One of the primary reasons I purchased shares in Opko was that Opko's CEO, Dr. Phillip Frost, was buying shares on a regular basis. For those of you who are not familiar with Dr. Frost, he made his mark when he sold drug manufacturer Ivax to Teva Pharmaceuticals (TEVA) for $7.6 billion in 2005. Since 2010, he has been the chairman of Teva, a $36 billion pharmaceutical company.
Here's another example that demonstrates Dr. Frost's investment skills: He bought the drug Rolapitant from Schering-Plough, developed it a little, and then licensed it to another company, receiving an upfront payment that covered what he paid for it in the first place. Starting this year, Opko should be receiving up to $100 million in milestone payments and royalties approaching 20%. This is for a drug that, at this point, has cost Opko absolutely nothing. Opko also ended up with shares in the licensing company.
Dr. Frost also took a large stake in Pershing Gold (PGLC.OB), which is up over 70% in the last few weeks. Another successful Frost investment is in a company I also invested in called Alliqua (ALQA.OB), which has risen 70% since Dec. 28, 2012. If you missed the run-up with Opko, you may want to take a look at one of Dr. Frost's newest investments, MusclePharm (OTC:MSLP). In my opinion, MusclePharm could provide investors with at least a 3 times return.
High Level of Due Diligence
In November, I wrote an article stating why I thought that MusclePharm presented a phenomenal investment opportunity. I was pleased to learn that Dr. Frost also likes this company.
When Dr. Frost considered investing in MusclePharm, I believe he conducted a level of due diligence way beyond anything any of us could have accomplished. I'm sure he met with MusclePharm management and had his seasoned team go over this investment with a fine-tooth comb. As seems to be the case with all of his investments, he would not have taken a position unless the odds were stacked heavily in his favor.
Here's Why I Like MusclePharm
MusclePharm has about $75 million in annual sales, has been growing revenue at over 400% annually, and currently has a market cap of only $12 million. Right now, MusclePharm only has about 0.3% of the $25 billion sports nutrition market.
Contrast that with a company that I just shorted, MedBox (MDBX.PK), which has recently had a market cap of over $1 billion, with annual sales in the $5 million range. MusclePharm is extremely undervalued, and with Dr. Frost's endorsement, Wall Street heavyweights should begin participating.
What Is MusclePharm Worth?
The simplest way to calculate MusclePharm's value, is to look at recent buyouts of other sports nutrition companies. Over the past couple of years, there have been about a dozen buyouts for an average of 2.3 times sales. But this is a low figure compared to England-based Reckitt's recent offer to buy Schiff at about 4.5 times sales, or 28 times EBITDA. To keep things conservative in my MusclePharm analysis, I will stick with the 2.3 times sales figure.
If we take 2012's estimated $75 million revenue and multiply it by 2.3, we get a buyout figure of $172 million. I'm going to assume that after all financings are completed, the company will have about 6 million shares. This would give us a share price of $28. If we base it on my 2013 estimate of $110 million in revenue, we get a valuation of $253 million, or a share price of $42.
Do you see my point? If MusclePharm uses these financings to clean up the balance sheet and achieves profitability in 2013, the company should be fairly valued at $172 million, or $28 per share. But let's say the market still isn't willing to give MusclePharm a fair valuation and only values it at $14 a share. That's still more than three times today's share price.
Why Are MusclePharm Shares So Cheap?
MusclePharm shares have been driven to this ridiculously low level primarily because the company has done a poor job with its financings, and the company's balance sheet is abysmal, although it is rapidly improving. This current round of financings should help clean up the balance sheet and in my opinion, MusclePharm's two newest members of the management team, CFO Gary Davis and COO John Bluher (Prudential Securities, Janus, Neuberger Berman), will continue to make improvements.
The company has also had a problem with exaggerated executive pay packages, but management's salaries and bonuses have been reduced from 12% of revenue down to 6% of revenue. Things are moving in the right direction.
Fortunately for us, the market doesn't yet realize the company is fixing its problems, and the share price has been knocked down to this extremely low level. That provides opportunity. Keep in mind, that it's not that difficult for a company like MusclePharm to clean up its balance sheet and reduce executive pay. If the company can improve its balance sheet and be left with only 6 million shares outstanding, that puts investors in a very good position. MusclePharm presents an ideal situation for investors because the company's problems are solvable, and management appears to be addressing them effectively.
If I'm correct in my assumption that MusclePharm has been profitable for part of Q4 2012 and will be profitable in Q1 2013, the company could pre-release information, indicating some level of positive information. Next, the company will announce Q4 2012 results in the next few weeks, and I believe we will receive more detailed information, which could move the shares higher. Then, when the company reports Q1 2013 numbers in May, the shares could surge as a result of strong EPS numbers.
But as low as the shares are priced, a catalyst may not even be necessary for the shares to move higher. Once institutional investors realize Dr. Frost has a new investment, interest in MusclePharm could rise substantially.
MusclePharm Financing Offers Little Discount to Investors
Dr. Frost must really like this company, because he is buying shares for $4, while they are currently trading at $4.07 (Friday's closing price). There is absolutely no warrant coverage. Most of the time, deals like this give investors significant discounts and warrant coverage. The fact that MusclePharm was able to get terms like this, is another demonstration that the shares are probably trading at the absolute bottom.
Risks for Shareholders
I see three areas that could derail MusclePharm:
- Sales growth stalls.
- The company is unable to raise capital.
- Management starts giving itself excessive bonuses again.
I believe that sales growth will certainly slow down from 400% annually. That's definitely unsustainable. But at this point, it appears the company is very close to profitability. Even if revenue growth were to slow to 30%, much of that revenue could still be applied to the bottom line. If sales growth were to stall completely, I would be concerned, and would probably liquidate my position. But I don't expect sales growth to go from 400% to 0% instantly. If that were to happen, it would take a long time.
I believe Dr. Frost's investment in MusclePharm eliminated most of the risk in terms of raising new capital. Most of the heavy hitters on Wall Street are aware of Dr. Frost's track record, and, in my opinion, any near-term financings will be easily oversubscribed -- mostly because of Dr. Frost's participation in this round.
I am concerned about management reversing its pay cut policy and re-instituting excessive pay packages. This could reduce the bottom line, and to some degree, negatively affect the share price. What could save shareholders is the fact that management also holds large number of shares, and it could ultimately be more profitable for management to profit as shareholders, rather than receiving gigantic pay packages. However, once MusclePharm becomes profitable, I wouldn't be surprised to see management reinstate large pay packages. But at that point, the share price should be well above $4, and investors who got in at this price could exit at a profit.
I liked MusclePharm before Dr. Frost became a shareholder. But his participation in the recent financing only confirms my belief that MusclePharm could be a multibagger. I believe this could be one of my best trades in 2013.