CEPHALON’S TRILLION DOLLAR SHORT SQUEEZE

Heard of mesenchymal precursor cellsCephalon will soon be bringing this miracle drug to a medicine cabinet near you.  MPCs are adult stem cells that secrete cytokines which encourage neighboring cell growth, repair and revascularization.  They hold the cure to several widespread diseases including heart disease, diabetes, bone/cartilage fracture, macular degeneration and others.

Phase II results just published in Nature [2] showed that Cephalon’s MPCs, branded Revascor, reduced MACE (Major Adverse Cardiac Events: chest pain, heart attack, death, etc) by 84%, virtually curing heart disease with a single injection. Current heart drugs get prescribed if they can reduce MACE by 5%. While two of the 15 untreated control patients died during the study (13%), not a single one of the 45 treated patients died and there were no adverse side-effects reported. While the study size was only 60 people, these results are 99.5% statistically significant and similar results have been demonstrated in animal studies [1]. Unlike embryonic stem cells, MPCs pose no ethical issues are widely believed to have no tumor or cancer risk.

With over 300 million present and 30 million new patients suffering and dying from these diseases each year, at $10K per pop, many trillions of dollars are up for grabs. Unproven stem cell treatments in India and China go for upwards of $20-30K. Cephalon is years ahead of any regulated treatment undergoing FDA trials and is leading the new wave of “biological drugs”.  Production costs are tiny, making margins tremendous, yet these drugs are potentially more difficult for competitors to reverse engineer and copy. Cephalon has the ambitions, channels and expertise to put “off-the-shelf” MPCs on hand at every single hospital in the world. Many tried and failed, but Cephalon is the first to get MPCs working in humans and Cephalon owns the patents.  The other traditional pharma companies are scrambling to catch up.

Revascor is already approved in Australia and US approval will come as early as 2012 [13]. Strong balance sheet, cash flow, diversification, pipeline and trillion dollar potential of Revascor makes CEPH worth upwards of $150/share.

Now is the time to buy Cephalon stock.  Here’s why:

1. Not a penny of the PII results (publicly released 1/10/2011) has been priced in.  Just look at the chart and P/E ratio if you don’t believe this.  Cephalon has a forward P/E under 10.

2. Cephalon released surprise earnings on 2/10/2011.  They beat EPS projections by 25 cents and raised 2011 sales and EPS projections. They increased revenues and were even able to increase drug prices.  [8]

3. Cephalon has the highest short interest of any stock in the S&P 500. As of 2/15/2011, there are 14 million shares short which will take 15 days to cover at average trading volume. This is an insane 26.5% of the outstanding float. [3,4]

4. Institutional ownership is at 122%.  Where do the shorts expect to find shares? The $800M of 2015 notes may be converted whenever the share price is above $56.04.  Even so, this will release only 800,000 * 20 * (p – 50) / p shares where p is the 20-day VWAP following the date of conversion; the rest is delivered as cash.  At a VWAP of $60, this results in only 2.7 million new shares. The $500M of 2014 notes only convert above $89.70, so will not help the shorts find shares.  [15,17,18]

5. The average analyst price target is $69.55. [16]

6. Cephalon has a highly diversified income stream from several drugs including Provigil/Nuvigil, Treanda, Fentora, Myocet and others.  They have a pipeline of over 25 drugs at various stages, many of which carry relatively low risk of failure [22].

7. Cephalon has a solid balance sheet and is net positive cash. It has the highest free cash flow per share of any public biotech company [14].

Quite suspiciously, a few analysts lowered price targets after the earnings release. Piper Jaffray had reiterated an $84 price target on 12/2/2010 already factoring in major revenue loss from coming generics competition [11]. This was prior to the Revascor PII announcement. A mere two months later, after earnings which surprised to the upside, they lowered by over 30%! The only half-credible reason given is that sales, general & administrative costs may be increasing from organic company growth. This is nonsense, in my opinion, as these costs are aimed directly at generating near-term increases in net income.  More likely, they are the ones who shorted the 14 million shares and were caught off guard by the upside surprise and the startling release of the Revascor results.  Goldman Sachs and Morningstar reaffirmed $68 and $73 targets [12].

“We have gained Australian Therapeutic Goods Administration (TGA) regulatory approval to use our cells on a patient-specific basis that will deliver earlier revenues.” [1]

“This is the first culture-expanded adult stem cell product to receive manufacturing approval anywhere in the world.” [1]

“The stunning [Phase II] stem cell data in CHF [congestive heart failure] came at an opportune time. . . . The seemingly expensive deal CEPH announced with Mesoblast in December makes more sense now that it has revealed Phase II data with stem cells for heart failure. The exceptional effect size appears to evoke images of Ponce de Leon’s fountain of youth by growing healthy new heart cells.” [7]

Financial Disclosure: I am long Cephalon.  Pick up your own shares and then help spread the word.  Revascor’s arrival will not just save our portfolios, but save millions of lives on the verge of being lost. The more people who know about this technology the sooner it will become available.  Not soon enough.

[1] Mesoblast Shareholder Presentation on MPCs bit.ly/fPbB2k
[2] Nature article bit.ly/dOKTwt
[3] Most Heavily Shorted Stocks in the S&P 500 http://bit.ly/f1UdpY, http://bit.ly/h0rtlA
[4] Latest & Historical Short Interest for CEPH http://aol.it/eegCYt
[5] Analyst Report on Mesoblast bit.ly/eiSoAX
[6] mesoblast.com
[7] CEO on Revascor bit.ly/fXCTdQ
[8] Cephalon Reported Record Sales, Adj Net Inc and Cash From Ops bit.ly/e2GdyC
[9] Cephalon profit tops Street; boosts 2011 outlook reut.rs/e3lkpN
[10] Cephalon Beats Street, Own Guidance on EPS, Net Income bit.ly/gp2Oby
[11] Jaffray $84 bit.ly/eLdHfv
[12] Goldman $68 bit.ly/gjULEn
[13] Mesoblast plans to sell first product by 2012 http://bloom.bg/aXVOFu
[14] Companies with highest FCF/share http://bit.ly/gA0X6E
[15] 123% institutional ownership http://yhoo.it/dMdxwq
[16] Avg Analyst Price Target for CEPH http://bit.ly/dFI0Dj
[17] Debt & Credit Rating Commentary for CEPH http://bit.ly/f2oGfS
[18] Convertible Debt Filings http://bit.ly/i5IznP, http://bit.ly/dRTuZx, http://bit.ly/fjV5Dm
[19] Interview: Mesoblast’s Cephalon deal was late CEO’s vision http://reut.rs/gwVRI0
[20] Mesoblast stock listing on Australian Stock Exchange http://bit.ly/6aQPB1
[21] Cephalon Q4 2010 Earnings Call Transcript http://bit.ly/fq4tPL
[22] Cephalon’s Pipeline http://www.cephalon.com/our-science/pipeline.html


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Market analysis and research.
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