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CIGX...Can it be the next tenbagger?

|Includes: Rock Creek Pharmaceuticals, Inc. (RCPI)
I'd say that the answer is yes... if you have at least a 1 year time horizon.   But if it  only winds up being a 5 bagger or a 8 bagger in a year, you shouldn't be that disappointed.
 
Star Scientific (CIGX) is an intriguing stock, especially now that the Court of Appeals of the Federal Circuit (CAFC) has validated their tobacco curing patents, The CAFC just reversed the jury verdict of invalidity on Star's two key tobacco curing patents and that clears the path for pursuing infringement against the entire tobacco industry.   I have followed this case for over 7 years and the odds of now winning against the major tobacco manufacturers are about as good as you can get in patent litigation cases.   Star had lost their original case heard by Judge Marvin Garbis (bench trial in 2005 with a ruling of inequitable conduct issued 2.5 years later).    Star appealed Judge Garbis' ruling to the CAFC and Star Scientific won.   The CAFC overturned the case and remanded it back.   A jury trial was then held under Judge Garbis in 2009, which Star lost again....but Judge Garbis kept out a lot of Star's evidence and allowed RJ Reynolds to use an exhibit in closing arguments (the Burton letter) that the CAFC had previously banned (sound familiar to Rambus investors?).   The Burton letter was simply a letter that discussed the low TSNA's of Chinese cigarettes, but did not include any "prior art" of why Chinese tobacco had low TSNA's.   RJR portrayed it as if Star had withheld something material from the Patent Office when they filed their patent application.   That was not the case, and both the USPTO and the CAFC agreed and validated Star's patents.
 
The validation of Star's patents is the primary thing that has now changed in this ten year old saga.   In March 2011, the USPTO finished an ex partes  reexamination of the patents and concluded that the patents were valid.   Now, in addition, the CAFC has overturned the MD jury verdict of invalidity and also affirmed that the patents are valid.  Various aspects of these patents are used for almost all tobacco curing in the US.   The USPTO validation of the patent is now final, since it was an ex partes reexam.    The CAFC looked carefully at numerous aspects of the MD jury verdict and overturned all invalidity issues found by the jury.   So, now both the CAFC and the USPTO have determined the patents are valid.
 
Virtually all tobacco cured in the US uses various aspects of Star's patent.    Based on the information revealed in the 2001 lawsuit, STAR has several Billion dollars in past damages due from RJ Reynolds and Phillip Morris, but they now must go back to court to prove infringement.  On an ongoing basis, Star could receive .10 -.20 per pack of cigarettes going forward once they prove infringement.   As a result of the CAFC ruling, the patent priority date was determined to be Sept 1998, so the patent is valid until Sept 2018.  The case against RJ Reynolds was only for two growing seasons in the 2001 time frame. Take a look at CIGX's Press Release after the announcement.

http://phx.corporate-ir.net/phoenix.zhtml?c=105863&p=irol-newsArticle_print&ID=1600763&highlight=

"We are gratified that the Federal Circuit Court of Appeals has affirmed the validity of the patents at issue in our prosecution of patent infringement against RJ Reynolds. The Court specifically rejected each of the four invalidity defenses raised by RJR, and the panel also reversed the district court's 2007 summary judgment ruling on priority date: the panel affirmed that the patents' claims deserve the September, 1998 priority date as originally claimed. We nonetheless are disappointed that the Federal Circuit did not reverse the jury trial verdict of noninfringement.

"However, today's decision fully reestablishes and reinforces the company's rights to assert its patents against all prior and future infringers. In particular, we anticipate that our litigation against RJR for curing seasons after the two years addressed in this case now can move forward. That litigation had been stayed pending the outcome of the appeal."


As you can see from Star Scientific's press release, the company can proceed against any and all parties infringing the patent, both for past infringement and for on-going infringement. They will go into their next court case with a patent that has been vetted by both the USPTO and the CAFC and has been determined to be valid. Barring a successful appeal to the US Supreme Court (or a successful en banc at the CAFC), then this is the final word on Star's patents...they are valid and that is the law of the land. When the market finally understands what this really means, CIGX will rise to new 10 year highs. Btw, the odds of a successful en banc appeal for RJR is less than 2%, and the odds of a successful writ of certiorari to SCOTUS is less than 1%. So I like Star's odds of the patent being valid until 2018.

