The Opko Health Battle: High Short Interest with Heavy Insider Buying

In the hyper-competitive biotech space, mid-cap name Opko Health OPK is a classic battleground stock. The company's unorthodox structure, which houses a myriad of diverse, speculative, and complicated business lines, has led to wildly varying estimates of the stock's proper value. As a result of the highly divergent investment theses regarding the company's future prospects, Opko Health is a heavily shorted stock with nearly 24% of its float sold short. While the high short interest could be viewed as a bearish indicator, these short-sellers are betting against a CEO who is aggressively buying back stock in open market purchases and who also has a significant track record in the pharmaceutical industry. Furthermore, he is rich enough, and maybe even aggressive enough, to attempt to squeeze the shorts using his own pocketbook. Given the frequency and size of his insider buys, it is not unthinkable that he might be angling to acquire more of the float and put pressure on short sellers. Of course this is merely speculation and it is impossible to know what his true intentions are. It would seem, however, that he personally thinks the company is undervalued given his acquisition of Opko Health stock at prevailing market prices. The company's CEO and Chairman is Dr. Phillip Frost, who has been a fixture on Forbes' list of the world's richest people in recent years, although his ranking has bounced around considerably. In addition to leading Opko Health, Dr. Frost is the Chairman of the Board at Israeli pharmaceutical giant Teva TEVA. He rose from relatively humble beginnings as a local dermatologist into a self-made billionaire through lucrative investments in multiple healthcare companies. In 1972, Dr. Frost and then-attorney Michael Jaharis purchased a struggling company known as Key Pharmaceuticals that was in dire need of cash. Dr. Frost and Jaharis turned Key Pharmaceuticals around and the company was later acquired by Schering-Plough Corporation in 1986 for $826 million. Subsequently, he founded a company called Ivax in order “to develop generic pharmaceuticals and veterinary products.” Records indicate that he personally invested around $100 million into his company which turned into a $1.5 billion windfall when Ivax was sold to Teva Pharmaceuticals for $7.6 billion in 2005. In addition to these high-dollar returns, Dr. Frost has invested in a myriad of other companies with varying amounts of success. It would seem that his track record of success has drawn many investors to Opko Health, with some viewing it as an opportunity to invest alongside a “genius.” For all of his successes, however, there have been a few failures, as well. A recent Seeking Alpha article (bit.ly/KNEDqW) suggests that his Midas touch may be exaggerated. Nevertheless, the bulls on Opko Health shares point to his incessant insider buying as a sign that the company is headed for the same kind of success as his previous ventures, Key Pharmaceuticals and Ivax. The authors of the above Seeking Alpha article note, however, that Dr. Frost has also “invested heavily in a fraudulent Chinese company and in numerous other pharmaceutical companies whose shares have subsequently fallen dramatically. Most damningly, he was a large shareholder and director in Protalix, a company that managed to destroy $1.8 billion of shareholder wealth in a single utterly incomprehensible day.” They argue that the market is assigning a "ludicrous" premium to the stock because of Dr. Frost's share purchases and his position as Chairman and CEO at Opko Health. The bearish skeptics on the stock make a fairly straightforward argument: Opko Health is wildly overvalued because its various businesses aren't worth anywhere near the company's $1.35 billion market cap. This argument should be analyzed carefully. Before examining the various components of Opko Health, which has a non-traditional structure in that it is basically a holding company for a diverse set of healthcare businesses, one should examine its history and the fluctuations in its stock price. The company came into being through a reverse merger in 2007 when Opko Health's predecessor company, eXegenics Inc., reverse-merged with two companies, Acuity Pharmaceuticals Inc. and Froptix Corporation. At this time, Dr. Frost became the CEO and Chairman of the Board of the newly formed entity. Opko Health initially focused on ophthalmology and traded at around $4 per share, giving it a market capitalization of roughly $500 million. To make a long story short, the company's foray into ophthalmology was a failure and in March 2009, Opko Health shares traded as low as $0.55 per share. At this point, the biotech firm changed course and began embarking on an unorthodox new strategy which has successfully re-branded the company in the eyes of investors and built Opko Health's market-cap back up to impressive levels. In the last year alone, Opko Health shares have risen better