Cabot Micro-Cap Insider Issue: June 14, 2023

Back to Biotech Land

If you’ve been a Cabot Micro-Cap Insider subscriber for the past year, you know that biotech has been a favorite hunting ground for me.

I will quickly rehash my thesis with a series of charts…

First, biotechs are in the middle of a three-year bear market, but it looks like the sector is showing signs of life.

As a result of the horrible performance, no generalists want to invest in the sector.

Thus, biotech valuations look very cheap.

This is best demonstrated by the below chart showing how many biotechs are trading below net cash on their balance sheets.

The good news is that large-cap pharma has enough cash to buy the entire small- and mid-cap biotech universe!

My preferred way to play this trend has been buying biotechs that are trading below their net cash levels in hopes of a liquidation.

And while I still think this is a good strategy, I’m doing something different with my latest recommendation.

This month’s new recommendation is well capitalized yet has an approved drug that is growing over 100% and is on pace to generate $500MM in sales in 2023.

The stock is dirt cheap.

Better yet, a two-year anniversary of its spin-off will pass in November 2023 which will open the door on a potential buyout.

Let me introduce you to 2seventy bio...

New Recommendation: 2seventy bio: Cheap Biotech Growing Revenue 100%+

Company: 2seventy bio
NYSE: TSVT
Price: 11.81
Market Cap: $611 million
Price Target: 30.00
Total Return Potential: 154%
Recommendation: Buy under 14.00
Recommendation Type: Rocket

Executive Summary

2seventy bio is a rare biotech. It is well funded with over $300MM of cash on its balance sheet and no debt, has a rapidly growing drug that could hit peak sales of $3BN, and features a dirt-cheap valuation. But I’m betting its cheap valuation won’t last for long. An obscure tax rule in the U.S. prevents tax-free spin-offs (2seventy bio was spun out of bluebird bio) from being acquired for two years. 2seventy bio’s two-year anniversary will pass in November 2023, and at that time, I expect M&A rumors to heat up.

Overview

Background

2seventy bio is a Cambridge, Massachusetts-based biotech company that was spun out of bluebird bio in November 2021.

It is well capitalized with over $300MM of cash on its balance sheet and owns a 50% interest in Abecma, which is approved to treat multiple myeloma.

Abecma is currently approved to treat patients with multiple myeloma who have undergone four previous therapies.

Abecma is a new class of drug called CAR T-cell therapies.

They work as follows:

“CAR T-cell therapy: A type of treatment in which a patient’s T cells (a type of immune cell) are changed in the laboratory so they will bind to cancer cells and kill them. Blood from a vein in the patient’s arm flows through a tube to an apheresis machine (not shown), which removes the white blood cells, including the T cells, and sends the rest of the blood back to the patient. Then, the gene for a special receptor called a chimeric antigen receptor (CAR) is inserted into the T cells in the laboratory. Millions of the CAR T cells are grown in the laboratory and then given to the patient by infusion. The CAR T cells are able to bind to an antigen on the cancer cells and kill them.”

Source: Cancer.gov

Abecma generated $297MM of U.S. revenue in 2022 and management expects 2023 U.S. revenue of $520MM (at the midpoint).

In December, the FDA will decide whether to approve that the drug can be used in multiple myeloma patients who have been treated with three previous therapies.

Approval is expected given that Abecma’s phase III trial indicated that patients treated with Abecma demonstrated a statistically significant improvement in progression-free survival (13.3 months vs. 4.4 months).

If the drug is approved for earlier use, the number of patients eligible to be treated with Abecma will increase by 400%, according to the company.

In addition to Abecma, 2seventy bio has a large pipeline.

While I don’t have deep insight into the quality of the pipeline, I’m encouraged that the company has already commercialized one blockbuster (Abecma) and partnerships with Bristol-Myers, Regeneron, and Novo Nordisk suggest high-quality R&D.

Outlook

At the current price, the pipeline beyond Abecma is a free call option.

The biggest driver for the company will be whether Abecma gets approved for use in earlier stages of treatment for multiple myeloma.

If it does, the growth outlook looks very large.

This chart does a nice job of illustrating how much of the market will be opened if the drug gets approved for earlier lines of treatment by the FDA in December.

We could see a billion-dollar drug by 2023 and a multi-billion-dollar drug by 2027.

