A Small Unnoticed Stock That Deserves Your Due Diligence

| About: Enzo Biochem, (ENZ)

In late July 2012 I received an email from an investor who explained to me that he had purchased shares in a small life sciences company called Enzo Biochem (NYSE:ENZ) after a one-year 50% loss. Like many others in the past, he tried to explain to me a company that he liked, then asked my opinions, and I informed him that I wasn't familiar with it nor was I looking to add any more healthcare stocks of this size to my portfolio. Now, I tell this story for two reasons: Since that date the stock has rallied almost 40%, more than double the S&P 500, and because it has a very close connection to a stock that I had purchased back in March of this year, Life Technologies (NASDAQ:LIFE). However, this is just part of the reason that this small and relatively unknown company is worthy of your due diligence.

The Lawsuit Against Life Technologies

For as many years as I have been investing, I had never been part of an acquisition. I have sold stocks days before an acquisition was announced, but I've never held a stock to enjoy the large one-day premium provided by an acquisition. Therefore, I was pleased with Life Technologies, as this was a company I had bought late; yet I truly believed in the company's technology and believed the company was, without question, the leader in a gene sequencing business that was both growing and promising.

As part of my Life Technologies research I came across Enzo Biochem and was taken back to that email that asked of my opinion. You see, I bought Life Technologies as a part defensive play, in belief that the company's technology was head-and-shoulders above others in the space. Consequently, I was very surprised to learn that this small company (Enzo Biochem) was suing and had won against the massive Life Technologies for infringing on its patents. The jury found that Life Technologies' DNA sequencing instruments induced its customers to infringe on Enzo's patent No. 5,449,767. Hence, I have taken notice of this small under-the-radar company, and upon further research, I think it's a stock to watch.

What is Enzo Biochem?

Vringo, Inc. (VRNG) did something we don't often see in small companies: It stood up to Google (NASDAQ:GOOG) for infringing on its patents and won a judgment of $30 million for past damages along with a royalty of some degree. In this long drawn-out battle between the $200 million and $200 billion company (which is still ongoing), Vringo has since built a business on chasing those that infringed on its patents. Enzo Biochem has done the same, having won $48.6 million against Life Technologies for infringing on its patent.

After the jury declared that Life Technologies infringed on Enzo's patents, the company's stock rallied from $2.00 to $2.78 in a matter of two days. Over the next month the stock slowly-but-surely trended to create 52-week highs over $3.10. However, then it trended back down to a price near $2.00 following weak FQ2 earnings, which were affected by Hurricane Sandy and reduced government expenditures. At the time, I had just started to research the company, so I spent a lot of time digesting the quarter and listening to the conference call. And in that conference call, I found one part very interesting as it relates to Life Technologies and the lawsuit against it (this is a bit long but important). Below you will see a very detailed explanation of the rulings and the company's take on what lies ahead in relation to Life Technologies and other suits.

"…We anticipate that an additional prejudgment or interest award will be awarded to us by the court. This is because the jury found that the infringement went back a number of years. Our legal team has estimated that the addition of the prejudgment award could add additional recoveries potentially in the tens of millions of dollars. As to where we stand now, this action, as of February 15, both sides submitted post-trial motions [sic]. Among the items we are now seeking are damages related to the jury's findings that Life Technologies sequencing instruments induced its customers to infringe our patent. The sales of such instruments during the time that the patents have been enforceable have been estimated to be about $770 million. We also believe that this decision could have a positive impact on the resolution of pending actions that we brought in the U.S. Southern District Court in New York City, which involve additional defendants, patents and contract issues. Among the defendants in those suits are Amersham, which is now part of GE Healthcare; Roche Diagnostics; PerkinElmer; Molecule Probes, which is also a division of Life Technologies; and Affymetrix.

In addition, we have brought additional actions against a number of other life sciences and diagnostic companies that we believe may have infringed on other key intellectual property. The companies include Abbott, Hologic, Becton Dickinson and Illumina, among others."

What you don't see from the statement above is that this is not another company that is just overhyping its suit against Life Technologies. For one, the company has already won and is simply waiting for an interest amount to be determined, which is anticipated to be imminent. This is a company that was highly critical of itself and its performance during FQ2 as revenue was weak year-over-year, and was not in any way trying to overhype its potential or its future performance. Yet we must acknowledge that the $48.6 million judgment, the company's pending suits, and future royalties are not valued into the stock, thus making it attractive and, at the very least, worthy of your due diligence.

A Look at Enzo as an Investment

Here's the thing: I really like this story and this stock. While a company such as Vringo doesn't really have a large and dominant underlying business to complement its patent suits, Enzo Biochem is a company that has produced $100 million in revenue in the last 12 months. It operates a very diversified life sciences and biotechnology business that is becoming a translational diagnostics company. Hence, patent litigation may present great upside in terms of growth, but the company's other two segments, Clinical Labs and Life Sciences, provide consistent sales and should produce consistent growth as the company prepares to launch new services and products.

