by Travis Johnson, Stock Gumshoe | June 5, 2015 3:57 pm
I’ve got a few stocks to mention in the medical space this week — one to update that’s in my portfolio, one to confirm as a teaser pick (since folks keep asking) after several Gumshoe readers discussed it last week, and one to note as a teaser idea that’s being pushed pretty heavily (though the teaser copy is a bit out of date).
So let’s jump right on it, shall we?
And yes, dear friends, the update is about Ligand, one of the stronger-performing picks I’ve featured for the Irregulars in recent years, though it’s been a wild ride (I first suggested it almost exactly two years ago)… the “confirmation” is that Paul Mampilly at Stansberry’s Professional Speculator is indeed teasing Accuray (ARAY), and the other teaser note is that the “doctor on a chip” stock pitched by the Angel Investing folks must be Opko Health (OPK), despite the fact that the ad mostly uses numbers from last year.
Let’s go through them in reverse order. First, Angel and Opko… since that one had a big move on news yesterday. I spent a few minutes looking at this teaser earlier in the week, when it was mailed heavily, and after finding that they were teasing Opko as a $3 billion company and thus must be using old data (that was six months ago, it got close to $9 billion this week) I lost some interest.
But folks have been asking, and they just announced a substantial acquisition yesterday that took the shares down a bit, so I thought I’d take a quick look.
The spiel from Technology & Opportunity over at Angel Publishing, now edited by Jason Stutman, can be found here if you want to get the full story, but here’s the gist:
“Doctor on a Chip
“This $3 “card” will soon be available everywhere…
“And insiders expect its biotech owner to return explosive 800% gains….
“A new medical ‘card’ has just left the four-year testing phase and is about to hit the mainstream.
“This medical “card” uses a single drop of blood to test for fatal viruses, including HIV (before it becomes AIDS), cancer, hepatitis, and a variety of sexually transmitted diseases.
“The best part is, it’s much, much faster than anything we’ve seen yet.
“With traditional testing methods, you have to make an appointment with the doctor, give vials of blood, sit through lab testing, and then wait weeks or even months for results.
“But this advanced ‘card’ accurately and safely tests for deadly viruses in just 15 minutes… while you wait.
“And it’ll soon be in every doctor’s office around the globe… not to mention in remote parts of the world where it would be impossible to transport labs and traditional testing devices.”
The ad goes on for a bit, with some more clues (don’t worry, I double checked ’em), but the pitch is clearly about the Claros 1 testing device from Opko, which incorporates a small desktop (or even handheld, if you’re hand’s really big) reader and a blood collection/cassette system where you put a drop of blood on a card-sized plastic piece, it gets sucked up into some micrufluidic arrays and nanoparticle channels (I’m probably using the wrong words there — there’s some gee-whizzery to it), insert that into a cassette, and feed it into a small machine that analyses the blood and produces results. (You can see some similar photos to what’s in the ad in this Opko Diagnostics presentation, if you’re curious.)
That’s only part of Opko’s business, and still quite a small part — under Dr. Philip Frost, a well-known and well-connected name in biotech and on Wall Street, Opko was created by merging several different companies, and since then they’ve acquired small stakes in a large number of small biotech firms to go with their drug development, lab business, and their most well-known product, the prostate cancer screening tool 4KScore. 4KScore is a blood test that looks for aggressive prostate cancer that actually requires an aggressive response (as opposed to the “wait and watch” approach often used). That particular test is one that gets sent in to a lab, not one of the Claros 1 tests, in case you’re wondering.
This biotech/diagnostics conglomerate has clearly been a hot story over the past year, tripling from where the stock was late in 2014, and it looks like they’re using that higher share price to try to consolidate their position in diagnostics — yesterday they announced a deal to acquire Bio-Reference Laboratories (BRLI), a smaller lab company (market cap of about $800 million before the deal was announced). The deal would in some ways be accretive for OPK, since BRLI has much higher revenue (despite its much smaller market capitalization) and is profitable (Opko is not), but OPK investors did not seem to like it very much — either that, or they just took the opportunity to do a bit of “profit taking.” OPK dropped 16% on the news, roughly, and BRLI jumped 20%. So in the end, an agreement to acquire a $1 billion company dropped OPK’s market cap by about $1.5 billion. This will make them much more reliant on diagnostics, which isn’t quite as sexy as new pharmaceutical development but certainly is a growth area.
Of course, financially Opko currently is a bit of a mess even if you can figure out the potpourri of businesses they own (there’s a good overview in their presentation they made to an investment conference earlier this week) — this is all about the possible future, not about what they’re doing right now. Right now they’re a $8 billion company that had about $90 million in sales and something like $250 million in expenses last year, and the share count keeps going up as they acquire more businesses using their stock as currency. Unless you want to spend the time to dig into all their different businesses and try to understand their prospects in some fundamental way, which is definitely beyond what I can do in an hour or two of browsing through their financials, this is really a bet on Dr. Frost and on their general push into diagnostics, if you’re convinced that the company is clearly worth $8 billion and not $4 billion or $2 billion or $20 billion then you understand the company better than I do.
