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Peter Lynch’s legendary book "One Up on Wall Street" encourages retail investors to search for and find "tenbaggers" before they become widely known. He suggests that we, as individual investors, can occasionally find opportunities on Main Street USA before the investment professionals on Wall Street discover them. In his book, he encouraged investors to try the company's products for themselves and to ensure that the products worked “as advertised.” He suggested that investors should try to find companies that have a niche market and preferably companies where people need to keep buying the product. He also suggested it would be good if insiders owned significant shares and were adding to their positions. With this article, I am sharing all my due diligence about how Star Scientific (CIGX) meets all these criteria and more. Star is not followed by a single analyst, and the company is flying well below Wall Street’s radar. Furthermore, Star Scientific is definitely a candidate to be a tenbagger when sales of their new Anatabloc dietary supplement ramp up (more on that later).

I first got interested in Star because I follow litigation stocks and Star Scientific owns patents for a process to reduce Tobacco Specific Nitrosamines (TSNA's). TSNA's are the primary cancer causing agent in tobacco. Star developed and patented a methodology to cure tobacco that minimized the formation of TSNA's by controlling the heat, humidity, and the aerobic conditions during the curing process. Their Star Cured Process reduces the TSNA’s to below detectable levels. These patents were recently validated by both the U.S. Patent & Trademark Office and a recent Federal Circuit Court ruling. I think the company will likely bring suit against the tobacco industry again after all RJ Reynolds (Reynolds American) (NYSE:RAI) appeals involving the patent validity are exhausted, but that could another six months or longer. Although I believe the tobacco curing patents are worth several billion dollars when they are fully monetized, that is not the interesting part of this story. In fact, the tobacco curing patents may be an afterthought when their Anatabloc nutraceutical supplement sales start to ramp.

First, potential investors should know that Star Scientific has been struggling financially (having been unprofitable for years). While they have always worked on ways to benefit mankind by minimizing the harmful effects of tobacco, their efforts to date have not resulted in benefits for their shareholders. In my opinion, that is about to change.

Star Scientific suspected there was something in addition to nicotine in tobacco that caused addiction and they were correct. They discovered that Anatabine, a minor alkaloid in tobacco (and tomatoes, peppers, eggplant, and cucumbers), satisfied the tobacco cravings of many smokers, but they also discovered that it had some remarkable properties to reduce inflammation.

Over a year ago, Star Scientific started selling a product with Anatabine called CIGRx to help reduce the cravings that smokers had for cigarettes. What they discovered was that people taking CIGRx (Anatabine) started noticing relief from a variety of afflictions related to autoimmune diseases. Star Scientific got independent experts involved from Johns Hopkins Medical School and from The Roskamp Institute (in Sarasota, FL) to evaluate Anatabine's effect on the immune system. Scientists from these respected institutions are now presenting data verifying that Anatabine has some remarkable properties to reduce inflammation. It appears that Star Scientific has indeed discovered a nutraceutical product that helps the body regulate the inflammatory response almost like a thermostat. Anatabine could be beneficial for almost all autoimmune diseases, especially those that are initially triggered by Nuclear Factor –kappa B (NF-kB). We can't eat 10 pounds of green tomatoes every day (approximately the amount of Anatabine needed for the body to control the immune response), but Star has developed and patented a way to artificially synthesize pure Anatabine. They have filed patents on the use of Anatabine for all types of inflammation, and they have filed patents on the method used to artificially synthesize pure Anatabine. Here is an overview of their Anatabine synthesis patent. One of the things Peter Lynch mentions in his book is to make sure a niche product can be protected and he specifically mentions patents. Star Scientific meets this criteria.

I was extremely skeptical of the health effect claims I had read on the Internet until I learned that world renowned researchers such as Dr. Paul Ladenson (Director of Endocrinology and Metabolism at Johns Hopkins), Dr. Patruzo Caturegli, also with Johns Hopkins, and Dr. Michael Mullan (Director of the Roskamp Institute in Sarasota, FL) were fully convinced about the efficacy of Anatabine to control inflammation. Anatabine's anti-inflammatory properties were proven in numerous studies at the cellular level (one study showing it to be four times better at reducing inflammation than aspirin, Advil, or Celebrex). It was also tested extensively in mammals with tremendous success. It was shown to have no toxic effects on mammals (even at a dose of 100 times the recommended human dose equivalent). It is now being used in several clinical trials with humans and those results should be available soon. Star Scientific started selling Anatabloc on the Internet on August 30, 2011 and sales are quickly ramping up. Dr. Ladenson, Dr. Caturegli, and Dr. Mullen have conducted seminars on Anatabloc for Medical Doctors in VA (Oct. 18th), MI (Oct. 22nd), and CA (Oct 27th). A peer reviewed paper on the use of Anatabloc for Alzhiemers both in-vivo and in-vitro) was published last month in the European Journal of Pharmacology.

