OPK: The Insider Cliff

Disclosure: I am short OPK(More…)

When I first raised the alarm about Ziopharm Oncology (ZIOP), I received death threats and threats of lawsuits from many retail investors. Some of these can still be found posted online. Many retail investors were so enthralled with this “guaranteed winner” that any suggestion to sell by anyone at any price was shouted down as being illegal manipulation.

I continue to believe that Ziopharm was a tragedy in waiting, and that retail investors never even stood a chance. Yet the stock quickly rose by as much as 25% even after I made my findings public. Following its collapse from near $6.00 to well under $2.00, I wrote an article entitled “Ziopharm: Why retail got slaughtered.” As has been the case in the past, I received a small number of “thank you” notes and an even smaller number of apologies. These are always meaningful to me.

Opko is a different company, with a different management team, a different billionaire investor and a different portfolio of products. But several readers of my most recent Ziopharm article quickly pointed out that the retail situation is entirely identical to what is now happening at Opko Health (OPK).

Like Ziopharm, Opko has an intensely loyal following of retail cheerleaders who constantly state that the right time to sell Opko is “never.” A small number of very vocal readers will no doubt reject all of the findings that I put forth in this article. Yet the parallels are quite clear.

Even Opko bulls admit that the stock is tremendously overvalued. Institutions refuse to own the stock, holding just 14.9%. Meanwhile, retail investors continue to chase the stock upward under the belief that continued purchases by billionaire Dr. Phil Frost mean that further upside is nearly guaranteed.

The problem is that (just like with Ziopharm), the recent purchases by the billionaire are so small that they do nothing to change his overall in price of just $2.99. If Opko falls to $4.00, Frost will make over $150 million, while retail will lose 45% of their money. Retail had also pushed Ziopharm to its limits following small purchases by billionaire investor Randal Kirk at over $5.00. But with his much lower basis at just $1.91, Kirk lost almost nothing when the heavily-shorted stock ultimately collapsed to $1.84.

Institutions are no doubt aware of these small and steady purchases by Dr. Frost, yet they continue to prefer to be short the stock rather than go long. Short interest current stands at $200 million.

The problem here is not Opko itself and the problem is certainly not Dr. Phillip Frost. Most would agree that Opko has now assembled a very interesting portfolio of healthcare products including medical diagnostics and Phase III drug candidates. The real problem is that, like Ziopharm, the price is now about 50-60% above where it should be, given the company’s current business prospects.

From a practical standpoint, the bigger problem for investors is that Opko’s string of acquisitions has created a group of entrepreneurs in multiple foreign countries who now own over $300 million of the stock. These entrepreneurs are now “insiders” but are not part of Opko core management and they are now sitting on tremendous paper gains right as their shares are becoming sellable.

For example, with Prost-Data, Opko delivered over 7 million shares of stock when the price was sitting at $4.33. The seller realized plenty of profit at $4.33, but is now sitting on additional paper gains of nearly 70% in just 6 months, totaling roughly $20 million. That transaction was completed in October, such that under rule 144, the shares will become sellable on or around April 18th, which is now quickly approaching.

As we know, there have been numerous other transactions completed in recent months, just prior to the tremendous surge the stock had. As these transactions start resulting in sellable stock, retail will face up against an “insider cliff.” Opko has issued over 37 million shares to non-management entrepreneurs who sold their businesses to Opko.

Recent developments probably make Opko a decent buy at around $5.00 or even perhaps slightly above. But with the stock hovering at levels 40% higher than that in just a few months, it is highly likely that we will soon start seeing the first sell prints from non-management insiders.

The last sale by an insider of just 50,000 shares took the stock quickly back down to $6.10. As a result, there may well be very good opportunities in the near term to buy on a pullback at prices in the $5.00-$6.00 range. Even Cramer, who loves the company, continues to describe the stock itself as “very speculative” and suggests that buying should come on a pullback in the stock.

It is likely the case that the upcoming release of 7 million shares has been the cause for the recent volatility and several steep drops in Opko’s share price. On April 3rd, 1.6 million shares were quickly sold at a price of $6.80, and we have now seen 7 steep drops (highlighted below) for no apparent reason.

Institutions will be well aware of the upcoming insider cliff, even as retail investors are not. And selling ahead of any upcoming sale of shares is sensible, just as it is when selling ahead of IPO lockup expirations.

(click to enlarge)

What do we mean by “huge”?

Dr. Frost has an enviable track record in making healthcare investments. He has demonstrated the straightforward wisdom of buy low, sell high.

Many retail investors view the weekly buying by Dr. Frost as being “huge,” “tremendous” or “enormous,” Relative to the purchases of retail, the buying does appear to be sizable. Some of his larger recent purchases have even exceeded $500,000 in a single day. $500,000 certainly appears to be a large sum to retail. Yet relative to his historical purchases (now worth over $1 billion) at far lower prices, these new buys are so small that they have virtually no impact on his in-price or his position size. This is nearly identical to what we saw with billionaire Randal Kirk’s buying in Ziopharm.

As we can see in the chart below, Dr. Frost has conducted the largest portion of his buying in the $4.00-$5.00 range. All combined, purchases above $6.00 are so small that they almost do not even show up on the graph. Purchases above $5.00 are also negligible.

(click to enlarge)

Dr. Frost began buying into Opko when it was known as eXegenics. The initial transaction was for $8.6 million to buy roughly one half of the company, translating to 44 cents per share. Dr. Frost has purchased 80 million shares at below $2.00 (much of it below $1.00). All transactions, including the recent ones, at above $5.00 total only 6 million shares.

The result of this is that his overall in-price is just $2.99 – more than 60% below the current prices where he continues to nibble.