The CAFC upheld the MD jury verdict that RJ Reynolds didn't infringe the patent.   Let's review what really happened.

First, let's look at a portion of the ruling from the CAFC.

http://www.cafc.uscourts.gov/images/stories/opinions-orders/10-1183.pdf

excerpt from CAFC ruling....

Dr. Otten testified that farmers curing tobacco for RJR did not infringe the Williams patents. Included in his testimony were test results from 200 barns of 57 farmers growing tobacco used by RJR. J.A. 45779, 45868-69. The jury heard Dr. Otten testify that the famers had not substantially prevented anaerobic conditions and Dr. Otten showed them that TSNA levels measured from the farmers’ barns were above the levels claimed in the Williams patents. J.A. 46328-29.

At first glance, it appears that the jury was right. But what is really going on here? What came out of the briefs and transcripts was that RJ Reynolds knew that using the huge fans to circulate the air during the curing process reduced the carcinogenic Tobacco Specific NitrosAmines (TSNA's)...so they instructed their growers to buy big fans and use them during the curing process.  The growers bought the fans that they were told to buy, but apparently they didn't control the environment (ie run the fans 24/7, maintain the proper temperature & humidity, etc.) to keep the formation of the tobacco specific nitrosamines down to the nearly undetectable levels that you can achieve when using Star's "StarCured" patented process. So when the tests showed reduced TSNA's (but not as good as the StarCured Process), the Reynolds expert witness simply testified that the farmers "had not substantially prevented anaerobic conditions" and the TSNA levels that were measured were not as good as the levels Star referenced in their patents. In essence, they used the fans to circulate air and prevent an anaerobic condition (which infringes Star's patent IMHO)...they just didn't do a good enough job.

The record shows that Reynolds knew about Star's patents because they got an opinion from outside counsel.   The outside counsel thought that RJR was infringing Star's patent, but they thought the patent would be ruled invalid. RJR growers just didn't use it carefully enough to get the TSNA's as low as the StarCured process can achieve, but they used it nonetheless. 
FWIW, I expect the stock to steadily rise over the next few weeks while the market digests what has happened.    

Also, Star just announced the introduction of Anatabloc.   I expect we will soon see peer reviewed medical journal articles about the efficacy of Anatabloc.   If these articles reveal that Anatabloc shows promise in successfully treating Alzheimers, rheumatoid arthritis, obesity, irritable bowel syndrome, Crohn's disease, thyroiditis, etc. etc.,)  then I would expect Star to surpass their ten year highs.  When Star wins their first infringement case against big tobacco, the stock could explode as patent royalties could yield earnings approaching $10/share, but that could be >24 months away.   BTW, Star Scientific is not a one trick pony...in fact, I think they are a four trick pony.    Their four different tricks are:
 
1.  Stop smoking lozenges called CIGRx which were just recently introduced and are not yet profitable, but are getting excellent reviews from smokers trying to kick the habit.  They are only available now by mail order or in select markets such as the Richmond, VA area...but a nationwide launch is expecetd soon.
 
2.  Dissolvable smokeless tobacco with no detectable TSNA's (not subject to FDA regulation).    This is for smoker's who have to have their tobacco, but are trying to avoid smoking or chewing (where they must spit).   This product is ideal for smokers who are in places they can't smoke for extended periods of time (long air flights, business meetings, training sessions, etc.).   These products (known as Ariva & Stonewall) are also only available in limited areas and are just starting to ramp.
 
3.  New provisional patent on anatabine.   Anatabine is a substance in Tobacco that reduces inflammation much better than Lipitor, Aspirin, or Celebrex and it is currently undergoing clinical trials on humans for use in Alzheimer's.   The Star Anatabloc product was just announced on  8/30/11.   Here is the Anatabloc website.

Also, here are some useful articles about Anatabine.
 
