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Biotech investment offers cash rich value plus investment: The StreetSignal Report

Danny Deadlock Danny Deadlock, TickerTrax
0 Comments| March 1, 2010

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U.S. Hospital study a very important (and unrecognized) catalyst for BioMS Success

Heading into 2009 we selected (through my microcap.com newsletter and on Stockhouse) only one biotech to follow for the year. That was YM Biosciences (TSX: T.YM, Stock Forum) in the 30s and 40s. We were fortunate to see the stock hit $2.40 within eight months forgains in the range of 500%.

Because biotechs require patience and are high risk, our strategy involved choosing a company that traded below its large cash position, with a well-controlled burn rate, and a market valuation that assigned zero value to the business itself.

A similar scenario may exist with BioMS (TSX: T.MS, Stock Forum) and all because investors are more focused on the past than they are on the future - and in typical fashion, the market on small stocks is usually wrong. Investors look at the trading ranges to tell them what the value should be, while often missing the underlying fundamentals. YM was a classic example along with several others we followed very successfully in 2009 using a "cash rich" approach.

BioMS

Shares Outstanding: 92 million
Estimated Cash: $35 million or 38 cents/share
Market value of investment in Spectral Diagnostics (TSX: T.SDI, Stock Forum) $15 million or 16 cents/share

MS was a high profile Canadian biotech story that lost 90% of its value in July 2009. The shares collapsed from $2.70 to 26 cents when its drug trial with Eli Lilly failed to meet expectations. This was a very unfortunate situation for existing shareholders and the company was instantly painted with a giant red flag by the Canadian investment community.

Unfortunate as it was... those are the risks of biotech investing. Potential for huge gains - but also high risk. That is why we always try to manage the risk first. And then consider the upside potential.

So while BioMS stock lumbers along with this giant monkey on its back, most everyone is forgetting one VERY important aspect to this story - this same management group put together one of the largest biotech licensing deals in Canadian history !

MS was criticized for its failure - but people forget they attracted huge investment from Elli Lilly and managed the entire process to accomplish that. These are clever people. In December 2007 BioMS and Eli Lilly announced that would enter into a licensing and development agreement that granted Lilly exclusive worldwide rights to BioMS's multiple sclerosis (MS) compound. BioMS received an upfront payment of US$87 million, with sales and development milestones of up to US$410 million if MBP8298 was successfully commercialized. By September 2008 BioMS had received a total of US$97 million from Eli Lilly.

People forget these facts, and instead choose to focus on the failure from July 2009. This deal was not negotiated because the senior management behind BioMS were incompetent or because pharma giant Eli Lilly didn't know how to perform due diligence and had nothing better to do with their billions. The drug did not perform as expected. Unfortunately this is the nature of biotech.

Investors painted BioMS as a failure, butthe drug compound was a failure, not the group that put together a giant licensing deal with a giant drugmaker. To think that any BioMS investor was capable of doing greater due diligence than Eli Lilly is utter nonsense.

So BioMS takes its public flogging, tucks away its remaining $50 or $60 million, and looks for the next deal to rebuild shareholder value. Many existing investors sold at huge losses and began the long road of rebuilding while the investment community as a whole (along with the media) viewed the entire episode as a giant failure and a blemish on the Canadian biotech scene.

Since the summer of 2009, many people have begun to recognize the potential value in BioMS, but the huge majority simply do what they did when YM Biosciences traded at almost half the value of its cash in the bank (which was well over $50 million). Investors look at the chart and follow what the rest of the herd are doing: nothing. They assume the market must be correct in their valuation so they ignore an opportunity directly under their nose.

BioMS may not amount to anything - that is the nature of biotech investing. However, take a moment to consider the following:

1) It has a management group that put together a huge licensing deal with one of the largest biotech companies in the world.

2) It trades at or near its cash value of more than $30 million - with a well controlled monthly burn rate.

3) It now owns a large percentage of another biotech that may have huge growth potential and that investment carries a value of ZERO by the market.

Sepsis


Feb 22, 2010

"The blood infection sepsis killed one-fifth of the patients who contracted it following surgery", Laxminarayan and his colleagues wrote in the Archives of Internal Medicine. The researchers looked at hospital discharge records from 69 million patients who stayed at U.S. hospitals between 1998 and 2006, and found that the patients who got sepsis after surgery stayed on average 11 days longer, at a cost of about $32,900 per patient.

The research study is one of the first to detail how the ever-worsening problem of hospital-acquired infections is adding to the spiralling costs of health care in the United States.

Sepsis is a complication of infection that kills thousands of North Americans each year. In the United States, pneumonia and sepsis cost $8 billion to treat and lead to 2.3 million total days of hospitalization. It is not unusual for a patient who lands in the hospital with severe sepsis to leave with at least $100,000 in medical bills. Twenty percent of these patients die.