This means that Dr. Frost’s return profile vs. retail (purchasing now) is as follows:

Stock price Dr. Frost Profit Retail’s Loss
$3.00 Breakeven -58.9%
$4.00 $151 million -45.2%
$5.00 $301 million -31.5%

Dr. Frost will still be able to make hundreds of millions of dollars on this position even in the case where the current purchasers suffer very steep losses. As with Randal Kirk in Ziopharm, this is why Frost is a billionaire. And as with Randal Kirk, the continued buying in small size serves his own interests very well.

The insider cliff

When I last wrote about Opko, I noted that insider selling had begun. As did Ziopharm, Opko responded forcefully to my article. And as with Ziopharm, the share price rose dramatically on their press release.

The biggest problem with the press release was that Opko stated that:

 

No other sales by Company officers or insiders are currently contemplated.

 

The problem is that the term “insiders” now comprises a far larger group of individuals than Opko’s core management. Opko has now completed numerous acquisitions in countries such as Chile, Mexico, Brazil, Israel, Spain, Canada and the US. In most cases, these acquisitions were completed by issuing Opko shares to the founders of the targets.

In “contemplating” further insider sales, it seems unlikely that Opko could have received much clarification from these numerous other insiders in various foreign countries during the 2 hours prior to putting out a press release.

We can see that the term “insiders” now comprises a far larger group than Opko management. The table below shows recent Opko acquisitions along with the number of shares issued.

Name Country Shares issued
Cytochroma Canada 20,517,030
Prost-Data USA 7,072,748
Farmadiet Spain 125,000
Finetech Israel 3,615,702
Claros USA 4,494,382
Pharmacos Exakta Mexico 1,372,428
TOTAL 37,197,290

We can see that the total is 37,197,290 shares valued at nearly $300 million. This is not Opko’s money, this is money that is now waiting to end up in the pockets of the entrepreneurs in various countries who sold their companies to Opko. We can see that many of these holders are now sitting on tremendous paper gains – even after the gains they made from the initial sale at then-prevailing prices for the Opko stock they received.

Under Rule 144, we will see that the first chunk of stock will become freely sellable in less than 2 weeks, and comes from Prost-Data whichreceived stock at $4.33.

With CytoChroma, we have a bit longer to wait, but the number of shares which can hit the market exceeds 20 million shares and the gain for the seller is now nearly $50 million – even after the gain on the initial sale. This could be part of the reason why we are now seeing increased volatility and sharp drops in the share price of Opko lately.

Why won’t institutions buy Opko?

Even more so than Ziopharm, we can see that the shareholder base in Opko consists almost entirely of retail investors. Institutional investors are neither blind nor dumb. They are just as capable of reading the “Latest Insider Buys” headlines. Yet we can see that institutions only hold tiny 14.9% of Opko stock.

There are several reasons why institutions are refusing to buy into Opko. First, the company has swelled to a $2.5 billion market cap, precluding making any reasonable profit on the stock vs. its near-term prospects.

Opko currently trades at over 60x Sales. This makes Opko one of the most expensive stocks to own among all healthcare stocks. Even if Opko starts to generate material revenues sometime later in 2013, the company is several years away from generating the type of profit that could justify this valuation. Even once Opko generates a profit of $100 million (vs. the current loss of $10 million) the company would still be trading on a healthy 25 P/E. This is likely to be years away.

Second, institutions have come to learn that Opko is looking to be a perpetual “deal and dilution machine.” Every time Dr. Frost issues another 10-20 million shares in an acquisition, it only further raises the bar for profitability because the market cap becomes that much larger. Most investors expect a continued string of deals, particularly given the sky high share price. Third, Opko has become a collection of disparate and distinct healthcare business ventures which makes it nearly impossible to value the company. It more closely resembles a VC company, which should be valued at a much lower multiple.

The only thing that institutions can currently be certain of is that Opko is tremendously overvalued. But they can’t even determine by how much due to the wide variety of unrelated businesses which Opko has now purchased.

No one knows how to properly value Opko, but they do know that the past acquisitions strung out over 3 years have still not produced meaningful revenues or any profit whatsoever – even though past expectations by retail were also very high at the time the deals were announced.

Lastly, institutions may likely have much larger reservations that retail investors regarding the longer-term risk of investing in a very richly valued “one man show.”

Right now the sky-high value of Opko stock is attributed solely to the current level of involvement by Dr. Frost. At age 77, Dr. Frost has had a much longer career than most and if there is any sign that his involvement in Opko looks to decline even modestly, then the share price could potentially trade at a significant discount to the value of Opko’s underlying business portfolio. Relative to the current “Dr. Frost premium” this could create tremendous downside. The eventual non-involvement by Dr. Frost is clearly inevitable, but the timing of it remains entirely unpredictable which keeps institutions out.

Retail investors need to ask themselves the downside question of what Opko is worth as a freestanding company, assuming little to no involvement from Dr. Frost. That is the downside scenario that institutions are unwilling to bear.

In any event, we can see clearly that for a wide variety of reasons, investors simply refuse to own Opko even despite its investment-worthy size of $2.5 billion.

Instead, institutions are SHORTING Opko

We can see that Opko is now a very sizable company and the institutions which choose to be involved express their interest preferably on the short side. Currently, there are nearly 28 million shares of Opko sold short amounting to nearly $200 million.

Again, short selling institutional funds are also neither dumb nor blind. They are well aware of the steady trickle of headline-grabbing purchases by Dr. Frost.

As with Ziopharm, short selling institutions love Opko as a short and they have committed to their short position in a very large size. When institutions refuse to go LONG but are extremely enthusiastic about going short, retail investors need to ask themselves if they really feel that they have an informational advantage which justifies chasing the stock to ever higher levels.

It should also not be lost on retail investors that the huge short interest in the stock has been present ever since the stock was at $4.00-$5.00, roughly 40% below current levels. It was also the same level where short reports began in earnest regarding Opko’s prospects and valuations.