Insider Ownership

As Cabot Micro-Cap Insider subscribers know, insider ownership is high on my checklist and is critical when investing in micro-caps.

In the case of 2seventy bio, insider ownership looks very low.

In total, insiders own just 2.6% of shares outstanding. I would like to see insider ownership significantly higher (I usually look for 10%+ ownership), but in this case, I think the low ownership could actually be a positive.

The company cannot be acquired until the two-year anniversary of its spin-off from bluebird bio in 2021.

That anniversary will be in November 2023. At that point, I think it’s likely that a strategic acquirer will attempt to buy the company.

Insiders’ low ownership will prevent their ability to block a hostile acquisition attempt.

Valuation and Price Target

2seventy bio is fairly easy to value because it has a rapidly growing commercial drug (Abecma).

The company has a profit-sharing agreement with Bristol-Myers (BMY) whereby it is entitled to 50% of profits generated from the sale of Abecma in the United States.

In the first quarter of 2023, Abecma generated $118MM of U.S. revenue, representing 26% growth over Q4 2022 and 111% growth over Q1 2022 revenue.

2sevento bio’s share of operating profit from Abecma was $23.0MM, or $18.1MM when subtracting its share of R&D expenses. $18.1MM in Q1 2023 annualizes to $72.4MM.

For a minute let’s ignore that Abecma revenue is growing at 111% y/y.

2seventy bio’s current market cap is $620MM and its enterprise value is $414MM (factoring net cash and operating lease obligations).

Thus, the stock is trading at an EV/Abecma operating profit of just 5.7x.

This is extremely cheap, yet it ignores the fact that Abecma is growing over 100% y/y and has multi-billion potential.

It further ignores any value attributed to 2seventy bio’s pipeline.

What is an appropriate valuation?

2seventy bio is guiding that Abecma can reach $2BN to $3BN of peak sales once it is approved for earlier lines of treatment.

Biotechs and Genomic companies trade at 7.1x revenue, as shown below.

Let’s assume $2BN in U.S. peak sales for Abecma. And we can assume a 2.5x revenue multiple (a big discount to median multiples, shown above).

In this scenario, 2seventy bio’s share of Abecma is worth $2.5BN ($2BN x 2.0x x 50%), or $50 per share.

This scenario doesn’t include any value for its $320MM of cash on its balance sheet or pipeline.

And to be clear, Abecma isn’t going to hit U.S. peak sales of $2BN this year or even next year, but over the long term (perhaps five years), it is achievable.

And there is one last kicker.

2seventy bio was spun off in a tax-free transaction in November 2021.

Tax-free spin-offs are prohibited from being acquired until the second anniversary of the spin-off has passed.

That anniversary will pass in November 2023, which means that the company will be eligible to be acquired without triggering any onerous tax implications.

While my investment case does not hinge on an acquisition, I believe a buyout by Bristol-Myers Squibb would make all the sense in the world.

Bristol-Myers has $9BN of cash on its balance sheet and trades at 3.5x revenue. For a cheap price (2seventy trades at 1.7x revenue), Bristol could buy complete control of a billion-dollar blockbuster and accelerate its top line.

As is always the case, micro-caps are illiquid. Be sure to use limits.

My official rating for TSVT is Buy under 14.00.

Risks

Secondary Offering

- 2seventy bio recently raised cash in the secondary market at $12.50 per share and the share price sunk as a result. While I don’t appreciate the dilution, I do understand that the company wants to stay well capitalized until Abecma is completely funding the entire company. Being strongly capitalized also increases Abecma’s negotiating power if an acquirer shows interest.

Competing Drug

- J&J has a competing drug called Carvykti. It is also attempting to get approved to treat patients with multiple myeloma earlier in the stage of the disease. Initial data from Carvykti seemed to suggest that Carvykti was superior to Abecma. But the data cannot be compared apples to apples because Carvykti treated patients after they had a powerful CD38 antibody (Carvykti’s study didn’t require this). Further, capacity is very limited for both drugs, and it’s likely the FDA will approve both drugs to be used in earlier lines of treatment given their life-saving efficacy.

