Tiny Arch Therapeutics Just Doubled: Time To Dump?

| About: Arch Therapeutics, (ARTH)

Summary

ARTH shares have doubled in 30 days. Red Flags: Tiny, high volatility promoted company started in 2013 as a reverse merger.

AC5 has an MIT pedigree and is in human testing in Ireland; European approval expected in 2016.

AC5 has shown superiority to current hemostatic and sealant options in animal testing and has many potential medical uses.

ARTH shares have a lot of room to rise further based on 2016 catalysts and AC5 market promise.

This is a high-risk high-reward microcap stock with a very nice upside at this stage; know your risk and volatility tolerance.

Arch Therapeutics, Inc. (OTCQB:ARTH) is a tiny Boston area developmental biotech company that has developed what the company calls a "novel approach to stop bleeding (hemostasis) and control leaking (sealant) during surgery and trauma care." The company has taken self-assembling peptide technology developed at MIT and developed a platform it has trademarked as AC5 to "make surgery and interventional care faster and safer for patients." AC5 is regulated as a medical device and the main pipeline opportunities the company projects for AC5 are for surgery, trauma care, military, and wound care. Management boldly predicts its first approval for human use will occur sometime in 2016. It would certainly be poetic justice if AC5 was carried by EMTs at the Boston Marathon in the not too distant future to treat potential trauma victims such as occurred there on April 15, 2013, close to the time the company began.

"What's the Catch?"

Many would point to "red flags" regarding this seemingly promising tiny company.

Red Flag #1: This company came to the market as a reverse merger with a tiny auto parts supply company that was not making any money. Most small companies that begin this way are not successful.

Red Flag #2: Shortly after the reverse merger was complete, ARTH was promoted by one of those "rent a promotion" companies and the share price soared temporarily and then plummeted back down. Again, most tiny companies that were once part of such a promotion do not end up being successful. Such a promotion, even when not linked directly to the company is usually a sign that the company will never be very successful and is more of a trading vehicle than an investment vehicle.

Red Flag #3: This is a "penny stock" that just more than doubled in one month. It has had similar moves in the past and the share price has always come tumbling back down. Most tiny companies that have a share price below $1 and show huge volatility are trading vehicles rather than investment vehicles. Many can be categorized as "Pump and Dump" schemes. I would almost always advise my readers to avoid such a company.

"Consider Buying Anyway - Is the Author Sane?"

So if it looks like a duck and quacks like a duck, it's a duck, right? Well, 99.5% of the time I would answer yes, but this is not one of those times. Let me explain: despite the red flags, this is a developmental biotech company with an excellent product that has the potential to have a solid market share in the hemostatic and sealant device space, which I will outline in the body of the article below.

The recent huge move upward in the share price is not linked to any stock promotion - it is due to the start of the first human trials for the company's AC5 hemostatic device platform and very good news related to safety results. While it is possible to be a biotech Pump and Dump scheme - it is much more difficult to pull this off, especially after human trials begin. There is already a myriad of pre-clinical testing and analysis that any intelligent biochemist or surgeon could pick easily apart if AC5 was a sham.

"But ARTH Stock Has Skyrocketed - What Do I Do?"

Having said that I believe the company to be reputable and its AC5 platform to be very promising, there is the question of what to do if you are currently long after the recent, huge positive move. Personally, I remain overweight ARTH stock and I am holding at this point. I have a short-term price target of .55, at which point I may sell about 20% of my shares just to hedge my gains.

I don't claim to be a stock chart expert, but right now, ARTH shares do not seem to be meeting significant resistance even after the recent 10-day surge. Of course, this could turn around very quickly. It is risky to try to time price movements of very small market cap stocks, so know your risk tolerance. For the bigger picture, I believe that the share price will be significantly above .55 with AC5 passing safety and efficacy hurdles in 2016, and I believe that it will be above .75 if and when it is approved for use in Europe later this year. There will no doubt, be considerable volatility in the share price. Investing in a nanocap stock, regardless of the promise of the company, is highly risky and not for everyone.