It also happens to be where I suggested the stock could now be considered a “buy” in my last article. The $4.00-$5.00 level remains the right price to be buying Opko shares, but doing so means waiting for some period of time until the stock corrects – i.e., as Cramer said on Friday, “buy on a pullback.” Investors can also stay short the stock through a correction, effectively playing both sides of the trade.

Since the $4.00-$5.00 range, Opko has had several new developments, including the CytoChroma acquisition and the RXi (RXII.OB) pooling of assets. Yet the value of Opko as a company has exploded upwards by an additional $1 billion since December. Regardless of whether one is long or short, it is clear that these developments do not in any way justify an extra $1 billion. As a result, the conclusion by institutions is that despite the recent developments, the rise in the share price simply makes Opko now more overvalued than ever. At any prices above $6.00, Opko is still a compelling short and the institutions know it. At prices of $4.00-$5.00, the stock becomes a buy. While in the $5.00-$6.00 range, it is just a “wait and see” for next results.

Evaluating current business prospects

4KScore

When I last wrote about Opko, I tried to inject a dose of reality regarding the prospects for Opko’s 4KScore test for prostate cancer. In Opko’sresponse, which drove the stock higher, they notably did not challenge any of my concerns.

As I previously stated, investors need to realize that 4KScore cannot generate even a fraction of the many billions projected by a small number of authors. We know that 4KScore could begin to produce respectable near-term revenues, but we also know that virtually all investors and analysts attribute the vast majority of Opko’s $2.5 billion valuation to the prospects of only 4KScore. It is the only near-term material revenue candidate.

In many cases, we can see that these projections have been issued after the rise in the stock, in an attempt to justify the valuation rather than predict what it should be. In forecasting many billions in 4KScore revenues, these projections were based on securing a tremendous market share (as high as 50%) even while incorporating a price which is nearly triple what other tests go for.

Since the time of my last article, The New York Times has begged to differ with the bullish forecasts for 4KScore dominance. The Times noted that:

 

More than a dozen companies have introduced tests recently or are planning to do so in the near future. Rather than looking at a single protein like P.S.A., which stands for prostate-specific antigen, many of these tests use advanced techniques to measure multiple genes or other so-called molecular markers.

 

The Times also noted that total spending related to prostate screening was around $12 billion. We still need to wait for the first sales of 4KScore to begin in the US. If it turns out that 4KScore is in fact more successful than any of the many alternatives, even then the revenue projections provided by many Opko uber-bulls, will come in at billions less than forecast. It has the potential to be a very successful product, but investors need to recognize the reality of this market.

RXi Pharmaceuticals

In March, Opko completed the pooling of assets with RXi in which it contributed all of its own RNAi assets in exchange for shares of the Pink Sheets listed company. The RXi trade could provide longer-term benefits to Opko, but investors need to be aware that any benefits in the near term (3-5 years) are basically out of the question.

While RNAi is an exciting area of biotech, it continues to be the case that the FDA has never approved a single RNAi therapeutic. RXi is a tiny Pink Sheets listed company which was spun out of Galena Biopharma (GALE).

RXi’s CEO recently described its first year in business as “nearly flawless.” Yet he mostly described the fact that the stock has gone up along with the deal with Opko. It had initially traded at 15 cents and subsequently doubled to over 30 cents. But aside from the stock price, it remains to be the case that RXi has only a single Phase I product and pulled in just $100,000 in revenues solely from government grants. The net loss for the year was $26 million.

In short, there is a very clear reason why this company is still on the Pink Sheets. If Opko eventually receives any benefit from RXi, it will be quite a few years away. In other words, the recent run-up in the stock cannot be attributed to RXi.

There are many other challenging details surrounding RXi and Galena, but given that the impact on the valuation on Opko is so small, I will save those for another article.

CytoChroma

The CytoChroma acquisition was completed in February in exchange for 20 million shares of Opko plus up to $190 million of additional milestone payments to be made by Opko. The 20 million shares were initially valued at $100 million, but that value has now jumped to $140 million given the recent rise in Opko’s share price. This has provided a quick gain of $40 million in just 3 months to the selling founder.

With two products in Phase III trials, CytoChroma clearly has greater near-term potential than RXi, but it also remains the case that these are not revolutionary products like those being investigated by RXi. Instead they are simply Vitamin D derivatives which are hoped to be able to treat Chronic Kidney Disease in Stage 3 and Stage 4 status. The total market size for this application is just 8 million patients such that even if one or both drugs passes Phase III, and even if Opko ultimately captures a significant market share, the overall revenue potential over the next three years certainly cannot justify the extra $1 billion in market cap for Opko. Yet some Opko bulls have suggested that these products will generate a staggering $6.5 billion per year in revenues, making it one of the best selling drugs of all time. Again, reality needs to be factored in against the current unlimited optimism.

The point from each of these examples is that the new developments, even though positive, do not come anywhere close to justifying the extra $1 billion in market cap that Opko has added in just a few months. Even Opko bulls agree with this sentiment.

Now that non-management insiders are sitting on over $300 million in Opko stock, the near-term risk is that they will sell the bounce. The sharp selloff after a small sale by Opko’s Chief Accounting Officer suggests that a much larger and faster drop will accompany the first sale by these very large insiders.

So why does Dr. Frost keep buying?

Even since my last article, Dr. Frost has continued buying small amounts of stock, typically in blocks of less than 50,000 shares at a time relative to his position of over 150 million.

If the stock were to go to $14.00, Frost would continue to buy in a steady trickle. If the stock were to drop to $4.00, he would also do the same. Part of the reason for this is that Opko continues to issue an enormous amount of stock for much needed cash and for acquisitions.

Some have likened Frost’s purchases to an “ongoing share buyback,” yet we can see that in 2013, Frost has purchased just 14 million shares even as Opko has issued 45 million shares in the past 3 months via the convertible and the CytoChroma acquisition. Dr. Frost also purchased some of the convertible bond issues for the same reason.

