Thursday, November 7, 2013

Stocks DD Opines: Is The Market Stupid ? Skewed Risk Perception(Valuation) & Following of Development stage companies vs Established Pharma

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Do you understand R-I-S-K ?
Most biotech/pharma "investors" esp retail investors either don't understand risk or don't bother to understand risk well. Majority of these biotech "investors" are traders trying to speculate on valuation changes based on clinical or regulatory or speculative M&A event of unproven companies/management. Investors chase 1 drug pony companies(esp buying at high valuations) without fully understanding various risks (clinical,regulatory,marketing,commercialization/reimbursement) if the event does not turn in their favor. The market usually disregards one of the biggest risks which is the market competition, and the longer the lead time for the drug to reach meaningful revenues, the bigger the risk for market competition (potential for new and improved competition drugs). Development stage companies also carry dilution risk all the way until company reaches profitability. At the same time, the market surprisingly continues to ignore blue chip businesses with solid earnings today and near future with relatively low risk profile trading at cheap valuations. 

Case in point is this undiscovered pharma company: Taro Pharma which although operates in generic business, has limited competition due to the "niche-ness"(higher technical barrier to entry) of the topical/dermatology sector and has delivered strong results in the last 4 years since the new control took over. And unlike a brand innovator that comes with R&D, Regulatory, Commercialization risk and a very-high risk R&D and Marketing/Commercialization dollar spend, this company has low R&D risk, Regulatory risk and Commercial risk, and spends productive R&D dollars on low-risk clinical equivalence studies. As a generic company it spends little to nothing on marketing/commercialization. The R&D spend(<10% of sales) replenishes part of its aging generic pipeline, while at the same time it enjoys limited competition on a good part of its portfolio, thus allowing it to enjoy a sustainable EBITDA margin of >40%. 
Below I have tried to objectively evaluate the favorable business characteristics of Niche Generic Pharma with Branded Pharma as well as Generic Pills Pharma.

This company has a lot going for it that should make it really attractive for investors and they are listed below. Yet as indicated by Seeking Alpha and Stocktwits it is covered/followed  30 times Lower than AMRN/DNDN . (Amarin is a 1-drug pony where the regulatory risk unraveled recently when the FDA's Adcom vote came in unfavorable for its Anchor indication despite a SPA. Interestingly about ~1000 Amarin shareholders have congregated to create a petition to FDA for considering approving "Anchor" indication). Hopefully the recent debacles of AMRN and SRPT highlights the regulatory risk for these 1 drug ponies.

Snapshot taken on 10/30/2013

Isn't the market stupid in chasing speculative 1 drug pony with enormous risks and disregarding relatively lower risk companies with a fundamentally solid business and proven performance ? I have highlighted in BOLD the 3 tenets to my Bullish Taro thesis: Valuation(& strong business highlighted above), Management's ROI record and Minority Shareholder protections.
  1. Number 1(Yes the Market Leader) in Generic Dermatology in the USA
  2. Operates in an Oligopolistic sector with unique barriers to entry
  3. Yet Trades at Only  ~7 times ttm EBITDA*
  4. Accumulated cash of $613m (end of June 2013) and est at $700m (by end of dec 2013)
    1. An opportunity to make an acquisition in the specialty sector
    2. Accretive acquisitions would add significantly because of synergies
  5. Top Class management that knows how to allocate capital (it has returned 38% annually for close to 20 years! Can it get better than that ?) see page 32 SUN IR
  6. Almost zero leverage with a debt of $29m
  7. Backed by a business with stable cash flow of >$250m/year
  8. Longstanding Brand name in the US amongst practitioners and patient
  9. A relatively untapped sales opportunity in the rest of world markets for its portfolio of 180+ products.. which they could monetize by selling ROW rights to their products in emerging and other international high growth markets
  10. Minority Protection including "majority of minority vote" for any strategic transaction and highly watchful & active activist investors. Israel has STRONG minority shareholder protections. Read pages 93-105 to understand this
  11. Robust generic pipeline in 3-4 years as well as a significant specialty product entering phase 2b which could garner $500m sales/year.
Note: The next 1-2 years may have some challenges due to entry of competition in some products but this company's earnings growth outlook in 4 years time is Solid. Plus, they have great leverage with est $700m cash, with just $29m debt and unlocking value in ROW markets which today is 1% of sales.


  1. Taro is trading at 95 right now. It's hardly neglected by the marketplace. What is your ceiling on the stock?

  2. at 95 taro trades at 7 times annualized last quarter ebitda. So you tell me if this under valued or over valued ?

  3. If market is able to hold on to these gains, there has been a run-up from the exit poll day, then it shows that it is clearly a bull market and may be it is a long bull market. It will last for at least five years
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