Description

At $0.33, SNTKY is currently trading at its net cash value and is on the verge of bringing to market a stream of products that have the potential to drive the value of the company to a multiple of the current price. The company is a player in the cosmeceutical skincare/anti-aging market, and has already had one successful product, which it recently monetized. It has signed a very favorable marketing agreement with a reputable partner to launch the next product early in 2008. Behind that, it has several other products in various stages of development.

The company’s annual cash burn rate is around $2mm; however, that does not take into account $6.5mm of guaranteed net cash payments the company will receive next year from a recent marketing partnership. Thus, Senetek trades at a 20% discount to its projected net cash position at the end of 2008. We believe Senetek’s current trading price is a result of its tiny market cap, lack of coverage, and an unsophisticated investor base that is either not focused on or does not appreciate the recent developments and prospects.

About the Company

Senetek is primarily a cosmeceutical product development company in the skincare/anti-aging category. Cosmeceuticals are cosmetic products that are sold at retail or by physicians and that make certain claims about effectiveness without rising to the level of requiring FDA approval. The company was started in 1983, and existed for many years as a penny stock (listed in the UK, with ADR’s) without meaningful revenues. In 1999, the company licensed a product called Kinetin to Valeant Pharmaceuticals (VRX), and Kinetic became a key ingredient in a Valeant cosmeceutical product called Kinerase. Over time, Kinerase became one of the most successful cosmeceutical products in the market, registering sales of $30 million in 2006, from which Senetek earned a royalty of $6 million. Earlier this year, Senetek monetized its right to future royalties in exchange for a lump-sum payment of $21 million from Valeant.

Over time, Senetek has assembled a portfolio of products and intellectual property, partly through its R&D partnerships with the Polish Academy of Science and the Institute of Advanced Botany in the Czech Republic (I admit these sound like organizations out of a Mel Brooks movie). The company has signed a very favorable marketing agreement with a reputable partner, Triax Pharmaceuticals, for the first product, due to launch in early 2008, and expects to launch at least one product annually after that.

Investors should be aware that the company is planning on a 8 for 1 reverse stock split in December.

About the industry

The worldwide market for facial skin care products is estimated at $20 billion. The physician-dispensed channel is a tiny part of that, estimated at $250 million in the US, but is growing at an estimated 20% annually. The leading company in the space is Obagi (OMPI). Key drivers of the growth are:

· Currently, less than half of the 22,000 physicians specializing in dermatology and plastic surgery in the U.S. are selling cosmeceuticals. Both the penetration level of dispensing physicians and the average level of sales per physician have been growing, as an increasing number of physicians view this as a significant source of additional income. Also, dermatologists have a tendency to use multiple tools when treating an aliment, so cosmeceutical products are often used along with other treatments.

· Patient demand has been on the rise, as aging baby boomers want to continue looking like children of the 60’s. The strong growth of non-surgical cosmetic procedures such as Botox are evidence of the same trends.

Skincare pipeline

Senetek’s skincare products differentiate themselves from many of its competitors through good product efficacy and solid clinical data. While we believe the company has a number of promising products in its pipeline, the main driver of performance over the next year or two will be Pyrapine-6, which is scheduled to hit the market in early 2008.

Clinical trials have demonstrated P-6 to be a substantially and quantifiably superior compound relative to Kinetin with respect to its anti-aging properties. In fact, management claims that they chose to monetize Kinetin because they preferred to bet on P-6, and saw a great opportunity to sell a product that was past its peak. The company recently signed a marketing collaboration agreement for P-6 with Triax, a private equity backed company led by two seasoned pharmaceutical/cosmeceutical executives. Triax has $200 million of private equity backing, and the PE firm and Triax’s top executives check out very well. We consider this to be a very positive development, and we believe the fact that Senetek was able to negotiate such terms is a strong endorsement of P-6 by a smart industry player. The key terms are as follows:

· SNTKY is guaranteed a minimum of $10.8mm in payments in 2008 regardless of actual product sales, in exchange for a marketing contribution by SNTKY totaling $4.5mm within one year. (We believe this part of the agreement was structured to allow SNTKY to recognize a smooth picture of revenues over FY2008; however, the spirit of this agreement essentially that Triax is paying SNTKY a $6.5mm net initial payment.)

· Subsequent to year one, the companies will share product revenues 50/50, with Triax responsible for sales, marketing, and order fulfillment and SNTKY responsible for the cost of product manufacturing.

· Triax is obligated to hire no less than 20 experienced sales force professionals in year one for the marketing of this product.

Most of the risk in taking a new product to market lies in the front-end loaded marketing costs. On the other hand, according to management, product and packaging costs for these products are in the range of 10% of sales (or 20% of SNTKY’s share of sales) and will be a completely variable cost since SNTKY will use a contract manufacturer. As a result, there is little risk to the company’s cash position should P-6 fail to meet expectations.

In addition to extensive discussions with Senetek management about P-6, we have also talked to Triax top management. Data on P-6 from a clinical trial at UC-Irvine’s Department of Dermatology shows high efficacy in several anti-aging metrics, dealing with reduction of wrinkles, fine lines, redness (in contrast to other existing products that tend to cause redness and irritation), and skin discoloration. Dermatologists we have spoken to says that if the clinical data holds up, P-6 has the potential to be a leading cosmeceutical product.

Triax has cited a $100mm sales target for P-6, which is typically a year 4 or 5 number. While this appears to be a fairly ambitious target in light of Kinerase’s $30mm of sales and industry leader Obagi’s $90mm of sales, it is not inconceivable given the product’s apparent efficacy and the strong overall industry growth.