The net result of these transactions is that despite his steady trickle, Frost’s percentage ownership of Opko has actually decreased during 2013. But his purchases have helped to offset his decrease in ownership which has resulted from ongoing dilution to all shareholders.

Anyone who follows Opko knows by now to expect numerous additional acquisitions, and they should also expect these acquisitions for stock. As a result, it is expected that Dr. Frost will continue to buy small amounts Opko stock regardless of the price. But the continued trickle of buys by Frost helps him to simply maintain some of his ownership, not increase it.

But a much more important reason for Frost to continue to buy is the signaling value, which keeps the share price high. This simply provides Frost with a much more valuable acquisition currency for continuing his purchases of other small companies.

A recent Bloomberg article described Frost’s incessant penchant for doing small healthcare stock deals and quoted him as follows:

 

The almost-octogenarian billionaire isn’t winding down just yet.

There are investors to placate, Teva to mend, Opko — and perhaps new companies — to build. Asked why he hasn’t adopted golfing or other hobbies of the superwealthy full time, his face gives way to a faint smile.

“This is what keeps me going,” he says.

 

Conclusion

Dr. Frost is in this business because doing healthcare deals is what “keeps him going” as he approaches his 80th birthday. With a cost basis of just $2.99, he still stands to make hundreds of millions of dollars even at stock prices below $5.00. Dr. Frost is nearly guaranteed to see a successful return from Opko at any foreseeable price.

Yet for the non-management insiders who have been issued over 37 million shares worth over $300 million, making themselves wealthy at a much younger age will likely prove to be more important than completing strings of deals with small healthcare companies.

And for retail investors who are now buying the stock at over $7.00, profit is likely the only objective. These are the investors who stand to lose up to 45% once the insiders start selling.

With a valuation of $2.5 billion, Opko shares are tremendously overvalued. At over 60x Sales, the stock is quite obviously overvalued relative to the current fundamentals. But more importantly, the stock is still tremendously overvalued even relative to the stock’s near-term prospects for 4KScore and its new Vitamin D products which are still in clinical trials. This is the reason why non-management insiders have a major incentive to sell.

Even those who are bullish longs on the stock now quickly admit that the only reason to continue buying Opko is that the continued buying by Dr. Frost makes this “safe.” The huge short interest from institutions continues to contradict this hope by retail investors. Meanwhile, institutions continue to refuse to own Opko on the long side.

As we saw in February, the sale of just 50,000 shares by an insider quickly took the stock back down to $6.00. In advance of the April expiration of the 144 restrictions on Prost-Data, the stock is again showing significant volatility to the downside, and retail is the only one wondering why.

In the near term, there are likely to be opportunities to get back into the Opko story, perhaps at prices in the $5.00-$6.00 range. In the meantime, staying on the sidelines or getting moderately short the stock are the best way to play Opko.

(click to enlarge)

Dose Of Reality: Opko Set To Pullback

 

Shares of Opko Health (OPK) have risen 65% in the past three months as a string of domestic and international acquisitions, along with a greater collaboration with Bristol Meyers (BMY), has opened up numerous new pathways for the company.

Opko’s prospects as a company continue to be bright, however at the current price of around $7.00 the market cap of Opko now exceeds $2 billion.

This is in spite of the fact that Opko has recently disclosed that it does not expect to become profitable in the near term, which implies that massive revenues (as predicted by various authors) are not on the near term horizon.

As shown on the Form 4’s, insiders have now begun selling, with Opko’s VP of Finance and Chief Accounting Officer selling $336,000 of stock on February 1st.

Based on the information below, at any prices above $5.50 Opko is a clear sell. Although at prices of $4.00-$5.00 the stock likely becomes an interesting buy once again.

Even those who are very bullish on Opko’s long term prospects are now leery of the recent run-up and the lofty share price. Various signals are now emerging that the stock is headed for a significant correction.

The signals include the following:

  • Insider selling: According to the latest Form 4, on February 1st, Opko’s VP of Finance and Chief Accounting Officer, exercised his options and immediately sold 100% of the shares underlying at $6.72. Total shares amounted to 50,000, resulting in proceeds of $336,000.
  • Heavy share issuance by Opko: Opko has been taking advantage of the run-up in the share price to issue 20 million shares for its acquisition of Cytochroma at $4.87 and another 25 million shares via a convertible bond at $7.07. These representsissuance of over 45 million shares all in the month of January alone.
  • Negligible buying by Frost: Purchases from Dr. Frost have continued, but the vast majority were in 2012 at prices of $4.00-$5.00. Only 70,000 shares were purchased above $6.00. Dr. Frost’s historical position is greater than 140 million shares.
  • Huge overhang from potential sellers: The recipients of shares from recent acquisitions along with the convertible bond shares now create a massiveoverhang of more than 50 million shares.

Author Kevin Quon has been bullish on the stock but also noted in his most recentarticle the market cap has become difficult to justify. The Motley Fool notes that Opko has “received an alarming one-star ranking“, meaning that it is expected to be a notable under performer. Author Josh Ginsberg continues to be bullish on Opko’s business prospects but notably made no evaluation of the share price following the run-up to $7.00 and $2 billion in market cap.

Clearly these comments do not reflect a lack of opportunities for Opko nor do they reflect a lack of faith in Dr. Phillip Frost or Opko management. Just about anyone familiar with Opko or Dr. Frost continues to be bullish on the long tem prospects for the company.

Instead bearish comments are a reflection on Opko’s share price, which has simply moved way too far way too fast and is now due for a meaningful pullback.

Back in November, Cramer noted that the company was a “$4.00 and change” stock but cautioned viewers

don’t jump all over this thing because you will lose money if you chase it up to $5.00 or something silly like that

That was just 10-12 weeks ago and now the stock is as $7.00. On his most recent show featuring Opko, Cramer continued to be positive on the company’s prospects but stopped short of calling it a buy.

