cst valuation spreadsheet

CST VALUATION SPREADSHEET.


These are the notes to accompany the latest iteration of my CST Valuation Spreadsheet. You can download the spreadsheet at members.optusnet.com.au/~omni1/CSTVAL.xls and these notes at members.coptusnet.com.au/~omni1/CSTVALNOTES.txt It is absolutely essential that you do read these notes. I say this because I don't want anybody to misunderstand what the spreadsheet is doing or draw any false conclusions from it.

As always, I have absolutely no problem with you copying, modifying, sharing or whatever with the spreadsheet. Of course I offer no warranty as to the accuracy, validity etc of the spreadsheet. On a personal note, my reasons for doing this work are twofold. Firstly, I have an investment in CST and my ongoing work on this as we become more and more informed as to the future prospects of CST is a part of managing this investment. The second reason is "self education". I continue to learn more and more about taming this sharemarket beast and putting this together in a more or less formal manner helps me to clarify my own thoughts. I have found that writing my thoughts in a presentation as if addressed to others (even when it is not) works well for me.

WHAT'S IT ALL ABOUT?

What I have tried to do with this spreadsheet is to gather all available facts together to draw a financial projection of the future of Cellestis. Of course nobody can predict the future but what I am trying to do is to make some sensible guesses. The spreadsheet does both a PE Valuation and a DCF (Discounted Cashflow) Valuation. I am personally more interested in the DCF Valuation that the PE Valuation. I very roughly equate PE valuations with trading and DCF valuations with investing. Thus, within reason, a PE valuation may, in fact, give a closer approximation of the share price, wheras the DCF valuation gives a better view of the actual value of the business as an investment. Of course the differentiation is not as clean cut as that. The actual PE value that may be used to set a price on the shares can vary widely over time. The current PE is often a factor of the feeling for the future growth of the company.

Still with me?

There is nearly always a difference between the share price and the actual value of the business. People like Warren Buffet use this to their advantage by knowing the value of the business and buying it at a discount. I am personally more interested in the value of the business than the share price. Hence that is where my Spreadsheet is directed. I guess in a perfect world we might expect that, over time, the share price and the business value might converge. We don't however live in a perfect world.

DOWN TO IT

The first section of the spreadsheet attempts to calculate the revenue of the company at various sales quantities. (between 1 million and 20 million tests). At the end of this first section I do a simple PE valuation using the assumption that these sales are recurring. This is where a PE valuation becomes very inaccurate. Remembering that the PE at any point in time will reflect a certain amount of anticipation. For example, when CST hits sales of 2m tests per year, the market might well anticipate that this is just the beginning of big things to come and price the shares with a high PE. On the other hand, if the company achieves 15m tests per year and sales volumes appear to be flattening then the market would be likely to price at a much lower PE.

The second part of the spreadsheet attempts to perform a DCF valuation, using the Nett Profit figures from the first section. The DCF valuation allows you to put in whatever you feel is a reasonable sales future and calculate a DCF valuation. More on this later.

There are many, many assumptions in this spreadsheet and the following is my reasoning behind the numbers that I have put in. Of course you may disagree and prefer to run with different figures.

SELLING PRICE

I have used a selling price of $US15 per test. This is the price that we have been told that QFT-Gold will sell for. WE know that the (cheaper) QFT-PPD test is to be discontinued so this has not been factored in. At this stage, we do not know the price of the QFT-Gold In-Tube test (though I believe it will be higher) so I have simple assumed that all sales are QFT-Gold. It is conceivable that the company might discount the price for large sales so you may wish to consider using a lower selling price. I have not anywhere in the spreadsheet expicitly provided for the sales of additional products that the company will be releasing.

$A/$USD CONVERSION

I can't predict the future exchange rate (otherwise I might be a currency speculator) so I have used an approximation of the recent rate - 70c

GROSS MARGIN

The company have never revealed what the Gross Margin will be - apparently it is Commercial in Confidence. The only guidance we have here was a statement made at a recent presentation. At this presentation they said something along the lines of "We cannot expect the 90+% Gross Margins common to Drug Comanies. Typically, diagnostic products are sold on a Gross Margin of between 60% and 90%, we will be targeting that range" I have used the low end of this range - 60%

It is worthwhile pointing out that any change to this Gross Margin has a very large impact on the final DCF valuation (try 70%).

