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I recently began accumulating shares in a promising pharmaceutical and diagnostics company, Opko Health (NYSE:OPK). Opko's CEO, Pharma guru Dr. Phillip Frost, has been buying large numbers of shares for the past couple of years. Given his remarkable track record, if he is buying shares in his own company, I pay attention.

I expect a major short squeeze based on near-term catalysts described below. But the short squeeze is just icing on the cake. This company has products that are addressing at least five different billion-dollar markets. I will analyze one of those markets, prostate cancer diagnostics.

Opko's next-generation prostate cancer test should reduce unnecessary biopsies by 50%

Opko just launched its new prostate cancer diagnostic test (called the 4KScore) in Europe and should begin selling in the United States later this year. This test is being launched in the U.S. as a Laboratory Developed Test ("LDT") under FDA guidelines, and no additional FDA approvals are necessary. Once investors realize that Opko will be generating a new revenue stream in a multibillion-dollar market, we could see major share price appreciation.

Urologists are in a tough position right now because if a patient has a slightly high PSA score (a test for prostate cancer), the urologist is more or less obliged to recommend a biopsy. Prostate biopsies are painful, expensive, and have recently become associated with a fourfold increase in serious infections. The biopsies themselves are costing insurance companies about $2000 per procedure, and if complications develop, and the patient is hospitalized, the costs become staggering.

But the story gets even worse. Approximately 75% of these biopsies are negative, therefore unnecessary. The PSA test alone is just not accurate enough to consistently predict prostate cancer. Urologists need a better diagnostic tool which Opko is now providing.

Opko's new diagnostic test gives urologists what they have been looking for, a more accurate tool for predicting prostate cancer. Here's how it works: if a patient has a high PSA score, the doctor will recommend Opko's new test rather than automatically ordering a biopsy. This test consists of four blood-based biomarkers that give the doctor what Opko calls a 4KScore.

If a patient then has a high 4KScore, the doctor will go ahead and order the biopsy. But if the patient has a low 4KScore, no biopsy will be necessary because there is a 99.4% chance that the patient does not have a dangerous form of prostate cancer. The patient will simply be put on an active surveillance program with regular checkups. In this way, doctors should be able to eliminate at least 50% of the unnecessary biopsies, thus saving insurance companies and patients billions of dollars.

How do we know Opko's new test works?

In a groundbreaking clinical study, over 10,000 men with high PSA scores were tested using Opko's 4KScore. The 4KScore trials were pivotal clinical trials. Biopsies were performed on all 10,000 men, and the results were compared to the patient's 4KScores. Here's what scientists discovered:

Men who had high 4KScores usually did have prostate cancer.

Only .6% of men who had low 4KScores had a dangerous form of prostate cancer. This represents an accuracy level of 99.4%, extremely good for any diagnostic tool.

To give you a doctor's point of view, here is a quote from Peter Scardino, M.D., Chief of Surgery at Memorial Sloan Kettering Cancer Center in New York. Dr. Scardino has long been considered one of the foremost urologists in the field.

"As a physician who sees many men with elevated PSA levels, I believe this novel panel of kallikrein biomarkers score (Opko's 4KScore) will help us reduce the number of unnecessary prostate biopsies substantially, avoiding the side effects and lowering the costs of care.

The foundation of research supporting the value of this panel is sound, and has been validated in thousands of patients in many different clinical settings, including initial PSA screening, repeated screenings, and in men with a previous negative biopsy. I believe this panel of tests will eventually replace PSA alone for the early detection of prostate cancers that truly need to be treated, helping us avoid the detection of small, indolent cancers that should be left alone."

Dr. Scardino's endorsement of this test will be valuable for Opko because he is so well known in the urological field. That combined with the demand for such a product, should cause sales to ramp up fairly quickly once the product hits the market.

This test could generate over $1.8 billion annually in the US

Opko hired outside consultants to determine what a fair price for the 4KScore would be, and the consultants arrived at a figure of $1,600 per test. When patients are given a choice between a $1600 blood test that reduces the need for a biopsy by 50%, and a $2,000 biopsy, I think most patients will choose the test.

The revenue potential for this test is huge. With 30 million PSA tests conducted per year, I believe Opko will be able to capture at least half of this market, or 15 million 4KScore tests per year.

If Opko charges $120 per test, annual revenue could be $1.8 billion.

At $500 per test, annual revenue could be $7.5 billion.

At $1,600 or test, annual revenue could be $24 billion.

Now you can see why I am accumulating shares. Even if all of Opko's other products were to fail (unlikely), Opko would be very profitable with just this one product. But knowing Dr. Frost's track record, I think many of Opko's other products will succeed as well, potentially making Opko one of the top pharmaceutical and diagnostic companies in the world.

Opko's Claros PSA test addresses $900 million market

Opko's other prostate cancer diagnostic product, the Claros PSA test should be hitting the market in 2013. Opko already has CE Mark approval in Europe and in the US, the company is currently conducting a 510K trial.

This device is basically a micro chemistry lab on a credit card sized testing platform. Doctors simply apply a drop of the patient's blood, and within 10 minutes, test results appear as a printout, as accurate as what you get in a reference lab.

30 million PSA tests were performed last year in the United States at an average reimbursement of $30 per test. This is a $900 million market in the United States alone.