Analysts think they’ll grow revenues by more than 50% both this year and next year, and will become profitable at some point in 2016 (that was before this week’s acquisition, of course, though that probably won’t make a particularly dramatic difference)… so if you take the (fairly massive) leap of believing that the 2018 analyst estimates for this fast-changing company have any possible merit at all beyond an intellectual exercise, then OPK is currently trading at about 20 times forecasted 2018 earnings per share of a little over 80 cents.
Interested? If you don’t like it at $8 billion, would you like it if it fell back to $3 billion, where it was when the Angel Publishing folks must have originally pulled this ad together back in November or December? Think about it, and let us know if you have any wonderful brainstorms on the matter. We’re moving on…
…to Accuray (ARAY). Yes, Paul Mampilly is teasing Accuray for his new Professional Speculator newsletter over at Stansberry. This letter is a higher-end one, seems to me to be going after the same general kind of ideas as Dave Lashmet’s Stansberry Venture (and they’re both successors, sort of, to the old Phase 1 Investor newsletter that Stansberry canceled last year when they cut ties with Frank Curzio — looking for higher-risk, higher-return ideas, currently largely in biotech because that’s where the fun is). Mampilly has been the pundit behind biotech and tech-focused newsletters at Palm Beach and at Agora (FDA Trader), so he doubtless knows that when it comes to pitching ideas it’s as important to be dramatic and exciting as it is to be right. The newsletter record, over time, will have to be pretty good if he’s going to keep subscribers — but the teaser ads just have to be compelling enough to get people on board.
I won’t run through the whole ad or all of the clues for you, a group of Gumshoe readers jumped in and solved this one and ran through a lot of the ad starting about two weeks ago and you can see that discussion here. Accuray makes and sells the CyberKnife targeted radiation “robot” — which effectively uses precise positioning to bombard a tumor from several directions without the radiation bleeding over very much into the surrounding tissue.
Mampilly says he’s been waiting seven years for the opportunity to pick this stock — which is believable, because ARAY has been a perennial investor disappointment for almost that long as they’ve been trying to build a decent-size installed base of their machines and build some kind of momentum. They were teased many times as the “next Intuitive Surgical” and the next wave of robotic surgery back in 2007, 2008 and 2009, when the stock was falling (along with all other stocks in 2008, to be fair) from the teens down to $5 or so… and it just never took hold and got critical mass of CyberKnife sales, so the stock has languished in the $4-6 range for most of the last seven years. When Mampilly says that he’s been waiting for this moment, I don’t know if the moment is that the stock jumped to $9 and started to show a little promise a couple months ago, or that the stock got crushed when it disappointed (again) last time they announced and the stock dropped to the current $6ish. Or if he’s just convinced that their distribution deals with some big hospital groups will mean that they really star to get meaningfully large orders.
I found ARAY pretty interesting back when it was a new public company back in 2007, though the stock was in a downtrend most of the time back then as well, and I might have even speculated on it myself at some point many years ago — though I haven’t paid any attention at all to it in at least five years. They did what was anticipated to be a transformative acquisition when they bought TomoTherapy (which makes another radiation machine) back in 2011, with lots of talk in the subsequent quarters (like this) about how that would allow Accuray to return to profitability (they had been barely profitable before that, at least some of the time).
As you can see by looking back at their financials, that hasn’t happened — they have not had a profitable quarter since the fourth quarter of 2010, when they earned seven cents a share. You’d expect a company that depends on sales of major capital equipment to be lumpy, but “lumpy” without an underlying growth trend is worrisome. These radiation machines ain’t cheap — a hospital has to hit up a lot of big donors and maybe think about building a new wing with someone’s name on it to buy a $5 million CyberKnife… and the lesson from Intuitive Surgical’s Da Vinci (which sold guys on the fact that their prostatectomy would give them a better chance of maintaining sexual function and staying out of diapers) is that if patients don’t demand the big new expensive machine and make hospitals compete for their surgical visit, hospitals won’t buy it. And incidentally, the Da Vinci costs less than half of what the CyberKnife does and has more possible applications, which is probably part of why they did achieve critical mass and get that large installed base that made them an important part of the surgical landscape.
