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Ampio Pharmaceuticals (NYSEMKT:AMPE)

In an earlier article, I presented a bullish case on Ampio, explaining that the firm has favorable risk asymmetry. Since Ampio is engaged in discovering new applications to NMEs and previously approved drugs, the firm faces significantly less regulatory headwinds than most of the competition does. As the firm secures major patents, the downside is further limited.

Ampio was recently awarded a European patent for broad claims to compositions involving an active ingredient of Ampion, DA-DKP, and for the compositions providing anti-inflammatory treatment. Ampion is a natural small molecular weight compound that tightens vascular permeability to prevent inflammation and inhibits memory T-cell's early activation. This non-steroidal drug has a potential market of millions of patients and a stellar human safety profile. It is capable of treating a variety of complications, including, allergic conjunctivitis and rhinitis, arthritis, inflammatory respiratory diseases, and neurodegenerative CNS diseases.

The biotech company also secured patents to a combination of diketopiperazines and methylphenidate derivatives, as well as the rights to the latter. These compounds have shown strong anti-angiogenic activity, anti-inflammatory activity, and anti-proliferative properties in cancer cell lines. Their value has yet to be fully appreciated by the market, as the stock has been flat since the announcement. Ampion, which is the same class as the elements of diketopiperazines, has had particularly strong trial results in treating nasal inflammation and osteoarthritis in the knee. In one double blind study, for example, Ampion demonstrated solid tolerance as a stand-alone treatment for nasal inflammation with no adverse events.

Going forward, one of the major catalysts for the firm is Zertane, a treatment for premature ejaculation. Ampio gained the rights to Zertane when it acquired DMI BioSciences. Towards improving the market acceptance of this product, Ampio recently acquired a major drug delivery technology. The firm gained IP protection to Zertane's orally disintegrating tablet (ODT) technology, which will likely further speed up commercialization . Zacks Investment Research currently rates the company a "strong buy".

Merck & Co. (NYSE:MRK)

Merck & Co. is another biotech firm that has patents significantly undervalued by the market. In regards to Vytorin and Zetia-- treatments for high cholesterol -- Merck is likely to prevail against Mylan's (NASDAQ:MYL) litigation. Earlier this year, Teva Pharmaceutical (NYSE:TEVA) agreed to not sell generic versions of the drugs until 2017. Mylan is still contending that Merck's patents are invalid, since Merck supposedly failed to give credit to a key doctor. In order for the complaint to hold any ground, the company would need to prove that the doctor deserved credit and that deception was involved, which is very challenging to do. A more pressing concern for Merck is the class action suit claiming that the drugs were falsely marketed as being more effective than less expensive anti-cholesterol drugs.

Despite having what is considered to be one of the weakest pipeline among peers, the firm has limited patent exposure and 17 potential launches. I anticipate that around 12% of the company's sales will face generic competition -- less than half of the industry average. Considerable diversification in treating a variety of complications, entry into emerging markets, valuable patents, and a stunning dividend yield of 4.7% makes Merck a very attractive defensive play.

At the same time, the firm is facing significant patent expiry. Adam Schechter, President of U.S. Global Health Group, noted this at the special call:

"As we look at the external environment, they're increasingly and diverse pressures on the industry and our business. Pressures that require quick and strategic action. With approximately $50 billion worth of leading prescription products going off-patent over the next several years, hurdles in the global pricing and reimbursement environment will become even more challenging. New products launched into the marketplace moving forward, will have to exceed the current standards of care. So the bar to obtain pricing and reimbursement would have been higher in the future than it's been in the past".

Consensus estimates for EPS are that it will increase by 9.6% to $3.75 in 2011, increase by 2.4% in 2012, and then start to decline slightly in 2013. Assuming a multiple of 10.5x and a conservative 2012 EPS estimate of $3.80, the rough intrinsic value of the stock is $41.80. The Street currently rates shares near a "strong buy".

Source: Ampio, Merck: 2 Biotech Plays With Undervalued Patents