With all the excitement, I wanted to see if Anatabine was the real deal or if it was typical Internet hype. I suffer from both rheumatoid arthritis and bronchial asthma, but with the miracles of modern pharmaceuticals, I live a normal life with few limitations. Although my RA is 80-90% under control from Humira and Methotrexate, I still have some issues. So, last summer after reading about the anti-inflammatory characteristics of Anatabine, I started taking CIGRx (and later Anatabloc). I have seen miraculous benefits. In the past, I couldn't play 18 holes of golf without the joints in my hand swelling up, making it impossible to play golf the next day. This kept me from going on annual golf trips with my friends. However, after I started taking Anatabloc, I was recently able to play golf with my sons for 4 straight days (36 holes on two days), without any swelling whatsoever. In the past, the joints in my hands would swell up after 18 holes of golf and I would not be able to play again for a couple of days. Although my Rx for Humira is for a weekly injection, I now stretch my Humira shots out to about three weeks with no ill effects. I’m sure a nutraceutical like Anatabine is much easier on the liver and kidneys than powerful biologic drugs like Humira. For asthma, I take a daily Singulair tablet and I use an Albuterol inhaler. Since I started taking Anatabloc, I no longer need to use the Albuterol inhaler (I didn’t even refill my Albuterol prescription). I have also observed numerous other benefits. My “tennis elbow” pain is gone and my knees no longer ache (three knee surgeries from football injuries). Other additional benefits I have noticed are my sinuses are clear, I sleep better, I wake up refreshed and raring to go, and my urine stream is about ten times as strong as before I started taking Anatabloc.

There are numerous other positive stories on the Internet, and now there are documented stories appearing on TV stations, such as this piece by a CBS affiliate about a woman cured of Crohn’s disease. If you don’t click on any other embedded link in this article, please watch the preceding video. Another Star investor has been keeping track of all the anecdotal stories on the Internet about those who have experienced benefits from using CIGRx or Anatabloc. He has maintained a list of various conditions that Anatabloc has helped. I would not believe all the amazing testimonials I am reading on the Internet if I had not experienced similar benefits for myself.

Here is a good background article on inflammation that was in Time Magazine a few years ago that I encourage everyone to read. In a nutshell, it says that inflammation may be the root cause of a variety of illnesses (including many cancers). Here a short video on the inflammation process at a cellular level and how Anatabloc stops it. So, it is my belief, based on my own due diligence, that Anatabine will help virtually any auto-immune disease caused by the body’s inflammation process running out of control. Patrick Cox of Breakthrough Technology Alert fame thinks Anatabloc will change the healthcare system in the U.S., as he reported in his analysis of Anatabloc. At this point, I would have a hard time arguing with him.

Star Scientific has a Facebook page on Anatabloc, and there is a website sponsored by Star on Anatabloc where you can read more about it and order the product. If you are a physician or a licensed healthcare practitioner, you can register under the healthcare section and get access to more scientific articles and free samples for your practice. Because Anatabloc is available for sale as a nutraceutical, Star has to be extremely careful about making health benefit claims on their Anatabloc website. In fact, numerous posts about the miraculous cures that have been posted on their Facebook page have been erased by Star due to concerns of violating FDA regulations regarding nutraceuticals.

Here is a key patent that Star filed with the World Intellectual Property Association (to see a list of conditions that Anatabine may help, please see Table 1 on pages 52-61). As you can see from these testimonials on Amazon, Anatabloc is getting rave reviews, as is CIGRx.

We are in uncharted waters here with the sales of a brand new over-the-counter nutraceutical that has such far reaching possibilities to cure a variety of ailments/diseases. We know from tracking the Internet order numbers that the company got about 1900 orders before the end of September or approximately 60 orders/day. From tracking order numbers, we know that in the last 14 days, the order rate has jumped to about 160/day. We know this because order number 3535 was placed on 10/28/11 and my order placed at 8:30 PM Eastern time on 11/11/11 reveals that over 2250 orders have now been placed in the last 14 days (~160 orders/day). So, the order rate has almost tripled in the past six weeks. I think we will see that trend continue as more people hear about the results of others taking Anatabloc.

We know that over 1,200 physicians heard about Anatabloc from doctors at Johns Hopkins and The Roskamp Institute since Oct 18th in the Anatabloc Seminars and at the annual American Thyroid Association meeting. These doctors are probably somewhat skeptical without human trial data being completed, yet they are likely curious to see if Anatabloc really works. I would imagine some of these Doctors are telling their patients about Anatabloc, and letting them know it is worth a try (it is safe since it is a nutraceutical in food like green tomatoes and peppers). If half of these initial 1,200 doctors only had 5 patients try Anatabloc, then Star could see the Anatabloc order rate grow by an additional 3,000/month or 100 per day. Because Anatabloc has really benefitted me, I have told over a dozen people who have ordered Anatabloc in the past 5-6 weeks. I think my experience will be typical, and word will spread relatively quickly. As word gets out, both from patients telling their friends and as doctors tell other doctors, we could see the order rate quickly grow to well over 1,000/day. If we keep seeing stories like the CBS affiliate ran in Michigan, it won't be that long before Star starts seeing > 50,000 orders per month (maybe 4 months). In addition, everyone I know who has taken it has reordered, so Peter Lynch’s repeat business requirement seems to be satisfied.

