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There is one change in the medical arena that investors are going to have to embrace, or at least accept: cell therapy. In 2012, some of the best performing stocks in biotechnology have been in cell therapy. Already, we have crossed a number of barriers. We've seen the first approved product with a cell therapy as a main component: Osiris Therapeutics' (NASDAQ:OSIR) Prochymal. Shares of Neuralstem (NYSEMKT:CUR) have nearly doubled in the last month alone as its cell therapy showed a benefit of motor function in paralysis, a benefit never before reached. StemCells (NASDAQ:STEM) has also been a big-time performer following data that its cell therapy restored memory and enhanced synaptic function in Alzheimer's disease. And if that's not enough, Baxter (NYSE:BAX) recently reached endpoints never before conquered, increasing exercise capacity and reducing angina due to chronic myocardial ischemia. The takeaway: It has been an incredible year, and with such breakthrough data, it is only getting better.

In biotechnology, we've seen a number of novel therapeutics with crucial data as we inch closer to curing and effectively treating life-threatening diseases. Cell therapy has been at the forefront of this movement - it has provided proof of concept curing some of today's most deadly degenerative diseases - but is still in its early stages of development.

With only one approved product that has a cell therapy as its main component, the potential for new treatments and the outlook for those treatments is at an all-time high. The valuation for companies in this space is particularly attractive, perhaps greater than in any other industry within biotechnology. The reason for attractive valuations is due to skepticism among some who have yet to embrace the benefits of cell therapy. These people may believe that we'll never see a large diversified product line of cell therapies, or that regulators will never accept the benefits of cell therapy. However, this argument doesn't make sense, because countries around the globe are spending more on cell therapies than at any point in our history. There is a significant cost benefit to cell therapies, not to mention efficiency, that will replace inefficient therapeutics that are being used to treat degenerative diseases. For this reason, we will see approvals in the cell therapy arena. We will see cheaper and more efficient therapies to treat diseases that have limited or no current treatments, and this will occur because of clinical results, and over a period of several years.

So how should investors play the growth of this space? Investors could invest in a company such as CUR or STEM. But these companies are still early in the clinical process, and are more likely to benefit from the approvals of other cell therapies; they will trade with far less upside than later-stage companies with similar valuations. You could invest in the first approved cell therapy and OSIR. However, its product Prochymal is more of a "door opener" and not a large revenue-producing product. The difficult aspect to finding a good investment is that there are a lot of cell therapy companies with a lack of diversification-or only one significant product of growth-and we must assume that, despite their promise, it may take a few years for cell therapies to gain full acceptance and reach full potential. So after searching throughout the entire space, and reading 100s of reviews, business plans, and assessing market potential, I feel confident that the best play in the space is NeoStem Inc. (NASDAQ:NBS).

NeoStem

NeoStem is a $105 million market capitalization company with expertise and a presence that stretches far beyond the norm of cell therapy and developmental-stage companies. The company operates in several segments, with a diversified presence in the space, and has been a great investment in 2012, with an 81% return over the last six months. The stock has returned a gain of more than 10% over the last month, but is now trading very close to its support, therefore indicating short-term upside. Unlike most biotechnology companies of its size, NeoStem has returned revenue in the amount of $77.20 million over the last 12 months, which is further proof of its well-diversified business model.

Clinical Development

Let's get right to it: NeoStem is most well-known for its Phase II cell therapy product, AMR-001. The product treats patients for acute myocardial infarction (AMI), and the company is also preparing for an additional congestive heart failure study. Both are large markets, as analysts have projected sales potential of $600- $700 million annually, and the company has stated that peak worldwide sales could exceed $1 billion for the treatment of AMI.

The product is strikingly similar to Baxter's cell therapy product; and seeing as how Baxter has already achieved its endpoints, some draw a direct connection to NeoStem's AMR-001. So far, no safety concerns exist, which is an important barrier for cell therapy products to overcome due to public perception. The product itself is a bone-marrow derived stem cell enriched for CD34+CXCR4+. The key component is CD34+ cells, as there is mounting evidence to suggest the cells play a crucial role in cardiac indications. When considering its similarities to Baxter's successful product, no safety concerns, and the data surrounding the mechanism of the product, there are many who are optimistic of its future, and believe it could be the most successful cell therapy in development, in terms of commercial success.

Manufacturing

Another crucial reason that investors are so optimistic regarding the upside and the long-term prospects of NeoStem is due to its manufacturing segment. This is the services aspect of the company's business: It includes over 55,000 square feet of manufacturing capabilities and the company has manufactured over 30,000 cell therapy products for more than 5,000 patients. These services include manufacturing cells, storage, logistics, and clinical study design.

