Phillip Frost and John Pappajohn are two famed biotech investors with quite a few similar traits. Both have made many fortunes spotting early opportunities to invest, while allowing anyone who invested alongside them to cash out for large multiples along the way. At the respective ages of 76 and 85, Frost and Pappajohn are revered veterans in the industry that have consistently proven their prowess in the early-stage biotech investing arena. Both have been extremely generous with their fortunes as well-documented philanthropists. Now it seems they both are placing their biggest bet in the burgeoning diagnostics segment of the biotech sector. Frost has been vocally placing his bet with Opko Health (OPK), while Pappajohn has more quietly accumulated a large position in the up and coming Cancer Genetics (CGIX).
Recent Movement in Frost's Portfolio
Frost's portfolio has seemingly been on fire lately, with many public companies in which he is a major holder all up significantly in recent months. These include: Musclepharm, Inc (MSLP.OB) which is up 144% since Frost invested at $4/share in the beginning of the year; a company outside of. Frost's typical biotech focus which is up 65% since I first covered it here on Seeking Alpha a month ago; and Opko Health which is up 80% so far this year.
Frost's most significant and most vocal investment, though, is clearly Opko Health. Opko has two segments: pharmaceuticals and diagnostics. The diagnostic segment has been the primary focus and the one that Frost seems most apt to discuss (e.g. on his handful of appearances on Jim Cramer's Mad Money). The company is developing molecular diagnostic tests to identify molecules or immunobiomarkers for Alzheimer's disease, non-small cell lung cancer, pancreatic cancer, and other cancers; point-of-care diagnostic tests to detect prostate specific antigen; and lab tests comprising 4Kscore test for the detection of prostate cancer.
Opko has been a topic of hot debate here on Seeking Alpha, with contributors extensively covering both sides of the debate (bull and bear). The bulls have been the clear winners thus far, with the stock up 80% so far in 2013 alone, 200% the past two years, and 300% the past three years. Fundamentally speaking, at its current ~$3.5 billion market cap, there is no question it has been a terrific ride for shareholders who got in at any point along the way.
As a quick reference for why I think Cancer Genetics is such an opportunistic investment here against the Opko backdrop: if Cancer Genetics reaches just 5% of the current valuation of Opko, that would equate to a $30 share price for Cancer Genetics (from its current share price of $9.90 with 5,816,691 shares outstanding).
Cancer Genetics Following in Opko's Billion Dollar Footsteps
I try to focus on finding the opportunities where savvy investors such as Frost and Pappajohn are placing their bets early on, before they transform into billion dollar market caps. This is why I found it so interesting to see that two veteran biotech gurus are both heavily focused on their respective diagnostic companies. Opko has already transformed into a multi-billion dollar company, where it is harder to find an edge as an individual investor due to the amount of thorough analysis that has already been performed on the company along the way to its current market cap. I believe the more overlooked Cancer Genetics will experience a similar transformation, as it continues to grow its revenues and expand.
John Pappajohn has been an active private equity investor in healthcare companies for more than 30 years, and has served on the board of directors of over 40 public companies. Among his most famous early investments was his role as founder of Caremark Rx, Inc, which sold to CVS for $582 million and now partially accounts for the $72 billion market cap company CVS Caremark Corp (CVS). Like Frost, Pappajohn is an avid philanthropist and has donated more than $100 million with the ambition "to be the greatest philanthropist in the history of Iowa." Pappajohn is the largest holder of Cancer Genetics owning ~22% of the company, while Frost is similarly the largest shareholder of Opko with ownership of ~34%.
Investing in Diagnostics to Invest in the Future?
While Pappajohn's involvement as the largest shareholder is what initially piqued my interest in Cancer Genetics, further analysis of the company and its current valuation relative to peers along with the pining to invest in the diagnostics space is what motivated me to become an enthused shareholder. I think James Altucher gave a great summary of why diagnostic companies have such high upside over the coming years:
We all know three things about healthcare over the next 10-30 years:
· Taxes are going up on medical devices. So this will be detrimental to the 77 million aging baby boomers who have just started retiring.
