Opko: More Hidden Value In Partnerships, Equity Investments

Jun.10.13 | About: OPKO Health, (OPK)

Recent coverage provided for Opko (NYSE: OPK) included a simple financial model that supported a surprisingly high (~$1 B) valuation for a Phase III pipeline product hGH-CTP (a modified version of human growth hormone) that was added to the company's pipeline after the acquisition of PROLOR Biotechnologies.

The projected revenues for hGH-CTP are based on the market penetration assumptions of some other analysts (generally in the 30-40% range), although we feel that these could be even higher due to the significantly improved once-weekly regimen that hGH-CTP would offer relative to standard human growth hormone, which must be injected once per day for patients with stunted growth. We pointed to a somewhat similar improvement made in the dosing regimen for VEGF inhibitors in wet AMD treatment that was introduced by Regeneron (NASDAQ: REGN), which was a huge commercial success because of the practicality of reducing total number of patient injections.

This note will focus on two other companies that caught OPKO's attention in recent history and triggered deals - RXi Pharmaceuticals (NASDAQ:RXII) and Tesaro (NASDAQ: TSRO). Due to the nature in which PROLOR was acquired by OPKO, we believe that Dr. Philip Frost (CEO and Chairman of OPKO) and his team see big potential in the respective pipelines of these two companies, and have positioned themselves accordingly (with the ownership of huge equity stakes) to acquire assets at a later date.

Unmentioned at this time is the importance of late stage clinical development for OPKO's own CTAP101 and Fermagate programs, although we will delve into these later.

RXi Pharmaceuticals

RXi is a company that focuses on RNA interference (RNAi) technology, which is a very promising area that may see much more interest from the biotech investment community as more efficacy and safety data is gathered in various ongoing clinical trials. In March 2013, OPKO closed the sale of its RNAi portfolio to RXi for $12.5 M and 50 million shares of RXi along with $50 M in milestone payment obligations.

What made this particularly interesting, and should drive M&A speculation into the future, was the additional purchase of 17.2 M shares of RXi as part of a $16.4 M financial for RXi which makes OPKO a near-20% owner of company stock. This better positions the company for a repurchase of the RNAi pipeline later on, which includes a particularly interesting compound from the RXi pipeline called RXI-109.

RXI-109 is an RNAi compound that inhibits the production CTGF (Connective Tissue Growth Factor), a protein that plays a central role in the formation of scar tissue and serves as a very good biomarker for abnormal scarring. The drug impressed the market after a recent presentation of the first of two planned Phase I studies, which showed that 15 RXI-109 patients had statistically significant reductions in CTGF expression at a RXI-109 injection site (versus a placebo injection site) and experienced no significant side effects or toxicities.

This is not only good news for RXI-109, but good news for the therapeutic viability of RNAi technology - and in this case, the specific platform developed and pooled together by RXi and OPKO Health.

Worth noting is that Dr. Phillip Frost, originally trained as a dermatologist, should have a particularly good read on the commercial viability of an anti-scarring product like RXI-109. The fact that he has linked OPKO's financial interests with RXi through a near 20% equity stake in the company implies that he is confident that the product will succeed in late-stage clinical development, and ultimately on the dermatology drug market.

RXi is a very young company and is only covered by one firm (Griffin Securities), which issued a"buy" rating in April.

Tesaro

Tesaro is an oncology drug developer that impressed the market with Phase I results presented at ASCO 2013 for a promising phase I compound called Niraparib, and achieved tumor shrinkage in 75% of patients (based on a standardized measure RECIST) with advanced ovarian cancer and 50% across all dosage arms in ovarian cancer patients with BRCA mutations.

OPKO's history with Tesaro goes back to a deal closed in December 2010 for the NK-1 receptor Rolapitant for the treatment of chemotherapy induced nausea and vomiting (CINV). Similar to the pipeline deal made with RXi Pharmaceuticals, the Tesaro gave OPKO the rights to future milestone payments (up to $121 M) and tiered royalties on future sales for the product, in addition to a 10% total equity stake in TSRO. After the company held a very successful IPO in 2012 and tripled its valuation in just a year, we can infer that OPKO is not only impressed with the results, but may at least consider additional investment into TSRO at some point.

We are expecting Rolapitant Phase III top-line data in the second half of 2013. Wall Street analysts are very bullish on the drug's prospects, with buy/outperform ratings from all 5 of the firms covering the company.

The Takeaway

Many claim that OPKO is overvalued based on the market prospects of its pipeline compounds, although the company is generating substantial value with business partnerships and equity investments in companies like RXi and Tesaro. RXi in particular has become a favorite of OPKO with the accumulation of 67.2 M shares (19.9% of shares outstanding) up to this point, making a full acquisition of RXi by OPKO very possible.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am long OPK via Short Puts