The CyberKnife, as far as I can tell, hasn’t distinguished itself as different enough from the competing radiation machines sold by Varian (VAR) and the major medical device makers (like GE and Siemens, among others) to get a critical mass of patients demanding CyberKnife treatment — and to further make sure that we’re not going back and making that Da Vinci comparison again, Da Vinci succeeded in part because they had no competition. There were no other generalist surgical robotics companies (well, there was one — but Intuitive Surgical bought them out very early). There are lot of other companies who make radiation delivery machines of various types, and Accuray is a small fish in many ways — Varian is nearly a pure play on radiation oncology, and they’re a profitable $8 billion company (Accuray has a market cap now of about $400 million).
Over the last ten quarters, Accuray’s sales have bounced around between $310 million and $380 million, with no real growth trend or consistency that I can see — so betting big on ARAY really coming into its own as a self-sustaining and profitable company means you have to be betting on a fundamental turn in their growth prospects. I don’t see it, but Paul Mampilly has very likely looked at the company in far more detail than I have and he does see something worth speculating on. Sound good to you? It’s your money, so make your own call — but do let us know what you think, ARAY has been baffling for eight years… a great story, a cool product that sounds fantastic, and terrible execution when it comes to actually selling machines and making money. Maybe it’s about to turn, maybe not.
Now to check in on Ligand Pharmaceuticals (LGND)
Ligand has been on a tear again in recent weeks, setting new highs. The recent bumps have been from earnings, and from more recent new guidance from the company that looks impressive largely because of the strength of their accounting gains from the spinoff/IPO of Viking Therapeutics.
That’s mostly a non-issue, though it might amount to something some day and it does help to get some development costs off of Ligand’s income statement (which is their goal in almost all things and the reason I was first interested in the stock — “let other people pay for development and take the risks” is the rallying cry of royalty companies in all sectors, whether it’s Altius Minerals in mining or Ligand in pharmaceuticals).
So what’s the story now? Can we justify this stock trading in the $90s, or is this just crazy valuations brought on by biotech enthusiasm? I’m personally comfortable with my position, but I’ve also sold portions of my LGND holdings twice along the way to cut my “at risk” exposure to this very volatile stock.
Here’s where they are now: Analysts expect Ligand to earn about $2 in 2015 (the company’s forecast is $2.14-2.18, or $3.50 if you include the non-cash gain from the Viking IPO, which was the reason for their recent increase in the forecast and shouldn’t be enough to make you buy the stock), and $3 in 2016. The market cap now is about $1.8 billion, the shares are right near $90. That’s a forward PE of about 30 and a trailing twelve months PE of a little under 60. A rich valuation that expects growth, to be sure, but not an outlandish one if the model is really scaleable and they can get a few more meaningful royalties going over the next few years (when we first suggested LGND they were a sub-billion-dollar company that had just become profitable, with a forward PE of about 30 and a trailing PE of about 80).
If analysts are correct about that growth rate, which depends largely on a few approved drugs generating royalties (and, they no doubt hope, a little “secret sauce” from milestone payments for their currently-being-researched partnered compounds that are in early phases of development), then it’s still perfectly reasonable to pay this much. That said, I wouldn’t be comfortable making it a huge portion of a portfolio because of the reliance on a couple products (Promactis and Kyprolis) and the significant volatility — my LGND holdings, after the stock tripled and accounting for the fact that I’ve sold about 30-40% of my shares over the past couple years, are about a 2.5% holding in my individual stock portfolio. (To give some perspective, my largest stock holdings like Apple, Berkshire Hathaway and Altius are generally 8-10% holdings as a percentage of that portfolio… and that portfolio itself is less than half of my full personal portfolio, which is about 50-60% actively managed and indexed funds and similar vehicles and not in individual stocks).
Over the past two years, on a rolling “trailing twelve months” basis, revenues have risen by about 30% (in total, not annualized) and both R&D and SG&A expenses have risen by about 20-25% — so they are getting some leverage from their royalty model, but not a dramatic amount just yet. Their one possibly substantial clinical trial that they’re running themselves, still just a Phase 1 trial (for a diabetes drug, LGD-6972), is still not costing them a lot of money, and they’ll probably partner it with someone else if it continues to show promise, so this is not a company that’s planning to spend a billion dollars to usher a new drug through development — that’s something they leave to others.
Ligand indicates that they see revenue hitting about $82 million this year, and accelerating in growth to hit about $150 million in 2017. They should be able to hit a net profit margin of at least 18% from those numbers IF the business is as genuinely scaleable as it appears to be, and if they can really keep expense growth at a substantially lower number than revenue growth, so that would mean $27 million in profit that year. If we add back in the non-cash stuff that they exclude from their earnings numbers, like the (pretty steep, frankly) stock compensation, then that could be an adjusted earnings number of above $40 million (that part’s a fairly wild guess). If margins are better, which is possible if a lot of that growth comes from Promacta and Kyprolis sales growth and royalty rate increases (increasing growth from those two royalties doesn’t cost them anything, and it brings a little bit of extra leverage because they earn higher rates whens sales grow past set thresholds), it could obviously be more.
