OptiBiotix Health - High Risk, High Reward?

http://www.optibiotix.com/

Analysing and placing valuations on pharmaceutical and biotechnology companies (BioPharmas) are particularly difficult given that industry knowledge or an appreciation of the potential is usually required - it is for that reason that I have tended to steer clear of these companies. However, OptiBiotix meets my current criteria of not relying on market movements to generate upside, plus there is a relatively simple investment case to understand given the micro market capitalisation. Although the company has far from perfect fundamentals, this is a high risk case where market sentiment is likely to drive upside regardless - a situation similar to that with Mosman Oil & Gas (LSE:MSMN) before they embarked on their drilling campaign. There are a number of reasons why OptiBiotix has the potential to perform well heading into 2015.

Technicals


As is always the case of analysing newly listed companies, there is little price data to work off, so the usefulness of technical analysis is extremely limited. Therefore, it's worth looking at the shareholder register and how that is likely to impact upon the share price.

Before that, the rationale for a theoretically high risk play such as OptiBiotix is important. In fact, I would stress that it's not high risk in the sense that is will suffer financial difficulty, rather that the company is early stage hence there are a number of hurdles to overcome operationally before it's possible to confidently assign a valuation to the company. However, in practice it is unlikely to be high risk for the foreseeable future - the reasoning revolves around the low market capitalisation and how retail investors are willing to attribute significantly higher valuations that what may seem 'fair', based on potential alone. Therefore, market sentiment plays a significant role in companies like OptiBiotix, and I drew upon Mosman Oil & Gas as an example of how upcoming news was likely to generate 'low risk' (in practice) upside. That did turn out to be the case as the market started paying up front for the potential that Mosman offered. This is only usually the case with micro-cap companies (x < £15m, but investor perception of this differs based on the sector), but there are numerous examples, and MX Oil (LSE:MXO) is a clear example of that.

That does mean that the underlying fundamentals of OptiBiotix do not necessarily justify a market capitalisation significantly higher than the current price, but the market is more interested in applying the 'potential premium', which it tends to do for micro/small cap BioPharmas, blue-sky technology stocks and natural resource stocks.

Therefore, the question is whether the risk is worth the reward; the risk that the market does not share the same viewpoint of the potential of the company such that you are left holding an illiquid stock. You have the option to take notice of the stock, knowing full well that the market's positive viewpoint could send the share price regardless, or avoid the stock on the premise that if it does rise higher very quickly, then it is likely to be fundamentally overvalued. In OptiBiotix's case, the risk is worth the reward, and it is highly likely in my view that the market's positive viewpoint will send the share price higher, when looking towards 2015. There is little reason to want to ignore the market in this instance and the spread makes this decision easier, given that it is often less than 5%.

Since I remain adverse to take up too many mid or large cap positions (such as Regenersis) until the market ends its consolidation pattern, OptiBiotix provides potentially high levels of upside without the general market risk, which is attractive currently. I would point out that holding stocks that are not fundamentally perfect (at higher prices) will only constitute a small part of the site portfolio (as mentioned with Mosman).

The company's shares are tightly held with almost 40% of the share capital held by directors and a fund headed by Non-Executive Mark Wyatt. That provides significant alignment with shareholders, although the grant of nine million shares as options with an exercise price of 8p leaves much to be admired.

Operations

OptiBiotix's AIM history began in early August when the firm reversed into investment company Ducat Ventures to obtain its AIM listing. Alongside the takeover was a share consolidation at 200:1 and gross £3.3m was placed at 8 pence for working capital; this equated to net proceeds of £2.8m. Ducat had such a low market capitalisation such that the placing shares amounted to over 90% of the total share capital, and whilst these stale holders may provide some initial selling pressure, it does mean that many holders are willing holders.

Before detailing the actual operations, one of the core attractions of OptiBiotix is the management team who bring a range of both commercial and scientific expertise to the company. With micro caps, this is core to an investment decision given their extensive roles within the company, thus it is ultimately their strategic decisions that determine long-term potential. Whilst CEO Stephen O'Hara and Non-Execs Mark Wyatt and Adam Reynolds all have highly credible backgrounds, it is Chairman David Evans' background and track record that is worth paying close attention to.

His track record is excellent, and obviously whilst not perfect, it provides significant reassurance to shareholders that material returns are not out of the realms of possibility. Here are some of his successful ventures:

- As CFO, listed Shield Diagnostics and then as CEO merged the company with Axis Biochemical to create Axis-Shield. He later resigned as Deputy CEO of Axis-Shield in November 2000 when the share price was over 500p versus the 90p IPO price
- Whilst involved with Sirigen, there was up to a 4x return
- Non-Exec Chairman of British Biocell, which listed at 47p in April 2004. British Biocell was taken over in December 2007 at a price of 185p.
- Non-Exec Chairman of Epistem which listed at 124p in April 2007. Reached as high as 582p in 2013 and is now around 300p
- Whilst involved with DXS, there was up to a 10x return
- Non-Exec Chairman of Immunodiagnostic Systems Holdings, which listed at 51p in late 2004. He stepped down in September 2011 when the share price was circa 1050p
- Non-Exec Chairman of Scancell Holdings which closed its first day of trading at an adjusted price of 8.55p. Currently circa 30.75p and reached as high as 60p