The reasons for his restraint are twofold.

First, the $2 billion valuation now creates far more chance of near term downside than further upside.

Second, according to Dr. Frost, Opko’s prospects for drug revenues are looking likely to be 2014-2015 events as opposed to 2013 events. Clinical trials for the various drugs will be completed in late 2013 and in 2014, such that commercialization will occur about a year after that, according to the interview.

While Cramer will telling investors to not chase the stock up to $5.00, Bill Alpert at Barron’s was telling them to sell outright at $4.00. The scathing article from Barron’sstated that Opko was only worth $1.00-$2.00. Alpert cited medical journals which showed that Opko’s diagnostic tests were failing to detect Alzheimers and prostate cancer as planned. Alpert did acknowledge that Opko would likely be presenting investors with other shots on goal in the future, noting:

With Frost’s deep pockets and a dizzyingly diverse project portfolio, Opko will surely have other stories to tell if these diagnostics don’t fly. But prospective investors might want to wait for the validation that comes with real fundamentals.

There are several misconceptions about Opko which are leading some investors to continue bidding up the stock even at prices above $6.00.

The misconceptions are as follows:

  • Many investors are under the impression that Dr. Frost has been purchasing alarge volume of shares at over $6.00 when in fact his purchases have been negligible. The benefit of these small purchases is more one of signaling to the market which has caused the share price to continue to rise.
  • Revenue forecasts from bullish authors seem to have significantly overestimated the revenue potential for Opko’s drugs and its 4KScore product. For example, authors are consistently predicting that expected revenues from numerous drugs will exceed those of the best selling drugs of all time for the entire industry. With 4K, authors are assuming the the test will sell for triple the price and immediately capture 50% of the market.
  • Many investors are pinning their hopes on a continued short squeeze, but the short squeeze on Opko is now fading. The number of days to cover the short position hasfallen from 43 days to just 11 days. Short interest itself has fallen by 30%, such that the covering shorts will no longer be supporting the share price and may now be re-entering the trade as a new short.

In decades past, Dr. Frost enjoyed spectacular success in selling Key Pharmaceutcials and Ivax Pharmaceuticals after the matured into substantial revenue generators.

But investors must keep in mind that his involvement with each of these companies lasted well over 10 years before the companies were in a position to ultimately be sold.

Those who choose to sell Opko on this latest run-up to $7.00 may well have the opportunity to buy back into the stock at prices back in the $4.00-$5.00 range, at which time they can still make a longer term bet if they are speculating on an ultimate sale of the company by Dr. Frost in the years after revenues begin to materialize.

The Dr. Frost Effect

Many investors seem to believe that the purchases by Dr. Frost are so large that they have pushed up the share price of Opko and caused a short squeeze. However this is demonstrably not the case.

Author Kevin Quon recently noted that:

As of January 11, Frost has effectively taken 135,764,800 shares off of the open market… For a company that held a 17.7% short position of the outstanding float, or 24.26 million shorted shares as of December 31, such continual buying pressure by the CEO has put a real pinch on those looking to profit from a decline in the company’s price.

Quon had separately noted that:

Despite having share prices climb nearly 50% in the last 3 months alone, Frost continues to steadily buy large volumes of shares.

In reality, the volume of shares being purchased by Frost at above $5.00 has actually been entirely negligible, as shown in the chart below. The data comes from the Form 4 filings to the SEC.

The chart on the left shows the volume of shares purchased by Dr. Frost at each price range over the past three months. This is the time period in which the share price has skyrocketed. As we can see, almost all of Frost’s purchases occurred at $4.00-$5.00. There were some purchases even above $6.00, but the volume on these was tiny.

The chart on the right is a subset of the chart on the left and shows the exact prices and volumes of each Dr. Frost’s individual purchases in 2013. As we can see, there have only been a few purchases and the largest one in 2013 so far has been only 50,000 shares.

As a result, it is clear that these purchases are not “large” and are not “pushing up the price” of Opko by themselves. Opko typically trades around 3 million shares per day.

But obviously Frost’s purchases do have a different effect that is distinct from the simple aspect of supply and demand. The real effect here is one of signaling. As Frost continues to buy, retail investors continue to take notice and jump on board with their own buying.

Dr. Frost currently owns over 40% of Opko, with outside institutions owning only 16% of the company. As a result, aside from Dr. Frost, the float is held almost entirely by retail investors.

Investors who pile in at the $6.00-$7.00 level are missing out on the simple economics of why this works for Frost in a way that doesn’t work for anyone else. This may be one of the reasons why institutional ownership continues to be quite low.

Smaller investors need to realize that the result for Dr. Frost has been an increase in ownership of only 0.2% during 2013. His position was already so large that the added shares (even at higher prices) have virtually no impact on his overall cost or on the size of his position.

Dr. Frost invested a mere 0.2% into new shares at higher prices but the signaling value of this boosted the value of his existing 140 million shares by 40%. The economics of this would be nearly identical even if Dr. Frost had purchased the shares at $10.00 or $20.00, so it can be expected that his small purchases will continue for the foreseeable future.

Obviously if the rest of us had the same effect from signaling, we would continue buying small amounts of Opko as well.

If Dr. Frost isn’t selling, then why does he care about the stock price ?

The first point that investors need to realize is that although Dr. Frost isn’t selling shares, Opko is selling frequently and in large size. Opko has already issued over 45 million shares just in the month of January as a result of the Cytochroma acquisition and the convertible bond.

Dr. Frost is using the greatly appreciated stock of Opko as a currency for going on his shopping spree for new companies to acquire.

Prior to the recent interview of Dr. Frost on Cramer, the stock had been at $6.00, however the Cramer effect quickly allowed Opko to issue shares under theconvertible at $7.07.

The disadvantage of the convertible is that it requires $5.25 million per year in interest payment by Opko, totaling $26.25 million in interest for the 5 years in which the bond is not callable by Opko.

