Description

Opko Health is one of the most overvalued, misunderstood stocks I have ever seen.  I strongly believe the company will never generate a profit. With around $200 million of stock likely coming off lock-up later this year, I believe Opko is a fantastic short at its current market capitalization of $3 billion.

DISCLAIMER:  We currently hold a short position in this security.  We may change our position at any time without posting an update.  The views expressed here are merely the opinion of the author.  Please do your own research.

I originally wrote up Opko Health as a short in February 2012 when the stock was around $5 per share.  Since then, the company’s main asset (an Alzheimer’s test) appears to be a complete failure, yet in the past few months the stock has risen from $4 per share to $7.50 per share primarily due to (1) a surge of retail buying, (2) CEO’s appearance on Cramer and (3) insider buys by the CEO (which I believe are a red herring as described later).  Including options, warrants, converts and shares issued in various deals over the past year Opko now has a fully diluted market cap of $3 billion, roughly double where it was in early 2012.   Since then, quarterly losses have doubled from $5 million to $10 million and tangible book value per share has fallen from $0.13 per share to around $0.01 per share.  Given how disconnected from reality the valuation and story have gotten, I wanted to briefly revisit the history of Opko and update the current state of the business. 

Opko is led by Dr. Phillip Frost (the 77 year-old Chairman of Teva).  The company started out targeting various eye diseases in 2007.  By March of 2009, Opko terminated its Phase III clinical study of its key product called Bevasiranib.  Following this failure and the market cap falling below $200 million, the company has attempted to reinvent itself through a series of investments and acquisitions.  Excitement built in the stock beginning in late 2011 around a series of potential opportunities the company was touting, mainly its Alzheimer’s diagnostic test and its Claros diagnostics machine (a small money-losing company acquired in October 2011 for $30 million).  Since that time, the development of both programs has been disappointing.  To quote an October 29, 2012 bullish Jeffries note, “OPK's focus/strategy continues to be fluid/evolving, continuously expanding via small acquisitions and replacing unsuccessful programs with new ones.”  While I have also noticed the many unsuccessful programs, I have yet to see a single success come out of Opko.  The current state of the business is described below.

This is a small drug distribution business in Latin America that Opko put together from a few small acquisitions.  The base Opko business saw organic revenue growth of less than 1% in 2012, with gross profit dollars declining over 3%.  The company’s 10-K states “…decreased gross margins in our Chilean and Mexican operations primarily as a result of product pricing pressures experienced in those markets.”

The business is tiny and appears to be challenged, with an annualized gross profit of only ~$10 million.  After a reasonable allocation of SG&A, there is no way this business makes money. 

According to the Jeffries analyst, this business is worth $1 per share.  That doesn’t sound like much, but at the current diluted share count, this amounts to a nonsensical $400mm in value (40x gross profit!).  By my math, this business is worth $0 per share. 

Alzheimer’s Test

This is a blood test that the company acquired rights to for basically no consideration.  It was an attempt to detect Alzheimer’s via a blood test as opposed to the current diagnostic approaches.  I won’t go into the science (and all the problems) here as I can refer you to my prior Opko write-up that discussed this in some detail.   As it turns out, the Alzheimer’s test has not proven to be as good as the initial study (which was based on just six Alzheimer’s patients).  The company continued touting the test as recently as July 2012 through the following press release : http://investor.opko.com/releasedetail.cfm?ReleaseID=692503.  In an interview with Barron’s just months later (September 29, 2012), Frost argued they are still working to improve the sensitivity “in various ways” and he continues to think they’ll have a “valuable test.”  Today, the company appears to have moved on, downplaying the test’s significance.  Even mention of the test is relegated to page 12 of their presentation.  Keep in mind, this was basically the whole company one year ago.

The Jeffries analyst notes the company “maintains its work on Alzheimer’s disease and cancer … however, there does not appear to be significant progress for potential launches of the Dx as previously expected.”   Previously, the Jeffries analyst assigned $3 per share ($1.2 billion in current value) to this business.  Today it has now been removed from their NAV given the test’s failure (and the value has been made up by increasing the value of the other businesses).  Here I agree with her… it is likely worth $0 per share. 