than 35%. Yet, short-sellers continue to bet against the company in droves, and a series of negative articles have been posted on message boards and investment sites. Furthermore, institutional investors are more or less shunning the name with institutional shareholders only owning a little more than 19% of the company. A particularly stinging analysis of Opko Health was posted to Seeking Alpha (bit.ly/Kk68gL) on June 12 which argues that the company might be worth just $166 million, even in an optimistic scenario. The authors subsequently followed up this detailed sum-of-the parts analysis with a close look at Dr. Frost's past history of failed investments (linked to in paragraph 6). The bears are focused on Opko Health's disparate collection of businesses and the seemingly speculative nature of most of them. As he has done in his past ventures, Dr. Frost has led the turnaround at Opko Health through aggressive strategic purchases and acquisitions along with forays into drug testing, equipment development, and commercialization of pharmaceutical treatments. The stock is covered by two investment firms, Jefferies & Co., and Ladenburg Thalmann. Both firms have Strong Buy ratings on the stock, although the latter firm's coverage is particularly problematic. In addition to Dr. Frost's other extensive business activities, he also happens to be the Chairman of the Board at Ladenburg Thalmann. Also, Jefferies helped to underwrite a $105 million equity offering from the company in March 2011. Due to the fact that the stock is only covered by two brokerage firms, neither of which is likely 100% objective, and the dearth of institutional investors who own Opko Health, there is little consensus about the company's proper valuation. Nevertheless, by all accounts, the proper way to analyze it is on a sum-of-the-parts basis. Remember, Opko Health is a holding company -- an unusual structure for its industry -- and the value of the stock should reflect the value of its various businesses. Opko Health's two most significant assets according to Jefferies, which has an $8 price target on the stock, are its Claro device business and its Alzheimer's / Cancer diagnostic tests business. In a report from November 2011 initiating coverage on Opko Health, Jefferies values these businesses each at 37.5% of the company's overall market value. Therefore, together they account for 75% of Opko Health's current $1.35 billion market cap according to Jefferies' valuation model. The bearish authors at Seeking Alpha note that Opko Health acquired (1.usa.gov/MYnnUO) Claros in October 2011 for $10 million in cash and $22.5 million in stock for a grand total of $32.5 million. The agreement also provides for potential additional payments of up to $19.125 million in Opko Health shares if certain milestones are met. Basically, Claros is a blood test that can be administered at a care center rather than blood samples being sent to an outside laboratory. While the device appears promising, it is unproven and is currently undergoing a multi-center clinical study. If Claros were to pass FDA standards, it would not be marketed in the United States until 2013. The bears point not only to the speculative nature of the future Claros market, but also to the acquisition price which Opko Health paid for it. Using Jefferies' valuation model, where Claros accounts for 37.5% of Opko Health's market-cap, the device is being valued by the market at more than $400 million. This compares to Opko Health's $32.5 million acquisition price last October. According to some, this just doesn't add up. Why would the sellers agree to such a bargain basement price if it was worth far more? According to the Seeking Alpha article, the company that developed Claros was backed by sophisticated venture capital firms, including Oxford Bioscience Partners, BioVentures Investors, Accelerated Technologies Partners and Commons Capital. They write, “It's likely that such savvy venture capital firms would have shopped the company to multiple buyers, and would have sold at a valuation that approximated what they believed to be the company's actual worth.” They estimate that Claros is worth between $40 million and $75 million versus the over $400 million that the market is valuing it at using the Jefferies' model. The other significant source of value identified by Jefferies, management, and investors is the company's diagnostics tests. According to the company's website, (bit.ly/KNTIZF) “in June 2009 Opko Health acquired exclusive, worldwide rights to a new platform technology for the rapid identification of small molecule diagnostics.” This new technology was developed by Thomas Kodadek, Ph.D., whose lab is now at the Scripps Institute in Florida. Opko Health says that “the initial molecular diagnostic is based on peptoid chemistry to detect disease-specific antibodies. Such antibodies have been found in patients with Alzheimers disease, Parkinson's disease, and non-small cell lung cancer, and potentially a wide