Opko's Lead Drug Could Double The Company's Valuation

Dec. 5.13 | About: OPKO Health, (OPK)

In my previous OPKO (NYSE:OPK), article, I predicted improving fundamentals and a major short squeeze. At that time, Opko was trading just over $4. Since then, OPKO's share price has more than tripled, rising to $12.95 last month. The company's fundamentals have improved dramatically and this article will provide investors with an update.

OPKO is basically an entirely different company with many new multibillion-dollar drugs in the pipeline. Most importantly, OPKO's lead drug, Rayaldy, could more than double the company's valuation.

OPKO's acquisitions have transformed the company

OPKO's pipeline growth has been the result of value enhancing acquisitions. On January 8th of this year, OPKO announced that it would be acquiring privately held Cytochroma Corporation. This gave OPKO ownership of 6 new drugs, each of which addresses billion dollar markets.

On April 24th, OPKO announced that it was purchasing Israel-based Prolor Biotech which added 4 more clinical drugs to its pipeline, targeting markets ranging from $700 million-$3 billion. Prolor is focused on developing proprietary long-acting forms of currently marketed therapeutic proteins and peptides. In June 2013, PROLOR initiated a pivotal phase 3 clinical trial in adults of its proprietary long-acting version of human growth hormone, hGH-CTP. The phase 2 trials were very successful in terms of demonstrating safety and efficacy.

And then on October 10th, OPKO announced it would be making a strategic investment in Zebra Biologics, a privately held biotech company. Zebra specializes in antibody engineering and will take advantage of the new technologies developed by Dr. Richard Lerner and colleagues at the Scripps Research Institute in San Diego to generate both agonist and antagonist antibodies for a wide range of therapeutic applications.

Also, in October, OPKO made a strategic investment in Arno Therapeutics, Inc, (OTCQB:ARNI) a clinical stage biopharmaceutical company focused on the development of oncology drugs. The company invested in Arno based on the potential of its lead product and cancer therapeutic, Onapristone, which focuses on breast and prostate cancer treatment. In connection with this investment, OPKO was granted exclusive first rights to negotiate with Arno regarding any potential strategic transactions with which Arno becomes involved.

Rayaldy should be a blockbuster drug

The product investors really need to pay attention to is OPKO's most advanced drug, Rayaldy. Rayaldy is being developed as a new treatment for patients with stage 3 or 4 chronic kidney disease. For a detailed scientific explanation, I recommend all investors read this analysis by fellow Seeking Alpha author, Dr. John Cannell. Dr. Cannell has an interesting perspective based on his work in the area that Rayaldy addresses.

Rayaldy is the first and only modified-release formulation of calcifediol, and is protected by newly issued patents. For those interested in looking at some of these patents, I recommend looking at United States (U.S.) patent numbers 8,207,149, 8,361,488 and 8,426,391.

Rayaldy is currently in phase 3 trials for the treatment of secondary hyperparathyroidism (SHPT) in patients with stage 3 or 4 chronic kidney disease and vitamin D insufficiency. Each of the two pivotal phase 3 trials involves approximately 210 patients recruited at about 40 sites in the U.S. Patients are being stratified by CKD stage and randomized in a 2:1 fashion to receive six months of treatment with either Rayaldy or a placebo.

The two pivotal trials are being followed by an open-label extension study in which patients are treated, at their election, for an additional six months with Rayaldy.

Rayaldy's path to commercialization

OPKO expects to announce the topline clinical results for the pivotal phase 3 Rayaldy trials in mid-2014. The NDA (new drug application) will be filed (accepted for review) by the FDA in the first half of 2015.

The goals of the NDA are to provide enough information to permit FDA reviewers to establish the following:

· Is Rayaldy safe and effective in its proposed indication(s) when used as directed, and do the benefits of the drug outweigh the risks?

· Is Rayaldy's proposed labeling appropriate?

· Are the methods used in manufacturing Rayaldy and the controls used to maintain the drug's quality adequate to preserve the drug's identity, strength, quality and purity?

From there, we can expect about 10 months to FDA approval. Commercialization will rapidly follow, in early 2016 at the latest. However, given OPKO's global reach, we could see Rayaldy introduced into other markets before the U.S. launch.

The two most important events will be the announcement of topline phase 3 results and FDA approval. We could see a share price run-up in anticipation of each of these events as is often the case with biotech companies.

What will Rayaldy be worth in 2 years?

Rayaldy should be hitting the market by early 2016 and, as we approach that date, Rayaldy's value should increase substantially. The total market potential for this one drug is at least $16 billion annually, although I have seen figures as high as $24 billion. The variances in market potential are dependent on OPKO's ability to penetrate the market globally and to expand the approved indication through appropriate line extension strategies.