Dr. Frost knows that he will continue making acquisitions and he knows he will be issuing much more stock to pay for them. But he is uncertain what the price of the stock will be in coming months, so he was happy to lock in a $26 million interest obligation in exchange for the certainty of issuing equity at $7.07.

As shown above, Dr. Frost made the vast majority of his purchases at prices below $5.00. Only a mere 70,000 shares have been purchased at prices over $6.00. But the signaling effect, along with some help from Cramer, has provided Dr. Frost and Opko with a higher share price for issuing stock in financings and acquisitions.

Mr. Quon also seems to agree with this conclusion, stating that:

By propping up the company’s share price with his own insider purchases, Frost was able to wield greater buying power in the latest acquisitions.

What is the right price to sell Opko stock ?

Obviously the $7.07 conversion price of the convertible says that selling stock at $7.07 is an attractive sale price in the eyes of Opko and Dr. Frost. This appears to be true even though it required paying $26 million in interest.

Just three weeks ago Opko agreed to acquire Cytochroma for an upfront price of $100 million. As in the past, Opko used its stock as currency with 20.5 million shares issuable in lieu of the $100 million. This equates to a share price of $4.87. In addition, there may be an additional payment of up to $190 million, which can also be paid stock if desired.

And now most recently the VP of Finance and Chief Accounting Officer sold 100%of his recently vested options at a price of $6.70-$6.74.

So for those investors who have ridden the stock up, each of these can be viewed as a signal from those who know best that the current level is a time to be sellingrather than buying the stock.

What are the recent acquisitions worth ?

In December Opko closed its acquisition of Prost-Data Inc (OURLab) based out of Nashville. One week later Opko announced that it had acquired Silcon Comércio of Brazil. Within the span of just one month Opko was already on its third deal with Canadian Cytochroma in January.

All three deals do appear to bring significant potential to Opko in the future. But investors do need to realize that doing three major acquisitions in three different countries in just four weeks is a huge amount for any one company to chew on when it comes to integration and implementation.

The current share price seems to reflect a view that completing the three deals on paper is equivalent to having already made them work for shareholders. Investors will need to be patient before expecting results from these recent acquisitions no matter how exciting they are.

In mustering up their patience, investors need to consider that over the past three years Opko has now acquired companies in:

  • Mexico
  • Israel
  • Chile
  • Spain
  • Canada
  • Brazil
  • The United States.

Opko had acquired the rights to rolapitant for anti-nausea and vomiting from Schering Plough (MRK) in 2009.

Despite this blistering pace of acquisitions over a three year period, Opko has only just broken through the $10 million mark for quarterly revenues in its most recent quarter.

Rolapitant has been in Opko’s drug portfolio for nearly four years. So again, if these past acquisitions are still works in progress, the most recent acquisitions can be expected to take a few years before they begin to bear the results that investors are currently hoping for.

At $11 million in Q3, revenue growth continues to be impressive relative to where it was in the previous quarter. However, investors need to keep in mind that Opko is not growing these revenues organically, but is instead buying these revenues, using its stock as a currency.

In addition, many investors seem to forget that while each acquisition brings thepotential for new revenues, it also brings the certainty of immediate new expenses related to the deal and all of the new employees that come with it.

Opko has made this point clear. In its most recent 10Q released in November, Opko stated that:

We have a history of operating losses and we do not expect to become profitable in the near future.

Clearly if Opko were expecting even a single billion dollar product to hit the market any time soon, it would be expecting an immediate swing to massive profitability. In its most recent quarter, Opko’s operating expenses totaled only $21 million against revenues of $11 million. An extra billion dollars in expected revenue would obviously change that equation.

In the past Dr. Frost demonstrated his long term focus and extreme patience. Ivax and Key Pharma both took more than 10 years before their revenues grew to a point where they were sellable companies.

Opko currently realizes the time frame which will be required to ramp up revenues as well as the uncertainty which is always associated with bringing new products through the FDA and then into the market. Opko also realizes that it will continue to absorb significantly larger expenses as a result of the acquisitions, even prior to any ultimate revenues which may be realized.

However, despite this clear communication from Opko, many investors are making their own forecasts of surging revenues that will seemingly lead to immediate near term profitability.

A dose of reality – how many billions in revenue ?

Many Opko bulls have predicted that Opko is going to launch a series of new drugs which will each immediately bring in multi-billion dollar revenues.

Opko does have numerous new and attractive shots on goal. Its drugs will certainly address very attractive market opportunities. Yet we can see that this extreme level of optimism is clearly a quite overdone when viewed in the context of the best selling drugs of all time.

Simon King of FirstWord Pharma recently posted a list of the all-time best selling drugs along with the revenue numbers they achieved in their absolutely best peak years.

In order to qualify as one of the best selling drugs of all time across all years, a drug needs to be able to generate peak sales of around $5 billion in any single given year.

A list from the Pharmacy Times shows that the cut off level for the best selling drugs in 2011 was much lower, at $2.7 billion.

In other words, if even one of Opko’s new drug candidates sells $1 billion, it would be going from a base of zero to the pharmaceutical stratosphere immediately.

And in this article, Rich Duprey provides numbers that are far more realistic based on global revenues realized by competing drugs for Replidea and Alpharen (Cytochroma’s drugs). The reality he shows is that competing drugs from Amgen (AMGN) and Sanofi (SNY) which are already established and successful in the market only generate revenues of around $300-$600 million. And the other reality is that it will likely take a number of years to ramp up to that level.

There are two points that the very bullish authors are missing when they provide their mega billions in revenue forecasts. First, there are established drugs which have been competing strongly in the market for many years.

Second, not all individuals with these conditions end up taking drugs. Duprey notes that “surgery is the typical standard of care for secondary hyperparathyroidism”.

