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, Joe Springer (133 clicks)
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Small healthcare firms are often speculative and not yet profitable, but offer tremendous upside. Finding one that is already profitable and has a lot of upside would be nice. Finding one that is already really profitable and offers upside would be really nice. Are there any?

According to Yahoo Finance there are 12 small healthcare companies (market cap $100 million to $4 billion) with a Price-to-Earnings multiple under 10. They are:

Company NameTickerP/E
Universal Health Services(NYSE:UHS)9.508
Wellcare Health Plans(NYSE:WCG)8.794
Community Health Services(NYSE:CYH)8.722
Taro Pharmaceutical Industries(NYSE:TARO)8.605
Health Net Inc.(NYSE:HNT)8.633
PDL BioPharma(NASDAQ:PDLI)5.646
Spectrum Pharmaceuticals(NASDAQ:SPPI)7.95
Exelixis Inc.(NASDAQ:EXEL)9.977
SciClone Pharmaceuticals(NASDAQ:SCLN)6.762
China Cord Blood(NYSE:CO)9.573
Five Star Quality Care(NYSE:FVE)3.132
MedCath Corporation(NASDAQ:MDTH)2.404

Of the twelve, Spectrum Pharmaceuticals might be the most intriguing. Here are three reasons why. In a subsequent article, I will present the bear case in a similar format:

1) Growth

The company is growing quickly as they showed in their most recent quarterly results. In the first half of the year Spectrum's revenues were $128.6 million, a very healthy 44% year over year increase from 2011's $89 million.

And even though they reduced the price of their colon cancer drug Fusilev, earnings for the quarter were up even more than revenues - 48% or 142% depending how you count. From the release:

Non-GAAP EPS of $0.37 per Diluted Share Compared to $0.25 Per Diluted Share in the Second Quarter Last Year. GAAP EPS of $0.29per Diluted Share Compared to $0.12 Per Diluted Share in the Second Quarter Last Year

Spectrum's main growth drivers are threefold according to CEO Rajesh C. Shrotriya on the second quarter conference call:

There are 3 primary drivers of growth that are most important to mention here. One, we believe there is opportunity for further growth from the cash flows generated from our 2 approved drugs, FUSILEV and ZEVALIN. With a potential addition of FOLOTYN, we should continue to enhance operating leverage.

You thought that was the three didn't you? But it was only one!

Second, given we have an exciting and robust pipeline, largest in Spectrum's history. Spectrum now has some 10 drugs in clinical development, of which there are 3 in late-stage development.

And third, the important and significant growth driver is our aggressive and successful business development strategy. This year alone, in first 6 months, we have already closed on 2 transactions and anticipate on closing a third one later this quarter.

Sounds good. Let's have a look at the PEG ratio for Spectrum and see if that growth translates into a good number. Investopedia on the PEG ratio:

A ratio used to determine a stock's value while taking into account earnings growth. The calculation is as follows:

Price/Earnings To Growth (PEG Ratio)

Spectrum's trailing PE of 7.95 can be divided by the 48 or 142 to get us 0.17 or 0.06. So are those good PEG numbers?

PEG ratio results greater than one suggest one of the following:

  • Market expectation of growth is higher than consensus estimates.
  • Stock is currently overvalued due to heightened demand for shares.

PEG ratio results of less than one suggest one of the following:

  • Markets are underestimating growth and the stock is undervalued.
  • Analysts' consensus estimates are currently set too low.

Yes, those numbers would be uber-bullish (also, looking at the PEG ratio on a forward-looking basis using analysts' estimates for the future can be useful, but those estimates are not always reliable.)

Now let's take a look at Spectrum's finances.

2) Balance Sheet

Some of these smaller healthcare plays are at risk of diluting shareholder's ownership by issuing a secondary offering of new shares. Not Spectrum! No, Spectrum has what you can call a "fortress" balance sheet. Not only is this company profitable - really profitable - but, per the conference call, they have $278.5 million dollars in cash and equivalents!

They have so much dough in fact, that rather than diluting shares, they are buying them back (re-luting?):

"Spectrum's Board of Directors and senior management have confidence in our Company's prospects and believe repurchases of Spectrum stock represent an attractive opportunity to enhance long-term shareholder value," statedRajesh C. Shrotriya, M.D., Chairman, President and Chief Executive Officer of Spectrum Pharmaceuticals, Inc. "This program gives us the opportunity to invest in our stock as we need to. We believe that the current share price represents a significant discount to the intrinsic value of the Company. We will be starting to purchase stock today."

Financing is not a problem for Spectrum.

3) Execution

Potential is never enough, you have to execute. Scott Matusow points out that this company is executing:

The Spectrum business model was brought to the company by the current CEO Rajesh Shrotriya, and can be attributed back to his years at Bristol-Myers Squibb (BMY). Most of BMY's cancer drugs were acquired with the same business philosophy that Shrotriya is currently implementing at Spectrum.

Zevalin (ibritumomab tiuxetan) was targeted and acquired by Spectrum while following Dr. Shrotriya's business philosophy. Zevalin is a treatment for certain types of non-Hodgkin's lymphoma, and was originally developed by IDEC Pharmaceuticals, which is now part of Biogen Idec (BIIB).

In December 2007, Cell Therapeutics Inc (CTIC) acquired the U.S. rights to sell, market, and distribute from Biogen for approximately $30 million, or the equivalent of about two years' net sales revenue in the U.S. for the drug. Outside of the U.S., Bayer Schering Pharma continues to have the rights to the drug.

Spectrum's strategy is tried and true, it is executing a soundly strategy, and has experience doing such things.

Conclusion

Small healthcare companies can offer a lot of growth potential, and if you can find one that is already profitable that can be a terrific situation.

Spectrum is very profitable now and is growing quickly. They also have a ton of cash! They are executing and there are things to be excited about for this business.

But, this stock also has some problems. The CEO has been dumping shares, millions of dollars worth, even after the recent pole-axing, and the share price continues to slide. Spectrum has been trying to acquire Allos Therapeutics, Inc. (NASDAQ:ALTH) for what seems like forever, and can't seem to close the deal, which might be for the best after all.

We will take up the bear case next, and in the end we will conclude that Spectrum has some pretty good reasons to go short or go long. So for now we say stay on the sidelines, there are better stocks to grab at these levels. One profitable small pseudo-healthcare play I like right here is Obagi Medical Products (NASDAQ:OMPI). They have a growing prescription-grade skin care line, and as Scott Matusow has pointed out in the past they may be getting a tender offer.

Source: The Bull Case: 3 Reasons Spectrum Pharmaceuticals Is A Buy