On Moxie, Oxytocin, And Shkreli: The Case For Retrophin

About: Retrophin, Inc. (RTRX)
by: Suresh Gupta

I'm always on the lookout for a fundamentally solid play when it comes to OTC stocks. While there is great risk on the volatility side of OTC stocks, I enjoy looking for a solid company backed by solid management that for whatever reason, was unable to make the cut to a major trading exchange. Last week, one OTC stock, Retrophin (NASDAQ:RTRX), applied for a $40M IPO on the NASDAQ exchange. Is now a time to jump into Retrophin before the IPO details and market response get folded into the stock price? Does it have something worth investing in? Or is prudence the wiser course here and a wait for the IPO hype (if any) blows over?

Why Retrophin? The SpaceX Analogy

If SpaceX were a publicly traded company, I would buy it in a picosecond. SpaceX is the first (and only) private company to launch a spaceship into orbit, and is currently now the only way the United States can resupply the International Space Station since the retirement of the Space Shuttle. SpaceX was started by eBay billionaire Elon Musk, who actively runs it while he's also heading Tesla. Why would I hypothetically invest in SpaceX? It's a high risk, high-cost business model, with any hope of generating a profit years away. My bullish optimism can be placed squarely at the feet of Musk - the tech evangelist who sees potential in a market and commits all of his formidable personality to bear in order to achieve that potential. Musk has done this successfully over the past three years. But alas, Elon's sights are set on the heavens, and he needs no help from us pithy investors.

Which brings us to Retrophin - a biotechnology company operating with a refreshing bit of moxie not usually seen in this sector. Retrophin was started in 2011, currently has 6 drugs in its pipeline, and has a respectable market cap of $130 million. Its refreshing moxie is provided by its founder Martin Shkreli, all of 30 years old, obviously a prodigy, a hedge fund manager who poured his hedge-fund millions into this biotechnology upstart. Shkreli earned his stripes under Jim Cramer (of CNBC's Mad Money fame), worked elsewhere in hedge funds, then went indie opening his own fund specializing in the biotechnology field. His fund, MSMB, specializing in biotech, was wildly successful. Shkreli, like Elon Musk, has a rare ability to foresee a need. Shkreli in pharmaceuticals, and Musk in technology. Both then use their personal fortunes and investor financing to execute and achieve their goals, satisfying the need with a solid business product.

Shkreli's company, Retrophin, is not your usual biotechnology upstart, and has a nice balance of cash flow, pipeline drugs, and good old-fashioned takeovers. Shkreli started Retrophin in 2011 and to date, as mentioned, it has six drugs in the official company pipeline. One is in phase 3, one in phase 2, and the rest are preclinical. But, for these drugs to pay off, much work and risk still needs to be completed.

Shkreli's Bold Move - The Love Hormone

But back to moxie. Shkreli's most recent move warms my capitalist heart: He bought the US rights for oxytocin, branded Syntocinon, from Novartis (NYSE:NVS). Oxytocin, colloquially known as the "Love Hormone", is currently being sold in Europe to help treat post-partum mothers with various breastfeeding problems. Oxytocin (not be confused with the narcotic Oxycontin) is known as the Love Hormone because it is the hormone released by the body after orgasm. It is also released after childbirth, and during labor to induce uterine contractions. It is also sometimes referred to as the "Trust Hormone", because studies have shown that taking the hormone "evokes feelings of contentment, reductions in anxiety, and feelings of calmness and security around the mate."

Anyhow, even with all of these affable monikers for oxytocin, Novartis stopped marketing the hormone in the US in 1997, but not for health reasons. It was for purely financial reasons - it just wasn't selling well enough. Novartis decided to focus its energy in the European market.

How does Shkreli's buying rights to a non-profitable hormone drug tickle my capitalist fancy? Rather than starting with a $0 revenue unapproved drug, and sinking millions into it, Shkreli is hedging his drug play with some level of revenue (beginning in Q2 2014) to offset the risk side. At the same time, with what is Shkreli's true play, Retrophin is actively testing Oxytocin to treat schizophrenia, which has shown some promising test results. Three small, but independent, studies have shown that oxytocin use improved patients with schizophrenia in a multitude of ways, specifically with scores on the Positive and Negative Symptom Scale (PANSS).

In 2010, a study from the University of California, San Diego, determined that oxytocin delivered via nasal spray "significantly reduced scores on the Positive and Negative Symptom Scale (p < .001) and Clinical Global Impression-Improvement Scale (p < .001)." It was also determined that the use of oxytocin was well-tolerated, and that higher dosages and longer-term use may improve symptoms in schizophrenic patients even more. In 2011, a study from the University of North Carolina, Chapel Hill, determined that that same nasally delivered oxytocin improved psychotic symptoms and social cognition in patients with schizophrenia. That study even went so far as to say that oxytocin worked better than other classic antipsychotic medications like Abilify, Zyprexia, and Risperdal, in that oxytocin helps patients better judge social situations, like understanding the implications of facial expressions.

This is a boon to the antipsychotic medication world in that rather than just masking the symptoms of schizophrenic behavior in patients, oxytocin may have the ability to help patients operate better socially in the world. In 2012, a study from the University of Tehran determined that oxytocin use "reverses emotional recognition deficit and might restore a sense of trust in patients with schizophrenia." Oxytocin seems to have impressive qualities helping those suffering from this psychotic disorder, specifically with regards to social and emotional situations - areas in which current antipsychotic medication is severely lacking.

