Description

Biotechnology General (BTGC) $6.80

Despite the name, BTGC more closely resembles a specialty pharmaceutical company that a typical biotech in that it has a broad lineup of eight approved niche products and has been strongly profitable on a cash flow basis more or less for the last five years. The company is not profitable on a trailing twelve month GAAP basis due to an acquisition that closed in March of 2001. BTGC is headquartered in Iselin, NJ, but does have an R&D center and manufacturing facilities in Rehovot, Israel.

At a recent price of $6.80, it is my opinion that BTGC is one of the best values in the biotech/pharma sector right now, and maybe the best in a long time. As of 6/30, BTGC had over $110 million in cash and securities and only $20 million in debt. BTGC had revenues of $85 million, operating income of $20 million, and produced $16.6 million in operating cash flow for all of 2000. Already in the first half of 2001, revenues are up to $61.9 million, operating profit of about $20 million, and cash from ops of about $21 million.

There are many potential drivers for future growth and lots of positive news flow.

The biggest driver in the near term is Oxandrin, the company's best-selling drug. After sales of $40 million, $28 million, and $32 million in 1998, 1999, and 2000, BTGC has benefited from a co-marketing deal with Abbott Lab's Ross Products. Oxandrin is indicated for involuntary weight loss, and originally targeted to the HIV patient population. Ross Products has begun taking the drug into the Long Term Care (i.e., nursing home) and other markets. With Ross's 300 salespeople on the case, Oxandrin has already generated BTGC sales of $34.6 million in the first half of this year, and full year sales are expected to almost double from last year at around $60 million. BTGC is conducting clinical and post-marketing studies for the use of the drug to a wider patient population, and Abbott's marketing effort should continue to drive prescription growth.

BTGC's next best seller is Bio-Tropin, a recombinant human growth hormone. Bio-Tropin has been doing about $18-20 million in sales in each of the past three years, primarily in Europe and Japan. Despite being approved in the US since 1995, the drug has never been launched in the States due to an orphan drug designation for Genentech's hGH product and patent litigation which was resolved last year. BTGC has licensed the drug in the U.S. to Teva Pharmaceuticals, but the launch is being held up by a dispute regarding a non-compete clause in a contract between BTGC and Serono Labs. I would expect the product to launch in the U.S. sometime in 2001 or 2002, and to take some market share from Genentech, whose product sold $226 million in 2000. If it takes 25% of the market, BTGC's royalties could easily add another $5-10 million directly to the bottom line.

Other marketed products include BioLon, an optical surgery lubricant marketed in the U.S. by Ciba Vision and Akorn, and Delatestryl, an injectible testosterone that BTGC markets itself in the U.S. First half BTGC sales for these two products have been $4.1 million for BioLon and $5.3 million for Delatestyl. Finally, BTGC sells a Hep B vaccine in Israel, for which it expects to begin filing for approval worldwide this year and next, and receives royalties on Mircette, an oral contraceptive, and Silkis, a topical skin product for psoriasis and other skin disorders.

The company recently launched it's eighth product, an injectible visco-elastic material used to improve mobility and reduce pain in arthritic knees. BTGC has licensed the product to J&J subsidiary DePuy Orthopaedics, which announced the launch of the product under the name Arthrease in Europe on August 6th. FDA approval and launch is expected by early next year. Arthrease is expected to provide some strong competition to the market leader, Synvisc, which should do US sales of around $150 million in 2001. BTGC will receive milestone payments upon approval in the U.S. as well as royalties on all sales worldwide.

In addition to the products mentioned above, BTGC has an impressive pipeline for such a small company, including a legitimate potential blockbuster in Phase 2. Before I get to that, there are two late-stage products that should launch in late 2001 and 2002.

The two late stage products are the company's human insulin product, which is licensed to Akzo Nobel, a $22 bln market cap company that will market the drug through its subsidiaries Organon and Diosynth. BTGC's insulin product will compete with Eli Lilly's insulin (both are made using E. Coli) as well as one from Novo Nordisk. Still, its a big market, and BTGC could see some material royalties from it. In addition, BTGC has licensed the insulin product to a company called Ibatech, which is expected to receive approval and launch the product in Poland and other Eastern European countries before the end of 2001.

