Eye On Cash-Rich Small Biotechs

Includes: CAPS, INHX
by: Wall Street Mayhem

In the last few trading days there has been increased interest in a few beaten down small biotechs. The first of these was Icogen (Nasdaq: ICGN) which rose from $1.80 to $3.00 in just a few trading days last week. There was no new news about Icogen during this time period. Although Icogen insiders did make some substantial purchases in early February, this news was already available before Icogen started its run.

On Friday NeoPharm Inc. (Nasdaq: NEOL) was up almost 30%. Like Icogen, there was no news released about NeoPharm on Friday. Both of these companies are downtrodden biotechs with a high percentage of cash per share and somewhat recent negative clinical trial results.

Before its recent rise, Icogen had a market cap of about $40 million, cash of about $30 million, and $1.5 million in debt. After backing out the cash and debt, Icogen had an enterprise value near $11.5 million. NeoPharm’s enterprise value was even lower before Friday’s run. At Thursday’s close, NeoPharm had a market cap of about $50 and an enterprise value around $5 million.

In August of 2006, Icogen announced that it would discontinue its phase III trial of ICA-17043 for the treatment of sickle cell disease after an independent data monitoring committee performed an interim safety, efficacy, and futility analysis. In December of 2006, NeoPharm announced that its phase III trial of cintredekin besudotox, a proposed treatment for brain tumors, failed to show statistically superior results compared to MGI Pharma’s (Nasdaq: MOGN) Gliadel Wafer.

Both Icogen and NeoPharm dropped about 75% after releasing disappointing phase III trial results. Since then their respective negative phase III announcements, both of these companies had traded relatively flat until the recent moves.

From time to time the market tends to give increased attention to a specific category of stocks. Right now it appears that traders are focusing on long forgotten small biotechs that are cash rich and have low enterprise values. When a company has a low enterprise value and a healthy cash position, any positive news, or even a rumor of positive news, can have a dramatic short term effect on the share price. Additionally, these companies often make attractive takeover candidates because the acquirer can gain access to valuable intellectual property at bargain prices considering the low enterprise values.

We believe that the trend of increased attention for small biotechs that have strong cash positions and low enterprise values has a good chance of continuing. Analysts agree that biotech mergers and acquisitions will continue to increase in 2007. Although the M&A activity involving larger biotechs will get the headlines, acquisitions involving small biotechs with low enterprise values could be an enticing way for big pharmaceutical companies to grow their pipelines.

Orthologic (Nasdaq: OLGC) and Inhibitex (Nasdaq: INHX) both have similar investment profiles to those of Icogen and NeoPharm. Orthologic has a market cap of about $73 million, $64 million in cash and no significant long term debt. After backing out the cash, Orthologic has an enterprise value just north of $9 million. Inhibitex has a market cap of about $53 million, cash of about $64 million, and debt of a little less than $4 million. After backing out the cash and debt, Inhibitex has an enterprise value that is negative by about $7 million.

Orthologic recently received some positive news about a subset of patients involved in their Chrysalin phase III trial. Osteopenic women with unstable wrist fractures showed a statistically significant reduction of immobilization time when treated with Chrysalin. Previously, Orthologic had announced that the Phase III trial of Chrysalin in unstable, displaced wrist factures did not demonstrate a statistically significant benefit compared to a placebo. This post hoc analysis of the osteopenic subset of patients could breathe some new life into Chrysalin.

Shares of Inhibitex cratered in April of 2006 when the company announced that the Phase III trial of Veronate failed to meet its primary endpoint. Despite the recent positive news about a license and commercialization agreement with 3M for the development of diagnostic products using Inhibitex’s MSCRAMM protein platform, Inhibitex shares still trade below cash per share levels.

For the short term, Orthologic and Inhibitex are appealing trades. Small, cash rich, biotechs have received increased attention lately without significant news. Orthologic and Inhibitex could be near term beneficiaries to the move in this sector started by Icogen and NeoPharm. Orthologic and Inhibitex have both recently received some positive news, yet Orthologic has a low enterprise value and Inhibitex still has a negative enterprise value.

Although companies like Orthologic and Inhibitex are risky long term investments because they are burning cash and potential drug approvals are still years away, these companies make appealing short term trades due to the stability added by their cash stockpiles and the recent upside moves by similarly situated small biotech companies. From a risk/reward perspective both of these companies look like strong short term trades. The downside is limited by high cash per share levels ($1.55 for Orthologic and $2.13 for Inhibitex), yet upside potential could be high considering the strong moves of Icogen and NeoPharm.

* BUY OLGC near $1.78, set stop loss at $1.55 (cash per share price)
* BUY INHX near $1.75, set stop loss at $1.50 (30% below cash per share price)

Full disclosure: Wall Street Mayhem is long OLGC and INHX.