I’ve been content sitting on the sidelines with the positions in my portfolio, so I’m not pressed to spend cash for the sake of spending cash. Seemingly each day that passes the market rises higher and higher, and the bargain bits and pieces are being steadily sucked up in the vacuum that is ‘animal spirits’, among other things. Once again, this isn’t an excuse, only an observation of the underlying market conditions. There is still value to be found if one presses hard enough. Oddly enough, I can’t seem to get away from biotech whenever I start digging for bargains. I am not sure if it is how biotech companies value the assets on their books or what not, but this is where I’m finding the most value. Unfortunately there is so much left to be determined on Capitol Hill that many of these smaller companies are left in limbo when it comes to decision making. Not having a consistent tax code in place, nor even knowing what the next healthcare system will look like plague the companies and those who seek to invest. One such company is Alcobra Pharma, or ADHD (clever ticker, right?). ADHD is a classic NCAV discount play trading at a 30% discount to its NCAV. Usually I would like that discount to be at least 50%, but I think ADHD is developing something that could be a strong catalyst in its market. Before we get into the catalyst, it’s important to take a look at the fundamentals of this company.
Starting with the Ratios to give a general overview, ADHD presents discounted value. The company has no debt and an Altman Z – Score of 5.07 signifying safety (for the record I am still not exactly sure on the validity of the Altman Z – Score, so I am going to include it in my analyses for a duration of time so that I can go back and check as a reference). ADHD sports a PB Ratio of 0.72, presenting a near 30% discount to book value. Price to Net Cash is 2.25, making it better than 85% of the companies in its industry. We already talked about the Price to NCAV being 30% discount to current share price.
Profitability & Growth
ADHD lost money each year since its inception, which to its credit, is the story for most biotech companies. Due to that, I place more importance on the trend of the earnings, and the scope of revenues, income, cash an debt over the course of the companies history. Since 2012, the trend in net income is disappointing. ADHD lost $1.58MM in 2012, but has delivered years of $-32MM, -$19MM, and -$24.6MM going back the last three years.
Cash positions show an inverse of net income for the company. ADHD held $0.66MM in cash in 2012, then in 2013 skyrocketed to $50.1MM in cash (mainly though stock issuances). The company plummeted their cash reserves in 2014, turning in $2.18MM. However, the brightest spot in this company is there increased cash position over the last two years, turning in $16MM and $17MM respectively. Looking at the financials, it appears that 2014 were the ‘dark days’ for the company financially. Between 2012 – 2014, the cash burn was excessive, and the net income loss was drastic. However, the company appears to be turning it around and not only slowing the burning of their cash, but increasing their cash sizes. The trend is similar for Free Cash Flow and Operating Cash Flow, with tremendous negative numbers in 2014, followed by an upward trend over the course of the last two years.
The Problem with Overdose in CNS Stimulants
Alcobra intrigued me because they are developing a drug to help with ADHD, yes, but it is less the drug they’re developing and more so the modalities of the drugs themselves, and how those modalities prevent overdose and abuse.
Alcobra released a corporate presentation that presents an interesting look at overdose in CNS stimulating drugs (think Adderall). One of the slides documents the different methods of overdose between Swallow, Snorting, and Other. For college – aged people, Swallowing accounted for 55% of overdoses, Snorting accounted for 40%, with 4% being Other. Interesting to note is that for Adult – aged individuals, Swallowing was the method of choice for 74% of those who chose to overdose.
When it comes to type of stimulant, overdosers seems to have a preferred choice: Short Acting. An Illicit Use Survey in ADHD Clinic of 545 people showed that 80% of those in the ADHD clinic have abused / or are abusing Short Acting stimulants, compared to 17% choosing the Long Acting stimulants. This is an issue because Short Acting IR Amphetamines are the fastest growing part of the ADHD drug market.
Why I’m Attracted to Alcobra
The company hasn’t proved to its shareholders that it has the ability to generate positive net income, so I’m not optimistic about the profitability of the company in terms of revenue generation, I am more interested in their cash position and their developments, which make them, in my eyes, a prime buyout target for larger corporations.
ADHD is focused on producing drugs that are unable to be overdosed one. I know, it sounds strange because in my head I thought, “if someone wants to OD, they’re going to find a way to OD.” Yet through their research they developed an oral drug that a) can’t be crushed down and snorted and b) cannot be melted and injected. This technology is much more valuable than any drug they create.
Looking at the charts there’s been a tremendous amount of consolidation in a tight price channel (ranging from 1.26 – 1.12). These are the kind of price channels and consolidations I love to see, because any sharp movement upward gives my bullish mental model more probability of being correct. Remember, for me, it is all about Bayesian probability. I like to have various mental models and predictions of what might happen in the future, and then adjust the weighting of the probabilities to those events in accordance with new and useful information.
For an entry point, I would venture to say anything above the 1.20 – 1.27 mark. The reason being there is resistance at that 1.27 level and I would rather enter on a clear breakout than a potential breakout. It would save me money on commissions and sleep. Stop loss would be set at 1. As always, money management is crucial, and since I am still extremely wary of biotech stocks, I would be hesitant to risk anything over 75 bps on this trade. However, if the breakout is clear and momentum is on my side, what I might try is entering a small position on the breakout, and then try pyramiding up as the trade moves with me. I’ve never been a fan of pyramiding (that might be for another post), but I want to try it out and keep an open mind. Too many great investors have praised pyramiding for me to cast it off into the trash bin of investor waste.