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John H. Ford
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For the past 30 years, I have been involved in startups, as a founder, and active investor. My first company was purchased by Johnson & Johnson, which set the foundation for future investments. My level of trading escalated after graduating from college, primarily as a result of my... More
  • Oculus Entering $6.5 Billion Acne Market 0 comments
    Aug 3, 2012 1:49 PM | about stocks: OCLS

    Oculus (NASDAQ:OCLS) and its partner, Amneal Pharmaceuticals, just announced that they will be entering the $6.5 billion acne market. Oculus's lead product, Microcyn, could become a new standard of care for the treatment of acne. It appears to work significantly better than one of the leading products, benzol peroxide, promotes no antibiotic resistance like topical antibiotics, and best of all, produces no side effects.

    The key part of this deal is that Amneal will be initiating a new drug application with the FDA: a full-blown clinical trial paid for by Amneal. This puts Oculus on a whole new level. As Amneal progresses through clinical trials and gets closer to FDA approval, Oculus's value will rise.

    Amneal is a rapidly growing, $300 million a year pharmaceutical company. By signing this deal with Oculus, Amneal is validating the quality of the Oculus product line. Amneal is backing-up that validation by investing millions of dollars into developing and marketing Microcyn in the acne market.

    This new partnership with Amneal should make it easier for Oculus to partner with other pharmaceutical companies, thereby opening the door for Oculus to receive FDA approvals for other drug indications, including surgical, scar reduction, and urinary tract infections.

    This deal also benefits Oculus in a couple of other important ways. Oculus received an upfront payment which will help its cash flow situation. It also will be receiving milestone payments as Amneal proceeds through the clinical trials. These cash payments will help Oculus reach profitability

    How long will an acne trial take? It's a fairly simple trial. Patient enrollment will be easy. There are no real safety issues. I estimate this trial will be finished within 2 to 3 years.

    The big question investors need to ask is whether or not Microcyn actually works for treating acne. Given the fact that Amneal chose to sign this deal with Oculus, it appears that Amneal scientists think so.

    If you recall, Amneal paid Oculus $500,000 just for the option to develop Microcyn technology in the acne market. Amneal's due diligence was thorough, and the company's decision to pursue the acne market could only have been based on positive pre-clinical results.

    Another thing to keep in mind, is that Amneal has been selling Oculus's products to dermatologists for a few months now, and some of these dermatologists have been treating acne patients. In part, Amneal probably decided to pursue this market based on positive feedback received from the dermatologists.

    But for me, the real proof comes as a result of a double-blind test that Oculus conducted in Mexico. The results were impressive.

    Oculus separated 87 patients into three groups: the Microcyn group, the benzyl peroxide group, and the placebo group. To be included, a participant needed to have between 10 and 50 inflammatory lesions (pimples). Patients were not to have used any other topical treatment for 14 days, systemic antibiotics for 30 days, or systemic retinoid for at least six months prior to the start of treatment.

    Patients applied a thin amount of the study products to the entire face daily during the 12 week treatment. Patients were evaluated at baseline and at week's 4, 8 and 12. Efficacy was evaluated by counting the changes in the number of facial inflammatory lesions. Here are the results:

    The average number of lesions per patient at the baseline was 34. At week 12, the placebo group had an average of 29 lesions, the benzyl peroxide patients had an average of 16 lesions, and the Microcyn patients had an average of 12 lesions.

    This data shows that compared to the placebo, Microcyn and benzol peroxide do actually work. It also shows that Microcyn works better than benzol peroxide. This is not surprising since Microcyn is not only an extremely effective antimicrobial, but also contains an anti-inflammatory component which benzol peroxide does not.

    Benzoyl peroxide has some undesirable side effects including severe allergic reactions: rash, hives, itching, dizziness, difficulty breathing, tightness in the chest, swelling of the mouth, face, lips, or tongue, excessive burning, itching, redness, swelling, or tenderness of the skin, and/or extreme dryness. Thus far, the Oculus products have generated no side effects, and that's with over 3.5 million patients treated.

