Neoprobe: A Persuasive Biotech Speculative Investment

  • Current Share Price: $3.65
  • Price Estimate (July 1st, 2012): $12.50

The biotechnology industry is one of intense volatility, endless speculation, and explosive gains and major losses. That being said, I believe Neoprobe (NEOP) has a very realistic chance at producing dramatic positive returns over the short and long-term horizons.

Neoprobe has recently been the target of some vigorous skepticism, and some great questions have been raised as a result. The most nagging question as of late has been the validity of Neoprobe's drug trials for its stage three oncological drug, Lymphoseek.

If approved, Lymphoseek will be used to determine whether or not cancer has spread. Lymphoseek will be injected in an area that is near the known cancerous tumor, and will proceed to what is called the lymphatic basin. These basins are a group of lymph nodes that receives and filters lymph that flows from a certain area of the body. Special dyes may be used to stain and identify the lymphatic basin in the tissues around a tumor, so that lymph nodes that may contain cancer can be removed and checked by a pathologist. When cancer spreads, it generally turns up in the drainage system of the lymphatic basin.

Because of this, Lymphoseek goes in to and through this lymphatic basin and attaches itself to the closest lymph node, and this node becomes the Sentinel lymph node (SLN). Next, the SLN is tracked by use of a Gamma Probe and is then removed by the surgeon. The node is then biopsied to determine whether or not cancer has in fact spread, and an appropriate course of action is then determined. This procedure, called Sentinel Lymph Node Biopsy (SLNB), is exceptionally efficient as only one lymph node (as opposed to potentially eight to thirty-two more nodes) needs to be extracted, thus saving time, money, and sparing the patient long-term pain.

Now, on to where the main arguments have their roots. The present-day SLNB procedure is performed using not only Blue-dye (VBD), but a filtered Technetium Sulphur Colloid. To date, all of Neoprobe's clinical trials have been compared not to the current combination of the two drugs, but only to either solely VBD (Phase 3), or just sulphur colloid (Phase 1). Some have pegged Neoprobe's decision not to use the combination of the radioactive colloid plus the VBD as a fatal error. But this argument instantaneously loses all credibility the second the word "decision" is said. Neoprobe did not really have much of a decision at all as to what their control would be. Dr. Robert Carretta (who was not compensated by Neoprobe Corporation), the former president of the Society for Nuclear Medicine, mentioned at the June, 2011 Society for Nuclear Medicine annual meeting that,

Having dealt with the FDA approval process for radiopharmaceuticals in a number of roles, including physician, clinical trial investigator, professional society leader and head of a commercial imaging agent development organization, I am well aware of FDA requirements for pivotal comparative studies. It is clear that only products specifically approved for the indication under investigation may be included as the appropriate comparator for purposes of registration with the FDA.

Several other physicians at the meeting echoed Dr. Carretta's knowledge of the standard and required FDA trial guidelines. In summary, after several meetings with the FDA, and valuable guidance from Dr. Fred Cope (who additionally mentioned that while Neoprobe initially considered comparing Lymphoseek to VBD + Sulphur Colloid, the FDA advised them not to, as Colloid is not FDA approved for lmyphatic mapping), Neoprobe had no logical control to use in their phase three trial other than Blue Dye, the only current radiopharmaceutical that is FDA approved for SLNB procedures. In other words, in the eyes of the FDA, the only current procedure for intraoperative lymphatic mapping is VBD.

The next argument is that the current standard of care (VBD+Sulphur Colloid) is nearly impossible to improve upon. I would first like to say that we are talking about science and technology here, and it is generally close-minded and, at times, ignorant to think another breakthrough will never happen again for a certain procedure. In this case specifically, it is my (and many others') opinion that Lymphoseek has actually already proven itself superior to the current combination of drugs.

Firstly, Lymphoseek has a radioactive half life of roughly a third of that of Sulphur Colloid. This is extremely important as doctors are very weary of the duration that radioactive elements remain in the body. Next, the injection clearance site of Lymphoseek is generally eight times faster than the current treatment. This allows surgeons to inject patients fifteen minutes before they began the procedure. Because surgeons can begin so quickly, costs to keep the operating room running are reduced dramatically, and the patient has a shorter stay in the hospital.

Thirdly, the use of sulphur colloid has been known to have several adverse affects. One common symptom is the allergic reactions that many patients have to the sulphur element. Another symptom is moderate to severe burning in the injection site due to an unbalanced pH balance in the drug. Lymphoseek has not only been proven 100% safe, it takes care of allergic reactions and is painless to inject due to its balanced pH level.

Sulphur Colloid was never intended to be used in SLNB procedures along with VBD. It is currently used as an "off-label" drug. Were Lymphoseek to be approved, as nearly every physician believes to be very likely, hospitals would be very reluctant to use a non-FDA approved drug for the SLNB procedures as long as a safer and even more efficient and effective drug was available on the market. Any procedure that went wrong could be wide open to a malpractice lawsuit. I believe that once Lymphoseek is approved, a fourth trial will be done comparing Lymphoseek to VBD and Sulphur Colloid, and the results will push any surgeons on the fence about to switching to in fact making the move.

