Last month, Opko Health (OPK) bought PROLOR Biotech (PBTH). Shareholders of PBTH will receive just under 1 share of OPK for each share of PBTH. Considering this even trade, current shareholders of PBTH will need to decide if they want to hold onto the OPK shares they receive, or deploy capital somewhere else. In this article I will take a close look at OPK, and try to assess its valuation, and from there make a recommendation to PBTH shareholders.
Opko Health: An Overview
Opko Health (OPK) does not have any large commercial scale operations as of now, but it has many assets in its pipeline. OPK reports these items in two segments -- diagnostics, and pharmaceuticals. It has three products in its diagnostic segment, and six in its pharmaceutical segment. Of these three products, two in diagnostics and one in pharmaceuticals have either reached some level of commercialization, or have made significant progress in that direction. In the diagnostics space the following tests have made significant progress
Opko 4K Prostate Test -- For patients with elevated levels of PSA, the current course of treatment entails a biopsy of the prostate -- a costly and difficult procedure. Opko's 4K test allows doctors to sidestep the prostate biopsy by using its proprietary software to analyze a patient's blood to see if their elevated PSA levels should cause worry. This test has already launched in the U.K., and Opko has stated that it should launch it in the U.S.A. at some point in 2013. Of the 30mm PSA tests administered each year, 1-1.5mm of them result in a prostate biopsy. Opko contracted a third party consultant who estimated that OPK could charge $1,600/test -- making it around a $2 billion market.
Point-of-Care card -- a card that can take a drop of blood, and when inserted into a small computer, can instantly analyze a panel of diseases. Currently, OPK has made progress in the commercialization of this product in the diagnosis of two diseases:
PSA Test -- used to test for prostate cancer -- $900mm market
Vitamin D deficiency test -- $2.5 billion market
OPK plans to use this card as a platform to test for many diseases, but its main progress has been in the PSA space, and to a lesser extent in the Vitamin D space. The basic selling point of this product over the current standard of care lies primarily in its ability to quickly analyze blood samples without the need to send the samples to a lab for analysis.
One of OPKO's pharmaceutical products has made significant progress:
Renal Drugs --earlier this year OPK acquired Cytochroma giving it access to Cytochroma's two drugs that treat patients suffering from Vitamin D deficiency because of chronic kidney diseases (CKD). The two drugs both treat patients suffering from CKD, but target patients suffering different levels of the disease. In an interview on CNBC, Dr. Phillip Frost, CEO of Opko, stated that this drugs addresses a $12 billion market. This drug currently stands in a phase 3 trial.
Taken together -- Opko's three products address a combined market of $17.5 billion. As mentioned, this calculation does not take into account OPK's other assets, but those assets have not made the same sort of regulatory progress, making them hard to value. Now that we calculated OPK's total addressable market let's take a look at PROLOR Biotech's.
PROLOR Biotech's Addressable Market
PROLOR has an innovative patent, which extends the life of therapeutic proteins, thereby decreasing the number of doses patients need to take. It has applied this technology to three areas:
hGH hormone -- $3.5 billion market
Clotting factors -- $2 billion market
Diabetes treatment -- $2 billion market
In my previous articles (see links above) on PBTH I broke down the exact market for each of these drugs, so please see there for more details. PROLOR's hGH drug has reached phase 3 trials in the adult version, and phase 2 trials in the child version. PBTH plans to begin phase 2 studies on its clotting factor drug in the near future, and the diabetes treatment has not progressed beyond pre clinical trials. PBTH's immediate addressable market (meaning, leaving aside its diabetes treatment, and the value of its platform, more on that later), then, stands at $5.5 billion.
OPK addresses a $17.5 billion market, and has a $3 billion market cap, using the same numbers then, PBTH should have a market cap of about $1 billion, right? However, this is not the case. As of the writing of this article, PBTH, even post buyout, only has a $400 million market cap. Why is this?
Why The Difference?
Why does OPK command such a premium over PBTH? Or turning it around, why does PBTH trade at a discount to OPK? We can sum up the answer to this question with a name -- Phillip Frost. We mentioned Dr. Frost above, but we should include a couple of words about his personal history. Dr. Frost bought troubled pharma company Key Pharmaceuticals in the early 1970's and after a lengthy period of turnaround he sold it to Schering Plough for $600 million in 1986. However, Dr. Frost still had more in mind. After the Key sale he became Chairman of Ivax Corporation, which he guided for just under 20 years until he sold Ivax to Teva (TEVA) in January 2006. This sale landed Dr. Frost the Chairman's job at Teva, a position he holds to this day. Currently, Dr. Frost runs OPKO health, where he owns 40% of the shares outstanding, encouraging investors to bet on this jockey one more time.
In a word, Dr. Frost has a storied career in the healthcare business, and investors think he will strike gold again with OPK.
However, even considering this storied pedigree, we must ask does Dr. Frost's presence justify a 100%+ premium over a similar company -- PBTH. I would hesitate to answer yes to such a question. We need look no further than J.C. Penney (JCP) where boss Ron Johnson came in with great fanfare because of his success running Apple's (AAPL) retail division. Needless to say, Mr. Johnson, despite his past success, could not replicate the same results at JCP. The upshot of this story, reaffirms Peter Lynch's old saying, "buy a business so bad even your idiot nephew can run it. Because one day he will". Obviously, investors have confidence that Dr. Frost can pull it off again, and we can attribute a lot of the premium to that fact, but considering the above, I don't think we can put the entire premium on Dr. Frost's shoulders. As such, I think we need to think about PBTH as relatively undervalued.
PBTH: A Platform For Growth
As mentioned above, PBTH has used its technology that increases the lifespan of therapeutic proteins to develop three different drugs. However, this only scratches the surface of possibilities for PBTH's technology. Biologic drugs have and will continue to play an important part of the pharmaceutical industry. Biologics make up seven out of the top ten drugs sold today, and account for $148 billion in sales. Over the next seven years, estimates show that pharmaceutical companies will lose $30 billion of those sales to patent loss. And while credible generics have not come around yet, we have to imagine someone will eventually crack that code. If so, companies will need to add features -- like longer lasting doses -- in order to retain sales. Considering this huge and important opportunity, many pharmaceutical companies will avail themselves of PBTH's critical technology. This ability to function as a platform for all therapeutic proteins puts PBTH in the center of one of the most important areas in healthcare today.
Despite this huge opportunity, as I have pointed out in previous articles (see above), PBTH seems to only get credit for its pipeline -- missing the forest for the trees. Putting this all together, we must ask (granted OPK has an above average premium, and PBTH trades at a discount) now that OPK has acquired PBTH, is OPK undervalued? I won't answer this question one way or the next, but the addition of a developed pipeline and a tremendous technology platform definitely put the question on the table.
Every share of PBTH will get essentially swapped with a share of OPK. Curiously, PBTH trades at $6.41, but OPK trades at $7.00 offering investors an interesting arbitrage play. You can buy PBTH and short OPK, or buy PBTH and buy a put on PBTH -- both protecting your downside should the prices converge.
Some attribute the price discrepancy to the shareholder litigation surrounding the merger. This seems a bit ridiculous, as Judge Shirley Korneich of New York pointed out (p.6 of decision) in the recent NYSE (NYX) and ICE (ICE) merger, 91% of mergers have some sort of shareholder litigation -- forcing us to consider the true motives of the lawsuit -- holding the merger ransom until shareholders receive some money. Undoubtedly this will happen, the merger will go through, and investors can make money in the short term through a clear arbitrage, and through the long term with the continued growth of PBTH within OPK.