Updates

Changes This Week: None

Cogstate Ltd (COGZF) had no news but continues to buy back stock in the open market (we know this because Australian companies must disclose when they buy back stock). On May 3, Eli Lilly (LLY) announced positive results for its Alzheimer’s drug, donanemab. Patients treated with the drug saw their Alzheimer’s progression slow by 27% versus placebo. Eli Lilly plans to proceed with regulatory submissions to get approval as quickly as possible. I expect FDA approval in late 2023 or early 2024. Cogstate worked with Eli Lilly for its phase III trial of donanemab. If the drug is approved, it will mean significantly more revenue for Cogstate as the additional studies are greenlit. Cogstate reported fiscal Q3 results on April 26. Revenue declined 15% y/y to $11MM. The revenue shortfall is due to slow patient enrollment in Alzheimer’s clinical trials. This isn’t lost revenue but revenue that has just been pushed out a year or so. Management also mentioned that smaller biotechs are a little more cautious spending money given the macro environment. In the near term, Cogstate has two significant catalysts: 1) Eisai’s LEQEMBI (Alzheimer’s) PDUFA date (FDA decision date) is July 6, 2023; 2) potential approval for Eli Lilly’s donanemab (Alzheimer’s) in late 2023/early 2024. Positive news for either or both drugs would mean significantly more revenue for Cogstate due to the need for additional clinical trials to expand the drugs’ labels and to monitor the effectiveness of the drugs in real patients. Finally, Cogstate announced that it is actively buying back its own stock. It currently has a $13MM authorization (5% of market cap). While Cogstate’s performance has been disappointing, I remain confident in the long-term outlook. Original Write-up. Buy under 1.80

Copper Property Trust (CPPTL) had no news this week. It announced on June 5 that it will pay out $0.107713 per trust certificate on June 12, 2023 (yesterday). The distribution is from cash flow that was generated from operations (minimal asset sales proceeds were included). As such, the run rate yield on the Trust is 11% - very attractive in my opinion! The Trust has pulled back, but this is largely due to rising interest rates which have impacted all real estate companies. Copper Property Trust continues to look attractive. I’m very happy to recommend a security that has no debt, is paying an 11% dividend yield, and is liquidating properties over time. Original Write-up. Buy under 14.00

Currency Exchange International (CURN) had no news this week. It reported another excellent quarter on March 15. Revenue grew 32% to $16.5MM, beating consensus expectations by ~$1MM. While we have grown accustomed to 100%+ revenue growth, typical seasonality is returning to the business (Q1 is typically the weakest quarter while Q3 is typically the strongest). Banknote revenue grew 26% while Payments revenue increased 60%. Currency Exchange’s valuation looks attractive at 9x forward earnings and 7x forward free cash flow. Original Write-up. Buy under 16.00

Epsilon Energy (EPSN) announced its $0.625 quarterly dividend on June 7. On an annualized basis, Epsilon is yielding 4.8%. It reported Q1 earnings on May 10, 2023. The company generated $3.6MM of free cash flow (excluding positive movements in working capital) in the quarter or $14.4MM annualized. EBITDA was $5.6MM in the quarter or $22.4MM annualized. Epsilon bought back 237k shares (1% of shares outstanding) at an average price of 5.72. It paid out $1.4MM in dividends. Despite both, net cash rose to $49.8MM. While depressed natural gas prices are negatively impacting Epsilon’s results, the company looks attractively valued even using draconian assumptions. In 2020, when natural gas prices were at similar levels, Epsilon generated $15.7MM of adjusted EBITDA. Thus, the stock is trading at just 3.6x 2020 (which I view as trough) EBITDA. This valuation appears compelling. Meanwhile, the company is paying a nice dividend and buying back stock. Downside is further limited given that cash represents 43% of Epsilon’s market cap. Original Write-up. Buy under 8.00

Esquire Financial Holdings (ESQ) had no news this week. The company reported a good quarter on April 25. Capital remains strong. The common equity tier 1 ratio stands at 14.89% and would be 12.97% including all after-tax unrealized losses. Tangible common equity to tangible assets stands at 11.77% and would be 11.38% including all after-tax unrealized losses. Credit losses remain low with no non-performing loans and a 1.34% allowance for credit losses. Total deposits increased $100MM to $1.3BN from December 31, 2022, to March 31. Uninsured deposits are just 33% of total deposits, and importantly, more than 90% of uninsured deposits represent clients with full relationship banking (loans, payment processing, and other service-oriented relationships). EPS came in at $1.47 or $5.88 on an annualized basis. As such, the stock is trading at just 6x earnings. Esquire looks compelling. Original Write-up. Buy under 45.00