The final crucial argument is that even if Lymphoseek does get approved, the market size for the drug and potential for market penetration would be so small, the drug would be effectively worthless and have no positive impact on Neoprobe's share price. I am going to attempt to display why many analysts have slapped $7-$9 price estimates on Neoprobe's future share price. Before I begin, I would like to point out that I am attempting to use very conservative estimates for dose prices, market penetration, and am employing a margin of safety to provide some breating room for any error in calculation I may make.

Neoprobe has roughly 150,000,000 shares outstanding. Lymphoseek was said to have a $450,000,000 potential market for revenue, and this figure was arrived at before the possibility of a superior label was brought up. In Phase 3 clinical trials, Lymphoseek was proven superior to the current standard of care as the FDA sees it, which is VBD. Again, I reiterate: because the only current approved drug for lymphatic mapping is VBD, Lymphoseek can only be compared to VBD, and can not be compared to a drug that is used off-label for this procedure. This is because the trial would have no positive effect on potential FDA approval, and could even harm their chances as the control group for the trial would not meet the parameters set forth in FDA trial guidelines and meetings. Some have said potential market revenue is closer to $600,000,000.

Here is how analysts have come to this market potential:

Lymphoseek has been developed to for lymphoscintigraphy procedures in breast cancer, melanoma, and head and neck cancer.

207,000 women develop breast cancer per year in the United States.

The American Cancer Society says that in 2010, there were roughly 115,000 new cases of melanoma in the US.

The ACS also says there were roughly 45,000 new cases of head and neck cancers in the US alone.

After deep analysis and estimates by several physicians and research groups, the combination of all previously mentioned procedures and the estimated SLNB procedures for those cancers leads us to a potential $450,000,000 market for revenue.

According to Dr. Anne Wallace, filtered sulphur colloid used in SLNB procedures cost about $150.00 per dose in 2003. Keep in mind that while the hospital may be able to buy the colloid at cheaper wholesale cost, they generally mark it up anywhere from 50%-100% for the actual procedure. In 2007, The Chalk River Facility, which produces nearly 70% of the world's TC-99 (Sulphur Colloid) shut down. This made the price of colloid for SLNB procdures shoot to $275.00. This is for sulphur colloid alone, which by the way, is not reimbursable by insurance companies, raising the cost for the hospital and patient. It is not reimbursable because it used off-label and is not FDA approved.

Next up is the cost for the blue dye used in the procedure. $6,504.00. That is pretty expensive. After dividing the amount of doses and viles in the box that the hospital receives from the manufacturer, one arrives at a cost of $650.00 per patient. Again, that is the wholesale, not retail price. Assume a conservative mark up of $50, due to the fact that VBD is reimbursable (FDA approved). Adding the cost of VBD and SC, almost $1,000.00 worth of drugs will be used for one procedure. The projected cost of lymphoseek per estimates for sales? $150.00. And lymphoseek will be reimbursable as it will be approved for SLNB procedures.

Now, let's discuss earnings for Neoprobe were this approval to go through. There are roughly 150,000,000 fully diluted shares, (.pdf, page 17) which are used for calculating EPS. Neoprobe has projected gross margins of 70%. Neoprobe has entered into a 50-50 revenue split with giant Cardinal Health (NYSE:CAH), so they will keep 50 cents on every dollar of revenue, and will earn 35 cents on every dollar after margins.

Let's assume a $550,000,000 market. In addition, I will assume 50% of market penetration within 18 months of approval. I feel this will be very realistic considering Cardinal Health's huge sales staff.

$550,000,000/2 (for revenue split) = $275,000,000.

$250,000,000 (for 50% market penetration in 18 months) = $137,000,000.

70% gross margins on $125,000,000 in Neoprobe revenue = $95,900,000

I will now calculate EPS for Lymphoseek: $95,900,000/150,000,000 (# of Shares) = $.64 EPS.

According to Fidelity, the sector that Neoprobe operates in (Healthcare equipment and supplies) has a P/E ratio over the last 5 years of 50 (scroll to bottom of page). Let's assume half of that, and slap a 25 P/E ratio on a profitable Neoprobe.

.64 EPS X 25 = $16.00 PPS.

Now, even after a fairly conservative calculation, I will add a margin of safety of 40%. After doing so, you arrive at $9.60 PPS.

We are still not done. Neoprobe Corp. also has a bit of a "dark-horse" drug in RIGScan CR. While I will not go into detail on the workings of RIGS, the drug's purpose is to locate cancerous tissue. The surgeon then removes all of the cancerous tissue. After 10 years, RIGScan has shown increased survival rates in patients who underwent RIGS procedures. RIGS ensures that the surgeon removes all of the tissue and doesn't miss any. Analysts have said RIGS has a market of anywhere from 1 to 4 billion dollars. If approved, RIGS would transform Neoprobe into a small-cap company into a very profitable mid-large-cap company.

Neoprobe plans to file a NDA for Lymphoseek in early Q3 2011. Approval for the drug can be expected midway through 2012. Anytime until then, major news regarding RIGScan CR could have a major positive impact on share price. In addition, keep in mind Neoprobe operates in a volatile industry where speculation can send stocks soaring. Look at DNDN. While I do not believe Neoprobe turns in to a $40.00 without RIGS approval, I believe fantastic returns are very realistic.

Lastly, rumors of a buyout from Cardinal Health or Covidien (COV) were brought up at the end of 2010. I believe that potential is greater than ever now, especially with a depressed market cap. Neoprobe will be fun to watch over the next few months, and later down the line as well.

Disclosure: I am long NEOP.

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