Valuing emerging biotech or healthcare companies exclusively based on past performance is like valuing an MBA prospect by little league performance. From developing a blockbuster product (good) to product recalls (bad), revenue can take off in any direction for healthcare. At the same time, my research has shown that the positives outweigh the negatives with a strong margin of safety. Thus, the industry, as a whole, appears to be trading well below intrinsic value - an opinion that is shared by the Russell 1000 Value Index Fund, whose 2nd largest holding is in healthcare.
By innovating around unmet clinical needs, healthcare can maintain strong free cash flow that dwarfs past performance well into that future. Accordingly, the industry should be valued based on future fundamentals, intellectual property, and catalysts while accounting for risk. Opko Health (OPK), for example, has favorable risk/reward that is not reflected in past financial statements. After all, development on a Phase 3 candidate registers as just a cash flow loss. By contrast, Eli Lilly (LLY) has a lack of catalysts to make up for exclusivity losses - its past revenue figures may exaggerate future ones.
Opko's favorable risk/reward stems from its diversification in a series of catalysts ranging from Alzheimer's diagnostic technology to STD-treatments, emerging market penetration, and blood testing, among others - all of which can generate hundreds of millions, if not above a billion, of dollars in revenue. Not everyone of these products may be successes (though positive clinical trials and stock market reactions suggest otherwise); but, when strung together, they offer more than an adequate margin of safety to reward an investment. Here's why:
Opko's recent 45% investment in an Israeli producer of a hepatitis B vaccine, called Sci-B-Vac, targets an unmet need and is backed by solid IP protection, favorable clinical trials, and large inelastic demand. In fact, clinical trials have been so favorable that Sci-B-Vac has demonstrated an enhanced antibody response in populations that elicited little to no response for conventional hepatitis B vaccines. The vaccine has even indicated efficacy in terms of inducing rapid seroprotection for treating chronic hepatitis B. With Sci-B-Vac receiving market authorizations in an increasing amount of countries, the fundamentals are pointing up.
How valuable is the vaccine? The World Health Organization estimates that one-third of the global population has been infected by hepatitis B virus (HBV)--400 million of which have chronic conditions. The chronic patients are at a high risk of developing lethal forms of liver cancer, so the demand for prevention is high. While there are commercially available treatments for HBV, a vaccine is the only effective answer. And Sci-B-Vac has shown that it is highly immunogenic and effective at low doses and 98% of vaccinated individuals have achieved protection after just 3 injections. Continued academic research behind the breakthrough is likely to cause Opko to further appreciate.
In addition to being a pharmaceutical and vaccine developer, Opko also provides diagnostics. This marks a noted contrast with Abbott Laboratories (ABT), which earlier decided to split into a research-based pharmaceutical company and a diversified medical products company. Abbott's decision will separate Humira from other lines and appears to have been supported by the market. The arthritis treatment is actually on track to become the world's top-selling medicine with more than $9B in sales this year. By 2016, Humira will peak at around $11.8B in sales - around $1.2B short of Lipitor's peak. As competition looms, however, Humira is a risky asset that is best left separate from Abbott's assets in diagnostics. For Opko, however, having the two divisions under one name is optimal giving the emerging-nature of its business.
Claros is Opko's proprietary blood testing technology that is groundbreaking in its ability to transition care from the laboratory to the bedside. As healthcare costs rise, supplier demand for efficient clinical workflow and improved customer experience rises accordingly. Fortunately, Claros has shown that it can safely produce quality lab results in just 10 minutes with minimal training. According to the company's billionaire Chairman, Dr. Phillip Frost, Claros is "the hardware part of the game". There are 30 million PSAs done each year with an average $30 reimbursement. Opko's four tests would imply at least a $3.6B market.
Diagnostic for medical illnesses and especially neurodegenerative diseases require early intervention, because in Alzheimer's and Parkinson's, for example, brain tissue can be lost quickly with deleterious effects. Opko's Alzheimer's diagnostic technology addresses this by delivering results cost-effectively and quickly. The test has been so successful that Bristol-Myers (BMY) signed a deal with the Israeli healthcare firm for continued development.
Then there is rolapitant, which helps prevent chemotherapy-induced nausea and vomiting ("CINV"), which a reported 90% of cancer patients suffer from. The double-blind Phase III trial is under way and, if Phase II results are of any indication, the results are likely to be favorable. In the Phase II trail, patients experienced strong five-day activity in CINV prevention in just one dose. This catalyst is further complemented by Opko's acquisition of Chilean drug maker ALS Distribuidora Limitado. By penetrating into emerging markets, Opko has opened itself up to multiple cross-selling opportunities.
There is also one key firm to the equation that is worth mentioning: Teva Pharmaceutical (TEVA). Frost is also the Chairman of this company that, in my view, is significantly undervalued. Analysts find that the company is struggling against generics and, hence, in need of catalysts. Towards addressing that concern, Frost brought on Jeremy Levin as President & Chief Executive Officer Designate. Levin was a former executive of Bristol-Myers that was in charge of implementing the pharma giant's "string of pearls" strategy in acquiring a series of catalysts. I believe that Levin will take a similar strategy at Teva.
Much of Frost's investments are in Israeli BioPharma, and Teva is the country's largest pharmaceutical company. Opko may be valued at just a fraction of Teva, but its local proximity to Teva and multi-billion dollar opportunities offer considerable cross-selling opportunities. Teva has access to large patient populations that could benefit from early diagnostics and treatments & prevention for unmet conditions. Ultimately, Opko's value ought to be based on these future opportunities.
Disclaimer: The distributor of this research report, Gould Partners, is not a licensed investment adviser or broker dealer. We are a consultant to a third-party representing Opko and have been commissioned five hundred dollars for independent research. Investors are cautioned to perform their own due diligence as information contained within this report has been derived from public sources and cannot be guaranteed by us to be fully accurate. Always discuss investments with a licensed professional before making any financial decision. Statements made herein are often "forward-looking statements" as defined under Section 27A of the Securities Act of 1933, Section 21E of the Securities Act of 1934, and the Private Securities Litigation Reform Act of 1995. Since these statements are uncertain, actual results may be materially different from those expected.