Another positive we recently learned from individual investors around the country is that Star Scientific has started a national rollout on the distribution of CIGRx to pharmacy chains. Rite Aid stores and CVS stores in the East, Southeast, and West Coast are now selling CIGRx. That just started in October, so none of those sales were reflected in the recent Q3 revenues reported (and it will probably take a few weeks for CIGRx to reach all the Rite Aid and CVS stores nationwide).

Right now, it is not about profitability, it is about sales growth. The company should be cash flow positive by early 2012, but if you wait to buy the stock until that gets reported in a 10-Q, the stock may be in double digits.

One of my biggest concerns about Star Scientific is that "big pharma" or "big tobacco" will come along and try to buy the company for well below the potential market value. After reading the International patent application on Anatabine, and looking at all the diseases/ailments that are affected by NF-kB and could be treated by Anatabine, I don't think it will be long before a big pharma makes an acquisition run on Star Scientific. Also, the big tobacco companies now know that Star's tobacco curing patents are valid, so they could also be targeting CIGX. I think most Star Scientific investors are in for the long run, but if a big pharma or big Tobacco company came along and offered a significant premium, it’s possible that a lot of investors would tender their shares. Although a poison pill typically is not favorable for investors, in this situation I am hoping the company reinstitutes the poison pill as it could prevent a cheap buyout.

Before I finish this article, it is worth taking one more look at the tobacco curing patents and what happened in the recent case against RJ Reynolds. The validation of Star's tobacco curing patents is the primary thing that has now changed in this ten year old litigation saga. In March 2011, the USPTO finished an ex partes reexamination of the patents and concluded that the patents were valid. Now, in addition, the Court of Appeals of the Federal Circuit (CAFC) has overturned the Maryland jury verdict of invalidity and also affirmed that the patents are valid. Various aspects of these patents are used for almost all tobacco curing in the U.S. The USPTO validation of the patent is now final, since it was an ex partes reexam. The CAFC looked carefully at numerous aspects of the Maryland jury verdict and overturned all invalidity issues found by the jury. So, now both the CAFC and the USPTO have determined the patents are valid.

Virtually all tobacco cured in the U.S. uses various aspects of Star's patent. Based on the information revealed in the 2001 lawsuit, Star has claims on several Billion dollars in past damages due from RJ Reynolds and Philip Morris, but Star now must go back to court to prove infringement. The CAFC upheld the jury verdict of non-infringement (see my instablog for details). But if Star is able to prove infringement in a new case, Star could receive past damages in the billions and a royalty of 3-5% per pack of cigarettes going forward. As a result of the CAFC ruling, the patent priority date was determined to be Sept 1998, so the patents are valid until Sept 2018. The case against RJ Reynolds was only for two growing seasons in 2001 and 2002, so Star could, at any time, file new suits against the industry for growing seasons past 2002. Take a look at Star’s Press Release after the announcement.

Excerpts:

"We are gratified that the Federal Circuit Court of Appeals has affirmed the validity of the patents at issue in our prosecution of patent infringement against RJ Reynolds. The Court specifically rejected each of the four invalidity defenses raised by RJR, and the panel also reversed the district court's 2007 summary judgment ruling on priority date: the panel affirmed that the patents' claims deserve the September, 1998 priority date as originally claimed. We nonetheless are disappointed that the Federal Circuit did not reverse the jury trial verdict of noninfringement.

"However, today's decision fully reestablishes and reinforces the company's rights to assert its patents against all prior and future infringers. In particular, we anticipate that our litigation against RJR for curing seasons after the two years addressed in this case now can move forward. That litigation had been stayed pending the outcome of the appeal."

As you can see from Star Scientific's press release, the company can proceed against any and all parties infringing the patent, both for past infringement and for on-going infringement. They will go into their next court case with a patent that has been vetted by both the USPTO and the CAFC and has been determined to be valid. Barring a successful appeal to the U.S. Supreme Court (or a successful en banc at the CAFC), then this is the final word on the validity of Star's patents: they are valid and that is the law of the land. Star may decide to allow the stayed case in Maryland to go forward, or they may choose to file a new case in a more favorable venue.

One last observation is that Star's executives own a significant amount of shares and they are buying more, as did the head of the Roskamp Institute. Based on a recent 8-K announcement, it also appears that Insiders will be buying more during the insider trading window (which is now open since they filed their 10-Q last Wednesday).

Star Scientific is a small cap stock without any history of profits and with a huge short interest. Most people would consider it a very risky investment. But, in my opinion, it is one of the few stocks I know of that has the potential to become a tenbagger, and I think buying at prices below $3 is a gift that doesn't come along very often.

Disclosure: Long CIGX (and wishing I had bought more)

Source: Star Scientific May Be 'One Up On Wall Street'