Can This Diversified Health Care Company Justify Its Lofty Valuation?

Opko Health (NYSE: OPK  ) is a polarizing stock. Bulls believe the company's growing portfolio of smaller companies will eventually put it on the map as a serious drugmaker. Bears point out that Opko generates very little revenue and that its losses are ever widening.

However, Opko stock has risen more than 140% over the past 12 months, indicating that the bulls are firmly in control. Let's take a closer look at this company to see where it might be headed.

Opko's origins
Opko's health chairman and CEO, Dr. Phillip Frost, came from Teva Pharmaceutical (NYSE: TEVA  ) , where he still serves as the chairman of the board of directors. Frost was previously the CEO of IVAX, a manufacturer of generic pharmaceuticals, before it was acquired by Teva for $7.4 billion in 2006.

OPK Chart

Source: YCharts.

Frost founded Opko by merging together three smaller companies. In 2009, Opko started acquiring a series of smaller companies, including a Latin American distribution business that would account for the majority of its revenue until 2013. It also acquired the maker of a compact blood analyzer and gained the rights to an Alzheimer's diagnostic test. In 2012, Opko purchased more companies in Latin America, and expanded its reach to Spain, Canada, and Israel, where it acquired a maker of hepatitis B vaccine.

In August, Opko acquired Prolor Biotech, which has drug candidates for growth hormone deficiency, hemophilia, obesity, and diabetes.

Analyzing Opko's revenue streams
Making sense of all those acquisitions can be confusing, so let's dig deeper into Opko's second-quarter earnings report for a clearer understanding of how the company generates revenue.

Opko's revenue comes three main sources -- products (point-of-care products, nutritional products, pharmaceutical products, pharmaceutical ingredients, topical medication, and veterinary products), services (lab diagnostics), and acquisitions. Many of its products are sold in Latin America and the EU.

Revenue Source

Second-Quarter Revenue

Growth (YOY)

Percentage of Total Revenue

Products

$18.6 million

88%

78.2%

Services

$3.2 million

2,188%

13.4%

Transfer of intellectual property (acquisitions)

$2.0 million

1,252%

8.4%

Total revenue

$23.8 million

133%

100%

Sources: Opko quarterly report, author's calculations.

Although Opko's year-over-year revenue growth is impressive, remember that Opko currently has a market cap of $4.3 billion -- and it is trading at a whopping price-to-sales ratio of 47. This means that it needs to generate a lot more revenue to justify its current lofty valuation.

Unfortunately, the company's losses are widening, and its expenses are climbing. Last quarter, Opko's total expenses surged 114% year over year to $41.8 million, causing its net loss to nearly double to $18 million.

Measuring the growth potential of Opko's new projects
To reconcile its current valuation with its stock price, Opko needs much stronger sources of revenue than its existing products and services. The company currently has four leading products, which could generate more top line growth.

Product

Indication(s)

Status

Citicoline

memory disorders related to brain injury/stroke/disease

approved in Spain

Rayaldy/Rayaldi

secondary hyperparathyroidism, stage 3 or 4 chronic kidney disease, vitamin D insufficiency

50% enrollment in phase 3 trial

4Kscore

prostate cancer diagnosis

preparing for U.S. commercial launch

Rolapitant

chemotherapy-induced nausea and vomiting

phase 3 trial by Tesaro

Sources: Quarterly report, press releases.

To hint at citicoline's growth potential, Opko noted that sales of another citicoline product in Spain, Somazina, generated over $80 million in sales in 2012. The company also points out the citicoline enjoys strong sales across Latin America. However, Citicoline is an off-patent drug that is currently manufactured by 30 different companies, and hardly a breakthrough product that can produce guaranteed revenue.

Rolapitant is another product that should be scrutinized. Opko originally purchased the drug from Schering-Plough (now part of Merck (NYSE: MRK  ) ) in 2009 for $2 million in cash upfront.

Opko could have been required to pay up to $27 million more to Schering if various milestones were achieved. However, Opko held onto the drug for a year without doing any clinical research on it, then flipped the drug to Tesaro (NASDAQ: TSRO  ) for an upfront payment of $6 million and up to $115 million in royalty payments.

That series of deals has raised some concerns, since Tesaro is now valuing the drug at $121 million -- more than four times Opko's original deal with Schering. Moreover, rolapitant isn't addressing an unmet need -- there are already plenty of medications for chemotherapy-related nausea, such as Kytril, Zofran, Anzemet, and Aloxi. There are currently generic versions of Kytril and Zofran available, whereas Anzemet and Aloxi are manufactured by Sanofi and Helsinn Healthcare, respectively.

Rayaldy is Opko's brightest hope, since current methods of treating vitamin D deficiency in patients with kidney disease can cause severe side effects, such as the accumulation of calcium, which further damages the kidneys. Rayaldy was designed to avoid these side effects. Prolor Biotech President Shai Novik stated that if Rayaldy can capture just half of the market, it could achieve annual peak sales of $6 billion.

The 4KScore prostate cancer test could be another potential winner in the United States, which Opko claims could reduce the number of unnecessary biopsies by 50%. The test launched in Europe last year.

The Foolish takeaway
Despite these possible growth catalysts, the future of Opko Health is too unclear for investors to make an informed decision.

In Frost, Opko has a well-respected and capable leader. Opko's products and services are generating impressive year-over-year revenue growth. The company has at least two new products -- Rayaldy and 4Kscore -- which could become major pillars of growth.

