Ocera Therapeutics: An Undervalued Biopharma Company With A Lot Of Upside

| About: Ocera Therapeutics, (OCRX)

Ocera Therapeutics [Nasdaq: (NASDAQ:OCRX)] announced the initiation of its phase 2b double blind, controlled, randomized clinical trial in early January 2014. The company's main product is OCR-002 (ornithine phenylacetate), an ammonia scavenger which was given orphan drug and fast-track status by FDA.

Clinical problem: Patients with acute liver failure due to various toxins like acetaminophen or chronic liver failure due to alcohol or various hepatitis viruses suffer from high level of ammonia in the blood (since the liver metabolizes the ammonia). High levels of ammonia cause a condition called hepatic encephalopathy (HE) which can cause confusion and coma in acute cases and cognitive impairment in chronic cases. OCR 002 combines with ammonia in the blood and the product is excreted in the urine. About 150,000 hospitalizations occur each year in the United States due to HE and the number is expected to increase by 4% compounded annually (source).

Trials: The company's main product OCR-002 reduced arterial ammonia significantly in animal models. In a phase 1 safety study (43 cirrhosis patients and 54 healthy volunteers as control subjects), the drug was found to be safe (ammonia level were not measured since this was a safety and dose determination study). In a phase 2a study (uncontrolled) in 10 patients, ammonia level normalized in 36 hours of intravenous (iv) infusion and there was no incidence of acute HE up to day 6 of treatment. In another phase 2a study in acute liver failure patients (sponsored by the National Institute of Health) all 8 patients with HE recovered. Based on these results, the company initiated the enrolment of 200 patients at 40 centers in the United States and Canada in phase 2b trial of iv form of OCR-002 (OCR-002 plus standard of care versus standard of care alone).

Potential catalysts: The phase 2b trial is expected to complete in early 2015. Phase 2 trial of the oral form of OCR-002 (which is expected to be of use in chronic HE) is expected to start in mid 2015.

Financial information: The company has a market cap of $227 million with 15.25 million shares (float of 7 million shares). It reported cash of $21.69 million on its balance sheet as of the last SEC filing.

Valuation: Considering a daily iv treatment cost of $1300 (as expected by the company, source) and expected treatment duration of 2 days in acute cases, I expect the company to have approximately $400 million annual revenue after the drug approval in first year. If the number of shares doubles from here (I expect the company to issue a secondary equity offering considering its cash needs), and if we consider a price/sales ratio of 3 (biopharmas normally trade between 3-6 times price/sales), I expect the stock price to reach $37.50 (the stock is trading at $14.88 as of February 24, 2014). If we consider a high-end multiple of 6, the stock price may reach 75. I have not considered revenue due to oral form of OCR-002 in my valuation (the company expects annual sales of $600-800 million from its oral form).

Institutional buying: The company's stock has been under significant institutional accumulation as of 4Q, 2013. These include Venrock Healthcare Capital Partners (703,730 shares, 4.62 percent of shares out) and Boston-based RA Capital (661,696 shares, 4.34 percent of shares out). Other institutional holdings can be found here.

Risks in the investment: There is near-term risk of a secondary equity offering which may cause a downward pressure on the stock. There is a risk that the clinical trials may not show successful results. Even after approval, there is no guarantee that the clinicians will adopt to the drug use (though in surveys, 74% clinicians voted for using the drug if approved, source).

Conclusion: I am confident that the clinical trials of OCR-002 will meet the end-points and the drug will get fast tracked to approval. The field of HE has primarily depended on using oral form of lactulose for last 30 years and rifaximin (an oral locally-acting antibiotic) has come in practice in recent years. As a critical care specialist, I treat HE patients daily and it is very difficult to use oral drugs in these patients as they are frequently obtunded. An iv drug showing a clinical advantage over current treatment modalities will easily be clinically adopted widely. I also expect oral form of OCR-002 to gain a significant market share in chronic HE. I consider this drug a major breakthrough in HE treatment.

Disclosure: I am long OCRX. 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.