That would mean that the stock is now trading at about 45X 2017 possible earnings, using my assumptions, so clearly the analysts envision either that the non-cash items will be higher or the margins will be better, with a more dramatic bump up as they scale. That’s possible, for sure, but it’s also possible that their drugs will falter or sales will plateau for Promacta (by far their most important royalty stream), so it’s worth keeping an eye on some more conservative possibilities to keep your greed in check.
There has been a pretty heavy level of activity over the last several quarters, which included issuing debt (partly to fight off a short attack from a small hedge fund about a year ago), making more deals and dealing with more Captisol orders (Captisol is their drug-delivery formulation that improves solubility, and the source of many of their royalty and potential royalty deals), and spinning out their Viking Therapeutics subsidiary into a separate company (which went public, somewhat underwhelmingly, in late April).
The upside potential is that some of their mostly unknown early stage drugs that are being pursued right now by partners, with roughly 120 “shots on goal” as they put it, could be dramatically successful and create big new revenue drivers in the long run — though over the next couple years there’s nothing in their pipeline that seems likely to actually hit the market to broad acclaim, they’ve generally had the potential for 3-6 new royalties to come onstream as revenue producers each year, but most of them are not potential blockbuster-size drugs (as some think Kyprolis can be) or huge-percentage royalties (like Promacta). The biggest revenue drivers over the near term will remain Kyprolis, which could boost results if their market increases with additional approvals, as seems likely as they get second-line approval this year and try to get approval as a first-line treatment in multiple myeloma over the next few years, and Promacta if they’re right and Novartis pushes the drug more heavily in their oncology division and their additional indications in pediatrics and other areas help to turn it into a blockbuster over time — they also expect rapid growth from Duavee, their hot flash drug with Pfizer that has been approved for about a year, but that’s a massive market and they’re still only getting 12,000 prescriptions a month and the royalty rate is probably still below 1% on that one (it ranges from 0.5-2.5% based on revenue levels).
The “big six” pipeline drugs for Ligand that they think have substantial possibilities are still mostly several years away from potential approval, though CE-Melphalan is expected to get approved in October and that has a 20% royalty rate (but it’s an orphan drug, too, so the size of the market is perhaps not overwhelming — this is a chemotherapy agent that they give to patients before stem cell treatment for multiple myeloma). They also expect Phase 3 data this year from Melinta for their Delafloxacin IV, which is in the often-hot “drug resistant antibiotics” area — it’s hard to judge how excited the market might be about Delafloxacin, because Melinta is still private, but that’s a potential 2016 launch according to Ligand (royalty rate not disclosed). Other than that, we’re looking at earlier-stage studies, or catalysts further out into the future for any big shakeups — with the possible exception of their diabetes glucagon receptor antagonist LGD-6972, which should have Phase 1b data available in the next several months. They would dearly love to make a deal on that drug, I expect, and get someone else to do the larger, more expensive trials once they’ve got a little bit of data on it, so that counts as another potential catalyst — a LGD-6972 deal that would hopefully include substantial milestone payments and a strong royalty rate.
So the stock has shot up by about 70% just this year, but the story has not really changed meaningfully in the last six months — they are continuing to invest in potential royalties (like their $4 million investment in Selexis to get royalties on 15 programs that they think have the potential for $40 million in peak annual royalties eventually), they are continuing to cross their fingers that Promacta and Kyprolis keep the sales increases coming, and they’re expecting that at least some of their other partnered “shots on goal” will hit the net.
There’s still plenty to be concerned about with Ligand — they are aggressive in rewarding their management (top management comes from an investment background, not a medical one), they do a lot of adjusting to make their earnings appear better (perhaps fairly, but still adjustments — and the cash numbers aren’t as good as their earnings numbers), and they are dependent on their partners to push drugs through so they are, to a large degree, passive participants. If I hadn’t already cut the size of my position, I would be taking some portion of my profits here — but as it is, I’ll hold and let it ride… the stock is expensive thanks to the biotech bull market, but they do have a real underlying growth story, and a great business model with some critical mass that has a decent chance of paying off nicely even from this valuation.
There are absolutely no guarantees with Ligand — a reasonable person could argue that the uncertainty means we should only be paying 15X 2017 earnings estimates instead of 30X, in which case the stock would be $45 instead of $90, but reasonable people differ. If I didn’t own the stock, I would wait for the almost inevitable dips when short-sellers criticize them in the future, or when one of their lesser programs disappoints (don’t buy if Promacta or Kyprolis gets genuinely bad news and revenues for either of those drugs are expected to start falling instead of rising — that would be a real disaster), but for now I’m still holding and think that’s a reasonable choice.
Your mileage may vary, of course — so what do you think? Anything light your fire about Ligand, Accuray or Opko? Have thoughts to share? Let us know with a comment below.
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