Of course, not all his ventures are successful, but these companies alone demonstrate that he has a knack of either creating considerable value for the companies that he works for, or he has a knack of working for companies with significant value potential. In any case, it bodes well, with some impressively high return multiples in past ventures. He is currently involved with several other early stage LSE listed companies: Venn Life Sciences (LSE:VENN), Premaitha (LSE:NIPT) and Collagen Solutions (LSE:COS).

Since potential is based on the products and technology that OptiBiotix has, it's reassuring that they are interesting and have a large target market.

Upon acquisition of the company, Adam Reynolds of Ducat commented, "With at least 2.8 million adults dying as a result of being overweight or obese, it is clear that weight related health problems are one the world's biggest public issues affecting both the developed and the developing world. We see a massive opportunity to address this market with our pipeline of products being developed to suppress appetites and reduce lipid and cholesterol levels. In addition, the development of novel non-digestible sugars is expected to have a huge impact on the healthy eating market place where major commercial partners are looking to find healthier sugar substitutes."

The operations can be broken down further. OptiBiotix has two areas of operation with patent-pending goods/services that are interlinked, and both relate to modifying microbiomes to generate health benefits. To put it simply, the human microbiome makes up 90% of the cells in or on the human body, and is thought to be important in determining how the body reacts to certain compounds. As a whole, the human microbiome is "described as ... one of the top 10 emerging technologies in 2014".

- Technology
There are two core pieces of trademarked technology. The first is Optiscreen which is a screening     and optimisation technology designed to identify useful microbes within the human microbiome (the aggregate of microbes). The second is OptiBiotic which is a proprietary platform that generates novel compounds and screens them for their ability to moderate the human microbiome. This technology allows them to create products.

- Products
Using the technology, the company has been able to create and research a number of products alongside Reading University and Holland-based Nizo Food Research. These products are to prevent or manage chronic/debilitating illnesses such as obesity and diabetes so the target market is potentially very large, which is good given the sheer number of BioPharma firms operating within the same space. 

The first product is involved with cholesterol and lip management; OptiBiotix has identified 3 microbial strains that have demonstrated the ability in lab studies to decrease cholesterol by 71%, 78% and 82% respectively. The next steps are complete independent clinical studies to establish safety and efficacy. The second product is "an ingredient formulation scientifically formulated to support and maintain weight loss", with the third product a compound that can selectively enhance the growth of specific microbial species. The touted products are cutting edge, but studies need to be done to confirm their effectiveness and safety - these will be the value creation events, as in the event of success investors can start to look at the market potential.

Commenting, Stephen O'Hara, Chief Executive, said: "The science behind the human microbiome, particularly how changes to the way microbes work in our bodies can impact our health, presents a huge opportunity for us to address many widely experienced diseases and a chance to significantly improve lives worldwide. We are at the frontline of research into using microbiome science to tackle weight related health problems and this move to AIM provides us with the support we need to advance our pipeline of products that support and sustain weight loss and reduce lipid and cholesterol levels."

The work to develop sugar substitutes is particularly interesting given that is a core focus of the industry; inroads have been made through partly substituting stevia (a zero-calorie sweetener) for sugar in some drinks, but taste issues have been noted and Coca-Cola removed stevia from their 'vitaminwater' after public backlash.

Although OptiBiotix could have opted to take the pharmaceutical route of development, they noted that this was high risk, high upfront cost and carried longer lead times than the food route. Consequently, they will look to release their first weight management product within six to nine months with the first clinical trials on the cholesterol product in January 2015 and set to last several weeks. Beyond that, the company will develop its own in-house capability and continue its research into microbes. The timescales provided by the company are shown in the table below.


Some progress has been made in this respect with a contract signed with Nizo to look at the three proprietary cholesterol lowering Lactobacillus strains; specifically, the manufacturability, gastrointestinal robustness and activity versus bile salts will be looked at. This process is noted to reduce the cost, time and development risk of potential future products such as cholesterol lowering yoghurts, fruit/vegetable juices and cereal bars.

Stephen O'Hara, CEO of OptiBiotix, commented: "Pre-clinical claims support is an important milestone in determining which of our three cholesterol reducing Lactobacillus strains is best suited for our first product, and is most likely to lead to a successful outcome in human studies. We expect this work to be completed by the end of 2014 so we can commence human studies in early 2015.  This is consistent with our core strategy of creating products with a solid science base validated by human studies allowing us to build a successful and sustainable business for our customers and shareholders. At OptiBiotix we believe that better science equals better health and we strive to ensure this becomes a reality."

