OPKO: AGONY AND ECSTASY? OR JUST AGONY?

“It seemed like a good idea at the time.”   

That is what several hundred, if not several thousand, Opko shareholders probably say to themselves every time they look at their stock portfolio and see poor pitiful Opko, once trading as high as $17, now clinging for life at $4. The share price has embarked on a steady downward spiral over the last two years, even as the Nasdaq has smashed records for performance and capital appreciation. It seems as if Dr Phillip Frost, who’s Midas touch turned Key Pharmaceutical and Ivax Pharmaceutical to gold for shareholders, just can’t get anything right. Has Dr. Frost’s golden touch finally turned to lead?  

Despite the gnashing of teeth, pulling of hair, and banging of heads against walls, the prudent shareholder will keep his cool and analyze the situation rather than just sell out of fear and disgust. In these cases, I like to revisit my original investment thesis, try to figure out what, exactly went wrong, how fundamental the problems are, and ask myself, “is there an opportunity in chaos, or just chaos in chaos?”  

So what attracted me to this stock to being with?  First, I thought that the company was addressing tough scientific problems that needed solutions. My time as a sales executive in the urology space left me with a keen understanding that current diagnostic practices around prostate cancer are woefully inadequate, which is a tragedy for many millions of patients, and a gargantuan financial opportunity for anyone with a solution. Opko’s 4K score test seemed to fit the bill. The more I learned about the company, the more I realized that targeting prostate cancer was no fluke; other Opko drug projects such as Rayaldee for kidney disease and MOD-6030, a novel solution for diabetes and weight control, all targeted big, unmet needs through scientific breakthroughs. Although the company’s pipeline may have seemed like an ungainly tangle of random science projects to casual observers, upon closer inspection there was clearly a master strategy in place.

A master strategy crafted by a master strategist. The second primary factor that attracted me to Opko was the unique ownership and leadership structure of the company. Dr Phillip Frost, the luminary founder of one of the world’s largest generic pharmaceutical companies, Ivax, had rounded up his posse for one last run at glory. He was working with many of the same team members who had transformed Ivax from a business plan into a business legend, and his total voting control of Opko’s shares meant that this tiny, money losing upstart had the full backing of a multi billionaire biopharmaceutical pioneer and icon. On a practical level, this support meant that the cash bleeding, unprofitable start up could never go broke, because the corporation’s worst cash incinerating moments were still just rounding errors to Dr Frost’s enormous personal net worth. I reasoned that, unlike most fragile biotechs involved in the risky business of innovation, Opko could not go broke as long as Dr Frost decided it shouldn’t go broke.

So, Opko had a promising pipeline of multiple “home run” type medical products, firm financial backing in the form of a legendary biotech billionaire,  and stock that had gone from $1.66 to $9 even before having a viable commercial product to sell. Surely the best was yet to come when I started buying shares at $9 in 2014. With so much going for the company, what could go wrong?  

What could go wrong?  In short, everything.

It started off well enough. The Opko story began to gain more and more traction in the media, as commentators and pundits began to realize that “The Ivax Cowboy Rides Again” was a compelling story. New York stock analysts started to get on board, realizing that the 4K score test could potentially profit from a huge unmet need in the urology community. The stock soared from $9 to an all time high of $17 in late 2015. With the stock flying high and pundits such as Jim Kramer fawning all over Dr. Frost on national TV, Opko made a bold move: using only its greatly appreciated stock as currency, tiny Opko, with less than $100 million in revenue and almost no products ready for prime time, bought Bioreference, America’s 3rd largest lab.  In one fell swoop, an unprofitable company with little revenue and few approved products swallowed a billion dollar business with hundreds of employees, millions of patients, and, most importantly, millions in real, positive cash flow. What a magic trick Dr Frost had pulled off! He had leveraged imaginary value (a soaring stock price but no actual cash flow) to purchase a real business with real income, all at once obtaining a national sales force, distribution facilities, and ongoing clients. Opko, the Pinocchio biotech, had finally been transformed into a real boy!

But it turned out that we were merely riding high on a wave that was about to crash. The first thing that went wrong was the failure of Opko’s growth hormone candidate in a phase II study. The agent failed to meet the study’s endpoint, which has not killed Opko’s growth hormone program, but dealt it a set back in terms of approvals and revenue producing products. The stock tumbled from the breathtaking heights from which it had ascended. The 4K Score Test, supposedly on the brink of wide adoption due to the recent acquisition of Bioreference salesforce, sputtered. There was no scientific failure, or blunder in front of the FDA. Physicians and payers just haven’t been as enthusiastic about the test as the Opko marketing team was. Well, if two products encountered setbacks, no fear! Opko’s robust pipeline meant that another potential blockbuster was just around the corner to convince the market that Opko could become another Amgen or Genentech……right?

Wrong. Rayaldee, the company’s much anticipated solution to Vitamin D deficiency in dialysis patients, has also struggled. Again, no problems with the FDA, no dramatic failures during clinical trials. In fact, clinical trial data has proven excellent. But the market of prescribing kidney doctors just hasn’t met the compound with open arms.

Well, if Opko has suffered several pipeline setbacks all at once, well, that happens sometimes, as biotech is a risky business. That is why Dr. Frost wisely used his formerly stellar stock price to buy a solid, established, cash flowing business like Bioreference. Surely Bioreference’s many years in business and established positive cash flow would help the more experimental arm of the company ride out a few failures, right?   Right??