Claros

Claros was acquired in late 2011 in a competitive auction process.  Upon acquisition, the company had book value of negative $1.8 million, total assets of $557 thousand and cumulative R&D spend of $5 million.  The business is trying to sell a mini blood test system that the doctor can use during an office visit to run tests in-house.  Over a year later, Claros seems to be going nowhere at this point.  In June 2010 (even before the acquisition by Opko), Claros was “preparing for the European launch” for a point-of-care prostate test but has zero sales at this point (http://www.businesswire.com/news/home/20100629005147/en/Claros-Diagnostics-Receives-CE-Mark-Approval-Point-of-care).  The company recently confirmed that Claros is not yet on sale in Europe.  And in terms of US potential, any potential launch would be in “late 2014 or early 2015.” 

To further highlight the lack of progress with Claros, consider the following passage from last year’s 10-K in which they state:

“We have already obtained a CE Mark for our point-of-care diagnostic test for PSA using our system in Europe and we intend to launch the PSA test in Europe in the second half of 2012… We intend to submit our application to the Food and Drug Administration (the “FDA”) for clearance of the PSA test in 2012 and expect to begin marketing the test in the U.S. in 2013.” 

Now, in the latest 10-K, they include an almost complete cut and paste of last year’s language but with all of the dates pushed back exactly one year: 

“We have already obtained a CE Mark for our point-of-care diagnostic test for PSA using our system in Europe and we intend to launch the PSA test in Europe in the second half of 2013. We intend to submit our application to the Food and Drug Administration (the “FDA”) for clearance of the PSA test and expect to begin marketing the test in the U.S. in 2014.”

In January 2013, Opko announced the acquisition of Cytochroma for $100 million in stock (plus various potential milestone payments in the future).  The company is a clinical stage pharmaceutical company working on drugs to help with Vitamin D deficiency. It has two products in Phase 3 and its main drug, CTAP101, is targeted for an NDA approval in Q4 2015 (and this is the company’s timeline – see page 15 of this presentation).  

CTAP101 would treat secondary hyperparathyroidism (SHPT) in patients with stage 3 or 4 chronic kidney disease and vitamin D insufficiency.  Even if the drug gets approval and enters the market in 2016, there are already existing therapies, specifically Hectorol (Sanofi) and Zemplar (Abbott).  Importantly, both drugs come off patent in 2014 (Hectorol:  http://www.renalbusiness.com/news/2009/07/genzyme-sues-sandoz-over-hectorol-patent.aspx and Zemplar:  http://www.jsonline.com/business/uw-foundation-sees-severe-drop-in-drug-licensing-income-ob6mdoh-168258836.html).  Other competing products include a generic product called Calcitriol and off-label usage of a product called Drisdol (Sanofi).  I imagine that CTAP101 would have little value even assuming it launches in 2016.

Even a recent Jeffries note in which they surveyed nephrologists on the potential for CTAP101 admitted that “according to nephrologists that we talked to, it appears that there is not significant unmet need in treating SHPT patients currently.”  Jeffries further notes that they are estimating peak sales for CTAP101 of “~$350M (vs current annual sales of ~$295M for Hectorol and Zemplar in CKD stage 3 & 4 patients).  Given that both Hectorol and Zemplar are going generic in 2014, our estimates could be viewed as aggressive.”  These assumptions make no sense.

However, the Jeffries analyst still ascribes a value of $1 per share to Cytochroma ($400 million).  This is a bit odd given the deal was just struck at one quarter of that value.  Given that the sellers accepted all stock in a highly valued speculative company, I estimate the value is less than $100 million, perhaps $0.10 to $0.25 per share. 

4Kscore

As just outlined, I think the three components of the bull case above have little or no value and under no reasonable scenario could it explain the company’s current valuation.  So I will focus on the last piece of the bull case, which is likely behind a lot of the current excitement:  the company’s 4Kscore test for prostate cancer.

As a bit of history, Opko issued two press releases in January and March of 2012, in which they disclosed a licensing deal with Arctic Partners of Finland for two biomarkers that would go into the 4Kscore test.  It does not appear from the press releases or the company’s filings that they paid anything for these biomarkers.  Data around using something called a Four-Kallikrein panel to reduce unnecessary biopsies was presented in the Journal of Clinical Oncology in May 2010 (http://jco.ascopubs.org/content/28/15/2493.full.pdf+html).  An editorial in that same May 2010 issue makes several points about such a potential test (http://jco.ascopubs.org/content/28/15/2491.full.pdf+html):

• “While use of the kallikrein panel advocated in the study may reduce the number of biopsies performed, it also seems to reduce overall cancer detection”
• “…24% of all cancers and 14% of high-grade cancers would be missed through use of a kallikrein panel”
• “Moreover, high-grade cancers might actually be missed with more frequency than the
  authors estimate”
• “…it seems unlikely that a strategy which misses some high-grade and potentially aggressive tumors would actually optimize screening”

In November 2012, Frost was interviewed on Cramer and talked up this new 4Kscore test that they basically acquired for free.  In that interview, Frost stated that the test “could be [a] very early 2013 [product]”.  We are in March and nothing has come of it.  Now they are saying it is a “mid-2013” product.  In any case, it will be sold through their recently acquired CLIA lab in Tennessee that has a small sales force of 18 to 20 people who will call on urologists and try to get them to use the test.