· "Prevention is the cure." People have ignored this for the past century but they can't anymore. Lifespans have gone up. People need good diagnostics to prevent cancer and other diseases that are common killers.
· Lifespans are going up. The average lifespan was 61 60 years ago. Now it's 79 and going higher. So people will need medical care. Since people can no longer afford medical care, they will need prevention. The FDA, drug companies, insurance companies, and the government, have made medical care too expensive. So diagnostics, which are easier to get approval for, are the answer.
Altucher believes in the diagnostics sector as a whole and chose Cancer Genetics for his portfolio according to the article. Altucher is most renowned for being one of the first to cover Vringo (VRNG), which rose from $1.65 to over $5 shortly after Altucher wrote about it and announced his investment. It has since dropped back to its current $3.10 price, but has also raised $80 million and been added to the Russell 2000 since then.
Cancer Genetics Recent Financing and Current Severe Market Mispricing
Cancer Genetics recently raised $15 million in a straight common stock offering at $10 per share, and currently trades below that level. This is another reason why I think it is such a compelling time to invest in the company, being able to get in around the same level as those that had the first look to participate in the actual financing. This financing gives the company a very comfortable cash position to progress on its proven business plan that has significantly grown every year in both total revenue and clinical volume since the company's launch in 2009, including 54% growth for the current year-over-year revenues.
Being able to invest in a company that has both the pie-in-the-sky upside potential of a biotech, along with the downside protection in terms of cash in the bank and actual revenues that are very significant when compared to current market cap, presents a rare opportunity for investors.
Cancer Genetics presents further diversification from a risk perspective due to its having launched five proprietary diagnostic products in three different target markets: hematological, urogenital, and gynecological. In these three target markets combined, Cancer Genetics' tests address a combined $15 billion global market and have the ability to impact over 610,000 new lives annually in the U.S. alone.
Here is a visual of the difference in success rate between the traditional approach today in cancer treatment and how Cancer Genetics' approach differs, leading from a current 25% success rate to possible 100% success rate with their personalized approach:
Cancer Genetics offers a comprehensive array of integrated laboratory services that add significant value to the process of diagnosing cancer. The laboratory is focused on providing comprehensive diagnostic, prognostic, therapeutic and disease-monitoring information on hematopoietic malignancies. The products Cancer Genetics has developed are poised to help transform cancer management while increasing treatment efficacy and reducing healthcare costs. Cancer Genetics has a number of collaborations with leading clinics in place, including Memorial Sloan Kettering, The Mayo Clinic, The Cleveland Clinic, and the National Cancer Institute.
Recent M&A in the Space
Another reason I think the time is now to invest in the space in general is the recent merger and acquisition activity, which has led to several additional companies trading for lofty valuations as possible takeout targets. On December 10, 2012, Amgen announced it agreed to buy Decode Genetics for $415 million. Decode Genetics was in the same business line as Cancer Genetics and generated less revenue at the time it was bought than Cancer Genetics does currently.
Several different smart money investors are aligning their investments in diagnostics. It seems clear that Cancer Genetics is one diagnostics company that has been overlooked by the market up until this point, outside of its largest shareholder who has a reputation of looking precisely for this type of opportunity in the first place. The use of any valuation metric or comparative analysis signifies exactly this type of situation which I look for as an investor. Cancer Genetics' partnerships with all of the prestigious research centers mentioned helps validate the technology, as does the consistent increase in revenues and volume of tests used. Investing in an overlooked and undervalued company in a hot diagnostics sector that many think could be the wave of the future presents an ideal combination.
Risks to consider
On the flip side of the coin, the biggest risk for any of these diagnostic companies, Opko and Cancer Genetics included, is that they operate in an industry that is subject to intense competition, government regulation and rapid technological change. I think these two in particular have managed to mitigate those risks with sustained revenues, solid balance sheets, and superior technology. For a full list of risk factors for Opko Health see its latest 10-Q here, and for Cancer Genetics see its latest 10-Q here.