If you are currently on the sidelines and you believe in the long-term prospects of AC5 like me, the question is "should I wait for a pullback or should I buy shares now?" That is certainly a decision for each investor to decide for him or herself. I think it's reasonable to take a small starter position right now and wait to add on pullbacks or to just wait for a pullback and then take a position. This is a High Risk High Reward investment so invest only from the speculative portion of your portfolio. Below, I will give you an introduction to the company and to the prospects of AC5.

Don't let this company's tiny market cap and a share price below 60 cents fool you as Arch Therapeutics has scientific bona fides and major accomplishments in the past 12 months. I believe that the company will get a European approval for AC5 in 2016 and this will be just the beginning of very good things to come. Here are some of the reasons why I believe that the Risk Reward is solidly in favor of Reward right now and likely will continue to be for the next several years. Much of the information I share can be gleaned from the company website on its slide show for investors. I will paraphrase and give what I consider to be highlights as an introduction to this investment opportunity.

"Advantages of the AC5 Hemostatic Device"

First of all, testing to date indicates that AC5 is Simple: easy to use, easy to prepare and easy to understand. Secondly, it is quite Effective: rapid, reliable and it assembles quickly right on the wound. Thirdly, it is Versatile: broad tissue applicability, can be used for either open or closed procedures and it has prophylactic effects. Finally, it is Safe: biocompatible which permits normal healing; it is made of natural, non-animal amino acids.

Some advantages of AC5 over many current tools to stop bleeding is that it is a clear, non-sticky, non-toxic liquid that can easily be squirted or sprayed and it stops bleeding promptly. The barrier created is clear so that a surgeon can see and operate through it. AC5 is bioabsorbable and enables normal healing.

The advantages above are all quite significant, but perhaps the most significant advantage of AC5 is that it also meets an unmet medical need in that it is "agnostic to the presence of antithrombotics (blood thinners)." In other words, AC5 not only stops the bleeding faster than most methods in the normal population, it works just as quickly and effectively for those persons who are on blood thinners.

"Other Strengths of Arch Therapeutics"

Another reason to be bullish on ARTH currently is that it has recently commenced its first human trial in Ireland in early March 2016. Arch Therapeutics actually has an "industry-academic collaboration " agreement with CURAM: Centre for Research in Medical Devices in Galway, Ireland. CURAM will doubly match (1:2) whatever Arch spends up to 250,000 Euros (the match by CURAM for 250K would be 500K).

Many a small biotech company has had a promising product thrown on the trash heap due to safety issues that developed during human trials. Usually, this has a devastating effect on the share price of the stock so this is a large risk factor. Let's take a closer look at the safety of AC5. All the pre-clinical animal testing came out superbly. AC5 passed all the tests with flying colors and is considered: non-cytotoxic, a non-sensitizer, a non-irritant, non-toxic, non-pyrogenic and no abnormal pathology developed with implantation testing.

In terms of recent safety news: AC5 achieved ISO 13485 Certification and on March 22, 2016, favorable safety data in skin irritation testing in humans was achieved. While there is a lot of data to come in terms of human testing, AC5 has a high probability of replicating its animal testing results in human trials as the skin irritation testing confirmation indicates. The simplicity of its mechanism and its composition of natural, non-animal amino acids bodes well for its future safety performance.

This author has great confidence that AC5 will prove to be both extremely safe and efficacious in the first modest dermatological human trial in Europe, which has enrolled 46 patients, with 10 of these being on a blood thinner. The procedure performed is a bunionectomy. After AC5 is proven to be both safe and effective in this procedure and is an approved medical device in Europe, there will likely be another human trial related to more significant bleeding either during surgery or in a trauma application, perhaps in the USA.

AC5 has performed extremely well in the animal testing (rats) and since this is a medical device and not a complicated drug candidate, the animal results are quite likely to be replicated in the human trials. There is really no logical scientific reason that AC5's mechanism to seal off bleeding quickly and effectively in another mammal wont translate to humans.

