Opko Health - Look Beyond the Diagnostic Tests

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Opko Health (NYSE: OPK), a multinational pharmaceutical and diagnostic company, is now among the most highly shorted stocks on the NYSE, according to a recent article in Barron's.

Dr. Phillip Frost's name is well-known throughout metropolitan Miami due to his philanthropy and endowments at educational and cultural facilities. And what Frost has touched has generally turned to gold though his professional life. The billionaire is now chairman of the board of Israeli Pharmaceutical giant Teva (NYSE: TEVA).

Opko now has short interest equaling 42 days of its average trading volume. For a stock trading at about $4 per share, that is truly an extraordinary spread of negative betting. The issue is that the company's prospects are perceived to rely upon two developmental tests, one for Alzheimer’s disease and the other for prostate cancer. However, during meetings this summer with investors, management stated that testing for the diagnostic treatments was not going as well as management had previously hoped. Barron's wonders, if the diagnostic products do not turn out to be revenue generators, it certainly does not appear that Opko is worth over $1 billion in market capitalization. Many agree with Barron's assessment, which is the reason for the volume of short interest.

But, as they say, “not so fast.” There is more to the company than diagnostic tests for two ailments. Frost has a Midas touch, and as a native Miami resident, I remember well his buildup of the former Key Pharmaceutical on North Biscayne Boulevard, and was saddened a bit when it was sold out to Shearing Plough in 1986. Over the next 20 years, he build up IVAX from a small, niche drug maker to a leading drug developer that was sold in 2006 to Teva for nearly $8 billion. Frost also sits on boards, often as chairman, of financial companies, defense contractors, and a myriad of other businesses. In sum, if there were a business Renaissance Man of this era, Frost is as good a nominee as anyone.

Frost has been chairman of Opko since early 2007. And as of today, he owns nearly 40% of the company. In my experience, folks high up on Forbes list of the wealthiest Americans tend not to make major financial mistakes. Another thing that tells me Opko has a future is a look at its past. Its focus on diagnostic testing is not the first incarnation of Opko. In 2007, the focus was finding a treatment for macular degeneration. It was only after that, and some retinal imaging products failed, did Opko focus its business on the current diagnostic tack. Opko has already planted the seeds for a future beyond diagnostics, as you will read below.

And for all the focus on the diagnostic business, there is far more still to Opko that that. Before becoming involved with Key Pharmaceutical, Frost was a professor in dermatology at the University of Miami Medical School. Opko now has a line of various pharmaceutical products in development, including vaccines, for Parkinson's Disease, asthma and chronic obstructive pulmonary disease, heart disease and various cancers. The company's Opko Curna unit is developing antisense medications with wide application potential.

One thing that Opko is not, at this time, is a sure thing. You all know the perils of developing drugs. Companies much larger than Opko have spent tens or hundreds of millions on specific products only to have those products fail late-stage testing. But what those big pharma companies don't have is a backer like Dr. Frost. This company has not turned a profit in its six-year history. But even so, I doubt Frost would allow what may be his last big business venture to fail. Certainly, he has the resources to pick up parts, or even all of other niche drug companies.

I fundamentally disagree with Barron's columnist Bill Alpert's view of Opko. While there are hurdles, the upside is considerable. If the company is able to increase the sensitivity of its Alzheimer's diagnostic, it may be a true, multi-billion-dollar blockbuster. It is harder to put a value on the company's other medications in development, yet with Dr. Frost at the helm, anything is possible.

There is very little analyst coverage of this company. But it is so small, with revenues now averaging about $38 million annually, that just one good outcome of any of its many things in development would be an absolute game changer for the company. I would like to have shares in this company at that time.

The other, larger drug company that occupies some of Frost's attention is, of course, Teva. This mostly generic maker of pharmaceutical products is a big time player with a market capitalization of about $36 billion. It recently acquired from Denmark's Neurosearch an experimental medication to treat symptoms of Huntington Disease. This is part of Teva's previously announced strategy to expand beyond its position as the world's leading seller of generic medications, into higher margined and high risk proprietary medications. The ultimate goal is to boost Teva's operating and profit margins, currently at 24% and 16%, respectively, closer to those of Pfizer (NYSE: PFE) at 30% and 16%, and GlaxoSmithkline (GSK) (31% and 19%).

Teva's revenue for the second quarter of 2012 of $4.994 billion was up 19% from the second quarter of 2011, and adjusted earnings of $1.12 billion, or $0.99 per share, were up by 14% from the second quarter of last year.

Analysts see five-year income growth at Teva averaging about 8%, far higher than some of the larger domestic drug companies that are fighting the effects of expired blockbuster drug patents. Pfizer sees five-year growth, for instance, averaging about 2%. That higher growth rate for Teva drives its PEG down to a highly reasonable 0.99. I see Teva as one of the best plays in the global drug industry over the three to five year time frame.

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