In August 2014, Dr. Louis Centofanti, the chief executive officer of Perma-Fix Environmental Services, Inc. (NASDAQ:PESI), delivered a paper at the 8th International Conference on Isotopes sponsored by the World Council on Isotopes. Perma-Fix is a self-described nuclear services company that provides "nuclear and mixed waste management services." Indeed, Perma-Fix's bread and butter come from government contracts like the one recently announced to characterize and treat wastes from the Los Alamos National Laboratory. These are wastes generated by government scientists as they developed nuclear weapons and energy technology. Granted isotopes are in the nuclear neighborhood, but why would a company with such weighty responsibilities rub elbows with health care industry representatives?
One need only see the words 'government contract' to appreciate that business for Perma-Fix can be choppy. The company has experienced a decline in revenue over the past four years, in part due to a reduction in spending by U.S. government agencies on environmental clean-up. Several large projects involving nuclear waste treatment and disposal for the Department of Energy were completed in 2011 and 2012, including a large subcontract to help clean up the nuclear development facility in Hanford, Washington that brought in over $50 million per year for several years. That kind of business may come by Perma-Fix's way again, but in the meantime it has only been partially replaced by similar smaller projects. The new contract with the U.S. Department of Environmental Protection to clean up at Los Alamos is valued at $4.5 million.
Perma-Fix reported a $36.7 million net loss on $55 million in total sales in the most recently reported twelve months. Looking closer, the company's situation might not be as dire as suggested by the outsized loss. Cash required by operations in that period was a much lower figure of $4.8 million. The company experienced a loss in both fiscal years 2012 and 2013, but had posted a tidy profit of $8.1 million on $118.1 million in total sales in 2011. Operations generated $21.4 million in cash in 2011, and that cash hoard has sustained Perma-Fix ever since.
This brings us back to Dr. Centofanti at the podium of the isotopes conference. To balance out its uneven government business, Perma-Fix needs alternative revenue streams, preferably from large, stable demand sources such as radiological medical procedures. Perma-Fix has plenty of nuclear expertise and a rich body of patent-protected technology, including processes to absorb and remove hazardous organic materials from waste streams. The company has found a way to apply this know-how to a new product.
The Trouble with Technetium
The material molybdenum may not be a regular part of your investment vocabulary, but the economics of one of its isotopes - Molybdenum-99 or Mo-99 - got the attention of the chemists and engineers at Perma-Fix. Mo-99 is a vital parent material for the production of Technetium-99 (Tc-99m), a highly effective isotope used in about 80% of the radiological tests completed each day in U.S. hospitals and clinics. Two of the most common killers of Americans, heart disease and bone cancer, are maladies that can be more accurately diagnosed with radiological procedures using Tc-99m.
Most of the supplies of Mo-99 are produced using highly enriched uranium (HEU) at five approved nuclear reactors around the world. Neutrons bombard the uranium until it fissions, producing a Mo-99 atom about 6% of the time. Mo-99 is extracted from the radiation containment chamber through a chemical process. Next Mo-99 has to be turned into Tc-99m by a company specializing in Mo-99 processing. With a half-life of only 66 hours Mo-99 is a fast depleting material. However, Tc-99m is even flightier, with a half-life of just 6 hours. As a consequence processed Mo-99 must be shipped just-in-time to the medical facility and then placed in specialized 'generators' to extract Tc-99m immediately prior to the medical procedure. This makes for a complex supply chain configuration that is not well tolerant of outages or supply deficiencies.
Here is the rub. Canada's Chalk River National Research Universal Reactor has been a prominent supplier of Mo-99 in North America. Unfortunately, the Chalk River facility is scheduled to be shut down in just two years. When that door swings shut, it will be felt around the world. Nowhere will it be more painful than in the U.S. The U.S. does not have a domestic supply source of Mo-99, making it necessary to import 100% of the Mo-99 required by U.S. hospitals and clinics for their Tc-99m procedures.
Many investors might look on the weak supply situation for Mo-99 and see the quintessential 'low hanging fruit,' ripe for the picking. Did I mention the significant barriers to entry? Production of Mo-99 using the conventional reactor method requires extensive nuclear technology and operational know-how. Capital costs for reactor construction are substantial, not to mention the working capital needed to bridge a time-consuming regulatory approval process.
Tc-99m "Gold" Rush
Coqui Radio Pharmaceuticals in Florida has not been intimidated by the high barriers to entry. This developmental stage company plans to build a reactor to produce Mo-99 using low enriched uranium at a site near Alachua, Florida. Coqui estimates it will cost as much as $250 million to construct the reactor. The company recently made a presentation to the Nuclear Regulatory Commission as part of its construction permit application and licensing strategy. When completed the facility capacity will be sufficient to satisfy about 70% of U.S. demand.
Another developmental stage company, Shine Medical Technologies, has made more progress with an alternative approach called acceleration. Shine is also using low enriched uranium in a high-yield neutron driver manufactured by its partner, Phoenix Nuclear Labs. In August 2014, Shine reached a critical milestone, operating a prototype for twenty-four consecutive hours. Shine plans to operate up to eight such neutron drivers that could produce as much as half the Mo-99 required in the U.S. Shine recently received a term sheet offering $125 million in financing to begin construction of a facility near Janesville, Wisconsin, and the company expects to begin commercial production in 2017.
NorthStar Medical Radioisotopes is also in the race with not one, but two technologies. NorthStar has been working with the University of Missouri on a reactor-based neutron capture process and a second process involves photon capture in a linear accelerator. The company recently broke ground on a new headquarters and research facility that will support its development efforts in Columbia, Missouri. NorthStar is also developing a special generator called RadioGenix that will be used to process its proprietary Mo-99 into the Tc-99m needed for medical tests. In July 2014 at a meeting held by the National Nuclear Security Administration in Washington, DC on Mo-99, NorthStar claimed "continued progress."
A fourth player in Albuquerque, New Mexico recently threw its hat into the ring. Eden Radioisotopes has licensed reactor technology from Sandia Laboratory that is thought capable of producing Mo-99 in a small reactor using low enriched uranium. Eden's chief technology officer, Richard Coats, is a retired Sandia engineer who had helped design the reactor. Coats estimates it will require $60 million to build the Eden reactor, well below the hundreds of millions for the other proposed reactors.
Here Comes the Bunny!
It may seem like a crowded race. However, it is a large market that is hard to resist. The global radioisotope market is expected to grow from about $5 billion in 2013, to as much as $8 billion by 2017. Tc-99m is the most commonly used radioisotope, involving as many as 40 million procedures each year or about 80% of the world market. Besides the Canada facility closure, at the end of 2015, France's Mo-99 producer OSIRIS is being put into moth balls by its operator the French Atomic Energy Commission. The two reactors account for as much as one quarter of the world Mo-99 production capacity.
Thus on top of being a lucrative race it is also critical there is a winner. When Dr. Centofanti rose to the podium at the isotope gathering, healthcare industry executives were eager to hear him explain whether Perma-Fix's technology will be ready in time to help solve the looming shortages in Mo-99 and ultimately Tc-99m.
Perma-Fix is using its nuclear technology know-how to develop a new production process that will ultimately yield the popular medical isotope. However, the company has gone down an entirely different path from the conventional approach. That path might allow Perma-Fix to reach the goal line in time to fill up at least part of the shortage in Mo-99 supplies. Importantly, it may require a substantially lower capital investment than the many of other developers who have been attracted to this large market opportunity.
The Perma-Fix Mo-99 process does not require uranium at all. Instead natural or enriched molybdenum is irradiated in a research reactor. Potentially, this low-specific-activity Mo-99 could have a longer life than fission-produced Mo-99. The Perma-Fix process also eliminates the need for management of waste materials that are generated in the conventional uranium fission process.
Importantly, conventional Tc-99m generators can be used in the final processing step to separate Tc-99m from the Mo-99 Perma-Fix will produce. The company can simply adjust the resin in the generator to Perma-Fix's proprietary resin, which holds the Mo-99 molecules until they decompose into Tc-99m. The company calls it Micro-Porous Composite Material (MPCM). These means Perma-Fix can enter the market without disrupting the existing supply chain. The company has successfully validated its Mo-99 through tests completed by the University of Missouri.
Perma-Fix expects to have the design for its prototype reactor completed by mid-2015. The company has been working with the reactor at Poland's Institute of Atomic Energy (IAE-POLATOM), which began producing Mo-99 using conventional processes in 2010. POLATOM had been working with Covidien (COV), a provider of medical devices and supplies, until Covidien and its partner Babcock & Wilcox (BWC) gave up on developing a low-enriched uranium process for Mo-99 production. POLATOM has completed additional tests on Perma-Fix's, providing further validation of the Perma-Fix departure from uranium and fission.
To protect its innovations Perma-Fix has applied for several process patents. The company recently received a patent allowance for its proprietary resin, MPCM. It was approved in record time. Perma-Fix expects the next regulatory step before the U.S. FDA or the European Medicines Agency to be relatively rapid. The U.S. has a vested interest in seeing a timely solution to the Tc-99m supply problem, so Perma-Fix's application for FDA approval could receive an accelerated review. The company believes it could receive FDA approval in twelve to eighteen months after the application is submitted.
If all goes as planned, Perma-Fix could be near commercial stage with its Mo-99 production process by the end of 2016, perhaps even before some of the other new market entrants who are working on processes involving low enriched uranium. Importantly, the company believes that it will require modest additional capital investment to complete its Mo-99 and get it approved by regulatory authorities.
Perma-Fix management has found the environment in Poland so friendly for its development work that it even registered its subsidiary Perma-Fix Medical S.A. (PFM: WE) as a public company. PFM trades on the Warsaw Exchange under the symbol PFM with an implied value of $25 million. It helps that the Warsaw stock market is growing and European Union policies have been very supportive of small biotechnology companies. Perma-Fix's Poland subsidiary raised approximately $1.8 million through a private placement of Series E common stock, after which Perma-Fix owns 69% of the Poland entity.
The capital raise has helped fill up Perma-Fix's bank account for the Poland subsidiary. The company also came by an additional $1.3 million in cash through the sale of the company's environmental consulting subsidiary, SY & Associates. Altogether we estimate the company has approximately $2.0 million on its balance sheet after paying financing fees and covering operating expenses. The company also got a break from its principal banking relationship that freed up approximately $2.4 million for working capital from insurance proceeds the company received at the end of the June 2014 quarter.
Perma-Fix remains competitive with its legacy nuclear waste clean-up products and services. The company's financial profile may look strained based only on the last quarter balance sheet. However, Perma-Fix has made considerable progress in extracting more value from its expertise by bringing to the market a new product, a medical isotope material. The progress has been enough to bring new partners and investors to the company's table and that is a solid recommendation for this small-cap company.
The company's stock recently bounced off a key level of support at the $3.75 price. PESI had fallen off since the stock established a 52-week high at $5.86 in April 2014. Currently, PESI is priced near 1.0 times book value and 0.80 times trailing sales. Of course, under GAAP accounting Perma-Fix's balance sheet does not reflect the value created by its Poland subsidiary. Perma-Fix's share of that is approximately $17.3 million. This does not seem to be reflected in the company's market cap of $46.7 million. Likewise, from the standpoint of sales it appears PESI investors are have not yet given Perma-Fix enough credit for future sales of Mo-99. Possibly investors are just waiting to learn with greater certainly the capital costs required to produce its version of Mo-99.
Valuation might also be somewhat frustrated by the practicality of trading the stock. A beta measure of 2.35 suggests the stock might be too volatile for nearly everyone except those who are prepared to take a long position in the stock and hold the shares for an extended period of time. Light trading volume near 32,000 shares per day also requires some patience to put on or take off positions.
Under the current conditions in the U.S. equity market it would be hard to characterize PESI as oversold from a technical standpoint. Yet the stock may not fully reflect the fundamental progress Dr. Centofanti and his team have made perfecting technology and products that will take the business into a large new market.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.
Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it. The author has no business relationship with any company whose stock is mentioned in this article.
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