Among NeoStem's many clients are well-known companies such as Baxter and SOTIO. These companies, and the many others, pay a flat fee for services-but once approved NeoStem could earn royalties on the approved products. The company used to manufacture Provenge for Dendreon (NASDAQ:DNDN), throughout its clinical studies, and some have speculated that Dendreon may begin to use NeoStem once more after closing its New Jersey facility.

At this point, we don't know the royalty rate, which NeoStem will receive for manufacturing approved products, but we can estimate that it's between 5% and 10%. The company's late stage clients-Baxter and SOTIO-could see approvals in the next 16 months, and are big revenue potential products. With these three companies alone, and possibly Dendreon (if the speculation becomes a reality), the company could earn anywhere from $100 to $400 million in royalties… and that's not counting its other companies in the early stages of development.

One final luxury that is a result of the company's manufacturing segment is the expertise that is created. Earlier I alluded to the similarities between NeoStem and Baxter's cell therapy products. Hence, I find it interesting that NeoStem is manufacturing the Baxter cell therapy product, and has chosen to explore a similar product in clinical studies. This should provide some sense of ease. NeoStem should know what's effective, and what products are ineffective, due to its ever-increasing level of knowledge in the field. This could prove itself to be beneficial in a rapidly growing and maturing industry.

VSEL Technology

The VSEL Technology is perhaps NeoStem's most promising technology and also its least developed. As of now, the VSEL Technology is only an idea. Very small embryonic-like stem cells are pluripotent cells located in umbilical cord and bone marrow tissue. Like embryonic stem cells, VSELs have the ability to differentiate into many different types of cells to help repair and treat disease without the stigma often associated with embryonic stem cells. VSELs have been tested in disease models but have not been investigated by NeoStem in larger studies. This is a technology that could break a lot of barriers in cell therapy, due to the diversification surrounding this technology. In early testing, it is believed that VSELs would be effective in traumatic wound healing, osteoporosis through bone regeneration, liver regeneration, regeneration of some motor neurons, and also radiation exposure. Of course there is still much to be learned of this technology. However, the potential benefits to its development indicate significant upside with a wide range of indications and potential targeted market size.

Balance Sheet (Pharmacy Divestiture)

In addition to having a clinical and manufacturing segment, the company also "had" a Chinese generic pharmacy. The pharmacy was expected to be a blessing for the company, allowing it to achieve profitability while in clinical studies. However, its blessing became a nightmare due to regulatory and pricing changes on behalf of the Chinese government. Thankfully, the company was able to divest and sell its 51% stake in the generic pharmacy for $12.3 million in cash and eliminate $35 million in debt obligations. For a small company such as NeoStem, a sale of this magnitude is huge for the operations of the business. The company already produces revenue from its manufacturing segment, but with the sale of its generic business, the company now has a strong cash position and more leverage on its balance sheet to operate without the immediate concerns of cash.

Conclusion

NeoStem is the most diversified company in the cell therapy arena. But in addition to being diversified, it is also the safest because of its valuation. There are many moving parts at NeoStem, and with this being a fast-growing industry, which is building in positive sentiment, the company has a good opportunity to succeed. If its late-stage clients were to receive approvals in the next 16 months, and if its cell therapy product reaches its full potential, then this is a company that could reach sales of $1.2 billion based on the manufacturing royalty estimates used above, and peak AMR-001 sales of $800 million. However, all pieces are unlikely to fall in place; so even if AMR-001 reaches sales at the bottom of its range, with $600 million, and it only earns $100 million from its manufacturing segment, then it's still seeing revenue potential of $700 million.

As you can see, if all pieces fall in place, then NeoStem has market leading upside potential. Even if half of its current catalysts fall into place, then its upside will still remain in the 1,000% range. However, this is cell therapy, and despite all of its promise and its encouraging clinical results, there is still a possibility that companies such as NeoStem will not see an FDA approval. Unfortunately, we cannot say with certainty what will occur in the next three years because there has never been a company before NeoStem in the cell therapy arena to earn an FDA approval. Osiris has earned an approval in Canada, but not in the U.S. As a result, NeoStem still presents the same risks as with any novel therapy, but because of its valuation, the downside is minimal while its upside is among the greatest in the biotech industry.

The exciting aspect to NeoStem is that its business is diversified and does not rely on any one segment to carry the company's performance. It is well positioned in the cell therapy arena, should benefit from its global growth, and is presenting significant upside potential. If we use a conservative price/sales ratio of 3.0, this is a company that could reach a market capitalization between $2.1 and $3.6 billion in the next five years. And what's even more exciting is that upside potential from earlier-stage manufacturing products, the VSEL technology and new partnerships are not being incorporated into these figures. As an investor, your own due diligence is crucial; but based on my research and my analysis of the industry, I don't see any other company with the same level of upside and diversification. This thought process is what makes NeoStem my choice as the best investment in the fast-growing and exciting space of cell therapy.

Source: NeoStem: The Best Upside In An Innovating Space