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ValueInvestor7
ValueInvestor7
Articles (8) 

Why Opko Health Is a Better Investment Than Apple

December 02, 2014 | About:

Venture capitalists are the richest class of individuals in the world, and all of them follow one simple rule: only invest in companies with 10x potential. No mind how "safe" or "sure." If it cannot rally 10x, do not invest in it. Life is too short.

Indeed, 2% of venture capital investments returned 95% of venture capital profits in 2012. Venture capitalists understand that investing exclusively in 10x potential means that you can be wrong 9 times out of 10 – a ratio that proves true for most venture capitalists – and still break-even.

Apple Inc (NASDAQ:AAPL) cannot rally 10x. At $700 billion, Apple is simply too big. Returns will be incremental from here.

Opko Health (NASDAQ:OPK), on the other hand... a $3.6 billion company, Opko Health certainly has 10x potential. Just look at the difference in Wall Street analyst opinions between Apple and Opko Health.

  • The average analyst price target for Apple is 3.5% higher than today's price.
  • The average analyst price target for Opko Health is 43% higher than today's price.

As a baseline, I argue that investors should consider the odds of Apple becoming a $7 trillion – trillion! – company versus Opko Health becoming a $36 billion company.

Of course, odds are just the beginning. Next is leadership. Apple absent Steve Jobs is now a mega-corporation. Its CEO position is interchangeable with a primary mission of increasing market share of the iPhone and iPad. Again, this is incremental business with incremental outlooks. Even if Apple were to hit a home run in a new category like TV or wearables, its stock might – might! – return 10-20%. Remember that a 14% Apple rally equates to $100 billion dollars of market capitalization.

In contrast, Opko Health still retains its original founder, Dr. Phillip Frost, the self-made billionaire of Ivax (acquired by TEVA) and Key Pharmaceuticals (acquired by MRK). Although Steve Jobs was certainly one-of-a-kind, Dr. Frost is nevertheless responsible for

  • Delivering a 68-fold return and $7+ billion acquisition for his prior shareholders
  • Prior to that, leading a near-worthless company to an $826 million acqusition
  • Chairing Teva Pharmaceutical Industries (NYSE:TEVA), the world’s largest generic drugmaker
  • Funding the largest systematic insider buy program in stock market history

Background of Opko Health's CEO

In 1972, Dr. Frost and Michael Jaharis purchased a company on the brink of bankruptcy called Key Pharmaceuticals. Under their management, Key Pharmaceuticals grew to generate annual revenues of $150 million and, in 1986, Schering-Plough Corporation acquired the company for $826 million. A year later Dr. Frost founded IVAX, a company that would specialize in generic pharmaceutical manufacture. By 2006, the company had grown to sell its products across Europe and America. In 2006, Dr. Frost sold IVAX to TEVA Pharmaceuticals for an initially agreed $7.4 billion, which grew to almost $10 billion by the time the deal closed.

In 2007, Dr. Frost merged two companies, Acuity Pharmaceuticals and Froptix, to form Opko Health. In the six years since the merger, and despite much media and analytical criticism, Opko Health has grown to be worth more than $3.5 billion at today’s market valuation. Dr. Frost still owns one-third of Opko Health's equity.

Aside from his primary companies, Dr. Frost has also earned 10x on several personal investments during his lifetime, including Continucare, Whitman Education and North American Vaccine.

Third, the companies themselves

I hope you agree that (1) it is easier for Opko Health than Apple to rally 10x, and (2) Dr. Frost has a verifiable record of delivering 10x returns to his shareholders. For the third comparison, we should look at the potential of the companies themselves.
Apple is a consumer products company. 57% of its revenue comes from iPhone, 17% comes from iPad, and the rest is legacy computer and digital product revenue with negligible growth rates. In terms of the iPhone, Apple's smartphone market share is approximately 12%, about half of Samsung's share. In terms of the iPad, Apple's tablet market share is approximately 22%, dwarfed by Google's 68% share. It turns out that neither Apple's iPhone or iPad division is growing anywhere close to what would be needed for a 10x for shareholders. (A 1x rally would be astronomical given that most analysts hope for just 3.5%.)

In contrast, the vast majority of Opko Health's 220+ employees are in research and development, so additional revenue at Opko Health will come from brand-new sources, not incremental additions to existing products. Opko Health is best understood as a holding company, structurally similar to Warren Buffett (Trades, Portfolio)’s Berkshire Hathaway. In the meantime, Opko Health's burn rate and debt devels are minimal, and insider buying consistently tops the charts.

Opko Health is focused on diagnostics: notifying people of health problems before they have an emergency. It just launched 4Kscore a few months ago, the only blood test that accurately identifies risk for aggressive prostate cancer. 4Kscore is newly available in U.S. and European markets after more than a decade of development. Opko Health also owns diagnostics for ebola, vitamin D deficiency, Alzheimer’s and low testosterone. It dovetails these diagnostics with remedies, such as its vitamin D insuficiency drug Rayaldee that completed Phase III trials and is pursuing a New Drug Application with the FDA.

The addressable market of these diagnostics is enormous. There are 20 million U.S. residents with vitamin D deficiency, 10 million U.S. men with low testosterone, 5 million U.S. Alzheimer's victims and 3 million U.S. men with prostate cancer. The potential math with per-customer lifetime values of tens or hundreds of dollars would be transformative for a $3.5 billion company.

I should note that Dr. Frost has signed Bill and Melinda Gates' Giving Pledge, so I presume he will bequest divisions of Opko Health in trust to charity upon his death. This means that Opko Health could be quite literally a forever investment; all of Dr. Frost's shares would never be available for sale again. This is a concerning possibility for shorts who hold a 24% position against the company, especially as Dr. Frost nears the age of retirement and continues buying shares of Opko Health in the open market.

Conclusion

While Apple certainly can increase revenues by large dollar amounts, unfortunately even billions of additional revenue would deliver a tiny percentage return for shareholders. Analysts predict only incremental returns for Apple's stock in best-case scenarios. We must face the fact that Apple has long graduated from its startup phase into a predictable, mature, comfortable corporation.

In contrast, Opko Health has an energetic pipeline of R&D products that will add brand new revenue once launched. It maintains its original founder – now a billionaire with a proven history of delivering outsized returns to his shareholders – and independent analysts predict 11x greater percentage returns for Opko Health's stock than Apple's stock.
If you were a venture capitalist, would you invest in a late-stage consumer products company growing incrementally, or an innovative diagnostics company with 10x potential?


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