Pain management is a huge market in the medical world, as you’re no doubt aware — and buckets of money are pouring down on the many, many little biotech stocks who are trying to develop new pain medications, or to tweak existing medications to make them safer or less likely to be abused. So it’s no surprise that the promise of a “tiny device that could end all unnecessary pain” caught the eye of quite a few Gumshoe readers recently when Byron King started sending out this ad for his Military-Tech Alert.

The basic premise of the newsletter, is currently being sold for $1,500 a year, is that the military is spending billions on new technologies — through DARPA and other ventures — and that some of those technologies will be hugely lucrative for the private firms that get DARPA R&D funding, making investors in those companies rich as the next wave of military-launched technology hits the “real world” … much like previous DARPA projects like the Internet and GPS created hugely profitable civilian enterprises.

Here’s how he puts it in the ad:

“It’s only a matter of time before military breakthroughs hit the mainstream.

“When they do, a small fortune can turn into a big one.

“Look what happened with Siri, the talking assistant that started out as military speech recognition technology back in the 1970s. Now it’s built into every iPhone.

“Or Google Maps, Skype, and Windows. Satellites and digital cameras. Microwave ovens. Plastic surgery. All are worth fortunes as products. And all owe their start to the military.

“Even Kleenex tissues first came out as filters in World War I gas masks.

“It’s only a matter of time before this miracle medical device that I’ll show you makes it out into the general public too. Along with all the valuable drug-free solutions.”

So, putting aside the fact that there’s not necessarily a straight line to be drawn between “very cool technology” and “who eventually ends up making money from it,” what’s the next wave that Byron King sees coming?

He thinks it will be the new “Brain Initiative” from the Federal Government that’s somewhat comparable to the human genome mapping project — a push to better understand (and image) the brain and all its pathways. He says that the government “poured $3.8 billion” into the DNA mapping initiative, though it was eventually Craig Venter and Celera Genomics (not without controversy) that put it over the final hurdle… more from King:

“When you tally it up, the genome breakthrough has — so far — added an extra $800 billion back into the American economy. That’s a $211 return on every $1 invested.

“Some of that work was done by publicly traded companies that got paid for research.

“And a lot of the wealth went right back to their investors.

“With soaring biotech stocks like Amgen, Celgene, and Biogen Idec.”

I’m not sure where the $800 billion value estimate comes from, but certainly the mapping of the human genome, and more recent advances like faster and cheaper genetic sequencing, have had a huge financial impact — the problem, of course, is that even a soothsayer would have probably had some trouble identifying the two or three companies that would be the largest eventual beneficiaries of that scientific advancement back in 2000 when the genome map was first published, but, well, if we weren’t trying to predict the future we wouldn’t be interested in investing in individual stocks, right?

Those three big examples, which will be among the few biotech stocks that sound familiar to most people who aren’t active biotech investors, have all done quite well since the last push of genome mapping in 2000, of course — Celgene is up almost 4,000%, Biogen about 800%, and Amgen about 150% (The S&P is up about 50% since then, incidentally). If you go back a bit further to enjoy some of the late-90s runup in tech and biotech (and in stocks in general), the numbers are more dramatic. Over the last five years, none of those stocks have beaten the uber-bull run in the Biotech index (as represented by the BIB ETF), which is up about 1,200% in just five years.

But I digress (again). So presumably Byron King has picked out the early winner of this brain/pain research, right?

Well, he does go into the early stage research being funded by DARPA, which is where we get that “tiny device that could end all unnecessary pain” pitch…

“We’re calling it the ‘Superhero Circuit’

“DARPA’s code name for this project is ‘ElectRX.’

“But we’ve got a different name for it — we call it the ‘Superhero Circuit.’

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“And not just because, as they wrote in Discovery News,

‘[These] tiny devices could give humans self-healing superpowers…’

“But also because — unlike many drugs — this medical device won’t bypass your body’s own natural system of immunity and recovery… it amplifies what’s already there.

“Doctors call this natural healing process ‘neuromodulation.’

“When it works, your body trades billions of nerve impulses between brain and body, instructing your organs to respond to pain, fix damage, and even rebuild body tissue.”

OK, so that’s the goal. Neuromodulation exists and is FDA approved in some devices, but we’re still quite a ways from the little implantable wire-sized doohickeys that are dreamt up by DARPA scientists — most of the devices are pacemaker-size, I gather, and have to be worn (and wired into your body) or surgically implanted, and they’re targeting a few specific diseases and symptoms.

The big dream is curing depression, ending pain, stimulating recovery from traumatic injury, ending obesity through appetite suppression, ending Alzheimer’s Disease… lots of big-money targets in that list, to be sure.

And then, the million-dollar question:

“A device that could do that could ultimately carve away billions of dollars from Big Pharma… radically cut back on surgical costs… and replace all kinds of medical equipment sales.

“Which companies could see the first wave of cash?”

That sends us, finally, to the individual stocks Byron King is teasing — and you thought we’d never get there!

“Miracle Device Move #1: According to MIT, This Is One of the ‘Smartest Companies’ on the Planet

“This first company already dominates in neuromodulation sensor technology. Unlike competitors, they’re also making huge strides in shrinking down sensors.