From Schizophrenia to Autism

As oxytocin seems to have a medical effect helping people better judge social situations, a natural extension for this medication would be to use oxytocin to help patients with autism. Sure enough, there are many studies showing marked improvements with autistic behavior, but its use for autism is less definitive and medically conclusive at this time.

In any case, here's the evidence: The same nasal spray of oxytocin discussed previously was shown to help children with autism as young as 12 improve emotional recognition - a major deficiency in autistic children. In adults with autism, oxytocin was shown to help with repetitive and affiliative behaviors. Inhaled oxytocin was shown to help autistic patients exhibit more appropriate social behavior. All of these results are very promising, and even though additional researchers show enhanced brain function in children with autism, the same researchers recommend that the use of oxytocin remain under the auspices of closely supervised clinical trials.

Even accounting for these positive results with autism, Shkreli has veered Retrophin away from testing its oxytocin spray Syntocinon with autism because he feels that as autism has such a broad spectrum, determining efficacy of treatment is highly unlikely to pass FDA approval. But that doesn't mean Retrophin can't still make money from the autism market. Shkreli is very open about the possibility of selling Syntocinon via off-label prescribing, which is the practice of doctors prescribing a drug for another purpose besides the one the FDA approved it for. What doctors would do with Syntocinon, for example, is prescribe it to treat autistic patients, (and not schizophrenia), using various studies as justification for doing so. As long as doctors are open about the pros and cons, and the drug company does not market its drug for these off-label purposes, this practice is perfectly legal.

From Autism to Orphan Drugs

The big question is, is Retrophin just a one-trick pony? Not exactly, but it's not far off the mark. Besides the very appealing play of using a cash-generating drug to potentially treat a major disorder, and make even more cash with off-label prescribing, Retrophin has another phase 2 trial being conducted to try and treat a rare, usually pediatric, kidney disorder, for which there is currently no treatment. This drug fits the bill for orphan status, which happens to be a self-described forte of Shkreli, and would be a boon to the company, if successful. With no competition for this potential treatment, this play seems like a high-risk/high-reward play for the former hedge fund manager. Treating his company's drugs as a fund, it appears he is balancing his portfolio with high-risk investments together with lower-risk cash cows.

There are no patents for oxytocin, so Shkreli has said that steps will need to be taken to keep generic versions of Syntocinon off the shelves. To wit, Shkreli dealt with a competitive synthetic manufacturer of oxytocin like a true capitalist: he bought the entire company, folded it into Retrophin, and made the previous owner a vice-president (not to mention an undisclosed amount richer). Mom and baby are doing fine, by the way. This may be how Shkreli plans on keeping generics at bay - using legal business maneuverings to keep the cash flowing.

Shkreli's moxie has been on display even during his hedge fund days when some have argued his tactics bordered on the unethical, for example, badmouthing companies his fund was short in, or even attempting a hostile takeover to try to fire the company's management who was trying an unfavorable (to Shkreli) merger. The takeover was abandoned after the merger was abandoned. Even these less-than-kosher tactics are somewhat appealing to a true capitalist, because while these actions had moxie, they were all quite legal.

One last metric which can't really be categorized well: Retrophin is expanding its office space lease by an additional 3,000 square feet on Manhattan's Third Avenue. Is Shkreli gearing up for near-term rapid growth? Is there more to his NASDAQ IPO paperwork than meets the eye? This metric, and much more, point to a positive outlook for this interesting biotechnology upstart.

Risks and Cash

Even though Retrophin appears to have a positive outlook from a business perspective, as well as from the pharmaceutical side, it bears mentioning again, that investing in OTC pharmaceuticals is very risky, and should only be funded with funds that you can afford to lose.

A look at Retrophin's cash position should give investors a rough idea of any dilution in the cards, excluding the announced $40M NASDAQ IPO. Retrophin currently has $13.4M in cash and about $17M in current assets. If we fold in the $40M pending IPO, that puts Retrophin at about $57M. Shkreli has been quite frugal with Retrophin with an average quarterly cash burn rate of just over $5M over the last 4 quarters. At the current rate, that gives Retrophin more than two-and-a-half years until cash runs out, plenty of time to get Syntocinon going. Let's assume the rate doubles with more company activity. In that case, there is enough cash for about a year. Debt to equity ratio is about 18%, so there is some room for debt financing as well before more dilution needs to be considered.

The real risk is in Syntocinon failing. It already did for Novartis, and if Shkreli can't revive life into it quickly, RTRX will plummet. I believe the market will give Retrophin a year grace period before it starts getting nervous. Shkreli also has the propensity to come out with surprise announcement like unveiling a new pipeline candidate which gives the stock sharp swings. Investors should expect a trading range of $4.50 to $9 until an approval or revenue starts coming in. That means a downside risk of about 36% given the current status of the company. Dilution is a risk, but it is a year away at least barring any surprises.

Risks aside, it appears that the archive of positive pharmaceutical studies coupled with Shkreli's deep pockets backing Retrophin mitigates the risk of the company outright failing.

Shkreli is playing big-league ball with a company that barely has a $130M market cap. His strategies warm the capitalist soul, and with the future looking bright for this A-baller, taking the plunge into RTRX doesn't quite seem as crazy as buying an OTC normally might.

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.