The other late stage product is an imaging agent called Fibrimage to detect blood clots that could indicate deep vein thrombosis or pulmonary embolism. BTGC has licensed Fibrimage to Canadian company called Draxis Health, and the drug is in Phase 3 trials, which are expected to be completed this year. Fibrimage isn't likely to be a big seller, but a recent Merrill Lynch report estimates sales potential of $25-50 million, which would add at least a couple million to BTGC's bottom line.

In Phase 2 is the potential blockbuster I alluded to, a compound for neuropathic pain associated with diabetes called Prosaptide. BTGC acquired the drug via a buyout of Myelos, a privately held company that discovered it, in March of 2001. Merrill estimates potential peak sales of $750 million should it achieve approval, as there are an estimated US patient market of 1 million or more. Prosaptide has already completed an initial Phase 2 trial, and BTGC has initiated a second Phase 2 trial. If approved, Prosaptide will likely immediately become the gold standard for treating diabetes-related neuropathic pain, for which the approved treatments are weak due to limited efficacy and side effects. In that case, the best comparable I can think of would be Biogen's Avonex, which is about an $800 million drug. Largely due to Avonex's success, Biogen's market cap is now about $8 billion.

Further down in the pipeline are two niche drugs which have been designated with Orphan Drug status by the FDA. Finally, BTGC expects to move another drug (for leukemia) into the clinic this year, and also has a deal with Teva Pharmaceuticals to develop generic versions of certain recombinant protein products for the U.S. market.

On to valuation. At a market cap of $400 million, and with first half operating cash flow and operating income at about $20 million, a conservative estimate of annualized profits is about $40 million. At that price, BTGC trades at 10 times operating earnings and operating cash flow. However, I believe that BTGC has the potential to much better in terms of future twelve month earnings and cash flow. First of all, there are the catalysts: continued growth in Oxandrin sales, European and US launch of Arthrease by DePuy, expected launches of Silkis in Europe and hGH in Poland, and potential entry into the U.S. of BioLon by Teva should all result in additional milestone payments, royalties, or increased product revenues. In addition, BTGC has been doing some capex spending to build a new production facility in Israel which should be complete by year-end, which will have cost $40 million. I expect capital spending to be reduced dramatically upon completion, which should increase free cash flow going forward. It would not out of the question for 2002 operating cash flow to come in at $60 million or so, and with a reduction in capex, free cash flow of $50 million is possible. This would put BTGC at 8X 2002 FCF. At the worse case, I would expect the next twelve month's operating cash flow to be no worse than trailing twelve months of $40 million, which would likely translate into about 13 X forward FCF.

The valuation analysis above doesn't include any value for the pipeline -- which I think has considerable value. At this point, it's a free call option.

There are some risks involved, of course. My guess is that there is a large perceived geo-political risk with the company's operations being in Israel. While this does present a risk with the potential escalation of military action in the Middle East, it should be noted that the company's biggest product is manufactured by G.D. Searle in the U.S., and Delatestryl is made in the U.S. by Bristol Myers-Squibb. Arthrease is also manufactured in the U.S. So, if the facility in Israel were to be disrupted in any way, while the R&D and some manufacturing (particularly for BioLon) would be affected, the biggest seller wouldn't be affected.

Of course, as with all drug and biotech companies, setbacks in clinical development is a risk, but I have basically ignored the pipeline in my valuation. With the company generating positive cash flow, it could surely weather a clinical setback. This risk / reward equation is one of the reasons I am so strong on the stock -- there's a tremendous amount that can go right, and the worst case is that you are stuck with a profitable little drug company with $100 million in cash at 10 times operating cash flow and 2.3 times book.

Thanks for reading. I will try to answer any questions as best I can on the message board.

Catalyst

Expected catalysts for the next 12 months include :

· Continued growth in Oxandrin revenues as Abbott penetrates market.
· Potential growth in Bio-Tropin hGH sales on U.S. launch by Teva.
· Recent European and expected 2002 launch of Arthrease by DePuy.
· Expected 2001 and 2002 launch of human insulin.
· Expected approval and 2002/2003 launch of Fibrimage.
· Expected European launches of Silkis in Europe in 2H 2001.
· Announcements of clinical advancement in the pipeline.