How Will Johnson & Johnson’s Ebola Investment Pay Off?

In early September, Johnson & Johnson (NYSE:JNJ) stated that it was accelerating the development of a vaccine against the Zaire strain of the Ebola Virus that has been responsible for the current outbreak in Africa. Now the company has announced that it will begin testing a vaccine by January 2015 and may be able to develop around 250,000 doses by May 2015 if the trials go well. ^[1] Johnson & Johnson is working with Bavarian Nordic, a biotechnology firm based in Denmark, to develop the Ebola vaccine. The company is investing close to $200 million to develop its vaccine, and another $187 million in licensing deals with Danish biotech firm for another version of Ebola vaccine. ^[2] Investors ought to be thinking about how this investment will pay off for Johnson & Johnson. It appears that despite the rush, there is a good chance that the company can earn positive return on this investment. However, the additive effect to its overall value will be small.

Our price estimate for Johnson & Johnson stands at $101, implying a discount of about 5% to the market price.

See our complete analysis for Johnson & Johnson

Why Treating Ebola Is Important?

Currently, there is no cure or vaccine for the Ebola virus and the fatality rates remain high. Ebola virus can be transmitted through multiple body fluids including sweat, and therefore it has been difficult for the authorities to contain its spread. While there have been many instances of the Ebola outbreak in Africa in the past, the current incidence is the worst in the recorded history, in part because it has reached urban populations. The CDC (Centers for Disease Control and Prevention) has predicted that in the worst case scenario where the disease spirals out of control, there could be 1.4 million Ebola cases by January 20th, 2015. ^[3] The CDC states that the total case count stood at 13,676 as of October 27 2014, with laboratory confirmed case counts totaling 7,606. Additionally, the number of deaths from Ebola have reached 4,910, resulting in a fatality rate of around 65%. Clearly, the efforts from health authorities have been insufficient and the shortage of personnel could make it difficult to quarantine all potential patients. The potential risk is immense and even if it doesn’t look like a profitable venture for pharmaceutical firms, someone has to develop the cure. Johnson & Johnson, Bavarian Nordic, Newlink Genetics and GlaxoSmithKline have taken initiatives in this direction.

Johnson & Johnson Will Aim For More Than $145 Million In Annual Revenues With Ebola Vaccine

The typical cost to develop a vaccine could be in the range of $200 million to $500 million. ^[4] This figure includes the vaccines that are abandoned during the development. Johnson & Johnson’s investment is not too far from this figure, which suggests that the company is spending an average amount on developing the vaccine, assuming that its efforts bear fruit and it doesn’t have to invest any further. However, the market opportunity tends to be much smaller for vaccines as compared to drugs, due to lower pricing and one-time use. Nevertheless, given that Ebola is rampant in poor African countries and pressure from various bodies to speed up vaccine development is high, we expect Johnson & Johnson to target relatively low return on investment as compared to its typical drugs.

Between 1967 and 2007, the average ROIC (return on invested capital) for pharmaceutical and biotech firms was 23.5%. ^[5] We assume that Johnson & Johnson will target a lower IRR (internal rate of return) of, let’s say, 15%. Considering an initial R&D investment of close to $387 million, the company will aim to recoup $75 million annually in profits. Considering that Johnson & Johnson has EBITDA margin of about 52% (this excludes R&D costs), we expect the company to aim for about $145 million in annual revenues. Is this achievable? To understand this, we need to look at the potential market.

To Get To $145 Million In Revenues, The Company Could Target 4.5 Million Vaccinations Annually

Ebola cases have been registered in Liberia, Sierra Leone, Guinea, Nigeria, Mali and Senegal, with the first three countries facing the brunt of it. Liberia, Sierra Leone and Guinea have a total population of little over 22 million and are still battling a rising number of Ebola cases. Whereas Nigeria, Mali and Senegal have a total population of close to 200 million and have been declared Ebola free. Assuming 100% vaccination rates in the first three countries and 40% vaccination rates in the remaining three, we get a potential market size of 100 million vaccine doses. Considering that there could be around 3 vaccines in the market next year, we estimate that these vaccine makers will collectively target around 15 million vaccinations per year. GlaxoSmithKline has already stated that it will have 1 million doses per month by the end of 2015. In such a scenario, it is plausible that J&J can target around 4.5 million vaccinations annually, which will put the price per vaccine at little over $30. This seems like a fair price and something that African governments can further subsidize to make these vaccines available for masses. Anything more expensive could deter the cause of making Africa Ebola free.

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1. Johnson & Johnson to Begin Testing Ebola Vaccine in January, The Wall Street Journal, Oct 22 2014 [↩]
2. Giving it a shot, The Economist [↩]
3. Ebola Cases Could Reach 1.4 Million Within Four Months, C.D.C. Estimates, New York Times, Sep 23 2014 [↩]
4. Assembling a Global Vaccine Development Pipeline for Infectious Diseases in the Developing World [↩]
5. Valuation: Measuring and Managing the Value of Companies, McKinsey & Company [↩]