IDT Corporation (IDT) has been weak since reporting earnings on June 5. It looked like a solid quarter albeit not quite as strong as previous quarters. Highlights were as follows: 1) Strong NRS (National Retail Solutions) growth continues. While growth slowed down from 100%+ in prior quarters to 65% growth in the current quarter, the performance was still impressive. NRS is profitable and has a huge runway for future growth. The division was negatively impacted by a pullback in advertising. This will eventually come back. 2) net2phone continued to grow nicely as well. Revenue decelerated from 30%+ to 20% but was still impressive. The division is approaching cash flow break-even. 3) The company generated $20.5MM of EBITDA. Thus, it’s generating $82MM of EBITDA on an annualized basis. As such, it’s trading at 7.8x annualized EBITDA. 4) The company bought back ~77,000 shares of its own stock. Given challenging market conditions for high-growth companies, IDT’s subsidiaries won’t be spun off soon, but we know that, ultimately, they will be monetized either through a sale or a spin-off. The investment case remains on track. Original Write-up. Buy under 45.00

Kistos PLC (KIST: GB) filed its annual report on May 30. Some takeaways: 1) The company generated €190MM of free cash flow in 2022. The market cap of the entire company today is €200MM. This company is insanely cheap. 2) Kistos is focused on diversifying away from the U.K. and Netherlands given the regressive policy of “windfall” taxes. 3) The company is positioned exceptionally well given its recently announced acquisition of Mime Petroleum, a Norwegian company. Given high insider ownership and excellent operating excellence from the management team, I remain an enthusiastic shareholder of Kistos. Original Write-up. Buy under 7.50

Liberated Syndication (LSYN) is working to gain liquidity for shareholders. I spoke to the CEO on February 17 and got an update. He is pursuing any and all liquidity options for investors including: 1) partnering with a SPAC, 2) merging with another public NOL shell, 3) raising money through an IPO, and 4) taking on private equity. I don’t have a sense of timing in terms of when LSYN shareholders can expect liquidity, but I know it is a big focus for the company. From a financial perspective, Libsyn continues to grow strongly. Revenue grew from $42MM in 2021 to $57MM in 2022. On a pro forma basis (full-year contribution from the acquisition of Julep), revenues are over $60MM. Profitability is down as the company is focused on expanding into the podcasting advertising market which has lower profitability than the hosting business. Still, I’m optimistic that Libsyn has a bright future. Original Write-up. Hold

M&F Bancorp (MFBP) had no news this week, but there was a good article written on Seeking Alpha last week that you can read here. The company reported excellent earnings on May 5. EPS increased 82% to $0.89. ROE reached 32% vs. 12% a year ago. This windfall is due to M&F’s deployment of new capital from the Emergency Capital Investment Program. The bank’s CEO stated, “We are pleased with our results for the first quarter of 2023, which exceeded our expectations. We achieved significantly increased earnings available to stockholders of $1.8 million and achieved a 1.55% return on assets, which is outstanding.” The bank remains overcapitalized with stockholders’ equity representing 26.95% of total assets. Non-performing loans represent 0.19% of total assets. M&F is trading at just 6.5x annualized earnings. I expect EPS to grow to $4.74 in 2025 (this might happen by 2024). Assuming M&F continues to trade at its average P/E multiple of 9.3x, the stock should hit 44.00 by 2025, implying significant upside. Original Write-up. Buy under 21.00

Magenta Therapeutics (MGTA) had no news this week. On May 3 the company announced that it plans to merge with Dianthus Therapeutics. The stock closed down ~20% but has recovered half the drop since then. The announcement is disappointing as I was hoping Magenta would pay out excess cash and then perhaps merge its public listing with another company that hoped to go public. Pre-merger Magenta shareholders are expected to own 21.3% of the new company. The new company is going to raise $70MM in capital from Fidelity, Venrock Healthcare, and several other institutional investors in conjunction with the merger. The new company will have $180MM of cash and several drugs in development focused on treating autoimmune diseases. I’m going to dig into Dianthus to try to determine how promising it is. At a bare-bones level, pre-merger Magenta shareholders will own 21.3% of $180MM of cash that the new company will have once the merger closes. That represents $39MM of value. Magenta’s current market cap is $43MM. Thus, the market is not giving Magenta much credit for Dianthus’s pipeline. I think it’s unlikely that the current merger gets approved by shareholders (the shareholder vote is on June 28) – I bet an improved deal will be reached. Original Write-up. Buy under 0.75

