Description

Thesis:

OPK is a one-of-a-kind collection of highly misunderstood emerging and market-leading healthcare assets benefitting from durable multi-year tailwinds. At $4.30 per share, we believe OPK is worth ~3x its current share price vs ~$1 downside. More importantly, the company is on the precipice of multiple inflection points that have only recently begun to show the massive underlying disconnect between the Street’s understanding of OPK’s fundamentals and its intrinsic value. These perception changing catalysts will only be magnified by the unique technical factors surrounding a stock that is 42% insider held, with 33% of the remaining float shorted. 

Company Overview:

OPK is effectively a combination of three separate businesses:

·         Diagnostics: (88% of 2019 Gross Profit): Bioreference (“BRL”) is the 3rd largest diagnostics lab network in the US (after LH and DGX), benefitting from near term testing tailwinds driven by COVID19 and long term tailwinds driven by recent market share gains.  Additionally, the industry is also at a positive inflection point for the three national lab players due to a consolidating oligopolistic market structure, an improving diagnostic regulatory environment, and potential ancillary revenue streams due to the increasing importance of testing data 

·         Pharmaceutical: (12% of 2019 Gross Profit): OPK Pharma’s revenue currently primarily comes from Rayaldee, the only FDA approved drug used to treat secondary hyperparathyroidism (SHPT) in patients with stage 3-4 CKD and vitamin D insufficiency and is currently also under trial for additional use cases including SHPT for patients with Stage 5 CKD (which as an addressable market that is greater than stage 3-4 combined) and as a treatment for mild-to-moderate cases of COVID19 

·         Somatrogon: OPK has a Royalty Agreement with Pfizer for Somatrogon, a once weekly growth hormone replacement therapy with orphan designation in multiple countries that is undergoing additional drug study trials in various areas of unmet need, is expected to begin generating meaningful milestone and royalty payments in 2021, and will benefit from oligopolistic market dynamics in each of its target markets

Differentiated View

Our differentiated view on OPK revolves around the following key points:

1.    The Street Broadly Believes that OPK will never be profitable / generate cash as Bioreference has been generally unprofitable since acquisition and the rest of OPK has been perennially unprofitable

1.    Bioreference had its first profitable quarter since 2018 driven by PCR testing and operational efficiency improvements. We believe Bioreference profitability will only continue to improve over the next several quarters as Bioreference PCR testing capacity ramps and testing demand will only increase. We additionally believe that even AFTER a COVID19 vaccine is found, Bioreference will remain profitable as its revenue base has increased due to gains in market share from its outperformance vs other labs during COVID19 as well as continued wins from its new focus on strategic partnerships which have already resulted in large multi-year contracts (e.g. Westchester Medical Center Network, Blue Cross Blue Shield Texas). Finally the new head of Bioreference, Dr. Jonathan Cohen, who joined OPK in 2019, was previously in charge of lab operations at Quest (DGX) and is ideally suited and incentivized to pursue the many opportunities at Bioreference for margin improvement and operating leverage as the company is operating at half the margins of its main comps (DGX & LH) whom have also continued to improve each quarter

2.    On the Pharmaceutical side, R&D expenses have already declined dramatically (annualized $40m decline on a $120m base from 2019) as the majority of expenses from Rayaldee and Somatrogon have dropped off. Additionally Revenue from Rayaldee will continue to grow both from domestic use of its current use case, internationally from its partnerships with Japan Tobacco in Japan and Vifor Fresenius in Europe, as well as additional use cases both for CKD stage 5 and COVID. Finally Somatrogon is on the verge of generating meaningful Revenue in 2021 from both milestone payments (~$275m as it reaches certain approvals) and royalty payments as Pfizer begins marketing Somatrogon (we conservatively estimate around $50m beginning next year, growing to approximately the mid $200ms over the next 10 years)

2.    COVID19 testing will go away after a Vaccine

a.    Nearly all potential vaccines have recently been halted, highlighting the risk of attempting to “warp speed” crucial clinical trials and accurately guide to an approval date. By way of example, after multiple instances of patients falling ill, including some with neurological symptoms, for unknown reasons during the Astrazeneca trial and JNJ trial, Astrazeneca’s trial was postponed for over a month and JNJ’s trial has been postponed since early October with a restart for both trials expected next week and the cause of the illnesses cited as “unknown”.  The timing of a potential vaccine distributed nationwide has only been postponed further and is highly uncertain. Indeed, both JNJ and PFE have now stated that it doesn’t expect approval until well into 2021 with headlines around “end of November” referring to the earliest possible date, should all go perfectly, for PFE to submit its data, not receive FDA approval.[1] Claims of vaccine approval have been politically driven and continually pushed back, with scientists continually stating from the beginning vaccines are a mid-to-late 2021 event at the earliest.[2]

i.      Further, even upon vaccine approval, time to manufacture and distribution adds 6 months. 