    Benzoyl peroxide appears to be more effective in higher strengths (although the side effects increase). Because of this, I would like to see the results of a trial where Microcyn was used at higher strengths as well. We could see even a higher reduction of facial lesions than those posted above.

    Right now, the big Pharma companies are capturing most of the $6.5 billion acne market. Novartis (NYSE:NVS) owns Clearasil, a top-selling benzol peroxide product. Glaxo Smith Kline (NYSE:GSK) owns Panoxyl, another benzol peroxide product. And, Johnson & Johnson (NYSE:JNJ) owns Neutrogena, which already has four of the top-10 selling anti-acne products available.

    Then there is Accutane created by Hoffman-La Roche, which is one of the most effective acne drugs ever developed. Accutane is a derivative of vitamin A that falls into the retinoid family of drugs. However, Accutane causes severe birth defects if taken by pregnant women, and the risk is so severe that several years ago the U.S. Food and Drug Administration requested an electronic tracking system requiring woman using the drug to have monthly visits to their doctor. Furthermore, the drug has reportedly raised risks of depression and suicide, although scientific studies have not substantiated those reports. With side effects like these, you can see why physicians are seeking a better acne drug.

    According to one of the leading data providers, Wolters Kluwer, the acne market is quite large for a specialty market, representing about 40 million prescriptions a year, with a retail value of about $6.5 billion. About 10 million of these prescriptions are for topical antibiotics.

    This is where an immediate market opportunity exists for Amneal and Oculus. Physicians have become frustrated with the current market leader, clindamycin, because of a rapidly increasing level of antibiotic resistance. At some point, clindamycin will become ineffective for treating acne.

    The big dilemma for physicians is that there is no known replacement for clindamycin. There is no new topical antibiotic. And, physicians are desperate for a next-generation product. As of now, the only new product on the horizon appears to be Microcyn.

    Physicians were in a similar situation years ago when the most popular topical antibiotic, erythromycin, began losing its effectiveness. At the time, this wasn't a problem because physicians could just switch to clindamycin. Clindamycin rapidly gained around 90% market share. The situation is different this time because there is no topical antibiotic to replace clindamycin.

    Pharmaceutical companies haven't developed a replacement because it's just not profitable for them to do so. They spend money developing a new antibiotic just to see it become obsolete due to antibiotic resistance. Once a topical antibiotic stops working, physicians no longer use it. This plays havoc on a pharmaceutical company's bottom line.

    The timing couldn't be better for Oculus and Amneal. Based on what is rapidly becoming an unmet medical need, I would not be surprised to see Microcyn displace clindamycin at a fairly rapid clip.

    Greg Gust, an analyst from Roth Capital, with 15 years experience in the dermatology space, told me that he would expect Amneal to capture between 30% and 40% of the topical antibiotic market in short order. This is based on what he has seen in the past, when new drugs enter the acne market. With an effective new product solving an unmet medical need, the adoption rate can be astounding.

    One advantage Amneal has is the relatively small prescriber base of only 8000 physicians in the dermatology market. These physicians are writing a disproportionately large number of prescriptions. (Dermatologists write more prescriptions per patient than any other outpatient specialty.) Amneal needs just a small sales force to reach these physicians. This kind of leverage could help Amneal reach a high level of market penetration fairly quickly.

    Another aspect that will help Amneal, is the fact that when patients are plagued with acne, they are generally willing to pay whatever it costs to have it cleared up. This makes any acne drug relatively resistant to managed care reimbursement policies. If something works, patients will gladly pay for it themselves no matter what the cost.

    Another possible scenario is that Amneal will capture a large percentage of the acne market before the acne drug receives FDA approval. Amneal is currently marketing Microcyn to dermatologists under the name of Atrapro, and some of these dermatologists are using Atrapro to treat acne. Dermatologists are famous for using products off label, so you can bet that many will be using Atrapro as a replacement for the fading clindamycin. Also, because of the undesirable side effects of benzol peroxide, some physicians will probably begin recommending Atrapro instead of benzol peroxide.