Opko believes it can capture a large part of that market because doctors and patients will prefer instant results from tests performed in doctor's offices. Doctors will benefit because they will be able to keep the profit, rather than passing it on to the laboratories. Patients will prefer immediate results because they won't have to deal with the stress of waiting for lab results.

Ultimately, with the 4KScore tests and the Claros PSA tests, Opko wants to capture 100% of the entire prostate testing market. Opko's two-part system is far superior to what exists today, and I believe the company's goals are realistic.

The Frost factor

For those of you who are not familiar with Dr. Phillip Frost, he made his mark when he sold drug manufacturer Ivax to Israel-based Teva Pharmaceuticals (TEVA) for $7.6 billion in 2005. Since 2010, he has been the chairman of Teva, a $36 billion pharmaceutical company. He's made a lot of money in this business, and he could certainly help Opko become one of the largest pharmaceutical and diagnostic companies in the world.

The two prostate diagnostic products I just described only represent about 25% of Opko's pipeline. The real value in Opko is Dr. Frost's ability to recognize and obtain valuable assets at bargain prices. He's been doing that since Opko's inception, but investors just don't realize the value of his acquisitions.

Here's an example of one of Dr. Frost's acquisitions which could bring in billions of dollars to Opko as pure profit. He bought the drug Rolapitant, from Schering-Plough, developed it a little, and then licensed it to another company, receiving an upfront payment that covered what he paid for it in the first place.

Starting in 2013, Opko should be receiving up to $100 million in milestone payments and royalties approaching 20%. This is for a drug which at this point has cost Opko absolutely nothing. Opko also ended up with shares in the licensing company.

Here is the story direct from Dr. Frost, taken from a recent Seeking Alpha article:

"Basically we're extremely opportunistic. You've heard what I've described already, but another example is a product that we brokered called Rolapitant, which came about because the CEO of Schering-Plough, whom I had known, had to divest himself of this product in order to complete their merger with Merck. Knowing that we move quickly he gave me a call and very quickly we had the product in our hands. We paid very little money for it; we got the ownership of the product, plus raw material to continue with it, it was worth more than we paid for it. We worked on it for a year, we invested very little money and turned around and out-licensed to another company, got the money that we put in plus we have the possibility of getting $120 million in payments in it, and as well as up to 20 percent royalty with almost no investment. That product can be a million dollar product. We also got some ownership in their company -- the licensee's company. So if that works out, I know the people in the company think it's going to be a billion dollar product, we can wind up with a serious income stream just from that one product, and we don't have to do anything further--they're paying for all the Phase III studies. They have finished Phase II studies by the way. So that's an example of the type of opportunism that we got to exploit."

Dr. Frost's decades of experience in this business is what allowed this deal to happen. Investors don't understand this side of the equation. Basically we could call it the Frost factor. We are investing in his experience and remarkable track record.

Jim Cramer has been bullish on Opko

In October of 2011, Jim Cramer interviewed Dr. Frost on his show, and Cramer recommended investors buy shares in the company. Again on his show last May, Jim Cramer reiterated his buy rating on Opko. I think Dr. Frost is due for a return to Jim Cramer's show, and if that happens, we should see a nice move in the share price.

Will Dr. Frost sell Opko?

In the past, Dr. Frost has sold companies with terms very beneficial to investors. For example, Ivax shares went from a split-adjusted price of $.38 in 1987, to $26 when he sold the company to Teva Pharmaceuticals in 2005. I assume he ultimately plans to sell Opko, although I have no idea when.

With products addressing multibillion-dollar markets, I definitely see Opko as a potential takeover target. Any of the big pharmaceutical companies, including Johnson & Johnson (NYSE:JNJ), Pfizer (NYSE:PFE), Merck (NYSE:MRK), Sanofi Aventis (NYSE:SNY), Novartis (NYSE:NVS), or GlaxoSmithKline (NYSE:GSK) could benefit from Opko's diagnostic and pharmaceutical products.

The short squeeze

With a float of 133 million shares, and a 23.1% short ratio, any positive news could trigger a serious short squeeze. But in my opinion, the short ratio is probably closer to 40%, because of those 133 million shares, Dr. Frost and his followers hold a large percentage, and will most likely not be sellers. That should give us a working float closer to 50 million to 75 million shares. With conditions like this, it's possible we could see a short squeeze that drives Opko share price higher than anyone expected.

Risks for investors

While some of Opko's businesses are profitable, overall Opko (valued at $1.25 billion), is still burning through cash. If Opko's new prostate cancer diagnostic test does not ramp up as quickly as expected, we could see a financing. The company currently has about $55 million in cash, which should be sufficient for at least a year, given that the burn rate appears to be below $40 million per year.

Also, with so many different products in development, some of the clinical trials could produce less than stellar results. While I expect this to happen to only a small percentage of the overall product base, any negative news could put temporary pressure on Opko's share price.

Conclusion

A couple of months ago, Opko was at the American urological Association meeting with about 13,000 urologists from around the world. Opko was overwhelmed with interest in its 4Kscore. There was literally a line in front of Opko's booth. Urologists need this product, and I believe we will see an unusually fast adoption rate with full penetration in just a couple of years.

But this is just one of Opko's potential multibillion-dollar products. No one understands Opko's business better than Dr. Frost. If he is choosing to buy shares on the open market, so am I.

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Source: Opko's 4KScore Could Generate Over $1.8 Billion Annually