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Cornerstone Therapeutics Is Selling Itself Too Cheap
Posted by: Magic Diligence (IP Logged)
Date: October 8, 2013 07:25AM

Cornerstone Therapeutics (CRTX) is an interesting case right now in Magic Formula Investing (MFI). A little under a month ago, Cornerstone announced that it would be purchased by Chiesi Farmaceutici for $9.50/share. Since then, the stock has traded just under that number, and continues to trade there today.

So what? you may say. This one is done, mark it as such and move on to the next MFI stock. But maybe, just maybe, it isn't that simple. Let's at least look a little deeper.

After the merger announcement, Cornerstone's news feed was flooded with one legal investigation after another, alleging that the deal undervalues the company and is not in shareholder's best interests. So is there any merit to these allegations, and is there any possibility of a sweetened deal to add to what is already a few cents of upside?

Cornerstone is a pharmaceutical firm with five marketed products and another that should launch any day now (if it hasn't already). The lead product so far in 2013 has been ZYFLO, an orally ingested treatment for asthma. ZYFLO for the first 6 months generated 37.6% of Cornerstone's revenue, a healthy 26% growth over 2012. While demand for ZYFLO has been steady, patent expiration is this year, and it could see declines going forward.

The second product is CARDENE (nicardipine), an injected treatment for hypertension acquired in 2012from EKR Holdings. CARDENE generated 35.9% of sales for the first 6 months, and management commented last quarter that unit growth was good at 8%, and pricing was holding steady as well (down only 1% against 2012). While the nicardipine market is in slight decline, Cornerstone has done a good job taking share, CARDENE has been a high margin product, and patents extend into 2027.

Next is CUROSURF, 26.6% of sales, which is a lung surfactant used for treatment of Respiratory Distress Syndrome (RDS), in infants. CUROSURF grew at a 23% rate for the first 6 months of 2013.

In addition to these, the company just in the past few months has launched three new products. PERTZE treats exocrine pancreatic insufficiency (EPI), common in cystic fibrosis (CF) patients, has patent protection through 2017, and is expected to generate nearly $20 million in annual sales for Cornerstone. BETHKIS is another CF-related treatment (for Pseudomonas aeruginosa - PA), with patent protection through 2022, launching this month, with about the same sales potential. Finally, a generic version of Tussionex (an allergy treatment) is also expected to go to market this month (as of the last conference call).

Whew! For those keeping track, that is a lot of product activity, on top of a legacy lineup that is doing quite well recently. This is no longer the firm that struggled to pull a profit in 2011. Cornerstone now is operating in normal pharmaceutical margin territory, forecasting about 75% gross margins and a high-20% operating margin for 2013 and, presumably, 2014. With all of this new product activity, revenues could easily be up 40% over 2012, and another 25-30% next year. That's big time growth for a MFI stock!

Plugging in these assumptions to my valuation model, I think Cornerstone could potentially be a stock worth $13, which is way over the $9.50 buyout price. In fact, were it not for the buyout looming, Cornerstone would be a strong contender for a Top Buy recommendation.

So, put simply, MagicDiligence absolutely agrees with upset shareholders and the law firms crying foul on shareholder's behalf. But the key question is: is it likely anything will be done about it?

It is highly unlikely that a deal gets done around $13. That's over a 40% premium. Another bidder would have to come into the process, which is not unheard of but probably unlikely. Chiesi has a very strong hand here. The company already owns 64% of Cornerstone, and with CEO Craig Collard's 8% on top of that, 71% of the shares are automatically voted "yea" on the deal. We don't yet know when the shareholder's meeting will be on the deal (it will be after October 31), but it simply won't matter from a voting standpoint. Even a second bidder would have to convince Chiesi.

At $9.35, my take on Cornerstone is simple - it is an easy, fairly low risk call option on either a higher bid or an operating valuation, both of which I think provide meaningful upside. There are two potential negative scenarios. One is only slightly negative - a buyout is completed at $9.50, in which case you tie up cash for a 1.5% yield. The second is a bit worse. If the deal falls through and Chiesi begins unloading its stake in Cornerstone, the share price will undoubtedly decline substantially. However, even in this case, Cornerstone represents a growing, cash generating pharmaceutical firm, and should be attractive to investors or even another buyer willing to pay a fair price.

Stocks Discussed: CRTX,
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