What is very clear is that Triax is making a substantial investment in the product and is anticipating significant levels of product sales in order to generate a reasonable return on their investment. ($6.5mm of year one net guaranteed payments plus what we estimate will be a $10 million investment in sales and marketing investment). We estimate that in order to achieve a 20% IRR on the partnership, P-6 will have to generate revenues of $25mm in year 6. At that level of sales, and using the same 20% discount rate, we estimate that the NPV to Senetek would be $19mm, or $0.32/share. Clearly, there is a huge discrepancy between the value Triax is placing on P-6, and the how the market is valuing it through Senetek – essentially worthless.

It is important to note that the Triax agreement pertains to distribution in the physician-dispensed channel only; management is in negotiations with a major cosmetics company for a retail product that will be marketed under a different name and emphasize different features to avoid cannibalization.

After P-6, Senetek has another product, 4H-BAP, which has shown some different anti-ageing properties than P-6. Assuming that the P-6 launch is successful, the company expects to be in a position to sign up a marketing partner towards the end of 2008, for an early 2009 launch. If the relationship is going well, Triax would be the obvious partner.

Invicorp

Outside of its skincare business, the most significant product is Invicorp, an erectile dysfunction treatment with an injection-based method of delivery (yes, a self-administered needle). It addresses the estimated 30-50% of the potential ED patient population is either non-responsive to or contra-indicted (as a result of taking certain cardiac medications) from using the existing oral treatments. We note that the company considers its core competency to be in skincare and might monetize its right to future Invicorp royalties if the opportunity arises.

Invicorp is licensed to Plethora (PLE-AIM) in the US and Ardana in Europe. SNTKY will receive a double digit royalty and can potentially earn large milestone payments. The distribution partners are responsible for all product approvals, marketing, and manufacturing. Invicorp was approved in Demark on December 2006, with other European approvals expected in 2008. US approval and product launch are expected in late 2009 or 2010.

The only existing non-oral ED treatment of significance is a product called Caverject, with $60mm in worldwide sales and growing. Caverject is also an injection based system and is marketed by Pfizer. Ardana is targeting $30mm of product sales in Europe, while Plethora is targeting over $200mm of sales in the U.S. for Invicorp.

We have met with Plethora management, who are very optimistic about Invicore’s prospects based on the targeted marketing strategy they intend to pursue, and their belief that Invicore is a superior product to Caverject. Plethora is an early stage company targeting the urology space, and has several products in their pipeline. We have not done a lot of work on the Invicore/Caverject comparison, but note that Plethora’s market cap on the AIM is less than $60 million, so the market is not giving them much credit.

Valuation

As Senetek’s financial commitments relating to P-6 consist of entirely variable manufacturing costs, there will be no material erosion of the company’s cash position if P-6 flops. The same is true for Invicorp. As a result, if we attribute no value to the company other than its cash position, the current price is a 20% discount to the expected cash position by the end of 2008 after factoring minimum royalties and expected cash burn. Currently, the company is running at an operating expense level of $4 million annually, but that is partly offset by interest income and some small income items on other products, for a net cash burn of slightly more than $2 million annually. If fact, assuming nothing happens over the next three years - but also assuming that management does nothing beyond the current expense level to squander its cash position - the company is trading at its projected year end 2010 cash balance.

There are different ways of looking at upside. With a 1-3 year time horizon, any upside will likely be driven by P-6, and if that is successfully launched in 2008, it will likely be followed by 4H in 2009. Assuming no significant increase in corporate overhead, and no other products, Senetek’s approximate overall pre-tax profit at different levels of P-6 sales are as follows:

                           Senetek Est.

P-6 Sales         Pre-Tax Income

$10 mm                 $2 mm

  20                         6

  30                       10

  50                       18

100                       38

Obviously, it is hard to know what level of sales P-6 will reach, and over what time period. A best case scenario might be a successful launch in 2008, leading to a marketing deal on 4H, and projections a year from now of P-6 reaching $20-30 million of 2009 sales, plus 4H beginning to contribute. At that point, with Senetek looking like a successful cosmeceutical company with a strong pipeline of products, it could be given a market cap of $100-200 million, or $1.60-$3.20 per share.

Recent Guidance

Management recently released projections for 2008 and 2009, which they claim represent a conservative outlook. P-6 is the main driver, and we estimate that it accounts for 85% of 2009 projected revenues. Most of the remaining revenues are projected to come from the sale of a P-6 derived product in prestige channel (higher end retail establishments) through a partnership with a major cosmetics company. However, management anticipates that the terms of that revenue sharing agreement will result in a fairly low gross profit margin. Thus, most of the projected $5mm in operating income comes from the Triax agreement.

	2008	2009
Revenue	13,397	21,891
Gross Profit	10,492	12,872
EBITDA	2,262	5,645
Operating Income	1,634	5,017

Why is it cheap?

Besides the obvious reason of being a penny stock trading over the counter, SNTKY is cheap for the following reasons:

1. Management has been overly optimistic in the past and has low credibility.

2. Except for Valeant, previous marketing partnerships have not contributed meaningfully to profitability.

3. Minimal IR effort.

4. Cash burn in the past two quarters has been unusually high due mainly to a $1.6 million tax payment on the monetization of Kinetic in Q2, and the first installment of the marketing contribution to Triax for P-6. Cash will
continue to fall through 2008 and should bottom at around $15 million, or $0.25 per share, as Senetek will not receive the guaranteed royalty payments from Triax until late 2008.

Risks

• - P-6 is not successful, which throws the entire strategy of positioning the company into a cosmeceutical business into doubt
• - Management does something stupid with their cash hoard and destroys value
• - Something “bad” happens – always a risk with a penny stock

Catalyst

* Successful launch (anticipated to occur on 2/2008) and market acceptance of P-6.
* Announcement of other distribution partners expected by the end of this year or early next year one of which could be a “big household name.”
* Potential monetization of future Invicorp royalties.