Medexus Pharma (MEDXF) had no news. On April 11, the company announced that it expects record fiscal year results. This is encouraging. On March 22, the company announced that it has secured a new licensing agreement to sell a topical treatment called Terbinafine. The product could be approved in Canada this year. Management hasn’t provided sales potential, but it will be a positive contributor. On March 8, Medexus announced that it has secured new credit facilities amounting to $58.5MM. The interest rate for the facilities is only 8.58%, an attractive rate. The new facilities include a $35 million loan, of which $30MM will be used to repay long-term debt, and an additional $5MM that can be used to pay off debentures. Additionally, there is a possibility of accessing an extra $20MM of uncommitted capital. Medexus plans to use this capital to repay convertible debentures in cash, which could potentially halve the dilution. Overall, this is a big positive. All in all, my conviction level remains high. The stock’s valuation looks cheap. Original Write-up. Buy under 3.50

Merrimack Pharma (MACK) had no news this week. It is a biotech company that has no employees. It relies on contractors to minimize costs. Its sole purpose is to receive milestone payments from Ipsen related to the drug Onivyde. Onivyde will likely be approved for first-line metastatic small-cell lung cancer in early 2024 which will trigger a $225MM royalty payment. Merrimack has committed to distributing any royalty proceeds to investors. I expect Merrimack to distribute $15 per share to investors within ~9 months, representing more than 125% of its current share price. Additional upside can be achieved through future milestone payments. Finally, insiders are buying stock in the open market. Original Write-up. Buy under 12.50

P10 Holdings (PX) had no news this week. The company filed a Form 4 statement on March 16 that seemed to indicate that an insider is selling. But it appears that the company repurchased those shares at an 8% discount to the market (privately negotiated transaction). What appears like a negative is actually a positive. P10 announced an excellent quarter on March 6. Fee-paying assets under management increased 23% y/y. Revenue increased 32% and adjusted EBITDA grew 29%. P10 continues to benefit from secular tailwinds in the private equity industry. Despite strong growth, P10 trades at just 12.9x EBITDA and just 13x cash earnings. This is too cheap a valuation. The investment case is on track. Original Write-up. Buy under 15.00

RediShred (RDCPF) had no news this week. It reported another excellent quarter on April 21. Revenue grew 57% to $57MM CAD while EBITDA grew 67% to $15.3MM. The strength was driven both by acquisitions and organic growth. Organic growth is being driven by increased demand for shredding by businesses. Higher fuel costs and driver costs hurt margins, but these are starting to moderate. The stock continues to look cheap at 5.8x forward EBITDA. I continue to see 100% upside over the next 12 months and significantly more upside looking out a few years. Original Write-up. Buy under 3.50

Transcontinental Realty Investors (TCI) had no news this week. The company announced on April 19 that its CEO had resigned. I’m not sure what this means. It could be a prelude to a sale but perhaps I’m just being optimistic. The company filed Q4 and 2022 results on March 24. The results looked great. As of December 2022, Transcontinental had $471MM of cash and notes receivable on its balance sheet. Its current market cap is $318MM. The company does have some debt for which it has no recourse as it’s tied to additional real estate that Transcontinental owns. Long story short, this stock is very, very cheap. Unfortunately, there is no hard catalyst now, and we don’t know what management is going to do with the stock, but we know that the stock is extremely cheap. Insiders are incentivized to buy out minority shareholders at a premium to the current stock price but at a discount to book value. Currently, the stock trades at a price to book value multiple of just 0.4x. Original Write-up. Buy under 45.00

Trinity Place Holdings (TPHS) had no news this week. It is a high-risk, high-reward stock. I see a legitimate case for the stock to go up 7x. At the same time, the stock could decline by 100%. The company’s real estate is well located and based in New York City. The stock represents an asymmetric opportunity with a 7:1 upside-to-downside ratio. Insiders own a significant portion of shares. Original Write-up. Buy under 0.45