OVERHEAD

Here, I am really guessing. We might perhaps get some guidance from the current "cash burn" of the company. As the company is making negligable sales at the moment then it is not unreasonable to assume that the cash burn approximates the costs of keeping the doors open (ie overhead). The style of the business plus comments from the Directors tend to indicate that as sales scale up the overheads won't blow out. As an example, the company have stated that they believe that they will be able to operate their entire US operation with a staff of eight. Of course we can assume that as the profits roll in some dicretionary expenditures may cut in (perhaps the Directors will upgrade from coach to business class). I have started the overheads at $2.5m (approx current cash burn) and increased them modestly as sales volumes increase. Perhaps I have been a little on the low side?

CSL ROYALTIES

According to the Prospectus, Cellestis pay a royalty to CSL of 5% of the nett sales for the life of the Quantiferon Patents. Additionally, CST pay a 2.5% "know-how" licence fee to CSL for a period of ten years. A total of 7.5%.

SSI ROYALTIES

The Quantiferon-Gold (and In-Tube) product uses antigens licensed from SSI. According to the company announcement the amount of this royalties is between 8% and 15.5%. Whilst it has not been detailed, it is reasonable assumption that the royalty percentage decreases as sales volume increase (though it could be the other way?). I have chosen a figure at the high end - 15%

DISTRIBUTOR.

Here I am really guessing. The company have stated that the distributor margin comes out of the selling price (ie it is not added on). CST will not be paying any distributor margin for sales in the US because they are doing their own distribution through a wholly owned subsidiary. Of course, the company will have to bear the costs of logistics (storage, freight, invoicing etc). I have used an all up figure to cover sales in all territories of 20% but as I said, this is a guess.

TAX RATE

Assuming that all profits will be repatriated to Australia, the company tax rate is 30%. The company does currently have some tax credits carried forward but I have not bothered to factor this in.

PE (PRICE/EARNINGS RATIO)

I have simply used a figure of 20 as this is close to the current PE of the Austrlalian biotech index. As I stated previously, this PE ratio will swing widely as sales commence and begin growing. It is not at all unusual for a young dynamic company to have a PE of 50 or even greater during it's speculative or growth phase.

DCF VALUATION

This is not the place to conduct a detalied discourse on DCF valuations. However, in explaining what I have done there are a few points that I would like to raise.

DISCOUNT RATE

In previous iterations of this spreadsheet I have attempted to incorporate a "risk factor" into the Discount Rate used. After due consideration, I have come around to Warren Buffets way of thinking on this. He says that it is impossible to do this as you are just making up an arbitrary figure. Should it be 15%, 25%? How do you decide which? Warren Buffett approaches this differently. He says that he wouldnt have got this far anyway if he didnt have faith in all the other important aspects of the company (management, franchise etc). So his approach is to discount future earnings by the bond rate to reach a valuation and then to buy the company (or shares) at a discount to this value. He calls this "buying dollar notes for forty cents" or "buying with a margin of safety".

What is the bond rate? Well I have never seen a bond in my life but if I have it right then it is not dissimilar to a Term Deposit. Basically it is a 100% (or nearly) safe investment that pays you a dividend (interest) each year. Warren Buffet usually uses the 10 year bond rate. I looked this up last week and the current 10 year bond rate (US) is a bit under 5%. So this would be a bit like a 10 year Term Deposit with a bank that sends you a cheque for the interest each year and then at the end of the 10 years, gives you back your initial investment.

If you want to be totally pedantic about a DCF valuation then there are a few other fine tuning issues that should probably be thought about. These are issues around dividend rate (ie return of profits to you) and re-investment of such. Frankly, I havnt dealt with these thoroughly in my own mind yet so have not taken them into account in my spreadsheet. For current purposes, given all the assumptions that we have made, it is probably not important.

SALES

I have performed my DCF valuation on a ten year sales plan. I believe that my figures are quite conservative, overall. You may disagree, of course.

FINAL VALUE (CELL M33)

This is an interesting one, and one that I have not yet appied myself fully to at this time. Of course, you could continue the DCF valuation out for more than ten years, if you felt that was usefull. I have decided to truncate this at ten years. So the question remains, how much would you receive back as capital, if you were to sell out at that point? (analogous to receiving your Term Deposit pricipal back). What I have decided to do is to take the simple approach. I have put in the 10th year earnings and priced the shares at a PE of 20. I can see a valid argument, however, for pricing the shares at this time at a lower PE (say 10?). This would more closely reflect flat future sales.

FINALLY

Okay, that's about it.

Peace
Fforrest