Description

Enzo Biochem Inc. (ENZ) is a $102MM market capitalization, $52MM enterprise value fully integrated diagnostics, clinical lab and life sciences company.  Enzo currently operates in three segments- Enzo Clinical Labs ($49MM in LTM revenues), Enzo Life Sciences ($29MM), and Enzo Therapeutics ($0).  Additionally the company has a portfolio of intellectual property assets including 406 issued patents and 75 patent applications. Enzo's business has been discussed in this forum in the past, thus this write-up will focus on the tactical opportunity.

Enzo has been a multi-decade story of value destruction.  The company has a one-year TSR of -37%, a ten-year TSR of -41%, and a 20-year TSR of -96%.  Enzo has been consistently unprofitable for well over a decade.  While the company’s clinical lab business has generated positive EBITDA at times, in aggregate Enzo generated negative consolidated EBITDA due to a bloated cost structure and gross mismanagement.  In recent years profitability has deteriorated sharply as the company was wholly unprepared for sharp pricing cuts driven by the Protecting Access to Medicare Act (PAMA).

Founder/CEO Elazar Rabbani and his brother-in-law, President Barry Weiner have presided over a tremendous amount of value destruction while compensating themselves generously and engaging in self-dealing transactions such as leasing lab property that they own to the company.  The only successful endeavors in the history of Enzo are multiple patent settlements which have allowed the business to remain solvent and operate with a significant net cash balance.  We believe the market fully understands the “baggage” at Enzo but has failed to take into account several underlying positives that point to a near-term inflection.  With the stock at $2.12 per share and sentiment completely lethargic, we see an attractive tactical set-up.  

The investment thesis on Enzo is based on the following points:

1.  COVID-19 testing is creating a tremendous opportunity for Enzo.  We believe this will lead to a material inflection in the profitability of the business.  On September 8th, Enzo announced that it had doubled capacity for molecular testing services while also expanding reagent and supply manufacturing.  Current processing capacity is now 1MM per annum.  Of note, CMS reimbursement has been $100 per test- this implies a $100MM revenue opportunity or effectively double the size of the company’s current aggregate lab business.  While it is impossible to say if they can come anywhere close to filling this capacity – it is clear that they are certainly processing samples and signing agreements. 

https://news.stonybrook.edu/university/stony-brook-university-aims-to-keep-students-safe-with-exclusive-covid-19-testing-center/

https://mcquad.org/2020/09/01/first-positive-covid-19-test-result-on-campus/

https://www.farmingdale.edu/news/news-room/2020/2020-07-02-enzobiochem.shtml

https://www.genomeweb.com/business-news/enzo-biochem-cpesn-ny-provide-covid-19-testing-52-pharmacies-new-york-state

https://www.pix11.com/news/coronavirus/get-a-covid-test-while-you-wait-for-your-flight-in-nj 

Job postings tell the same story – Enzo is in growth mode – for example, they are hiring an Account Manager in California Hot Springs.  This is a geographical area where the company has no historical presence.  There are multiple other examples.  

What exactly could a surge in COVID-related testing look like from a profitability perspective?  BioReference Labs is the historically money-losing clinical lab subsidiary of Opko (OPK).  For the second quarter of 2020, Opko reported second quarter Diagnostic segment revenues and EBITDA of $251MM and $56MM.  In the prior year the segment generated revenues of $178MM and EBITDA of NEGATIVE $12MM.  Additionally, the core business was still down 20% year-over-year.  This delta was wholly driven by COVID testing.  Of note, investors have not seen the impact of COVID testing on Enzo as they have a July 31 fiscal year and will not report until October.  Additionally there is no sell-side research coverage.  The stock has been orphaned and left for dead at $2 per share.

2.  Corporate governance and focus is improving at Enzo.  After an extremely acrimonious proxy battle, on February 25th Enzo announced that shareholders added two dissident nominees from Harbert Discovery Fund’s slate of Directors.  New directors include Peter Clemens, the highly successful former CFO of Caremark and Surgical Care Affiliates, and Fabian Blank, a former McKinsey consultant in their HC practice with substantial additional success in private healthcare endeavors.  These are serious and competent executives and it is likely they will drive a far greater degree of accountability and transparency than has historically been seen.  Additionally, as a tactic to try and counter Harbert – Enzo hired a high quality CFO in December – David Bench.  Bench appears to be adding discipline to the organization and speaks in a clear and coherent manner.  Pressure is a powerful motivator.  “Brother-in-law” Barry was badly beaten in the recent proxy battle.  As it stands, the board consists of CEO Rabbani, the two Harbert directors, Rebecca Fisher (CFO of NYC Bellevue) and Dov Perlysky.  Rabbani knows he is vulnerable due to the horrific job performance over multiple decades and the crushing defeat in early 2020.  He is likely highly motivated to create value or perhaps finally face the consequences for years of mismanagement and incompetence. 

3. The stock is undervalued on a sum-of-the-parts basis.  Using a wide range of underwriting assumptions on trailing (depressed) revenue assumptions points to between 54% and 314% upside.  A reasonable base-case scenario that assumes 2x revenues for the clinical lab, 4x revenues for Life Sciences, $20MM for the company’s Therapeutics assets and zero for the patent portfolio point to a fair value of approximately $5.89 or almost 3x upside.  

The bottom line is that I believe Enzo is an excellent risk/reward proposition – the stock trades at $2 per share with approximately $1 per share in net cash and earnings that are likely to inflect meaningfully higher beginning with the company’s fourth quarter earnings announcement. 

Catalyst

Fourth quarter 2020 results will likely reflect a clear inflection in Enzo’s financial performance driven by COVID-testing as well as efficiency initiatives.  This momentum should continue in fiscal 2021 and numbers will inflect.