Aside from having countless tests, products, services, etc. in its Life Sciences and Clinical Labs segments -- enough to produce sales of $100 million annually -- the company also has other potentially large revenue growers in the works. Here are just a few catalysts to note (updates of these catalysts can all be found in the company's most recent FQ2 conference call):

  • Introduction of new laboratory tests in the Clinical Labs segment, directed at the potentially lucrative Women's Health business.
  • New products derived from the company's proprietary nucleic acid target amplification platform, also known as AmpiProbe.
  • Introduction of new esoteric high-margin lab tests
  • The continued recruitment and enrollment of the clinical product Optiquel, a drug that is being studied for autoimmune uveitis, which is a serious inflammatory condition that often causes blindness. The clinical trials of Optiquel are being run under a CRADA funded by the NIH.
  • A Phase 2 product, Alequel, based on Enzo's proprietary immune regulation technology platform that harvests the patient's own immune system to alleviate the symptoms of Crohn's disease. At both 6-9 weeks and 9-12 weeks Alequel showed an advantage over the placebo-treated group, hence meeting both the primary and secondary endpoints of the study.

Typically, the reason that small biotechnology companies only study one product is because trials and studies are too expensive to study multiple products. For example, look at Galena Biopharma (NASDAQ:GALE), a hot name right now and a stock that I said to "buy" at $0.60. For the last year the company has been studying one product, NeuVax, and has been enrolling and opening trial locations for the breast cancer vaccine. Last year Galena Biopharma finished with a net loss of $34.97 million and had operating cash flow of ($20.96 million). Enzo Biochem, despite two large revenue-producing segments, two drugs in clinical development, and an expensive litigation team, had a net loss of just $14.73 million minus a one-time unusual expense of $24.54 million, and had a loss of operating activities of less than $6 million!

How is it that Enzo Biochem lost just half as much income as Galena with less than one-third the loss in cash flow while having a larger clinical segment? The answer is because of its revenue-producing segments, as there is no doubt that Enzo's operations are more extensive and expensive; yet because it is an established company it is also more efficient. With that said, Enzo Biochem is a relatively unknown company with a market cap near $100 million that I believe is one of the more promising in the biotechnology sector with large upside.

The upside potential I place on Enzo Biochem is much related to its clinical development and the operational platform that it already has in place, compared to its market capitalization. However, the patent litigation offers the company an entirely new level of upside in addition to my presumed value. I already explained that the company has won its suit against Life Technologies for more than $48 million, although the payment has not been received and the royalties are to be announced. Yet still with a $48 million judgment to be had, the company can operate for near four years without any fear of dilution.

In addition to the eliminated fears of long-term dilution, Enzo's patent portfolio and presence in IP litigation also validates the company in the space as having a meaningful IP portfolio that can produce even more revenue in the future. For example, Enzo also won a settlement with Qiagen (NASDAQ:QGEN) in 2004 and has received more than $50 million to date, with up to $100 million possible. Then, there are others named in the quote above, such as Abbot Labs (NYSE:ABT), Illumina (NASDAQ:ILMN), Agilent Technologies (NYSE:A), etc., with many expected to be heard in court later this year. The complexity of these patent suits runs deep, hence I suggest reading a recent article by clicking here, which will walk you through both the revenue potential and a bit of a timeline for future catalysts, all which add value to the company and create upside for the stock.

Conclusion: Investing In Clinical Biotechnology Companies

When I invest in small clinical phase healthcare companies, I like to buy at such discounted prices that it won't matter the outcome of the company's biggest catalyst. I like to buy companies that have a favorable risk-reward ratio to succeed and that are undiscovered, much like Galena Biopharma at $0.50. Today, Galena is very expensive when comparing its risk-reward ratio (too expensive for me), but when I bought GALE the stock was cheap. In my opinion, with all of Enzo Biochem's moving parts, it fits into the same scenario; perhaps even better.

Enzo Biochem is not a biotechnology company per se, but does have a biotechnology segment including the two noted products in development. In a sense, the company is a mini Johnson & Johnson (NYSE:JNJ), Boston Scientific (NYSE:BSX), with a little bit of Life Technologies, combined with Vringo. It's really a neat company -- with a small market cap - and one that's not throwing spaghetti on the wall and hoping for it to stick. Enzo Biochem is succeeding in most phases of development, whether it be clinical, laboratory, or in IP infringement against the largest of corporations. For this mere fact, I think Enzo is definitely a company to watch over the next year(s), one with many exciting developments, and with a lot of cash (courtesy of Life Technologies) to fund its road ahead.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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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