ii.    Recent surveys have shown only 50% of people would take a vaccine even when approved, dampening any effect an even effective vaccine would have.[3]

iii.   Given the flu vaccine’s marginal effectiveness; most experts believe the same will be true for a Covid-19 vaccine, especially as Covid-19 strains mutate more rapidly than influenza A/B, with >8 strains reported in the US alone.

iv.  Both New York and California have announced that due to the politicized nature of forcing the acceleration of a vaccine, they will not permit vaccines until they have conducted an independent review.[4]

b.    A vaccine, as described by Quest on its earnings beat and raise on 10/22, significantly increases the demand for antibody/serology Covid-19 testing as post-vaccine, the population will have to get antibodies measured at multiple time-intervals post vaccine, driving demand for serology testing to multiples of current levels.

c.     Given the uncertainty of a vaccine’s effectiveness against mutations of the strain and over time, current Covid-19 PCR testing which is the “gold standard” of testing and the only test with definitive accuracy, combined with the risk of people taking reduced safety-precautions post vaccine & the rapidity of the disease spreading if a single person infects others, means Covid-19 PCR testing levels which increased in 3q by 50% over 2q and will increase in 4q by a further 33% will at a minimum stabilize at levels in 2H’20 after the flu season and school year ends. 

d.    We believe the current pandemic has permanently driven an increase in laboratory trading multiples as it has proved the heightened importance of having regular testing available to prevent future outbreaks similar to COVID19. Public awareness, as well as government re-funding of Pandemic task forces and stockpiles are clear evidence of this, as well as employer-mandated testing providing tailwinds significantly longer than consensus expects [Just 6 months ago, bears thought Covid-19 testing would decrease by 4Q, only to be proved wrong as testing is only increasing]. Note that the past two days broke the previous high record for new cases, showing that 9 months after the pandemic started growth in infections is still increasing, proving the virus is significantly more resistant than first believed.

a.    CEO of Quest, Steve Rusckowski, on a recent earnings call stated, “This crisis has brought to the forefront the importance of testing. And I never believed when I joined this company over eight years ago, that we would be on the front page of every news story in America, and all over the media, but we are. So it's much easier now for us to make our case with members of Congress and administration in HSS for the value of testing and the need for us to get fairly reimbursed and also to reinforce the intent of Congress and making sure we get a new process put in place that properly reflects the market rates. So it is actually a very good fact for us. We're going to leverage that.”

e.    The aforementioned reasons have increased the political capital and importance of Diagnostic laboratories like Bioreference. Further, as evidenced by the current agreement between Republics and Democrats for the need for a national testing plan and the highest level to date of a $75B stimulus for testing and tracing already agreed, the only three national laboratories (as opposed to smaller regional players) of DGX, LH and OPK (with a combined market share of >50%, with the rest of the industry fragmented) become even more crucial to our national infrastructure. Further, only these laboratories can serve national employers, national government programs, sports leagues, etc. They are also the only companies with the capital to increase capacity and implement protocols with Public trust. 

i.      This political capital has also removed the regulatory headwinds that had held growth and the multiple of the diagnostic laboratories artificially down in recent years. For example, PAMA mandated continued large cuts in testing prices for Medicare.  PAMA has been halted for 2021, and given the nuances of the law that require data collection to examine if Medicare prices have come down to parity with commercial insurance over the past three years, PAMA is likely permanently stopped with clear analogs to the Med-tech device tax that was to be implemented by Obamacare that was “holidayed” year after year until it was permanently removed.

f.      Additionally, as Bioreference continues to expand its business, its value as a strategic asset or an acquisition vehicle will only continue to increase. Acquisitions, due to the fixed cost nature, operating leverage and size of laboratory improving negotiations with commercials insurers are extraordinarily accretive in the laboratory industry. 

g.    Finally, COVID19 has only highlighted the increased importance of data in containing outbreaks and developing vaccines, all of which cement the importance of the diagnostic industry in the healthcare value chain as the Lab sits in the crucial information supply chain path between doctor and insurer as the only entity with a patient’s past symptom history from the doctor, the current lab results, and interfacing in the future with the insurance company. Further, for contact tracing, the laboratory is in the path to immediately be the place to most accurately and cheaply advance tracing.