“That makes them a near-perfect match for the Pentagon’s big plan.

“They’re also leading the way in memory restoration.

“And this first company already has DARPA’s attention.

“In fact, they’re already using DARPA money — in a partnership with the University of Pennsylvania — to develop brain stimulating technology that could help restore memory….

“Thousands of patients are also using this company’s brain stimulation technology for other brain-based disorders, like taming the tremors caused by Parkinson’s disease.

“Chronic pain patients use this same company’s handheld device to dial down pain, another one of their expert areas that’s attracting Pentagon attention.”

Well, if you’re looking at neuromodulation this is probably as close to a “blue chip” as you’re going to get, Thinkolator sez he’s touting megacap medical device maker Medtronic (MDT), which has been on a really nice run for the last three years or so (after languishing for a decade or more). You may well know Medtronic for their stents, pacemakers and similar implanted devices, so it makes sense that they’re involved in lots of other eletrical-stimulation and computer controlled implants and devices — including neuromodulation thingamabobs, insulin pumps for diabetics, etc.

Their deep brain stimulation (DBS) device is used to treat some Parkinson’s symptoms, and they have other stimulation products and technologies as well — you can get a bit of an overview of their business here, and of the neuromodulation division here. Neuromodulation isn’t their largest business, but it is a growth area and it’s already bringing in almost $2 billion in sales, similar in size to their Diabetes business. Dwarfed by their cardiac businesses, but still big enough to move the needle.

Medtronic’s fiscal year just ended a few weeks ago, and they’ll be releasing their results on May 19 — I don’t know if there’s anything surprising to come out of that announcement, they’ve been keeping analysts happy for the last several quarters with “beats” on their earnings, but I usually prefer not to make big investments in companies just a couple days before they report… if you end up being enthralled with MDT after doing your research, it might make sense to nibble your way in.

Will you want to? Well, that’s up to you — but I think you’ll have to price in some optimism about potential new products or breakthroughs if you want to justify Medtronic’s current valuation. Right now it trades at about 25X earnings (18X next year’s expected earnings), and analysts only think they’ll be able to grow earnings at 4-6% a year. That doesn’t sound terribly appealing, but it could be that analysts are being too cautious, perhaps in part because of their strong memories of Medtronic’s many challenges of the past decade or so in the highly competitive and litigious stent market. I don’t really know. Their balance sheet is fine, they pay a small but growing dividend, they are certainly a leader in many of their businesses — in my mind it’s really just a question of whether you think they can grow earnings fast enough to justify this valuation. They are a leader in the neuromodulation space, and they’re doing a lot of research (including some with DARPA funding, I’m sure), but that’s pretty early stage R&D that’s not going to make much of an impact on a $100 billion company in the next year.

How about the other stocks touted by King?

“Miracle Device Move #2: This Next Takeover Target May Have a Powerful Drug-Free Treatment for Epilepsy and Depression

“This second neuromodulation company is much smaller.

“For years, that made them a target for one buyout deal after another.

“And for years, they’ve turned those deals down.

“But there’s just been some big news…

“Instead of a takeover, this second company recently pulled off a surprise merger.

“They’ve combined forces with a major Italian company in a deal that could rapidly open up their access to world markets… and radically slash their corporate tax bill.”

This one is Cyberonics (CYBX), which is much more of a “pure play” on neuromodulation. Their approved product is a vagus nerve stimulation (VNS) implanted device, which is approved for epilepsy and depression in some cases.

And yes, they did (in February) announce a planned merger with the Italian company Sorin, a pacemaker and cardiac surgery company… so they’ll become more diversified, and also, well, in some ways more like a smaller version of Medtronic.

OK, that’s not fair — they’ll still be dramatically tinier than the big medical device companies, with a combined market cap of just a few billion dollars, and they’ll still be far more nimble than Medtronic. They say in the merger presentation that they expect this deal to be accretive to earnings after next year, and both companies are small competitors in huge markets so I don’t expect there will be much trouble getting regulatory approval for the merger.

Still, companies with world-changing breakthroughs that are on the verge of massive growth aren’t generally obsessed with getting synergies to cut overhead or reduce corporate taxes. It’s a little hard to get excited about cost synergies and optimizing sales networks when you’ve got a taste for breakthrough innovation products built up in your head, but these look like decent and profitable companies that are growing earnings pretty well already and might build a worthwhile corporate base together — the risk, I suppose, is that they’ll lose whatever innovation edge they have to companies like Medtronic and the other huge players, but the good news is that they’re small enough to do meaningful work in niche markets.

Cyberonics has been trading at a valuation pretty similar to Medtronic’s, so that might be an opportunity because even before the Sorin deal CYBX should have been on pace to grow earnings several times faster than MDT — but it is also, of course, substantially riskier because they are (or were) a one-product company, they don’t have a stable of established, market-leading products like Medtronic’s stents and pacemakers that provide a fairly predictable income stream.

And… one more?

“Miracle Device Move #3: This Multi-Billion-Dollar Pentagon Play Is Hiding Right Under Your Nose

“You might never spot this third move as a ‘hidden’ Pentagon play.