As a result, when authors simply start multiplying numbers of sufferers by expected drug prices they come up with spectacular forecasts which end up being far higher than what we see in the real world.

Launching a drug from zero to $300 million in revenues is obviously a major accomplishment. However, in making an evaluation of the current share price, investors need to realize that this level is actually 70-90% lower than what is being predicted by various authors who have set ultra-high expectations of numerous multi-billion dollar drugs.

The dramatic rise in the share price and the $2 billion market cap make it clear that many people are betting that the stock will realize these bullish forecasts even when they are impossible to reconcile with real world revenue potential.

And also of importance is the fact that these revenues are not expected to ramp up until 2015.

Revenue potential is reflected in the acquisition prices

These lower but more realistic revenue projections should not come as a surprise to anyone who has followed the terms of Opko’s acquisitions.

With Cytochroma, Opko issued $100 million in stock up front and may provide up to $190 million in additional payments subject to certain performance milestones.

Cytochroma has two drugs in late stage trials, Replidea and Alpharen. If it were the expectation that these drugs would be pulling in several billion dollars in revenues within the next 2-3 years then they simply would not have sold for a mere $100 million upfront. And in fact there would have been numerous other buyers who would have been happy to bid far more than the $100 million plus $190 million in milestone payments.

The fact is that when an acquirer such as Opko buys a new drug (company), it expects to obtain its payback over the course of several years and it discounts the price based on the uncertainty involved in getting the drug successfully approved by the FDA and accepted by the market.

For Opko, they were willing to pay $100 million upfront, and Cytochroma was willing to accept. If everything goes perfectly, then Cytochroma founders will get an additional $190 million over coming years, if or when the success happens.

Pulling in several hundred million dollars off a newly purchased drug is no small accomplishment and it would certainly be yet another coup for Dr. Frost.

But with a valuation of over $2 billion before the drugs are even through their clinical trials, investors need to ask if the regulatory and commercial success of these drugs is already being priced in before the events have been proven. The sellers of Cytochroma were more than willing to put the value at an immediate $100 million.

A balanced look at 4KScore’s prospects

The nearest term revenue development is expected to be the launch of the 4KScore test for detecting prostate cancer. As a result, it is arguably the most important element for evaluating the current share price and the results are expected to be positive for Opko.

Opko notes that the 4KScore test as “a next-generation prostate cancer test” which “could create a diagnostic test able to accurately predict prostate cancer-positive biopsies”. In addition, Opko notes that 750,000 unnecessary prostate biopsies are performed annually in the US. According to Opko, “A panel combining our PSA test and our novel kallikrein markers could create a diagnostic test able to accurately predict prostate cancer-positive biopsies”.

However Barron’s challenged Opko’s prostate test, saying:

A May 2010 Journal of Clinical Oncology report by the test’s developers claimed that their four-marker test would reduce unnecessary biopsies by half. However, an accompanying editorial in the same issue pointed out that the new screen was less sensitive than existing tests-failing to detect 14% of high-grade cancers-and was not likely to change prostate-cancer mortality.

The 4KScore test has already been launched in Europe and is expected to be launched in the US in 2013. Opko’s recent acquisition of OURLab provides the company with 18 phlebotomy sites in the US, with a national sales force that calls on urologists.

Ongoing sales of competing PSA tests suggest that the revenue potential for this market is indeed quite large. However, investors in Opko do need to temper their optimism with some amount of realism in terms of what to expect and when, in terms of sales of prostate cancer diagnostic tests.

The sales force will no doubt help the marketing effort for the 4KScore, but it cannot increase the test’s ability to actually detect prostate cancer.

There are two issues that investors should consider when making their revenue forecasts: competition and emerging medical trends regarding PSA testing. As for competition, Opko will certainly not be the first company to launch a revolutionary new PSA based test and then see its stock price soar. As noted in the New York Times quite a few years ago:

The stock price of Biomerica Inc. quadrupled yesterday after the tiny medical technology company said it would produce a five-minute test for the diagnosis of prostate cancer. … The company said it would first sell the test outside the United States and would begin sales here if it received clearance from the Food and Drug Administration…..Biomerica’s shares soared $7.375, or 311 percent, to close at $9.75 on volume of 3.6 million shares in Nasdaq trading.

As with Opko, Biomerica’s EZ-PSA prostate cancer test was first launched outside of the US and was subsequently approved in Japan as well. The EZ-PSA test is still commercially available. However Biomerica (BMRA) never had blockbuster success from the test. Biomerica’s stock has now traded down to $1.20 and has a market cap of just $8 million.

Biomerica actually bears some similarities to Opko and describes it business as:

Biomerica, Inc.(Biomerica), develops, manufactures, and markets medical diagnostic products designed for the early detection and monitoring of chronic diseases and medical conditions.

The company will do close to $8 million in revenues this year, and with a market cap of just $8 million and no debt it actually appears to be a very interesting speculative buy.

Competition has meant that the prices of PSA tests have come down substantially, with some test centers providing various tests for as low as $49.00.

In assessing revenue prospects for Opko’s 4KScore, some bullish authors have assumed that Opko will immediately capture a 50% market share while simultaneously charging triple the price for PSA tests. The result was $1.8 billion in annual revenues expected by a recent author.

Each investor will have his or her own individual method of forecasting, however using more realistic assumptions for price (below $100) and market share (15-20%) would yield a number that is at most $200-300 million. This is still a considerable amount of revenue to realize from a new product, however investors do need to realize that such estimates fall around 85% below the $1.8 billion level that many seem to be hoping for.

Author Josh Ginsberg recently estimated that Opko would be realizing as much as $8.3 billion per year based on the 4KScore and Opko’s near term drug prospects. In doing so, he quoted the $1.8 billion forecast for 4K from another author.

However Mr. Ginsberg does suggest that individual readers conduct their own due diligence in arriving at such estimates.

