Cabot Micro-Cap Insider Issue: January 11, 2023

Feeling Optimistic

I don’t know exactly why, but I’ve started the new year feeling optimistic.

Maybe it’s because my brokerage account is finally showing positive year-to-date results for the first time in 12 months!

But based on history, my optimism is warranted.

As shown below, typically the S&P 500 bounces back nicely following a negative year.

Hopefully, the strong start to the year is a harbinger of good things to come.

As you know, I don’t try to time the market.

I subscriber to Peter Lynch’s belief that “far more money has been lost by investors in preparing for corrections, or anticipating corrections, than has been lost in the corrections themselves.”

I’m solely focused on identifying opportunities from bottom-up analysis.

In other words, I try to analyze a stock’s fundamentals and valuation to determine if its prospects are attractive.

But it is encouraging to know that the market usually bounces back following a down year.

One area of the market that I’m noticing a lot of opportunities in is the biotech sector.

While the entire market is in a bear market, the biotech sector has been in a bear market since February 2021 when it peaked. The biotech bear market is approaching 2 years!

I’ve noticed that many biotechs are trading below net cash on their balance sheet yet distributing cash to shareholders.

Catalyst Biosciences (CBIO) and Kineta (KA) – formerly Yumanity – are two that come to mind.

With that in mind, my latest recommendation is a biotech.

The stock trades at 11.90 but I expect it to pay out a dividend of 15.08 within 15 months. Further, there will be remaining value after the dividend that could drive asymmetric upside.

Without further ado, let’s discuss my newest recommendation, Merrimack Pharmaceuticals (MACK).

New Recommendation: Merrimack Pharma: Uncorrelated Upside Potential

Company: Merrimack Pharma
NYSE: MACK
Price: 11.90
Market Cap: $158 million
Price Target: 16.00
Total Return Potential: 36%
Recommendation: Buy under 12.50
Recommendation Type: Rocket

Executive Summary

Merrimack Pharma (MACK) 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 ~15 months, representing 126% of its current share price. Additional upside can be achieved through future milestone payments. Finally, insiders are buying stock in the open market.

Overview

Background

Merrimack Pharma is a biopharmaceutical company that is based in Cambridge, Massachusetts.

On April 3, 2017, Merrimack sold itself to Ipsen.

Ipsen paid $575MM in cash plus up to $450.0 million in additional regulatory approval-based milestone payments.

Merrimack currently has a market cap of $158MM.

The $450.0 million in contingent milestone payments resulting from the Ipsen Sale consist of:

- $225MM upon approval by the FDA of Onivyde for first-line metastatic pancreatic cancer.

- $150MM upon approval by the FDA of Onivyde for second-line treatment of small-cell lung cancer

- $75.0MM upon approval by the FDA of Onivyde for an additional indication unrelated to those described above

Outlook

Merrimack is highly likely to receive the $225MM milestone payment related to the FDA’s approval of Onivyde for first-line metastatic pancreatic cancer.

On November 9, 2022, Ipsen announced that Onivyde met its primary endpoint in its trial to evaluate its effectiveness as a first treatment therapy for patients with metastatic pancreatic cancer.

Most importantly, patients treated with Onivyde demonstrated a statistically significant improvement in overall survival with no unexpected side effects.

Onivyde is already approved for second-line pancreatic cancer, so we know the drug works. Nonetheless, pancreatic cancer is notoriously difficult to treat and so the success in first-line patients was very well received.

As such, the FDA is expected to approve this drug with minimal controversy.

Ipsen expects to file Onivyde with the FDA for first-line metastatic cancer in the first half of 2023. Assuming a 12-month review (it could be shorter), the FDA will approve the drug in the first half of 2024.

At that point, Ipsen will owe Merrimack a milestone payment of $225MM and the net proceeds will be distributed to shareholders.

Merrimack could also receive an additional milestone payment ($150MM) if Onivyde is approved for second-line treatment of small-cell lung cancer.

Onivyde’s trial in this indication did not meet its trial endpoint of an improvement in overall survival.

Nonetheless, it could be evaluated and approved on a non-inferiority basis. However, this is by no means a slam dunk and I’m assuming a 10% probability that it occurs.

Insider Ownership

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

Executive officers and directors own 25.8% of shares outstanding as shown below.

This ensures that we are aligned.

Further, insiders have recently been buying in the open market.

Valuation and Price Target

Merrimack Pharmaceuticals is a special situation as it really has no ongoing business.

Its business plan is to just collect milestone payments and pay them out as discussed above.

The key valuation metric is future distributed cash and the probability that that milestones are received.

Given the excellent data reported so far, I’m confident that Onivyde will be approved for the treatment of first-line metastatic pancreatic cancer.

Assuming FDA approval, Ipsen will owe Merrimack a milestone payment of $225MM.

On a diluted basis, there are 15MM shares outstanding.

Merrimack has millions of net operating losses (NOLs) but it’s likely that there will be some small tax liability.

Assuming a $17MM tax liability, there will be $208MM of proceeds that can be paid out – or $13.84 per diluted share (including stock options).

The current price of the stock is $11.90 and we are highly likely to receive $13.84 from this milestone payment.

How soon will we receive it?