The company is also extremely confident as they state on their website that they will have their first approved product in 2016. A highly qualified M.D. and PhD in biochemistry has written and commented extensively on AC5 on the Stock Gumshoe site (premium access portion) and there is considerable discussion among investors and even an ARTH's dedicated thread. If one is considering investing in ARTH, you can garner a lot of good information on this site.

Another strength of the company is the quality of its leadership. Its board and advisors have significant experience and success in the biotech industry, especially in areas that will help bring AC5 successfully through human testing and then to market, while safeguarding its patents and proprietary procedures. One can read about each person on the company website. Below is the abbreviated bio of the CEO.

Terrence W. Norchi, MD, is the co-founder and serves as President and Chief Executive Officer. Prior to Arch, Dr. Norchi was portfolio manager of one of the world's largest healthcare mutual funds and a pharmaceutical analyst at Putnam Investments.

Dr. Norchi brings experience and knowledge of the core technology and proposed product candidates as a result of his firsthand experience with the development of that technology, having ushered it from the research laboratory to its current stage of development. His investing experience as a former public company analyst and a portfolio manager provides further insights and value as the company advances toward commercialization.

"A Sample of Pipeline Opportunities"

Here are just three examples of pipeline opportunities that the company points to in its presentation to potential investors. The first example is as a treatment for Chronic Cutaneous Ulcers. Currently, 2.5 million Americans suffer from pressure ulcers and 1-1.5 million suffer from diabetic foot ulcers in the U.S. Arch management states that there is a clear unmet need for a barrier top cover to protect and promote a moist environment so as to enable the healing opportunity. They are confident that AC5 can meet these needs. The market is estimated at $2 billion per year.

The second opportunity is Adhesions. 2.5 million patients per year suffer from adhesions in the U.S. Adhesions form in 70-90% of major abdominal surgery and in 50-100% of women after pelvic surgery with the market growing at approximately 15% a year. The need is to cover, protect, and promote a moist environment and to enable healing. The market opportunity is estimated at $2 billion per year and growing.

Thirdly is Burns - 500,000 U.S. patients per year with an existing treatment that is long and expensive. The need: a barrier to cover, protect, mitigate infection, lessen scarring and enable healing. Arch believes that AC5 is ideally suited for these needs as well and the estimated market opportunity is $1 billion annually.

Even if AC5 were only to capture 5% of this $5 billion annual market opportunity this would significantly exceed the current market cap of the stock in just these three opportunities in one year. Of course, one cannot count one's chickens before they are hatched, but this illustrates the large upside of this stock's and this company's potential.

"Additional Risks and Challenges"

I've mentioned and addressed most of the main risks in the article already - volatility, the risk of a safety concern during the trial and the risk of the product not being as efficacious as thought. Personally, I am not overly concerned with any of these risks, but if I am wrong, the share price could plummet to near zero.

The one risk that I do think likely is share dilution. Despite the collaboration in Ireland, Arch could easily run out of cash reserves during the trials in 2016. The company will need to either borrow money or do a Private Placement unless it enters a partnership with a larger company or gets bought out. I think that the latter is unlikely as Arch management knows the potential of its technology and does not want to be purchased. A buyout would have to be at a large premium to the current market cap. Some type of partnership in a symbiotic relationship with a larger company seems like the most probable scenario, but the larger company usually wants to wait for an approved product before signing any deal.

Another reason that some type of mutually beneficial partnership is likely ARTH's preferred plan is that the company has only a handful of paid employees. It will not be able to launch any product at this point unless it hires a sales and marketing force or it partners with a company that can do this with AC5 for Arch.

Conclusion

In animal testing, Arch Therapeutics' AC5 platform has shown many advantages over other hemostats and sealants that are currently on the market. AC5 has now begun human testing and has passed its first safety test in humans. Human trials for medical devices are much faster than those for drug compounds. If AC5 shows the same impressive results for safety and efficacy in its first human trial, it will almost certainly get its first approved product in Europe before 2016 is over.

Despite the likelihood of some share dilution, the stock's "penny stock status" and a stock promotion several years ago, the large upside for this company and its AC5 pipeline makes the current share price and market cap look like a risk worthy of taking for the more speculative investor.

Disclosure: I am/we are long ARTH.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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