There hasn’t been a new drug approved for lupus since before we put a man on the moon. So today, we are witnessing one small step for a biopharma company but a giant leap for medicine. Shares of Human Genome Sciences are up more than 200%. Look at that, 213% on huge volume, while its lupus drug partner, GlacoSmithKline is up as well.” — CNBC’s Power Lunch 7/20/2009

There is a lot of excitement for Human Genome Sciences (HGSI) today after a late stage trial conducted by the company and the FDA met its objectives in treatment of lupus patients.  As the quote from CNBC says, this is one of the most hopeful signs for treatment of lupus in 50 years.  The drug will still need to complete one more similar study before going before regulators, but today’s announcement is a certainly a step in the right direction.  The stock has more than tripled from its closing price on Friday and is now trading for around $11 per share with less than two hours left in the trading day.

The new drug is called Benlysta, and it has the potential to be a blockbuster with Lazard Capital Markets estimating that there is $2.9 billion market opportunity.  With so few advancements in the treatment of lupus in the past this drug would certainly capture a large portion of that market share.  Interestingly, Lazard analyst Terence Flynn thought that the trial had a an 85% chance of failure in a note prior to the studies results, but he said if it did succeed the stock would pass $10.  When it becomes available the drug will be marketed in a deal with pharmaceutical giant GlaxoSmithKline (GSK), which has given birth to rumors that GSK might just buy Human Genome Sciences.  There has been no word from Glaxo on a possible deal, but there is nothing in their agreement that prevents them from buying shares in the smaller HGSI.

Our valuation methodology has a hard time with small biopharma companies like HGSI because they are often traded based on potential instead of fundamentals.  For example, Human Genome Sciences has traded for between 92x and 246x times revenue per share because the company hasn’t had much revenue until recently, as sales are supposed to more than quadruple in fiscal 2009.  Even with the better sales results and improving earnings couldn’t save the company from falling to well below one dollar just four months ago.  This is not the normal behavior of most stocks we follow, but small drug companies often do act this way.  So, taken with a grain of salt, our valuation methodology rates HGSI as Undervalued.  However, we are not recommending chasing today’s breakout performance, although it does greatly enhance the company’s earnings potential and attractiveness as a takeover target.  HGSI still has a fair amount of debt that is coming do in the next few years, so investors are placing a lot of faith in Benlysta to help pay down those obligations.  So far, it looks like that trust is being rewarded in a big way.