    In terms of economic potential for Oculus, let's assume that Amneal begins by addressing the topical antibiotic market. This is a good market to start with, because dermatologists are fed up with the antibiotic resistance problem, and are in need of a new product.
    This willingness for dermatologists to embrace cutting-edge technologies will make it much easier for the Amneal salesforce to penetrate the market.

    Amneal's acne drug will be priced at a minimum of $100 per prescription, which gives us a total addressable market of $1 billion. (10 million topical antibiotic prescriptions per year times $100 per prescription). Let's assume that Amneal can capture 20% of that market, or $200 million per year. At a 10% royalty, Oculus could receive $20 million per year. If Greg Gust is correct and Amneal captures 40% of the market, that would bring Oculus $40 million per year. (I actually believe Oculus will receive royalties greater than 10%.)

    That $20 million is worth something today in terms of share price. When I run the standard pharmaceutical company present value calculation (10 year time frame with revenue beginning in year four, using a 25% discount rate), I come up with a present value of about $38 million. That is a substantial number, considering that Oculus's current market cap is around $24 million.

    Let's translate this future revenue into an approximate share price valuation. If we take the $20 million figure, and divide it by the 32 million shares outstanding, that gives us $.62 per share in pro-forma earnings. With a PE ratio of 20, we get a valuation of $12.40 per share. If we discount that back to present value, we have about $5.07 per share. That's for a company that is currently trading between $.60 and $.70 per share.

    Wall Street is completely ignoring this future revenue stream and acting as if the deal with Amneal never happened. The market is assigning a future and present value of zero. If Oculus continues to execute as well as it has in the past, (25% to 30% annual revenue growth), the market should recognize the mispricing, and assign a higher value to Oculus shares.

    The topical antibiotic market is only a starting point for Amneal. I believe physicians that are currently using benzol peroxide will begin switching to Microcyn, partly because Microcyn appears to work better, but also because the benzol peroxide side effects can be fairly severe. This is a very large market opportunity for both Amneal and Oculus.

    One risk for Oculus shareholders is that one of the big Pharma companies, Roche (OTCQX:RHHBY), Glaxo SmithKline, Novartis, Sanofi (NYSE:SNY), or Johnson & Johnson may develop a new acne product. You can bet that these big companies are trying. But as it stands now, Amneal appears to have the lead, and should have the advantage of being first to market with the next-generation acne product.

    This new deal with Amneal could put Oculus on big Pharma's radar screen as an acquisition target. If Microcyn is truly the superior acne product, any of the big Pharma companies could save a lot of time and money simply by buying Oculus.

    An important thing to remember is that Amneal will only be able to market products in the United States and India with a first right of refusal for all member states of the European Union, Canada, Brazil and Japan. Oculus retains all rights for the rest of the world. With Amneal paying for all development costs, Oculus will have a much easier time attracting partners from these other countries.

    In terms FDA approval, given Microcyn's phenomenal efficacy and safety profile, I believe Amneal will receive FDA approval. Keep in mind that Oculus already has seven FDA approvals, so the FDA is familiar with the Oculus products, and has generally responded favorably. The acne indication in particular should receive a positive ruling from the FDA, because acne is not life-threatening, and Microcyn's safety profile is impeccable.

    In terms of efficacy, given the results of the Mexico clinical trial, efficacy should not be an issue either. If Amneal and Oculus tweak the formula, probably to a higher strength, the results could be even better. An acne drug could become one of Oculus's largest selling products.

    But let's not forget, this is just one of many products that Oculus holds in its portfolio. Oculus is currently generating about $13 million a year in revenue from its other products, so the acne deal alone could easily double its annual revenue. This Amneal deal presents tremendous opportunity for Oculus and its shareholders.

    Disclosure: John Ford is an outside contractor for Oculus innovative sciences and a shareholder. For disclaimer and SEC rule 17 b disclosure information, please click here.

    Disclosure: I am long OCLS.

    Stocks: OCLS
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