3.    The Street erroneously believes past equals future; though it ironically also ignores a rich 30 year operating history prior to the last three years. The Street has also failed to recognize clear signals of the Company’s changing trajectory.

a.    Founder and CEO, Phillip Frost, is 84 and has recently undergone some well publicized medical challenges and is extremely frustrated with OPK’s decline as well as the resulting blow to his reputation and net worth (we estimate his net worth due to OPK has declined more than $3 bn), leaving him economically and socially incentivized to increase OPK’s stock price. Additionally, our diligence has led us to believe that there have been several indications of interest from strategic buyers for Bioreference as well as Financial Royalty buyers for the Somatrogon Royalty Stream and the Rayaldee Royalty Stream. 

b.    Additionally we find Phillip Frost’s recent actions: i.e. applying for HSR-Antitrust approval completely unprompted,[5] followed by suddenly not purchasing a single share (Mr. Frost purchased OPK shares in the open market nearly every day from January to June 2020), strongly indicative of near-term strategic action.[6] Suddenly halting frequent near-daily open market share purchases, especially after seeking and receiving permission to purchase to go over 50% ownership (or buyout the Company), often indicates the desire to buy shares but an inability to do so due to possession of material non-public information.  Adding to this, Mr. Frost’s two lieutenants who have worked alongside him for >30 years and hold along with Mr. Frost, the top 3 positions in the Company, have also engaged in signaling behavior.  Jane Hsiao, CTO and Vice-Chairman of the company and one of its largest shareholders, filed for and received HSR-Antitrust approval to go over 50% ownership/buyout the company on 8/21.[7] On 8/26, Philip Frost applied for and received the same approval.[8] That same day, Steve Rubin, the effective President of the company, made his only open market purchase of the year. Since then, there has been no buying activity by mgmt. or the Board.

Valuation

We conservatively estimate OPK is worth at least $10-$12/share on a Sum of the Parts Basis. We get there through the following assumptions:

1.    Bioreference: We value Bioreference at 14x our forward estimate of Bioreference EBITDA of $300-400m EBITDA ($4-6bn)

a.    We get to 14x EBITDA by applying a ~15% premium to DGX’s average multiple of ~12x due to Bioreference’s growth rate >5x higher than DGX and its strategic value as an acquisition target or acquisition vehicle.

b.    Our $300-400m EBITDA estimate includes a conservative 50% reduction to Bioreference’s current COVID19 PCR test volume, moderate operating leverage and probability weighted upside based on market share gains because of its superior performance during COVID19, significantly enhanced insurance coverage and recently announced accretive strategic partnerships.  This EBITDA estimate does not include upside from other highly achievable sources of upside such as enhanced margin improvement in-line with comps, digital health initiatives headed by a new Chief Digital officer (previously the head of Digital at Pfizer and Quest), [9] the recent launches of high growth new products such as a new combined flu and COVID19 test[10] and two best-in-class Next-Generation-Sequencing[11] genetic tests (an $8B market projected to grow to $25B by 2025).[12]  We expect BRL will produce >$50mm EBITDA in 4q’20, a >20% growth rate over 3q, and grow at this same quarterly rate throughout 2021.

2.    Rayaldee: We value Rayaldee in-line with the street, at 6x our estimates of Rayaldee’s 10 year average EBITDA of ~$120m (~$700m). This EBITDA estimate does not include significant upside from the highly anticipated current COVID19 treatment trial opportunity (expected results in 4Q’20/1Q’21), explicitly fast-tracked by the FDA on June 1, of Rayaldee for the treatment of mild-to-moderate COVID19 symptoms.[13]

3.    Somatrogon: We value Somatrogon at 8.6x our estimates of Somatrogon’s 10 year average Royalty Stream of ~$190m (>$1.6bn) plus $275m of milestone payments

a.    Our 8.6x Multiple is based on recent precedent royalty transactions such as Inclisiran and Crysvita, also an extremely conservative valuation due to Somatrogon’s orphan designation which provides it with regulatory protection from competition throughout the decade as well as other regulatory benefits.

4.    Adding to the margin of safety, we have ascribed no value to the Company’s rich pipeline of products in multiple stages of clinical trials, NOLs and minority stakes in numerous public and private companies.

