The last stock we bought was OrthoLogic Corp (OLGC), an Arizona based drug development company with a $63 million market cap. Before reading any further, please note the following:
A. This is a highly speculative company which one day may be worthless.
B. We have only a superficial understanding of the company’s drugs.
C. Depending on the stock’s behavior, we may add to or close out our position in the near term.
Until November of 2003, OLGC sold proprietary products that promoted bone and tissue healing. Since then, the company has sold all of its revenue generating operations, gathered a pile of cash, and purchased intellectual property from Chrysalis Biotechnology, Inc. and AzERx Inc. OLGC is now using acquired technology to develop drugs that assist tissue repair.
Most of OLGC’s product candidates are based on an amino acid synthetic peptide called TP508, or Chrysalin. The general theory is that Chrysalin can help the body heal by mimicking certain properties of the human thrombin molecule. In company literature Thrombin is described as, “a naturally occurring agent responsible for blood clotting and initiating the natural healing cascade of cellular events responsible for tissue repair – both soft tissue and bone.”
Chrysalin has shown promise in pre-clinical animal studies. In one study, “a single injection of Chrysalin into the fracture gap accelerated fracture healing by up to 50% as measured by mechanical testing.” As we’ll describe in a moment, human studies of Chrysalin have had some stumbles.
Here are OrthoLogic’s product candidates and status as of year end 2005:
Acceleration of fracture repair: Phase 3 human clinical trials
Diabetic foot ulcer healing: Phase 1/2 human clinical trials
Spine fusion: Phase 1/2 human clinical trials
Cartilage defect repair: Late state pre-clinical trials
Tendon repair: Early stage pre-clinical trials
Cardiovascular repair: Pre-clinical trials
Dental bone repair: Pre-clinical trials
In March, the company announced that its latest Phase 3 clinical trial of Chrysalin “did not demonstrate statistically significant benefit compared to placebo in the primary efficacy endpoint,” although it did demonstrate statistically significant benefit of the secondary endpoint. This means that in the latest study the drug failed to accomplish its main goal but it did accomplish its secondary goal.
A spectacular sell off followed this announcement. In April, CEO James Pusey resigned, which is not a good sign. In early March, OLGC shares reached $6. Now the company is trading at under $1.60, with new 52 week lows being made almost daily.
So why are we gambling (yes, we call this gambling) on drugs we know nothing about?
Reason one: The balance sheet. OLGC has cash and investments of about $74 million and total liabilities of about $4 million. The current market cap of $63 million is a discount to cash, net of all liabilities. The company is losing money, but there are fewer than 40 employees and management expressed confidence that “cash and short-term investments will be sufficient to meet our presently projected cash and working capital requirements for the next two years.” (3/31/06 10Q)
Reason two: Incentivized insiders. From the 10K: “As of December 31, 2005, there were 38,124,742 shares of common stock issued and outstanding. . . . As of December 31, 2005, we had stock options outstanding to purchase approximately 3,040,785 shares of our common stock, the exercise price of which range between $2.43 per share to $17.38 per share.” Note that the low end of the exercise price range is still 57% above the current trading price. Some might argue that there’s no incentive here because the exercise prices are too high, but we believe that this is an important incentive due to the extraordinary volatility of drug stocks.
Reason three: The selloff is an overreaction. Results of Phase 3 clinical trials of Chrysalin for fracture repair were clearly a setback, but there is still more analysis to be done on the study (results should be announced shortly) and there are still a whole bunch of drugs the company is working on developing. Any good news could send OLGC’s shares higher.
Bottom line: It doesn’t make sense that a basket of so many potential drugs should sell at a discount to net cash. The balance sheet gives management time to right the ship, and stock options provide the economic motivation. We recognize that with no sales, no products, and a recently departed CEO there are huge risks, but we are willing to take them with a small, speculative part of our portfolio.
OLGC 1-yr chart: