BioSpecifics Technologies: Microcap At Inflection Point Has Upside Potential

Summary

• BioSpecifics is an interesting microcap that licenses an injectable collagenase clostridium histolyticum ("CCH") for multiple indications to partner Endo International.
• The company earned royalties of $38.2m in 2019 and $9m in Q120 from XIAFLEX®, the only FDA approved neurosurgical treatment for Peyronie's Disease and Dupuytren's contracture.
• This month, BioSpecifics and Endo saw injectable CCH approved for treatment of cellulite - a potential multi-billion dollar market opportunity.
• BioSpecifics is also advancing CCH as a treatment for adhesive capsulitis and plantar fibromatosis, providing investors with further upside opportunities.
• The company filed a $200m shelf in June which suggests BioSpecifics may be looking at options outside of the Endo relationship, with a new management team in place.
• Looking for a portfolio of ideas like this one? Members of Haggerston BioHealth get exclusive access to our model portfolio. Get started today »

Investment Thesis

BioSpecifics Technologies Corp. 5-year share price performance. Source: TradingView

BioSpecifics (NASDAQ:BSTC) is a small microcap with a market cap of just $474m and revenues of $38.1m in 2019, but the company is entering an exciting phase in its development with the recent FDA approval of its injectable collagenase clostridium histolyticum ("CCH") treatment for cellulite.

BioSpecifics owns and controls the patents for its CCH, marketed and sold as Xiaflex by Endo International (ENDP) currently as a treatment for Dupuytren's contracture ("DC"), and Peyronie's disease ("PD"), and earns royalty payments in the low double digits from Endo's sales - which were $89m in Q120, and $328m in FY19.

That provides a nice income stream for BioSpecifics. The company's net profit margins in FY19 and Q120 were 63% and 47% respectively, and its cash burn is minimal - OPEX in 2017, 2018 and 2019 respectively was $9.2m, $9.8m and $9.6m and the company has no debt to speak of - total liabilities in 2019 were just $2.2m, whilst net income was $24.5m.

Having recently filed for a $200m shelf funding agreement, and with $123m of near term assets and a new management team in place, as well as new board members, BioSpecifics could be set for a period of dynamic growth.

On July 6th Endo won FDA approval to market Qwo for treatment of moderate to severe cellulite in the buttocks of adult women. Qwo also uses BioSpecifics' CCH enzyme, and will target a market that has been forecast to reach $1.5bn in size by 2026, potentially earning BioSpecifics an extra >$100m of annual revenues over the medium to long term.

In addition, BioSpecifics and Endo are hoping to secure approval of Xiaflex for Adhesive Capsulitis - an inflammation or thickening of the shoulder capsule, and plantar fibrosis - a cellulite-related foot problem, potentially opening up 2 further revenue streams which could be worth >$50m per annum to BioSpecifics, based on the treatment of hundreds of thousands of new patients.

As such, the company looks set to grow revenues by at least as much as 2-4x in the coming years from its Endo agreement alone, and may well put its spare cash to good use developing further products and partnerships independently, or with another licensee.

Based on projected future cash-flows from only a modestly optimistic forecast - that BioSpecifics achieves revenues of ~$80m by 2025 - I make the company a strong potential buying opportunity with a target price >$100, and plenty of extra price catalysts created by the company's strong cash position and stated desire to pursue new opportunities.

Company Overview & Recent Performance

BioSpecifics, founded in New York State, has been in existence since 1957, and has worked with both Columbia University, and more recently UCLA, as well as numerous local biotech companies. In 1990 Biotechnologies Corporation was founded and the company IPO'd in 1991.

Today BioSpecifics consists entirely of its collagenase-based therapies franchise, specifically its injectable collagenase clostridium histolyticum ("CCH") enzyme, marketed and sold as Xiaflex by Endo International. Endo acquired the rights as part of its acquisition of BioSpecifics' former development partner Auxilium in a $2.6bn deal in October 2014.

Endo secured approvals in 2013 for Xiaflex in Peyronie's Disease - the presence of collagen plaque on the shaft of the penis - and in 2010 for Dupuytren's Contracture - a deforming hand condition in which one or two fingers contract towards the palm. The company grew sales of Xiaflex by 23% between 2018 and 2019 to $327m, and by 30% between Q119 and Q120 to $89m.

In their recent Q120 10Q statement BioSpecifics refers to the percentage of Endo's sales it receives as royalties as being in the "low double digits", whilst Endo describes it as "a range of 5% to 15%" of net sales for products covered by the agreement. BioSpecifics earned $9.67m of royalty payments in Q120 - up 19% year-on-year, but has warned that revenues are likely to decline in FY20 (from $38.1m in FY19) owing to COVID-19-related suspension of most non-elective surgeries.

Cellulite and other indications

Clearly, revenue of $9m per quarter does not make a strong investment case for BioSpecifics, even when considering the company's extremely small share count of 7.35m, which earned investors EPS of $3.3 in FY19 at a P/E ratio of 19x.

But BioSpecifics injectable CCH has been developed for a total of 12 indications to date, and this month Endo secured approval to use it as part of a treatment for cellulite - which it will market as Qwo and expects to launch in early 2021. The size of this new opportunity is likely to significantly exceed those of the prior 2 approvals, since cellulite (BioSpecifics estimates in a recent presentation) can affect >85% of post-pubertal females, and there is currently no other FDA approved injectable treatment on the market.

Potential approvals on the horizon for Adhesive Capsulitis ("AC") - currently in a phase 2 clinical trial - and Plantar Fibromatosis ("PF") - still at the pre-clinical stage - offer the promise of further royalties - my best estimates would be in the $50-100m per annum region - given the size of the unmet need in these relatively large (PF market size is estimated to be >$700m, whilst the global market for shoulder replacement has been forecast to hit $4bn by 2027) and untapped markets, whilst BioSpecifics is also exploring an opportunity with uterine fibroids, and actively seeking new development partners.

Management Upheaval

The company has undergone significant changes to its board and management in the past year. At the beginning of 2020 it was announced that BioSpecifics would be relocating its corporate headquarters from Lynbrook, New York, to Wilmington, Delaware, probably for corporate income tax reasons. 5 employees were let go and in April, BioSpecifics parted company with its CEO and company Director J. Kevin Buchi, by mutual agreement, replacing him with interim CEO Joseph Truitt.

Truitt has a background in early stage biotech and big pharma and is one of only 2 employees listed on the company website, the other being Patrick Hutchison, CFO, who also has an extensive background working at early stage biotechs. Jennifer Chao is Chairman of the Board of Directors and upon appointing Truitt, commented that he joined at:

a crucial inflection point in the Company's evolution, as we have set forth a clear, twofold value creation strategy for maximizing the CCH portfolio of commercial and clinical assets and as we begin to take well-considered steps toward identifying external strategic opportunities."

Chao's comments regarding external strategic opportunities seem to imply that BioSpecifics is looking to diversify away from its reliance upon Endo for revenues, by attracting new partners.

Endo Relationship + Other Opportunities

At present, however, the relationship with Endo looks very promising. Although it has had to push back the launch of Qwo into mid-2021, Endo CEO Blaise Coleman had this to say on the company's Q120 earnings call:

We grow more excited by the day as we continue to learn about CCH for cellulite and its potential. We look forward to receiving our expected FDA approval and are preparing for a highly successful launch in the first quarter of 2021.

The cellulite opportunity came about after Endo conducted the largest ever cellulite-related clinical trial of more than 800 women, divided into 2 cohorts. Each cohort received the same treatment - up to 3 treatments of CCH, or a placebo, spread 3 weeks apart, with up to 12 injections administered in total. The results were announced as follows:

In the first cohort, 7.6% of subjects receiving CCH demonstrated a highly significant (two level or greater) improvement in the composite investigator and patient assessments of the appearance of cellulite at Day 71, compared to only 1.9 percent of placebo subjects. In the second cohort, the figure was 5.6%. 37% of all subjects in one cohort and 41% in the other experienced a one-level response, whilst more than half of patients reported being "satisfied" or "very satisfied" with their treatment at day 71, compared to ~20% of placebo subjects.

Although the final data was good enough to secure approval, it did not overly impress some analysts, who had expected more robust data.

Xiaflex is one of Endo's fastest growing product lines and it is clear the company is heavily invested in its success, and the success of Qwo, which is a good sign for BioSpecifics. On the flip side, however, Endo faces a series of crippling lawsuits related to its role in the opioid epidemic. Its shares trade at just $3, having fallen from a price of $88 in late 2015. These ongoing issues could hamper its ability to sell Xiaflex and Qwo as widely as it might want to, which would be a frustrating scenario for BioSpecifics.

BioSpecifics' patents related to Xiaflex are protected until 2028 and cellulite to 2027, which more or less guarantees the company a growing source of revenues unless Endo terminates its agreement, which seems highly unlikely, or falls into bankruptcy - a worst case scenario, but one that cannot be discounted.

Endo has the right to opt-in at the development stage of one or more additional indications for injectable collagenase developed by BioSpecifics, besides those it already has rights to, which include frozen shoulder, cellulite, canine lipoma, plantar fibromatosis, lateral hip fat and human lipoma. But if Endo does not take up its option on new indications, then BioSpecifics has the option to develop them under its own steam, or to work with a third party developer and manufacturer.

With a potentially >$300m war chest available to it, all options are currently on the table for BioSpecifics' future development. The company could opt to try to develop and commercialize its own treatments, which would offer greater financial rewards (revenue rather than royalties) but would also require substantial investment, including hiring entire teams from scratch, developing a manufacturing facility, and dealing directly with regulatory authorities.

Finding another strategic partner besides Endo is perhaps a more realistic option for the company, although with Endo having first refusal on any new assets in development, BioSpecifics would need to tread very carefully since the company will not want to sabotage its profitable relationship with the Pharma.

The third option, to simply reinforce the relationship with Endo and wait patiently for the rewards, remains an excellent strategic hedge against the failure of options one and two.

Target Price

Due to its large net profit margins and small share float, even a modest growth outlook justifies a fair value price for BioSpecifics' stock at a significant premium to current trading price.

For example, if we consider a scenario whereby the company's revenues drop by 15% year-on-year in FY20 as a result of the ongoing pandemic, then begin growing again at a rate of 20% per annum (only slightly higher than the 16% achieved between 2018-19), this would result in BioSpecifics earning ~$82m of revenues in FY25.

In order for this to occur, all that needs to happen (assuming BioSpecifics' royalties from Qwo are in line with prior agreements) is for Endo to slightly more than double its overall sales of its CCH franchise over the next five years, from $328m, to +$800m , which seems more than likely given the cellulite opportunity - which I suspect may grow significantly beyond its forecast $1.5bn size given the uniqueness, convenience and satisfaction rating of the treatment - plus the approvals for AC and PF, which would be likely to occur in 2022 and 2024, I estimate, based on current trial progress.

In this scenario, using DCF analysis, and my calculated free cash flow figure of ~$42m in FY25, we can set a conservative target price for the stock of >$98.

Conclusion - Endo Agreement Alone Proves Strong Whilst Company May Unlock Further Sources of Revenue

Having now secured 3 approvals in the past decade, and with at least 2 more on the horizon, CCH ought to become a source of blockbuster (>$1bn) sales for Endo, giving BioSpecifics the opportunity to at least double and possibly triple its revenues, and income (since its costs of sales are so low), over the coming years. And it could get even better for the company.

The leader in the injectable aesthetics industry is Botox which made sales of $3.7bn for Allergan in 2019. Botox also grew by steadily expanding the number of indications it was approved to treat. Although it may be unrealistic to compare BioSpecifics' CCH to an all-time great medical aesthetic like Botox, it helps to illustrate the attraction and popularity of an injectable cosmetic treatment with a proven efficacy and safety profile.

If Endo is unable to deliver on the promise of its Xiaflex and Qwo franchises due to its opioid-related issues, then my suspicion is that there would be plenty of companies willing to partner with BioSpecifics in exploring other treatment options and routes to market.

This may be the reason for the recent upheaval at the company. With its patents protected until 2027/8, BioSpecifics' board will be looking to maximize its growth opportunities while its product is exhibiting best-in-class treatment qualities. I would expect to see the company make use of their shelf arrangement to raise funds and explore as many new opportunities as it can over the coming months and years.

This may result in investors being diluted, but in the long run, the transition of BioSpecifics from a passive company with a single - albeit high margin - revenue stream, to a more actively managed company leveraging an asset responsible for ~$400m of annual sales across 3 indications, would be a riskier strategy, but also a welcome one in my view.

I would advise investors to consider a strategy of opening a position at a price under $75, and holding for the likely spike in revenues, and share price, caused by the Qwo launch, and at least a half-year of sales in 2021. By this time, I would expect the company to be making progress towards a value-generating new initiative or revenue sharing agreement, designed to make the most of its CCH franchise and as a hedge against Endo's exposure to opioid litigation.

In essence, my thesis is that BioSpecifics' CCH patents make the company a high-margin, profitable business, currently undervalued based on the strength of its future cash flows, but I believe there is significantly more value to be extracted from these assets. In the short term, this will be achieved via the Endo partnership, and the new cellulite opportunity, whilst over the longer term, it's clear that management is considering pursuing new opportunities.

Hence, investors find themselves in a win-win situation. If the company chooses not to expand the current business (and share price) offers excellent value plus upside opportunity, whereas if management targets growth and new opportunities, it has a high chance of succeeding, since it can point to a track record of securing lucrative approvals across a range of indications. In this scenario, the share price gains could be sudden and substantial, as opposed to incremental.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BSTC over 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.