Company History

Prior to its all-stock acquisition of Bioreference in June 2015, OPK was a top performing pure play pharmaceutical company, outperforming the market by 280% from 1/2013 to 6/2015 trading as high as $19/share. OPK’s Chairman and CEO Phillip Frost was previously the Chairman of TEVA and had a successful history of creating shareholder value from his prior roles as Founder and Chairman of Key Pharmaceuticals until selling the Company to Schering in 1986 and then Chairman and CEO of IVAX Corporation until its acquisition by Teva for $7.4 billion. Indeed, just a few years ago, Jim Cramer referred to him as the “Warren Buffet of biotech”.[14]

Following OPK’s acquisition of BRL however, a confluence of events including market volatility driven by Hillary Clinton’s stance on drug prices and general shareholder skepticism/turnover around OPK being the first pure play pharmaceutical company to expand into the diagnostic lab business, caused the stock to decline over 50% by the start of 2017. OPK shares continued to further decline over the next three years, driven by a Hindenburg Short Report (addressed below) and a non OPK related SEC Settlement by Phillip Frost (also addressed below) which caused the stock to halt trading, banks to drop sell-side coverage, both passive and active indices to drop the stock from its portfolios, all of which culminated in a value dilutive equity offering at $1.50/share on October 2019. 

Since those events, OPK has largely been left for dead by institutional investors, has no natural sell-side coverage base as Pharma-focused analysts and investors do not invest in the lab industry, and Lab-focused analysts do not typically understand how to value the Pharma business.  Recent improvements to both businesses, as well as news-flow around a number of high-profile wins with Bioreference becoming the exclusive COVID19 test provider for the NFL, NBA, and MLS, as well as government wins in NY, NJ, Michigan and Florida has attracted largely short-term retail investors into the stock looking for ways to “trade” COVID19 while fundamental long-term investors have not focused on the 2020 inflection of declining costs, increasing revenue, management incentives, industry tailwinds and Company signaling behavior.

Hindenburg Short Report

Hindenburg’s 2017 Short Report primarily focused on OPK’s large amount of short-term cash burn driven by its R&D spend on Rayaldee and Somatrogon, both of which were at much earlier stages of development at the time and had experienced a series of delays. Since then, Rayaldee has been approved by the FDA and proved to be commercially successful (most recently growing >90% per quarter pre-Covid-19 and 54% in Q2 2020 despite COVID19 restrictions) and Somatrogon remains on track to launch in 2021, with commercial partner Pfizer recently announcing Phase 3 results has passed all trial endpoints and guiding for launch in 2H’21,[15]. Further, R&D expenses declined 36% y/y in the last quarter as the majority of its Drug development costs are complete with R&D costs at a permanently lower level. 

Finally, we note that every one of Hindenburg’s claims ultimately proved to be false as the short report largely capitalized on the timing disconnect between the lengthy timeline required to prove clinical trials and his [ultimately false] claims these drugs would not be approved.

Frost SEC Settlement

The SEC charged Phil Frost and a number of others for inflating the price of penny stocks by purchasing stocks, writing them up on websites like Seeking Alpha, and selling the stock. Phil Frost settled for $5.5 million as his large name left him to be made an example of by the SEC. However, with a net worth at the time of over $5 Billion, there is little reason for this claim to be true. In fact, a reading of the complaint, which is admitted by the SEC, is that Frost was merely an investor, among numerous other investors who were charged, in a small fund run by Barry Honig who was the “primary strategist [orchestrating the scheme]” and who “[called] for [his investors] to buy or sell stock; it being unclear Frost even knew this was occurring by merely responding to capital calls. Further, Frost paid more than double his entire profits over the 6 years of alleged stock manipulation by Herzog (in fact, total profits, for all investors, were $27 million over 6 years), a sum completely immaterial to him and as former Chairman of $50B company Teva and the founder of three multi-billion dollar Companies, is a bit absurd to believe he has time or inclination to behave in this alleged behavior.

Irrespectively, the claims have nothing to do with OPK, but the taint by association, combined with the BRL acquisition being misunderstood by the Street and the temporary cash burn from clinical trials, served to feed off each other to further drive the stock down to its all time lows in early 2020.  However, as discussed above, upon successful completion of the phase 3 trial for Somatrogan, Phil Frost purchased stock nearly every trading day from January to June (when he entered 2Q earnings blackout period), followed by his filing for HSR-Antitrust approval in August, as he opportunistically capitalizes on OPK’s dramatic undervaluation and inflection of declining expenses (due to the successful completion of the Somotrogon trial) and rapidly increasing revenues (due to shortly anticipated 100% margin royalty payments for Somotrogon and Rayaldee, operational improvements at BRL, and the current pandemic’s related tailwinds highlighting the laboratory value). 

Catalyst

Shareholder Engagement, Earnings, Strategic Action