Given my diligence, assuming people do choose to use an unproven test for which there are very ample available alternatives, the addressable population is probably (at best) only those individuals with elevated PSA levels (as a first step before a biopsy). 

At this point the 4Kscore test has been launched in the UK with a partner, International Health Technology (IHT).  However, my discussions with physicians in the UK indicate that the level of excitement around the test is fairly limited.  They have only heard of some use of the test in a few London private practices.  Opko gets an undisclosed royalty from IHT but given the apparent limited market opportunity in the UK, any such royalty is unlikely to represent a material income stream for Opko.  In fact, given that the test launched early in the fourth quarter of 2012, I was surprised there was no disclosure in Opko’s 10-K regarding initial sales in the UK, particularly given that the MD&A breaks out revenue contribution from several of their recent acquisition during the period (including one acquisition that contributed a total of $0.6 million in revenues for 2012).  So it would seem likely that any revenues to Opko thus far have likely been immaterial.

The new Jeffries NAV build-up values the overall prostate franchise (presumably including Claros) at $5 per share (an astonishing total value of ~$2 billion).  I just don’t see any real market potential here given the concerns around the test and the preexisting alternatives.  My value estimate is ~$0 per share.

Phillip Frost Purchases

Phil Frost has been consistently purchasing shares in the open market, and it has become clear to me that many investors are buying the stock at any price based on this fact alone.  The logic goes:  “if Phil is buying, he must know something.”  I am convinced this is untrue.  Phil has engaged in insider purchases at Opko for years and it is now obvious he didn’t know “anything” since everything the company has done has failed.  While I can’t explain his motivation for buying shares, I think there are three possible explanations:

1)  He is trapped.  He started buying shares and people followed him into the stock.  If he stops, the stock plummets and the company could cease to exist, causing harm for employees and his fellow shareholders.  To highlight how focused the company is on this issue, consider this odd press release from February 8, 2013 after the company’s stock fell a few percent (one of the strangest, most defensive press releases I have ever seen):

 “OPKO Health, Inc. (NYSE:OPK), in response to statements regarding the sale of Company common stock by Mr. Adam E. Logal, OPKO's Vice President, Chief Accounting Officer and Treasurer, would like to clarify that no other Company officer has exercised common stock options or sold any shares of Company common stock during the last twelve months and that the nominal exercise of 50,000 common stock options and sale of such common stock by Mr. Logal was done to address pressing family circumstances. No other sales by Company officers or insiders are currently contemplated. Further, Dr. Phillip Frost, the Company's Chairman and Chief Executive Officer, purchased a total of 11,218,067 shares of the Company's common stock during 2012 and has purchased a total of 383,500 shares of the Company's common stock so far during 2013. Dr. Frost, along with other Company officers and insiders, also invested in the Company's recently completed $175 million convertible debt offering.”

2)  Perhaps he margins his stock and his purchases are funded with debt backed by the collateral of worthless Opko shares.  So he is basically playing with the houses money.  If this is true, if the stock declines, his position would be liquidated and the lending bank would be left holding the bag.

3)  He is inflating the price to issue more shares cheaply.  The company has been a serial issue of stock, warrants and converts and issues way more shares than Phil buys.  In the last year alone, the company has issued 52 million shares (acquisitions and convert) vs. Phil’s purchase of 11 million shares.  Again, if Phil really “knows something” and thinks Opko is a buy then one should ask why would he is comfortable with the company issuing shares so freely.  Although the company hasn’t disclosed the details, the 28 million shares the company issued for acquisitions should be coming off lock-up which should correct the price distortion.

Conclusion

Opko has one of the most disconnected valuations that I have ever seen compared to its underlying fundamentals.  There are few examples I can think of where $3 billion has bought you so little.  I believe the company will continue to burn cash at a high (and expanding) rate and I do not believe any of the company’s businesses will have any value. In summary, (1)  feverish retail hype, (2) an unprofitable business with  poor prospects and (3) $200 million in stock likely coming off lock-up during 2013 all make for a highly compelling short opportunity.

Catalyst