Most biotech and specialty pharmaceutical companies have to spend millions of dollars and often a decade or more to discover, develop, test, and, eventually, to market new drugs and medical treatments to patients and doctors. It's a long, expensive, and ultimately very risky process, and it's what makes investing in development-stage drug companies such a gamble.
Of course, once on the market, drugs are a very high-profit business, but few people realize how brutal the odds are against most startup drug companies making it that far. But what if a company could somehow just skip the development and clinical testing stage, and get right to the business of marketing approved drugs -- now that would be an attractive business, right?
One such company that popped up on our Small Cap Foolish 8 list a couple of years ago, King Pharmaceuticals (NYSE: KG), has been an amazing performer and now sports a market cap in the neighborhood of $10 billion. King has accomplished this outstanding growth by acquiring neglected pharmaceutical products from the shelves of the big drug companies at bargain prices, and then marketing the heck out of them. With that $10 billion market cap, King is certainly no longer an undiscovered small cap, but there is a company on the current Foolish 8 list that is following the same road map to growth: Bradley Pharmaceuticals (Nasdaq: BPRX).
Like King, Bradley specializes in acquiring products from major drug companies that are too small or unprofitable to justify the efforts of the big players, and then to market them effectively to increase sales and profits. Since the company's founding in 1985, Bradley has acquired 16 products from Big Pharma. These products treat symptoms that won't be making the major medical headlines -- acne, foot fungus, warts, and dandruff may not make big drug company executives tremble with greed, but they helped Bradley Pharmaceuticals stock increase in value by more than 1,000% in 2001 alone.
Bradley acquires these ugly-duckling products from other drug companies and builds promotions around them, using clever slogans, creative marketing techniques, and a ton of hustle to get the attention of dermatologists and other specialists who prescribe them. These are usually slightly older products, and they are therefore on the lower end of the prescription price spectrum. This means that doctors are less hesitant to prescribe them, and patients don't mind giving them a try. Importantly, though, the company does have patents protecting their major products.
By far the best feature of the company's business model, however, is that the hefty research and development expenses that characterize most pharmaceutical companies aren't present on Bradley's income statement -- in fact, there isn't even a line item for R&D on the company's financial statements! Also of critical importance in evaluating a company like Bradley is that the biggest risk of most small-cap drug and biotech stocks isn't present -- namely, the failure of the company to gain FDA approval for its products. Since Bradley and the other drug acquisition specialists usually purchase only approved products, this risk is essentially nonexistent.
Of course, since these companies don't possess a core competency in drug discovery or development, they had better be darn good at the bread-and-butter of the business, which is marketing and distributing their products to doctors, healthcare providers, and in many cases, consumers. In the case of Bradley Pharmaceuticals, the company markets niche medical treatments to doctors through its two subsidiaries, Doak Dermatologics and Kenwood Therapeutics. Doak sells mostly skin care products, while Kenwood targets products for respiratory and digestive ailments. In 2001, Doak accounted for approximately 60% of total revenues, while Kenwood accounted for the other 40%.
Bradley's biggest seller is Doak's Carmol line of urea-based skin moisturizing lotions and creams for the treatment of dry skin, as well as shampoo for the treatment of dry scalp and dandruff. Sales of Carmol products have grown from right around the million dollar mark to about $11.7 million in 2001, making up nearly 45% of total sales. Bradley acquired Carmol from Swiss drug giant Hoffmann-LaRoche back in 1994.
Another Bradley success story has been Kenwood's Pamine prescription product for digestive discomfort caused by hypermotility (increased muscular activity in the GI tract). With Bradley's strong sales efforts, Pamine sales have increased from less than $400,000 in 1998 to almost $5 million in 2001. Pamine was acquired from Pharmacia (NYSE: PHA), also in 1994.
These two products are evidence of the success of Bradley's "acquire, enhance, and grow" mantra -- the company looks to acquire what for another company is a non-strategic product, and then enhance the product through improvements in the formula and more attractive packaging, and then grow it by adding line extensions and getting the word out via the company's dedicated sales force, presence at medical conventions, and spending marketing dollars in other ways to get the product in front of prescribing doctors.
Sales have been growing strongly, from $12.6 million in 1996 to $25.7 million in 2001. The most recent year's sales increased 38%, and the company turned in a net profit of $3.6 million, or $0.37 per share. Management also recently upped its guidance for 2002 to $34.1-$35.9 million in sales and earnings per share in the range of $0.55-$0.58, or 33% growth in sales and almost 50% growth in net income.
Bradley's stock rocketed ever higher throughout 2001 and into 2002, hitting an all-time high in February of $24 per share only to drop back on disappointment that the fourth-quarter results and management's guidance, as strong as they were, weren't even better. This is a problem with buying small, fast-growing companies at nosebleed P/E ratios -- inevitably, there are virtually impossible expectations priced into the stock. The best course is often to wait until the momentum traders and growth mavens jump ship, which usually comes at the first failure of the company to meet their inflated expectations.
Now that Bradley's stock has dropped back to under $12 a share, it's starting to get interesting for investors looking for growth at a reasonable price. The company still trades at about 33 times trailing earnings, and even with the aggressive estimates guidance provided by company CEO Daniel Glassman of $0.55 to $0.58 per share in 2002, the company trades at a forward P/E of 22. Free cash flow has been better than reported earnings, and the company generated $7.9 million in FCF during the 12 months ending in September of 2001 (the cash flow statement for the fourth quarter is not yet available). If sustainable, this would put the company's valuation at somewhere around 13 times its free cash flow. If Bradley can continue to acquire, enhance, and grow its top and bottom line, that's not at an unreasonable price.
Until recently, Zeke Ashton did not know that such a thing as urea-based shampoo existed. At press time, Zeke did not own shares of Bradley Pharmaceuticals or any other company mentioned in this article. The Motley Fool has a disclosure policy.
