Description

This one is quite illiquid but quite interesting if that is not a disqualifying factor for you.  ProPhase Labs (PRPH) is a microcap that I found via using one of their products that led me to a very shareholder-friendly CEO who has divested assets, bought back stock, paid dividends and entered new businesses: some of which provided sizable temporary windfalls (like COVID testing).  He/PRPH now have several different growth engines and at least a roughly break-even business on a go-forward basis.  It is hard to make projections but I will try to convey order of magnitude what might play out relative to the current ~$125m market cap/$80m enterprise value. If you believe in the CEO’s decision making and capital allocation abilities then there is a multi-bagger ahead. 

Business Description

I am most interested in the company for its CEO. He previously invested in and advised a Canadian biotech called ID Biomedical from $25 million and near bankruptcy to a $1.4 billion GSK exit in 2005  He took over PRPH via a 2009 proxy contest.   Here is a brief overview of the company’s business lines:

Lozenge legacy consumer + ongoing contract manufacturing:  CEO Ted Karkus sold PRPH’s legacy Cold-eeze lozenge assets in 2017 to Mylan (now owned by Meda) for $50 million while continuing to contract manufacture the product.  He returned a portion of the proceeds to shareholders and reinvested the rest into new businesses.  This left it with a small supplements business with broad retail distribution.  Apparently there has been some tumult in the lozenge industry which has driven new business to PRPH and it is now forecasting $25 million of revenues in 2024 up from $8.7m in 2022.  There is further growth potential beyond that but will require additional investment either by PRPH or a customer looking for dedicated reliable capacity. 

Supplements: As for the supplements, one is called Legendz XL for male enhancement and I look forward to reading product reviews in the comment section after your/your spouse’s next visit to Walmart, Walgreens, Rite Aid or CVS.  The company has also acquired another antiviral supplement called Equivir that sounds a lot like a Coldeeze 2.0 (recall that 1.0 is a zinc lozenge to decrease severity/duration of colds that PRPH divested).  The supplements only generated a few million of revenue in 2021 and 2022.      

Diagnostic Testing – COVID & Beyond: In October 2020, PRPH purchased a CLIA lab in NJ for $2.5m to offer COVID testing and expanded into a second lab in NY in December 2020.  The labs executed well and generated $68m in 2021 and over $100m of revenue in 2022 at mid-60s% gross margins.  It used its success to raise $40 million in 2021. Now that the COVID emergency is over, PRPH is getting its facilities certified to offer a wide battery of tests (like toxicology, blood tests etc.) and has made acquisitions to develop its own proprietary tests.  Oddly enough NY State has a tougher certification process than the Federal one so getting a NY cert as planned will increase the value of this business. 

Lowest Cost Whole Genome Sequencing: In August 2021, PRPH acquired Nebula Genomics for $14.6 million (6.5x 2021 revenue that doubled in 2022) which offers direct to consumer whole genome sequencing (and is how I found them although I am sure Krusty75 will say that it was through the supplements).  I think this is a fascinating area and PRPH claims to be the low cost provider of sequencing at under $300.  This appears to be true and in addition to the profit on sequencing there is a subscription business to get updates (which I use and think is great).  There will also be synergy with the CLIA lab above which will further decrease turnaround times and help with economies of scale. The company will also leverage its retail distribution to get kits into retailers, hopefully in time for the 2023 holiday season – what a stocking stuffer!  It is projecting that it will double revenues in 2023 and 2024 but that would still leave a long runway for growth with a network effect.  In addition to the consumer business, the company does sequencing for researchers as well.  The CEO has mentioned IPO’ing this asset separately at some point in the future if it would be best for shareholders.  There is also potential for expansion internationally, especially the Middle East where the company just announced a deal. 

Future Products from Recent Low-Priced Acquisitions: In March and July 2022 the company in-licensed a supplement, an anti-viral drug (pre-clinical) and 2 cancer compounds (pre-clinical) for $50k upfront (you read that right) plus $1.9m of future cash milestone payments and a 3% royalty. It added a potential diagnostic test called BE-Smart for esophageal cancer in Jan 2023 for $4.5m upfront plus a future 5% royalty.    

Future Diagnostic Test – the BE-Smart Esophageal Cancer Test Add-On to Endoscopies: Partnered with the Mayo Clinic, the test is intended to detect early esophageal cancer in patients with a condition called Barrett’s Esophagus (I have always wondered who Barrett was). BE itself is a complication of GERD/heartburn so be careful with those hot sauce slathered Buffalo Wild Wings next time.  In 200 samples the test had a 99% sensitivity in detecting cancer that was confirmed by RNA sequencing and subsequent surgery or endoscopic ultrasound.    The 5-year survival rate of late stage esophageal cancer is in the low single digits so early detection is paramount.  Just like a colonoscopy can snip polyps, guided by this test an esophagus can be ablated to remove early cancer. PRPH claims it can find cancer years earlier than the current standard of care which is called EGDS.  A key factor for potential adoption is that this test can just be added on to an endoscopy procedure.   