 

 
4.   Patents on the Star Cured Process to reduce carcinogenic TSNA's in the tobacco curing process.  These patents have now been validated by both the USPTO and the CAFC (see first few paragraphs above).
 
 
If Anatabloc has just 10% of the success that many are predicting, the sky is the limit for this stock.  I'm waiting for peer reviewed medical journal articles by reputable doctors before I completely load the boat.   But, I believe the stock at prices below $3 is a unique opportunity and one that is too good to pass up.   If we are not careful, we will turn around and see the stock back at $4-5 in a few weeks.   Who is going to be shorting or selling a $2.50 stock with the potential upside that Star has?    

When I saw CIGX drop to $1.50 on Friday, I knew it was just too good an opportunity to pass up.   That's why I started buying like crazy and telling everyone at Investor's Village to take a look at CIGX.   It surprised me that it bounced back to $2.59 for Monday's close.    I was thinking it would take a week to get back to $2.50.    
 
From about 1:09 PM to 2:45 PM on Friday Aug. 26th, anyone could have bought about all the CIGX they wanted at prices <$1.60.    My average buy price for Friday was $1.57.
 
So...what happens now?    The CAFC ruling validated the CIGX patents, and that now changes the game.   Big tobacco is back on the hook for infringment for the way they cure tobacco in the US.  They only got out of infringement liability for 2 growing seasons around 2001.    They are still liable for past damages and on-going damages related to their infringement of Star's patents.    Ultimately, I think Star will be getting .15 (+/- .05) per pack of cigarettes sold.
 
This stock has a huge short interest, and I think it also has a significant naked short interest that needs to exit their positions now that Anatabloc has been announced. The medical community is just learning about the anti-inflammatory properties that will make Anatabloc a popular treatment for a variety of ailments that are caused by beta amyloids that cause inflammation.

There are several pending events that could lead to a quick rise to new ten year highs.   These include:
1.  Any peer reviewed medical journal articles published on the efficacy of Anatabine (RCP-006) from the human clinical trials
2.  Big Tobacco starts accumulating CIGX stock in an attempted hostile takeover
3.  Big Pharma starts accumulating CIGX stock in an attempted hostile takeover
4.  FDA comes out with a position on maximum TSNA levels on domestic tobacco
5.  A major magazine (ie Time) prints an article about the miraculous healing properties of Anatabine for people afflicted with Alzheimer's, Crohn's, rheumatoid arthritis, thyroiditis, irritable bowel syndrome, obesity, and a host of other ailments that are associated with inflammation.    The above list is just a few of the ailments that I have seen mentioned that are helped by Anatabine (RCP-006).
 
So, I think the shorts will want to exit their positions over the next few weeks (before any of this can happen).    That could cause the stock to rise to the $5 range.    If we get a couple of the events I listed above, we could see the stock surpass it's 10 year highs in 2-3 months.   One thing is for sure, the stock is still a great buy a prices below $3 now that they won validity at the CAFC.
 
FWIW, I still want to see some peer reviewed medical journal articles on the efficacy of Anatabine.   But, even if it is only 10% as good as all the hype I have seen, this stock could still run to over $10 before the end of the year.   
 
With their recent win at the CAFC (on the patent validity), I think that alone will make the stock worth >40 bucks in 2-3  years when they win their first infringement trial against big tobacco.
 
This stock reminds me a lot of VHC because of the way it languished for years.   When VHC won against Microsoft (and ETSI said they were using VHC's patent as part of the 4G standard), VHC climbed from ~12 to ~40 in  a 4 month period.   I could see CIGX climb from $1.50 to $8-10 in a 3 month period. 

For more details on Anatabloc, here are three good Seeking Alpha articles.
 
 
Congratulations to those that got in on Friday for under $2/share after the panic drop from the CAFC opinion.
 
 
Disclosure:  Long CIGX
 
JMHO,
 
NJ
 


Disclosure: I am long CIGX.

Additional disclosure: I have used CIGRx for about 3 weeks and I find it extremely helpful in minimizing arthritis symptoms (better than Aspirin, Advil, or Celebrex) all of which I have tried.