Some of the competition may not come from competing PSA tests at all, but instead will come from competing non-PSA technologies.

According to a 2012 article in MedCity News:

Armune Bioscience Inc. is developing a test based on serum autoantibodies,which the company says are more stable than antigens and may be easier to detect during early stage cancer. First, the company is focusing on creating analternative to the low-specificity, prostate-specific antigen test that’s the current standard for detecting prostate cancer.

The company has already raised over $3 million from investors to develop the test.

According to a 2012 article in Fierce Biomarkers:

Beckman Coulter (DHR) has received premarket approval from the FDA for its biomarker-based Prostate Health Index (PHI). According to the company, this test is 2.5 times more specific in detecting prostate cancer than PSA (prostate-specific antigen) tests in men with raised levels of PSA, and could cut the number of unnecessary prostate biopsies 31%.

In addition, Quest Diagnostics (DGX) currently offers a urine based screening test for prostate cancer.

Medical pushback against prostate cancer testing
In reality, a much bigger potential impediment to Opko realizing 4K’s full revenue potential could be the increasing amount of backlash that PSA tests are facing from the medical community. The backlash against PSA testing has been building for two years now and seems to have escalated substantially in 2012.

These criticisms are coming from many of the most respected names in the medical field with respect to prostate cancer. Surprisingly they are calling for a near halt to the widespread use of PSA tests used as an advanced screener.

The PSA test was actually invented by Dr. Richard Albin. In a New York TimesOpEd piece entitled “The Great Prostate Mistake” Dr. Albin decried the currentover-use of PSA tests as:

“a profit-driven public health disaster.”

Later, an article entitled “PSA Screenings: a Money-Making Scam” went even further to hammer home the same point.

Most recently, the backlash against PSA testing seems to have come to a head in much broader medical circles. The San Francisco Chronicle noted that:

many possible screening programs turn out not to do any good – and in fact some tests like PSA cause harm. That’s why virtually all expert public health panels do not recommend the PSA test.

Also in 2012, an article entitled “Harvard expert urges caution for use of new prostate cancer test” raised similar concerns. Each of these authors raises a wide range of points which suggest that the problems with PSA testing outweigh the benefits for many of the men who end up getting the test done. The authors go on to strongly criticize the industry for over promoting PSA tests in pursuit of profits.

They suggest that the appropriate target market should consists primarily of men who have already had prostate surgery, rather than as a predictive measure performed in advance. Clearly such a shift would result in a very dramatic reduction in the size of the addressable market.

For now it seems safe to say that PSA tests will continue to be widely used for the foreseeable future. However the increasing trend in the medical community to curtail their use should certainly be considered as a factor by those who are expecting multi-billion dollar revenues from 4KScore alone and in the very near term.

Such investors should also keep in mind the strong cautionary comments raised by the medical community specifically with respect to Opko’s prostate cancer test, as was highlighted in Barron’s.

Playing the short squeeze

Even when the share price was just over $4.00, the short interest in Opko was enormous. During 2012 the short interest in the stock typically ranged from 30-32 million shares, so about 25% of the outstanding share count at the time.

The bet on the short side was premised on the fact that at $4.00 Opko was still a $1.2 billion company with almost no revenues and with losses that were increasing substantially each quarter.

Much of the recent surge in the share price can be clearly attributed to short sellers scrambling to cover.

We can see from the Nasdaq that the overall short interest has now fallen by nearly 30%. Meanwhile the number of days to cover the short interest has fallen from 43 days in August to just 11 days at present. The short in Opko was very large, but is now very moderate.

As a result, short covering cannot be expected to continue to prop up the share price going forward, and in fact shorts will likely begin re-entering the stock at current levels.

Settlement Date Short Interest Avg Daily Share Volume Days To Cover
1/15/2013 23,901,216 2,174,211 10.993053
12/31/2012 24,263,036 1,262,059 19.224962
12/14/2012 29,785,788 1,456,180 20.454743
11/30/2012 31,705,090 1,067,204 29.708556
11/15/2012 32,320,163 1,636,147 19.753826
10/31/2012 31,845,538 1,178,310 27.026451
10/15/2012 30,818,850 1,179,777 26.122606
9/28/2012 31,105,015 1,102,191 28.221075
9/14/2012 31,612,311 753,306 41.964767
8/31/2012 31,243,465 844,779 36.984188
8/15/2012 31,220,187 719,274 43.405138

Conclusion – knowing when to take profits and when to re-enter

Share of Opko have been on a spectacular run and have been boosted by a series of simultaneous positive factors including:

  • The positive signaling effect from Dr. Frost’s small purchases
  • Ample positive attention from Jim Cramer
  • A notable short squeeze
  • Ongoing enthusiasm from bullish authors with ultra bullish revenue forecasts

However with a market cap of over $2 billion, the stock is clearly one of the most overvalued names in the healthcare space relative to its actual revenue prospects over the next 2-3 years.

The only new near term revenue event will be the market launch of the 4KScore in the US in coming months. Realistically revenues from the 4K product may be around 85% lower than what has been predicted by bullish authors, and will certainly take time to ramp up even to that reduced level.

Opko itself has cautioned investors that it does not expect to become profitable in the near term, which basically tells us that any potential billion dollar revenue events are still expected to occur much further out than many authors are currently forecasting.

The near term signals of an impending correction in the share price include:

  • The onset of insider selling of shares by management / insiders
  • The signaling effect of over 45 million of new shares being issued by Opko in January alone
  • The overhang from the convertible and from the shares issued to acquisition targets
  • A sharp decline in short interest such that the short squeeze will no longer be supporting the share price

At prices any prices over $5.50, Opko isn’t just a good short, it is a great short. But once the share price pulls back to the $4.00-$5.00 range it likely becomes an interesting buy and hold stock for some time, depending on how results begin to shape up in 2013-2014.

Disclosure: I am short OPK. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.