Also wrong!   When Dr Frost bought Bioreference, he would be buying America’s third largest laboratory, but Opko’s number one problem!   It turns out being third in a commoditized market isn’t really such a great thing, after all. Think about it…..everybody loves Coke and Pepsi…..does anyone even remember RC Cola?   Apparently not, because Bioreference’s revenues and cash flows have shrunk every quarter that Opko has owned it, prompting several frantic reorganizations and leadership changes in just a few years.

So, once flying high where only angels dare to tread, Opko’s share price has been relentlessly beaten down from $17 to $4 because the company is now displaying a range of symptoms that Wall Street Analysts love to hate

-Shrinking revenue and cash flows from Bioreference.

-Several failed trials on pipeline candidates

-Slow commercial starts on scientific products that have been introduced into the market

-An oddball ownership structure where by one shareholder controls voting rights (Dr Frost)

-No clear succession plan after Dr Frost’s demise

(he is now a lively but beleaguered Octogenarian)

-Never ending cash bleed, with diminishing cash resources

All Opko shareholders have spent the last year or more looking at the red stain on their brokerage statements and cringing. Should we just bite the bullet and sell at a loss? Could it go from $4 to $2, from $2 to $1?   

Let’s take a deep breath and go back to the original investment thesis;  strategic pipeline of scientific innovation married to deep pocketed, patient leadership.  Are we merely sailing through a hurricane, or is the ship going down altogether?

Let’s start with the first part of the thesis.  Dr. Frost’s pipeline, an innovative collection of potential solutions to big problems,  is down, not out.

-The growth hormone program has faced setbacks, but phase II and phase III studies continue with an eye towards product launch.

-Rayaldee has experience a much slower start that we hoped for, but there are signs that the agent is beginning to gain traction. In its report for Q1, 2018, the company reported that Rayaldee sales were up 730% year over year, and 38% quarter over quarter.

-The 4K score test has faced setbacks on everything from testing volumes to payor acceptance, but the test continues to have solid scientific data behind it.

-Development continues with at least three different drug candidates in the phase II testing. Each candidate targets novel methods of treating big problems (diabetes/obesity, enlarged prostate, point of care testing)

-The situation with Bioreference is bad, but not THAT bad. The market believed that Opko was worth $17 per share BEFORE it ever purchased Bioreference, and now the market values Opko at just $4 per share…..that would imply that Wall Street believes that, not only is America’s third largest lab worth $0, but actually is a value destroyer to the tune of several billion dollars. Does it really make sense to believe that all of those millions of patients, expensive laboratory equipment, and national sales force is really worth NEGATIVE billions of dollars?

Now let’s examine the second part of the original investment thesis……the commitment, support and voting control of a multi billionaire pharmaceutical legend means that Opko can never go broke.  It is true, that the company’s current financial situation would look precarious under any other situation. Opko incinerated $95 million in cash for 2017, and as of March, 2018 had only $100 million in cash on the books. The stock price has crashed, making an equity sale tough, and due to the many commercial setbacks listed above, there is little chance of rapid improvements in revenue. But Opko isn’t just any biotech… Opko is the only child of a man with a net worth estimated to be somewhere in the $5,000,000,000 range. So, if Opko burned $100 million in cash each year, it’s controlling shareholder could only afford to fund it for 50 years….

In the end analysis, Opko cannot go broke until Dr. Frost throws in the towel. The entire “fight or flight” shareholding decision comes down to the following question……Do we trust in Dr. Frost’s commitment?  Even as he ages through his 8th decade, will he continue to captain his ship through the current hurricane of misfortune, or will he simply shrug, wash his hands of this late career failure, and go play shuffleboard with the other men his age?   

Let me share an experience that I had that makes me believe we should hold on and continue to have faith in the good Dr.  As a resident of South Florida, where Opko is based, I have had the opportunity to personally attend shareholder meetings for several years in a row. Remember, these are shareholder meeting where every vote, every proxy motion, is already determined because Dr. Frost controls the majority of votes.  This 80+ year old man could essentially arrange to have the conference with himself and the voting results would be the same every time. At the least, he could hire a vice president to deal with the ritualistic aspects of annual meetings, while he himself sailed around the Caribbean or whatever billionaires are supposed to be doing.

But Dr. Frost didn’t do either of those things. The meeting was held not in a sumptuous corporate palace befitting a pharmaceutical titan, but in the undecorated, threadbare cafeteria of the Ivax pharmaceuticals building, presumably because it was the cheapest place where shareholders could gather.  We sipped coffee and watched and 80 year old mogul lead a powerpoint presentation with the same grit, determination and sheer enthusiasm that he must have displayed when founding Key Pharmaceuticals all those decades ago. After the powerpoint and presentations from several vice presidents, we sipped costco coffee out of styrofoam cups while Dr. Frost patiently answered questions from his fellow shareholders, providing the same polite and engaged answers to each question, whether the shareholder had invested $5,000,000 or $5.  This would not be much different from Donald Trump showing up at the condo board meeting of Trump Tower and dealing with the often nonsensical inquiries of his most unmedicated residents. As if this wasn’t enough, Dr Frost stuck around after the presentation, personally shaking hands and answering one on one investor questions. Did Steve Jobs do that?

To me, these don’t seem like the actions of an old man ready to live with defeat. Dr. Frost has no children; his legacy is Opko. As long as the old man continues to fight, I will fight with him.