The potential market in the U.S. includes 2 to 4 million patients. Competitive prescription and over-the-counter (OTC) vitamin D repletion products have been recently proven (in numerous controlled clinical trials) to be ineffective in managing SHPT in chronic kidney disease. Competitive prescription vitamin D hormone replacement products sell for $3000-$7000+ a year, and they are either less effective (when used at the highly popular safe but sub-therapeutic doses) or potentially toxic (when used at therapeutically relevant doses). In my opinion, Rayaldy could capture a large portion of this market.

Let's say that OPKO captures 12.5% of a $16 billion market, or $2 billion in annual revenue within the first couple of years, which in my opinion is conservative. With a 3X revenue multiple, (a multiple that I would give Rayaldy in a buyout situation), that would give the Rayaldy portion of OPKO a $6 billion valuation. That would translate to $15 per share for OPKO, just for this one drug. This does not include any of OPKO's other assets.

What could OPKO be worth in 2 years?

If Rayaldy is worth $15 per share in 2 years, OPKO's share price should be considerably higher than today's $10 level. In 2 years, most of OPKO's other products will be further developed, which will increase their value. All these products combined are addressing markets in excess of $80 billion. If we give these products a value of $10-$15 per share, that would bring OPKO's share price up to $25-$30 per share.

OPKO's near-term revenue sources

One factor that makes a $25 or $30 share price within 2 years a realistic target is that OPKO has three additional products besides Rayaldy that should soon be generating large revenue streams, including:

• Once-a-week human growth hormone. The current market for daily injections is greater than $3 billion per year. This product is currently in phase 3 trials for adults, and phase 2 with children. The big advantage of this product is that it only needs to be given once a week instead of once a day.

• Rolapitant, licensed to Tesaro. Enrollment in two of the three phase 3 trials has been completed, and we should be getting top line results from these trials by the end of this year. This product should be hitting the market in early 2015. OPKO stands to gain more than $100 million in milestone payments and double-digit royalties. Rolapitant should be the best in class drug for nausea and vomiting connected with chemotherapy. OPKO believes the product can achieve up to $1.5 billion in annual sales.

• 4Kscore test for prostate cancer. Results on 10,000 men show that when the test is performed on men with high PSA scores, 60% of biopsies can be avoided. This is a $300 million market in the U.S. alone. The goal is to eventually replace the PSA test, which gives 70% false positives and is currently used for about 30 million tests per year in the U.S. As I stated in my previous article, I believe the 4kscore test will replace the archaic PSA test. The company expects to commercially launch its 4Kscore in the first quarter of 2014. The pivotal validation study will be run in 15 different centers in the U.S. with an enrollment of about 1,200 patients. The results of the study will support the CLIA (clinical laboratory improvement amendments) validation as well as help secure the 4Kscore reimbursement.

OPKO has many other products in its pipeline with longer-range timelines, but the three products I just detailed are valuable because of their near-term revenue generation. Given the proximity and size of these near-term revenue streams, this definitely makes one more argument for OPKO's current valuation to be above $4 billion.

The Frost factor

For those of you who are not familiar with OPKO's CEO, Dr. Phillip Frost, he made his mark when he sold drug manufacturer Ivax to Israel-based Teva Pharmaceuticals (NYSE:TEVA) for $7.6 billion in 2005. Since 2010, he has been the chairman of Teva, a $36 billion pharmaceutical company.

Dr. Frost's ability to find and develop promising companies was also demonstrated when he and Michael Jaharis purchased a company on the brink of bankruptcy called Key Pharmaceuticals. Under their leadership, Key Pharmaceuticals grew to generate annual revenues of $150 million and 14 years later, Schering-Plough of Merck (NYSE:MRK) acquired the company for $826 million. Dr. Frost's return: +3500%.

Here's another example that demonstrates Dr. Frost's ability to purchase high quality assets, on extremely favorable terms. 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.

Here is the story direct from Dr. Frost, taken from a Seeking Alpha article:

"Basically we're extremely opportunistic. You've heard what I've described already, but another example is a product that we brokered called Rolapitant, which came about because the CEO of Schering-Plough, whom I had known, had to divest himself of this product in order to complete their merger with Merck. Knowing that we move quickly he gave me a call and very quickly we had the product in our hands. We paid very little money for it; we got the ownership of the product, plus raw material to continue with it, it was worth more than we paid for it. We worked on it for a year, we invested very little money and turned around and out-licensed to another company, got the money that we put in plus we have the possibility of getting $120 million in payments in it, and as well as up to 20 percent royalty with almost no investment. That product can be a million dollar product. We also got some ownership in their company - the licensee's company. So if that works out, I know the people in the company think it's going to be a billion dollar product, we can wind up with a serious income stream just from that one product, and we don't have to do anything further - they're paying for all the Phase III studies. They have finished Phase II studies by the way. So that's an example of the type of opportunism that we got to exploit."

