Why Pharmathene Could Go From $2 to $20

| About: PharmAthene, Inc (PIP)

In the biotech sector I try to find stocks that have minimal downside but potential for 10x returns. Back in July, 2007, for instance, I took a lot of heat writing bullishly about DNDN on TheStreet.com. More recently, I wrote this article for The Wall St Journal on June 30 about Pharmathene (NYSEMKT:PIP) when it was at 1.56. I listed three catalysts then and suggested that the stock should minimally be catapulted in the $7-10 range. I wanted to give an update on what's gone on since then and why I think the stock could eventually be even double what I initially thought.

First off, the stock is now at $2 after a competitive company, SIGA, three days ago received a contract from the government that could be worth conceivably up to $2.8bb for its smallpox antiviral product.

This potentially $2.8bb contract for SIGA is very significant for PIP, which is engaged in a lawsuit with SIGA that could be worth billions to PIP. SIGA produces the smallpox antiviral ST-246, which was just awarded the government contract. SIGA and PIP were at one point, back in 2006, planning on merging. As part of the merger agreement, it was determined that if the merger did not go through that PIP would be able to exclusively license development and marketing rights for ST-246. The merger did not go through, BUT PIP never got the license agreement. Hence, PIP sued SIGA. In my original article I asserted that this was a catalyst for PIP to go higher but it was hard to quantify that catalyst since we didn't know what sorts of revenues ST-246 could generate.

Well, now we can quantify it. Potential revenues are $2.8bb. Pharmathene is a $70mm market cap company. On the basis of this contract alone, Pharmathene would potentially make up to a billion dollars in cash earnings. So what is going on with the lawsuit since I wrote my original article?

In July a judge reviewed SIGA's motion to dismiss the case. Note, this is the same judge that rejected an earlier motion to dismiss in January, 2008. The judge is expected to rule on the motion by the end of this month and then the court is expected to go to trial in January. I've thoroughly reviewed the transcript from July. The basic point that SIGA was making in court is that they had no idea how good (or bad) ST-246 was going to do so there was no way to assign a number to damages. The judge, though, basically made the point (I am paraphrasing) that if that were the case then anyone could walk away from any contract if the future potential of that contract was still unknown. He then implied that should the trial go forward and SIGA were to lose then he, the judge, would have the power to determine what the damages were.

However, let's forget that he said all of that. Because we now know what potential damages could be. And the number is in the billions for a $70mm market cap company.

Can the judge dismiss the case? I don't think he will. Specifically he said, "Everybody should proceed on the assumption that there is no way that I am changing the trial date." He then set a trial date for January 3, 2011.

Given that the trial is probably going through and that there is a very reasonable chance SIGA could lose (and lose billions in revenues as a result), the best result for SIGA would be to settle the case before a trial. My guess is they will settle by January. In every scenario, a settlement would benefit shares of PIP.

I have no idea what sorts of terms PIP would accept but here are some possible settlements:

A) A cash settlement between $100-400mm. Since PIP has a market cap of $70mm, this would create anywhere from a $5 to $10 per share value for PIP.

B) An ongoing royalty of 20-30% on sales of ST-246. Again, this would instantly catapult the stock up to $10+.

Most likely a settlement would be some combination of the above two (e.g. $150mm in cash, 5% royalty, etc).

On this one catalyst I think PIP is potentially a $7 - $12 stock, particularly given the two events that have occurred since my article first appeared: the court appearance, and the contract award for ST-246.

While I think this catalyst alone is enough to quadruple the stock price I don't think it's the main fundamental catalyst for the company.

The main catalyst is the product that Pharmathene produces, a next-generation vaccine for Anthrax. According to this report on a military website Anthrax is considered the "DOD's Number one biological threat". The US is required to have a stockpile of 75 million doses of vaccine. Right now, the only approved supplier of doses of vaccine is EBS, which has a long-approved first-generation vaccine that requires 5 doses over 18 months and costs $120 per dose. PIP’s second-generation vaccine requires 3 doses over 60 days and costs about $45 a dose, according to Eric Richman, the CEO of Pharmathene. EBS’s vaccine uses live anthrax to make the vaccine, which increases the cost of and loses scalability versus a second-generation version. There are many problems with the older generation (35 years old) Anthrax vaccine from EBS which is why the government has recently approved $80mm in funding for Pharmathene to continue their work (EBS tried to protest this funding but BARDA threw out their protest).

What is the fundamental value of this vaccine? I'll quote my earlier article: "Assuming Pharmathene can build out the manufacturing processes in three years and their experimental studies continue to produce good results, a dose would cost $45. Since the only customer is the government, this essentially eliminates sales and marketing costs as well as research and development costs. Most biotech firms (think: DNDN, GENZ, GILD, HGSI) enjoy 85% margins on their products because they have to absorb those costs. PIP won’t have to — although it is beholden to a single customer. Let’s assume 20% net margins, or approximately $10 per dose. Let’s assume the government buys 25 million of its 75 million dose requirement from PIP (remember, there is only one other competitor). That means $250 million in earnings in three years. This alone could easily justify a stock jump to the $7-10 level, or even significantly higher. Also, once the U.S. starts buying, there will be demand from outside the country. This does not factor in significant government funding for several other products including Protexia, a nerve gas vaccine." Note that PIP does not need FDA approvals to start selling the to the government but that they have already tested for safety (no issues) and efficacy in animals (depending on the test, they are 85-100% effective).

So $5-10 in value from the SIGA lawsuit and another $7-10 from their Anthrax vaccine leaves PIP with a $14-$22 stock from these levels, much how SIGA has gone from below $2 to $13 in the past 4 years and EBS has gone from $5 to 20 in the past 3 years. Given these two completely separate catalysts I also think downside is minimal.

Disclosure: Long PIP