Financials

Generating a valuation for OptiBiotix is not only incredibly difficult, but incredibly subjective given the potential aspect. Indeed, the actual acquisition cost that Ducat paid for OptiBiotix is not necessarily a good indicator for a medium-term market valuation. To illustrate the point, Ducat paid £2m in shares for the company that had minimal tangible assets upon acquisition; that could be low given the absence of cash on the balance sheet or could be high given the lack of tangible asset backing. It's all about the potential, and the fact that the acquisition was settled in shares suggests that upside potential remains.

Recall that OptiBiotix's market capitalisation is currently £6.75m. Pre-admission, Ducat had around £0.1m in cash and negligible other assets/liabilities. Net proceeds from the placing amounted to £2.8m, which gives a combined cash backing of £2.9m, albeit that £0.1m can probably be written off as expenditure since. Therefore, the enterprise value of OptiBiotix is £3.95m, which is already nearly double the £2m paid in shares. If you strip that £2m out, then essentially £1.95m of value has been added by the market; in other words, the market values OptiBiotix's potential at nearly double the level that Ducat paid.

Does that ultimately mean that upside is limited? Not in this case. The market is fond of companies with low enterprise values hence the £3.95m enterprise value of the company will attract a significant number of retail investors in itself. The cash balance is significant at 41% of the market capitalisation, and should remove the need for any near-term placing at these levels.

However, what really stands out is that BioPharmas have considerable value added potential as they develop their products and the market is willing to pay upfront for that. For example, two companies that have IPO'd in 2014 have already seen significant uplifts.

- Tiziana Life Sciences
A BioPharma focusing on cancer drugs that listed in April 2014 at a placing price of 12p. The share price has since advanced to hit intra-day highs of 75p and is currently 55.50p. That is despite the early stage nature of the company and their financial position. In addition, Tiziana's AIM listing was also born out of a reverse takeover of Alexander David Investments. Tiziana was valued at £7.5m under the reverse takeover yet the market capitalisation at 55.50p stands at £47m.

- 4D Pharmaceuticals
A BioPharma focusing on live biotherapeutics that listed in Q1 2014 at 100p. The share price is currently 332.5p implying a 233% value uplift, and 4D has in fact traded as high as 400p. As a result of placings undertaken, the share price does not tell the whole story either; the market capitalisation has risen from £36.6m to £171.5m to date.

This illustrates the significant potential that BioPharma stocks can hold and whilst there is zero direct translation, it reaffirms the theory that investors are willing to pay materially higher prices than what the company was acquired for. To further that point, it's interesting to check a sector filter to examine companies that trade within a similar market cap range (£0m -> £10m). Completing such a filter shows that, although there are medical equipment companies within the zone, there are surprisingly zero other companies trade within this bracket, with the 'least valuable' BioPharma having a low double digit market cap. That is crucial as it also reaffirms the likely attractiveness of OptiBiotix to some retail investors who will see value on a comparative basis. A market capitalisation of £10m would imply potential upside of 48%.

To re-state the point earlier, the current market cap is £6.75m, of which £2.8m is cash and £2.0m was the acquisition value during the reverse takeover. The low market capitalisation and strong cash balance combined with the products that OptiBiotix offers is likely to see investors drive a higher share price heading into Q1 2015, especially given the limited free float (although this is obviously a medium liquidity risk).

Addressing a Substantial Market Opportunity

There is no doubting that OptiBiotix's products will address a substantial market through initially focusing upon cholesterol and weight loss. After all, retrospective health care costs are high and obesity alone costs the UK between £6.6 billion and £7.4 billion every year. That alone does not justify a Buy tag, but whilst understanding that OptiBiotix is early stage, the strong management team and likely positive medium-term market reaction are sufficiently strong reasons to expect considerable upside as the company heads towards further studies in early 2015, and commercialisation of their first product. The cash balance represents a good buffer against further downside at present; it would not be unreasonable to see the market capitalisation pushed towards the £10m mark in due course hence an initial 15p target is sensible. The excellent track record of David Evans in particular is enough to be optimistic of the potential for value creation significantly above and beyond that figure taking a medium-term perspective and the low market cap relative to the target market in the event of positive operational progress or bullish market sentiment. I have therefore put a Buy tag on OptiBiotix at 9.375p, initially targeting 15p or 60% upside.

UPDATE (17/11/14) - OptiBiotix has exceeded the 15p initial target within 6 weeks; now the bid is at 16.50p. Whilst there is still potential for decent further upside from this level, the speed of the rise means that it may be better to exit at the current point in time. Investors with an appetite for greater risk may hold given the scope for appreciably higher share prices in the event of positive news.

4 comments:

  1. Your web site is always an interesting read. Thanks for your efforts. Is there a web site that you use for company news? I rely on google

    Sunderland1975

    ReplyDelete
    Replies
    1. Brilliant article :0)

      Sunderland have you checked www.investegate.co.uk?

      Delete
  2. Low value + low free float = success IMHO

    ReplyDelete