Truxton (TRUX) reported earnings on April 20. The quarter was solid. EPS came in at $1.47. Asset quality remains high with $0 in non-performing loans as of March 31. The bank’s capital position remains strong with Tier 1 leverage at 10.3%. The one negative in the quarter was that deposits decreased, albeit slightly (by 4%) from December 31, 2022, to March 31, 2023. I’m going to watch this trend closely to see if it continues. In the meantime, Truxton looks attractive at ~10x earnings. This isn’t the most exciting stock, but it’s a slow-and-steady winner. Original Write-up. Buy under 75.00

Unit Corp (UNTC) declared its Q2 dividend of $2.50. It did not indicate whether a Q3 dividend will be paid. My sense is it will, but the company/board of directors is still finalizing the plan. Based on conversations with Unit’s CFO, I believe Unit’s dividend policy will include a standard “normal quarterly dividend” that is sustainable (perhaps $1 per quarter) and then periodic special dividends to return excess cash. This clarity will be a major positive. On May 11, Unit Corp filed its 10-Q, and the fundamentals look terrific. The company generated over $50MM of free cash flow in Q1. My estimate for the entire year was $94MM so I’m obviously too low. Areas of upside: 1) Upstream operation expenses are tracking $25MM lower than I had modeled (this is obviously a source of material upside). 2) BOSS day rates were $30.8MM in the quarter, but 8/14 of the BOSS rigs will reprice higher in Q2. 3) Drilling operating expenses are tracking slightly lower than I expected. As a result of the strong free cash flow generation, Unit currently has $171MM of cash on its balance sheet, or 35% of its market cap. All in all, it was a very strong quarter, and the investment case remains on track. Original Write-up. Buy under 65.00

William Penn (WMPN) announced on May 6 that it has authorized another share repurchase representing 10% of shares outstanding. It will commence this share repurchase after the existing authorization is complete. William Penn announced earnings on May 6. Despite the turmoil in the banking market, William Penn grew deposits in the quarter. The bank remains well capitalized with a tangible common equity ratio of 19.7%. The company continues to aggressively repurchase shares. During the quarter, the Board of Directors authorized a fourth repurchase program to buy back up to 698,312 shares. The company is being quite aggressive. In the first half of April, it repurchased nearly 400,000 shares in the open market. Tangible book value is $12.54 so the stock is currently trading at 75% of book value. This looks like a compelling valuation. Downside is low given the stock is trading below liquidation value. Original Write-up. Buy under 10.80

Watch List

Enhabit (EHAB) is a home health and hospice company that was spun off in 2022. It has performed poorly and cannot be sold until 2024. But there is tremendous consolidation in the home health market. Last year, UNH paid 21x EBITDA for LHC Group and currently Option Care Health and UNH are in a bidding war for Amedisys for 15x EBITDA. EHAB currently trades at 9.5x EBITDA. I need to do more work to understand the current issues facing Enhabit and whether they are cyclical or secular. But this idea looks very interesting.

FFBW, Inc (FFBW) stays on my watch list. It is a similar setup to William Penn Bancorp. It is a thrift that probably will get acquired for a nice premium. The CEO will even get a nice bonus if a sale materializes. The only reason that I went with William Penn Bancorp instead of FFBW is because of the aggressive insider buying currently at William Penn. But FFBW looks like another low-risk idea.

Sandridge Energy (SD) stays on my watch list. It is yet another dirt-cheap energy name. It just announced a $2/share special dividend and $75MM share repurchase authorization. The special dividend has been paid out and the stock continues to lag. It looks compelling.

Recommendation Ratings

**Original Price Bought adjusted for reverse split.
* Return calculation includes dividends

Buy means accumulate shares at or around the current price.
Hold means just that; hold what you have. Don’t buy, or sell, shares.
Sell means the original reasons for buying the stock no longer apply, and I recommend exiting the position.
Sell a Half means it’s time to take partial profits. Sell half (or whatever portion feels right to you) to lock in a gain, and hold on to the rest until another ratings change is issued.

Disclosure: Rich Howe owns shares in PX, MEDXF, LSYN, IDT, DMLP, NXDT, KIST, and RDCPF. Rich will only buy shares after he has shared his recommendation with Cabot Micro-Cap Insider members and will follow his rating guidelines.

The next Cabot Micro-Cap Insider issue will be published on July 12, 2023.