In December 2008, BioMS invested $12 million to acquire up to 48% of Spectral Diagnostics which has exclusive U.S. rights to Toraymyxin, a therapeutic hemoprofusion device that removes endotoxin from the bloodstream. Toraymyxin has been used in more than 70,000 patients globally and has demonstrated in clinical trials that it safely and effectively removes endotoxin andreduces mortality in patients with severe sepsis.

This number may change slightly as originally BioMS was paying $12 million for 30 million shares plus warrants, but because the offering was oversubscribed, Spectral recently announced that total amount would be $19.5 million. I do not know if MS increased its investment.

Spectral is a little-known Canadian biotech that recently had no trouble raising this money to advance its Sepsis treatment through FDA trials. This is also the first company BioMS chose to invest with in an effort to rebuild shareholder value. Again, keep in mind this is the same management group that put together the Eli Lilly deal - contrary to what the market wants you to believe, these are not stupid people.

The timing of this investment - and the upcoming FDA application - could not have been better. The stock market did not recognize this report and the huge relevance to SDI, but it is extremely important and gives us an indication of the underlying value to BioMS. In particular, keep in mind that Toraymyxin (which SDI has exclusive U.S. rights to) has been used very successfully overseas in more than 70,000 Sepsis cases.

"TUESDAY, Feb. 23 (HealthDay News) -- Sepsis and pneumonia caused by hospital-acquired infections killed 48,000 people and led to $8.1 billion in increased health care costs in the United States in 2006, says a new study by a project called Extending the Cure." - Published February 22nd in the journal Annals of Internal Medicine.

Here is a link to one of the stories.

This U.S. study is similar to studies we saw in Canada during 2009. Of particular importance to BioMS and Spectral is the fact they are recognizing the huge burden this places on the health care system. Obama is focused on health care and Spectral (owned by MS) will be looking for FDA approval to start a critical drug trial by summer.

The potential for Spectral is unrecognized by the stock market but is significant as the market for a process treating sepsis is large (estimated at more than $1 billion annually). Typical for biotechs, it will require patience, but risk is dramatically reduced by holding MS because a person is ONLY paying for BioMS's remaining cash and the carried investment in Spectral Diagnostics is carried for NO cost.

Given the fact it has been used very successfully around the world in 70,000 cases, it will be hard for the FDA to deny an application to begin trials for the drug in the U.S.

Spectral's existing endotoxin activity assay (EAA) is the only FDA-cleared assay for the measurement of endotoxin in the bloodstream. With the growing awareness for the role of endotoxemia in sepsis, the EAA can be used to identify patients, enable therapeutics and monitor treatment. Spectral's big pay day would come with FDA approval of Toraymyxin.


Market & Economic Insight: From a list compiled over the past decade, we track 60 of the world's best money managers, market strategists, and economists. Weekly we will summarize the most relevant insight

The long-term floor for gold prices is likely to be $1,000 per ounce. Recent announcements of the International Monetary Fund's plans to sell 191.3 tonnes of gold bullion on the open market under the Central Bank Gold Agreement had put pressure on prices from perceived lack of demand. However, we believe the reaffirmation by the Federal Reserve that rates are likely to remain low for an extended period should be supportive of gold prices in the long term [Daniel Sacks, co-portfolio managers of the Investec Global Gold fund]

Lowry’s, one of the oldest technical analysis firms on the Street, notes that buying demand for stocks is now at its strongest levels since June 2009. Lowry’s believes the markets are in “the lowest risk period for new buying,” reaffirming the lengthy rally the markets have put together since hitting multiyear lows last March. In fact, with the current absence of typical market correction red flags (low buying demand and heavy selling pressure), it suggests that the market’s recent correction “has run its course and a new leg higher…has begun.”

One should not expect history to offer much optimism about a strong showing for the market in March [Sam Stovall, chief investment strategist at Standard & Poor's]

The huge and inflated bond market is a dangerous bubble. “The individual investor has been more or less abandoning stocks” and buying bond funds, Prechter says. “I think that is going from the frying pan into the fire. The bond market is the biggest bubble in the history of the world." [Robert Prechter of Elliott Wave International]

As the crisis has dragged on, as we reached the bottom of freefall and moved into the next stages, I have become increasingly concerned and pessimistic. The regulatory reforms are stalled. There are a lot of worries about debt reduction. The speculative attacks in Europe on Greece and Spain and the response of Europe to those speculative attacks are just very depressing. So, I guess at this juncture, I think there is a real risk of a very slow recovery at best [ Nobel Prize-winning economist Joseph Stiglitz].


Disclosure: Danny Deadlock owns 50,000 shares of BioMS acquired in the market between July and December of 2009.


To send a confidential email (tips, rumours, research) for consideration in the StreetSignal report, please visit www.StreetSignal.com or post directly to our moderated message board at: https://stockhouse.com/Groups/GroupInfo.aspx?g=50540


Danny Deadlock has specialized in microcap and smallcap companies for over 25 years and is a registered member of the Stockhouse community since 1997. You can find his website at www.MicroCap.com - a service which has specialized in TSX and TSX.V penny stocks since 1998. You can also email Danny at microcap@telus.net



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