly large range due to the company posting significant losses after 2012.

Vertex Pharmaceuticals’ Valuations Suffer from Continued Losses

The above graph shows that in the second quarter of 2015, Vertex Pharmaceuticals was trading at EV-EBIT multiples lower than peers Regeneron (REGN) and Alexion Pharmaceuticals (ALXN) but higher than AbbVie (ABBV).

Relative valuation

The value of a biotechnology company depends on the commercial success of its existing drug portfolio as well as the expected success of the company’s research programs. So discounted cash flow (or DCF) and real option valuation is used by professionals to value a biotechnology company. However, both DCF and real option require several inputs that have to be estimated. Error in a single input can lead to excessively wrong results.

Instead, relative valuation can be used to give an approximate estimate of the value attributed by the market to the company compared to its peers in the biotechnology industry.

Vertex Pharmaceuticals’ fundamentals

Vertex Pharmaceuticals has been registering losses since 2012. So EV-EBIT multiples are being used instead of PE (price-to-earnings) multiples for valuing Vertex Pharmaceuticals. As losses continue to mount, the company has witnessed a significant decline in valuation multiples.

In July 2015, Vertex Pharmaceuticals’ new drug, Okrambi, was approved by the FDA (U.S. Food and Drug Administration). In case this drug and the drug Kalydeco manage to earn revenues in excess of total expenses, the company will witness a rise in valuations.

Vertex Pharmaceuticals is also involved in several other cystic fibrosis–related research programs. The company’s future valuation multiples also depend significantly on the commercial success of these programs.

Investors can reduce exposure to Vertex Pharmaceuticals’ low valuations and still participate in the future upside potential by investing in the iShares Nasdaq Biotechnology ETF (IBB). Vertex Pharmaceuticals accounts for 4.24% of IBB’s total holdings.