Dr. Frost's decades of experience in this business is what allowed this deal to happen. One of the main reasons I've established a long position in OPKO is because of Dr. Frost's ability to find and develop high quality assets like Rolapitant.

All of my Dr. Frost investments have been profitable

As many of my readers know, all of my Dr. Frost investments have done well. I initiated coverage on MusclePharm (OTCQB:MSLP) when it was trading at $4, and it rose beyond $13. ChromaDex (NASDAQ:CDXC), another Dr. Frost company, has gone from $.62 where I initiated a position, to $1.24. BioZone (BZNE) was also a good Dr. Frost trade as it rose from $.45-$.97 within a couple of weeks.

My point is that Dr. Frost has made many good investment decisions, and the fact that he continues to buy OPKO shares is a bullish indicator. Investors need to remember that when Dr. Frost was buying OPKO shares at $4, he was criticized. It turns out that he was right in that case, and I believe he is right now.

Will Dr. Frost sell OPKO?

Patent expirations are problematic for Big Pharma, and these companies are in need of near-term revenue-generating drugs. OPKO has multiple drug candidates that Big Pharma would love to own, so I see OPKO as an ideal acquisition candidate. Any of the big pharmaceutical companies, including Johnson & Johnson (NYSE:JNJ), Pfizer (NYSE:PFE), Merck, Sanofi Aventis (NYSE:SNY), Novartis (NVS) or GlaxoSmithKline (NYSE:GSK) could benefit from OPKO's diagnostic and pharmaceutical products.

In the past, Dr. Frost has sold companies with terms very beneficial to investors. For example, Ivax shares went from a split-adjusted price of $.38 in 1987 to $26 when he sold the company to Teva Pharmaceuticals in 2005. I assume he ultimately plans to sell OPKO, although I have no idea when.

Dr. Frost continues to buy OPKO shares

Dr. Frost has made 13 separate purchases of the stock so far just this month, mostly over $10 a share. But as all OPKO investors know, his purchases of OPKO shares has been going on for years. And it's important to note that he has never sold a single OPKO share.

George Soros could increase his position in OPKO

A couple of months ago, George Soros began initiating a long position in OPKO by purchasing 745,000 shares. This is a miniscule position for him, and in my opinion, he will ultimately build a considerably larger position in OPKO. You can imagine the level of due diligence conducted by the Soros group, so it's just not worth it for them to take small positions.

As a side note, Soros also has a $136 million position in Teva, another company Dr. Frost is heavily involved with. One has to assume that Dr. Frost and Soros had numerous conversations before Soros decided to invest in OPKO.

Another significant factor is that Carl Icahn and Dr. Frost are both greater than 10% owners of the Vector Group. The Vector Group owns positions in several of Frost's companies, including OPKO. I would not be surprised to see Carl Icahn investing directly in OPKO at some point down the road.

OPKO's current financials

OPKO just reported cash and equivalents of $180.8 million, as of September 30th, 2013, an increase of 6.9% from the previous quarter cash of $169.1 million and up substantially from the $55 million I reported in my last article.

The revenues for the third quarter increased 75% at $20.6 million, as compared to $11.8 million in the same period of 2012. The reason for the increase was attributed to the agreement with RXi Pharmaceuticals (OTCQX:RXII) which generated revenue of $12.5 million.

From my perspective, as OPKO's new products hit the market, we could continue to see 75% to 100% year-over-year revenue growth. This is what makes the OPKO investment so compelling, because it's rare to see a $4 billion company growing revenue at such a rapid rate. Also, with Dr. Frost's ability to find and acquire valuable assets, this level of growth could continue for years.

What's the risk?

While some of OPKO's businesses are profitable, overall OPKO is still burning through cash. I cannot predict when OPKO will be profitable as a company.

There is also clinical risk because with so many drugs in the pipeline and a drug could always fail a clinical trial. If Rayaldy were to fail its current phase 3 trials, OPKO's share price would be negatively affected.

OPKO has a high level of short interest, but I believe short interest is good once the trades have taken place. I actually see more risk when a company has low short interest because once investors begin initiating short positions - that's what hurts the share price.

Conclusion

OPKO is a completely different company than it was 14 months ago when I initiated coverage. The company's pipeline has grown dramatically, as has its future revenue potential.

In my opinion, the fact that many of Dr. Frost's investments have more than doubled this year is an indication that Dr. Frost is at the peak of his career. His unofficial title of biotech guru has been earned by decades of experience and success in the biotech arena. Given Dr. Frost's track record, I believe OPKO could become his greatest accomplishment.

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Disclosure: I am long OPK, BZNE, CDXC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.