However, Opko is also a Frankenstein's monster of various treatments, services, and products that don't necessarily complement each other. Opko must eventually find a way to reduce its expenses and narrow its losses. Meanwhile, some of Opko's new products, such as Citicoline and Rolapitant, simply aren't impressive considering the available generic alternatives.

Last but not least, the stock trades with a P/S ratio of 47, which suggests that its market valuation might not be sustainable.

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Read/Post Comments (5) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 22, 2013, at 5:36 PM, staypositive777 wrote:

    The timing of this article is impeccable after a large upswing. Comparing a startup to an established company like Teva is apples to oranges. Using the term Frankenstein may be ok for this time of year but remember OPKO has over 600 employees worldwide so the infastructure is there to bring to market the companies/products it acquires (Think Berkshire Hathaway). Dr. Frost has been wildly successful before and I am betting OPKO will be the crown jewel. As far as specifics, I urge you to digest these two articles, and there has been more acquisitions lately. I commend Dr. Frost for using his own money to invest in products that help people.

    http://www.globes.co.il/serveen/globes/docview.asp?did=10008...

    http://seekingalpha.com/article/1528352-opko-health-valuatio...

  • Report this Comment On October 22, 2013, at 6:21 PM, sgardinvestor wrote:

    Another poorly researched article. It is incorrect to compare drugs such as Kytril and Zofran, both serotonin 5-HT3 antagonists to Rolapitant, a NK-1 antagonist. The current cancer institute guidelines recommend that cancer patients receive a combination of 5-HT3 antagonist, dexamethosone and a NK-1 antagonist. Each of these substances work in different ways; 5-HT3 antagonists are most effective during the first 24 hours after chemotherapy is administered while NK-1’s are meant for the delayed phase, two to five days after therapy when most vomiting and nausea problems occur.

    Rolapitant’s NK-1 competitor is Merk’s Emend, available since 2003. What differentiates Rolapitant from Emend is its much longer half-life and lack of drug interactions. Emend can cause other drugs to be over or under-metabolised. Perhaps this is why Emend is only administered 20% of the time instead of 100% as the guidelines recommend.

    Additionally, the major market for Rolapitant will be in its IV formulation which is 80% of the CINV market. Rolapitant will also compete against another new NK-1 formulation, Netupitant from Helsinn which is expected to reach the market late next year. But Netupitant will be in oral form only and an IV formulation is years away. TESARO (Opko outsourced Rolapitant to them but will receive royalties) has already begun clinical trials for the IV formulation of Rolapitant.

    There are many other promising diagnostics and drugs in Opko’s very rich pipeline. I don’t understand why you call it a “Frankenstein’s monster of various treatments, services and products that don’t necessarily complement each other.” Within a few years many diagnostic tests will be available via Opko’s Point-of-Care system including the 4KScore test for prostate cancer and vitamin D deficiency test which Rayaldy treats. Additionally, Opko is building a worldwide distribution network for its products. While it’s true Opko has many different initiatives in its pipeline and a few may not work out, most probably will. If you wait to invest in Opko until all diagnostics and drugs are commercially available worldwide you’ll have missed a great deal of the alpha potential this stock offers.

  • Report this Comment On October 22, 2013, at 6:52 PM, Paulson545 wrote:

    OPK may not be done growing. There are several other companies Dr Frost is involved with that have been rumored to be take over targets of OPK. SFES-BZNE-MSLP to name three...Biozone Medical tends to trade up or down with OPK....jmhi

  • Report this Comment On October 22, 2013, at 7:08 PM, vix1830 wrote:

    A very poorly researched piece. There are 40+ million shares short in OPK so I would have to assume this is intended to aid that position.

    GOOGLE SEARCH THESE WORDS!

    Large study to examine if vitamin D prevents diabetes

    NIH-funded research tests much-touted vitamin in people with prediabetes

    ALSO- look up Dr. John Cannell - "Three weeks ago, I invested all my available funds in OPKO Health Inc. (OPK). I did that when I learned about its new vitamin D drug, Rayaldy." "In my opinion, sales of Rayaldy-like drugs will eventually easily outstrip the sales of corticosteroids."

    Rayaldy, is the first and only modified-release formulation of calcifediol, protected by newly issued patents (see, for example, US Patent No. 8,361,488). It is currently in phase 3 trials

    Vitamin D is metabolized to calcitriol in two steps via a more active prohormone intermediate known as calcifediol, the circulating form of vitamin D. Like corticosteroids and other steroid hormones, calcitriol directly regulates hundreds if not thousands of human genes. In calcitriol's case, those genes are involved with the repair and maintenance of the human body. It is crucial to realize that steroid hormones have as many mechanisms of action in various diseases as genes they regulate.

    Science has discovered much about vitamin D in the last ten years, almost all of it promising. If they know anything about vitamin D, most people think of it as something that may protect against various diseases. Indeed, the evidence is so strong for prevention of disease, four large and very expensive phase 3 trials are currently underway around the world to see if vitamin D prevents common diseases like cancer and heart disease. The largest of these trials is the VITAL study at Harvard where scientists are conducting a randomized controlled trial of vitamin D in 20,000 Americans. Obviously, these large studies would never have been funded unless solid reasons exist indicating these vitamin D trials will be positive. For more on vitamin D, go to Harvard School of Public Health's website on vitamin D.

  • Report this Comment On October 25, 2013, at 10:31 AM, mpr120001 wrote:

    You article is so full of BS and it is time to report you to the SEC for manipulation. The new SEC commander hired 985 new agents to go after people like you that may provide bogus info to manipulate an stock -

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