variety of other diseases. The development of accurate and reliable blood tests to diagnose these diseases early may have profound impact on disease outcome. In addition, these blood tests can be used to follow progression of disease, response to drug treatment, and even to select patients who are most likely to respond to a given therapy.” In their revenue estimates for Opko Health, Jefferies points to cancer diagnostic tests and, to a lesser extent, Alzheimer's diagnostic tests, as significant forward-looking revenue generators. For example, in 2020, Jefferies estimates the cancer tests could bring in $343 million in revenue. In the absolute best-case scenario, this particular business could be very valuable. The bears, however, point to numerous problems with this highly speculative business line being given such a lofty valuation and its role in creating hype around the stock. In their view, the diagnostic testing business is wildly overvalued and “potentially worthless” for a host of reasons, including its extremely premature state, intellectual property questions and future market adoption rates. With regard to cancer testing, in particular, the company has shown little to no evidence of actual progress. Opko Health also has some other business ventures which analysts believe have value. These include its emerging markets medical device businesses and potential royalties from Tesaro, an oncology-focused biopharmaceutical company. In a June investor presentation, Opko Health highlighted its emerging market presence in Chile, Mexico, and Israel. Through Pharma Genexx, S.A., Opko Health says that it is “rapidly growing sales” of over 100 products in Chile. Revenues were $18 million in 2010 and $21.5 million in 2011. Revenues are expected to be between $26 million and $30 million in 2012. In Mexico, through Pharmacos Exakta de C.V., Opko Health sells 25 products across a range of therapeutic indications. Revenues were $3.8 million in 2010 and $6.4 million in 2011. In December 2011, Opko Health acquired an Israeli company called Fine Tech Pharmaceuticals, Ltd., which develops and produces high value, high potency active pharmaceutical ingredients. The company also operates a FDA registered state of the art facility in Nesher, Israel. For the first 3 months ended March 31, 2012, Opko Health says that revenues from this subsidiary were $1.6 million. These emerging markets businesses account for the bulk of the company's current revenues, but Jefferies' valuation model only values them at 12.5% of the company's total value. The other 12.5% in the firm's sum-of-the-parts valuation is a potential royalty stream from Tesaro, mentioned above. Opko Health “out-licensed” a drug called Rolapitant to Tesaro in December 2010. According to a Tesaro press release (bit.ly/MEQpoj), “Rolapitant is a Phase III-ready neurokinin-1 (NK-1) receptor antagonist in development for chemotherapy induced nausea and vomiting.” Tesaro received worldwide development and commercialization rights to Rolapitant. In April 2012, Opko Health announced (bit.ly/LSQBFf) the start of Phase 3 clinical trials for Rolapitant. If the treatment is successful, Opko Health is entitled to payments of up to $121 million. This includes an up-front payment and additional payments based upon achievement of specified regulatory and commercialization milestones. In addition, Opko Health will receive double digit tiered-royalties on sales. Clinical trial results are expected in the second half of 2013. In the company's investor presentation, it says that the market opportunity for Rolapitant could be $1.25 billion. The four business lines highlighted here -- Claros, Alzheimer's / Cancer diagnostic testing, the emerging markets medical device business, and the potential Tesaro royalty stream -- make up the bulk of the company's current $1.35 billion valuation. In addition, there is also a premium in the stock given Dr. Frost's prominent track record within the healthcare industry. Market investors are expecting these businesses to generate significant future revenues for the company, and this could be a potentially troubling sign for the forward-looking trajectory of the stock price if something goes wrong. Remember, almost all of Opko Health's valuation is underpinned by expectations of explosive future revenue growth. In 2011, the company had total revenues of just $28 million. While this optimism could be misplaced, it should be noted that in the highly speculative biotech space, staggering gains are not uncommon. Yet, they are much less common than epic failures. Nevertheless, just because there appears to be a high amount of speculation and optimism priced into Opko Health shares, it doesn't mean that the potential rewards are not worth the risks. The proper view here, it seems, is that Opko Health is a low probability, high-reward play, which is par for the course in biotech. Furthermore, it fits in with Dr. Frost's risk-laden approach to investing in, and operating healthcare companies.