“For one, it’s a household-name stock with a giant footprint.

“Its reach extends into 150 different markets and an endless line of products, most of which have nothing to do with the military or defense.

“So why did this same non-military contractor… recently sign a $14 million deal with Pentagon insiders? Simple. Because the new front isn’t just on the battlefield.

“It’s on our computers, in our public spaces, even floating invisibly in the air we breathe.

“When the Pentagon came knocking at this third company’s lab door, it was to get them to develop a whole new way to ramp up the production of self-replicating vaccines.”

Might need a few more clues on this one…

“This third company’s latest breakthrough is a special kind of ‘smart pill.’

“It’s small, about the size of an aspirin.

“But it’s also made out of resistant silicon.

“When you swallow it, it broadcasts back key health signals like your blood pressure, heart rate, and temperature. It also sends alerts to your doctor if something suddenly goes wrong.

“It doesn’t need batteries — it runs on the fluid in your gut.”

And then a wee bit more for the Thinkolator…

“This company also has its own ‘hidden’ $1 billion startup-tech investment fund…

“… on top of everything they do that makes owning their shares worthwhile, this third company also has a secret $1 billion venture fund.

“They use it to quietly partner with smaller developers. That includes neuromodulation device makers like the ones that could also soak up investment from the Pentagon.

“One of these companies makes a device that can shut down a migraine.

“Another has a device that monitors hearts.

“In all, you’re getting a stake in over 40 different biotech and medical developers… just by picking up this third company’s already valuable shares.

“What’s more, you’ll get part of the stake in a $100 million deal that this same company just locked into with a major wireless company… for what some call ‘digital medicine.’

“In short, the partnership will develop a whole new way to collect, transmit, and store reams of health data. This will be absolutely crucial going forward, with these neuro-devices.”

Well, it’s not the old “pill cam” folks who were touted and teased a few years ago, because they (that was Given Imaging) were bought by Covidien… which has recently agreed to be bought by, you guessed it, Medtronic.

No, this time we’re being teased about Swiss giant Novartis (NVS)… which did indeed get a $14 million R&D grant from DARPA several years ago to help develop a RNA self-replicating vaccine platform (they’ve put a lot of their own money into new vaccine technologies too, of course — this is a truly gigantic global company with a $250 billion market cap, and $14 million is about equivalent to the amount of profit Novartis will generate over the next ten hours or so. This is one of the largest companies in the world, milling around with Johnson and Johnson and Roche at the top of the list of “biggest healthcare stocks.”

And yes, they do also have a billion+ dollar venture fund that includes lots of interesting little companies — including a little company called Autonomic that’s selling an implanted device that can help with headaches, and they do have a partnership deal with Proteus to license their smart pill technology (mostly designed to track where and when drugs are being delivered to the gut, and what conditions are there at the time)… etc. etc.

None of which matters very much to Novartis’ bottom line — but, like all mega-caps, they have to keep investing in new ideas, speculating, and doing sometimes unusual R&D projects to be prepared for the next great breakthroughs. In the present, Novartis is like most of the big pharma companies — highly diversified, but somewhat challenged by a few large patent expirations in branded drugs… and financially indomitable, but also juggling a development pipeline that includes a few new drugs expected to be approved every year, plus a handful of new indications for or variations on existing drugs. They’re not as dividend-focused as Pfizer and Merck, nor, arguably, are they as aggressive at investing in growth through new drugs or acquisitions as Bristol Myers or Actavis (those are just a few examples), but they do pay an annual dividend that has grown nicely over time, and they have managed to generally grow earnings nicely most years.

Most big pharma stocks that are dividend-focused trade at pretty steep premiums to their growth rate, with price/earnings/growth (PEG) ratios of sometimes 4-6 or so — Novartis looks a bit more reasonable, with a PEG ratio of about 2.5 (meaning the PE ratio is about 2.5 times as large as the expected earnings growth rate — doesn’t mean anything by itself, but that’s a common shorthand metric for valuing companies that are growing at different rates, some folks think PEG ratios under 1 are possible bargains and those over 2 or 3 are indications that you might be overpaying).

I did own Novartis for a while several years ago, largely because it was kind of like owning a healthcare ETF — but more recently I’ve decided to actually diversify and use funds, letting others manage my pharma and biotech holdings for a variety of reasons, so I don’t own any of these individually now. For what it’s worth, over the past two years Cyberonics and Novartis have trailed the broad healthcare sector (as represented by the Health Care Select Sector SPDR ETF, ticker XLV), and Medtronic is within a whisker of that average performance (of course, MDT is also a top-ten component of the XLV ETF).

Will Novartis, Medtronic and Cyberonics do better than other medical stocks at profiting from the next wave of brain research, per Byron King? I dunno about that, and I suspect any impact from more brain research funding from DARPA and the other Federal programs will take many years to percolate into the real economy, but they’re all decent companies with real financials and marketed products. If you’ve got an opinion on whether any of these stocks (or their competitors) are appealing for those or other reasons, feel free to shout them out with a comment below — thanks for reading!