Future Pharma Products: 2 Preclinical Cancer Drugs and an Antiviral: While these products sound intriguing a didn’t cost much to bring in, I am excluding them from the discussion since they are early stage.  PRPH is hoping to file an IND in 2024 and run Phase 1 trials only before finding a partner to carry the development forward beyond that point.  See the 10-K for further description of Equivir-G and the two Linebacker kinase inhibitors. 

Finally, I don’t think the CEO is done allocating the cash balance.  In June PRPH tried to buy pharma assets from Navidea but was rebuffed.  It issued a press release to let the public know that the Navidea board would not transact.  Perhaps the price was too low and the CEO would not raise it but this is evidence that there will probably be further value creation ahead. 

Investment Positives

CEO owns 18% and has previously successfully helped scaled a business and sold it (ID Medical $50m to $1.4b sale to GSK) – note that he was not that CEO but he hired that person

So far, CEO has done a great job acquiring assets cheaply and then turbocharging them

CEO also has turned over some parts of his team and he puts a huge premium on hiring the right people but seems pleased with who he has now

Several ways to win as each business could have excellent growth prospects and a long runway

Benefits of owning consumer-facing tests, prescriber facing tests and a general lab under one umbrella

CEO not afraid to return capital – PRPH paid $9.3m of dividends in 2022 which is highly unusual in a microcap

$100m unused ATM facility if necessary / volume improves

God forbid that there is another pandemic but this would be a beneficiary when other sectors of the economy are threatened  

Investment Concerns

Initially hard to believe that assets worth just a few million could be worth significantly more so quickly but the proof is/will be in the results

If the growth falls short with little evidence of better prospects ahead then the company will burn cash and would be worth substantially less where it trades today as it is not cheap on 2023 ex. COVID testing revenue. 

Other personal genomics companies like 23&Me that today offers low-coverage genotyping for common variants could add whole genome sequencing capabilities which could dampen growth prospects for Nebula

Allowance for doubtful accounts related to historical COVID business based on estimates but will be less relevant going forward

Not all capital allocation decisions have worked out: there is something weird with an unaffiliated COVID consultant where in 2020 PRPH loaned this group $4m and expected to earn it back with services.  It had to issue a notice of default and write it off

False claims lawsuit in CA filed in April 2023 for the male enhancement product – a very small part of the business but still worth noting

Switched Auditor for 2022 – likely innocuous but still don’t like to see changes.  There was a material weakness in 2021 but it appears to have been remediated

Illiquid stock

Valuation

The company has a $123m market cap (there are also some slightly in the money options 3.9m @ 5.35 and some warrants) with $15.5m of cash and $9.6m of debt (recourse to the manufacturing sub not the parent).  In addition the company has $37.8m of A/R from insurance companies and the government that is linked to its COVID testing business.  With that business effectively winding-down upon the ending of the emergency, I am treating that as a release of working capital into cash as collections occur from these longer paying customers.  Note that there has already been a bad debt provision applied to this amount and in fact in early 2022 the company had to migrate from uninsured to insured patients to reflect abrupt changes in government funding.  Including the A/R, the net cash is $47.8m and the enterprise value is $80 million.    

As the CLIA lab business plans to offer a wider battery of tests and I project some continued very small COVID revenue that is 5% of the 2022 amount (5% of 108.3m is $5.4m), I am assuming $25m of revenue by 2024 and a 64% gross margin similar to Q1 of this year.  On the consumer side, the company has guided to $25m of contract manufacturing revenue in 2024 and a doubling of the genomics business in 2023 and 2024 to $17m of revenue, respectively.  The supplement business is small and I assume that the new Equivir product brings the 2024 total to $5m (it was $2.5m in 2021 but dipped to $1.3m in 2022).  Q123 gross margin for the non-diagnostics business was 25.5% but I assuming a 35% margin as the genomics business increases its contribution (its margin may be closer to 40%).    Finally I annualize the first quarter’s Opex/corporate expenses before D&A of $7.5m to include $30m of additional expenses although that certainly sounds high but can include some R&D spend.  Taken together, 2024 could have $73m of revenue and could be slightly profitable at the EBITDA level.  With a portion of the business poised for continues extreme growth beyond 2024 an EV/Sales multiple of 1.1x does not seem demanding especially if there could be substantial EBITDA ahead that is hard to quantify. 

I have not included the esophageal cancer test or the two preclinical cancer compounds in the above.  I think it is prudent to exclude the preclinical compounds but I think it is fair to include some additional value for the test given that it is going to be available on a limited basis in early 2024 with a goal to get a CPT code in a similar time frame.  What is it worth? If there are 2 million people with Barrett’s Esophagus getting scoped annually and PRPH can get $1,000 per test then there could be a $2 billion opportunity.  Even very modest adoption would create value at least equal to the current market cap and perhaps several multiples.  There could be a larger market in all patients getting upper GI endoscopies as there are 7.5 million done per year.    

Disclosure 

We make no claims, promises or guarantees about the accuracy, completeness or adequacy of the contents of this document and expressly disclaim liability for errors and omissions in the document.  We have no obligation to update this document.  We may change our position at any time without posting an update.  The views expressed here are merely the opinion of the author.  Readers should do their own research.

Catalyst

Growth, Further Wise Use of Cash, Improved Liquidity