Ipsen will submit its application for approval in the first half of this year. Approval should happen within 12 months.

So we will have to wait a little over a year (let’s call it 15 months) to receive my estimate of $13.84 per share in proceeds.

But the good news is there is additional value beyond that distribution.

Merrimack currently has $13.1MM of cash as of 9/30/2022.

It burns roughly $2MM per year.

In its 10-Q, Merrimack writes, “We expect that our cash and cash equivalents as of September 30, 2022 will be sufficient to continue our operations into 2027, when we estimate the longest-term potential Ipsen milestone may be achieved.”

Merrimack also has 1.6MM of stock options with an average exercise price of $11.46.

These will be exercised if/when Onivyde receives approval for the treatment of first-line metastatic pancreatic cancer.

Once the options are exercised, Merrimack will receive an additional $18.7MM or $1.24 that can be paid out to shareholders, immediately.

In total (milestone payments + stock option proceeds), ~$15.08 can be paid out to shareholders in ~15 months. This represents a 26% return compared to the current share price.

But it gets even better.

The “stub” – or the stock post-distribution – will have remaining value.

Merrimack is entitled to receive two additional milestone payments.

1) $150MM upon approval of Onivyde for second-line treatment of small-cell lung cancer.

2) $75MM for a third undisclosed indication.

Regarding the lung cancer indication, Ipsen reported in August 2022 that the Onivyde trial did not meet its primary endpoint of overall survival.

However, there is still a possibility that it ultimately gets approval on a non-superiority basis.

If the drug ultimately gets approval for lung cancer and a third undisclosed indication, Merrimack shareholders will be entitled to another distribution of ~$10.50 per share (I included potential taxes in this estimate as NOLs would be exhausted in this scenario).

What are the odds? Tough to say with certainty, but probably low – maybe 10%.

Therefore, the potential other indications are probably worth ~$1.00 per share.

Add it all up, and I believe Merrimack is worth ~$16 per share, significantly above its current share price.

This price target represents an attractive upside scenario, but it’s especially attractive as I expect it to be achieved within ~15 months.

Finally, the return should be uncorrelated with the broader market, another benefit.

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

My official rating is Buy under 12.50.

Risks

Approval of Onivyde for first-line Metastatic Pancreatic Cancer

- If the FDA doesn’t approve Onivyde for first-line Metastatic Pancreatic cancer, shares would fall sharply. They traded at 4.00 per share prior to the positive news announcement. While Onivyde met its primary endpoint and is the first drug to show improvement in pancreatic cancer in a long time, you never can have 100% confidence in the FDA’s decision. I believe there is a 5% probability that the FDA rejects or delays Onivyde for first-line Metastatic Pancreatic cancer.

Taxes

- I have high confidence that tax obligations related to the Onivyde milestone payments will be minimal given Merrimack’s substantial NOLs, but I’m not a tax expert and there could be something unexpected.

Updates

Changes This Week: Sell Cipher Pharma (CHPRF) to make room for new recommendation.

Aptevo (APVO) had no news this week. The company announced positive data for APVO436 in a Phase 1b trial in early December. In the trial, 100% of patients showed clinical benefit and 50% of patients showed a complete response. As a result, the stock skyrocketed higher but then fell even further than where it started. Aptevo continues to be a high-risk/high-reward stock. It’s trading at a negative enterprise value but will likely have to raise cash within the next 12-18 months, which could dilute shareholders. On the other hand, it could be acquired or strike a lucrative partnership with a large pharma company which could be worth multiples of the current stock price. Original Write-up. Buy under 7.50

Atento S.A. (ATTO) had no news this week. It reported earnings on November 15. Revenue was flat but EBITDA margin increased 3.3 percentage points to 11.1% in the quarter, driven by cost efficiencies. The company generated operating cash flow of $8MM in the quarter. It has a cash balance of $66MM with no near-term debt maturities. Investors were relieved with the quarter as the stock has almost doubled. Subsequent to the quarter, MCI Capital announced a tender offer to buy 1.5MM shares of Atento for 5 per share. It’s unlikely that any shareholders will accept this offer given the stock is trading well over the offer price. While Atento is in a turnaround, the stock is incredibly cheap and is not at risk of defaulting on its debt (no maturities until 2025). Thus, it makes sense to stick with the stock. Original Write-up. Buy under 10.00

Cipher Pharma (CPHRF) continues to be attractively valued and has positive fundamentals, but I must make room for my new recommendation. Cipher Pharmaceuticals is a low-conviction idea at this point as it has appreciated considerably since I originally recommended it (+68%). As such, I’m switching my rating to Sell. Original Write-up. Sell

Cogstate Ltd (COGZF) had no news this week. The company got a boost when Esai and Biogen announced positive results for its Phase 3 Alzheimer’s trial on September 27. This is massively positive news as it will drive more Alzheimer’s trials (and revenue for Cogstate). Ultimately, Cogstate’s revenue potential this year and beyond will be determined by these three key Alzheimer’s drug read-outs which are expected this year and next year: 1) Lecanemab from Eisai (Phase 3 data: already announced and positive), 2) Gantenerumab from Roche (Phase 3 data expected in Q4 2022), and 3) Donanemab from Eli Lilly (Phase 3 data in mid-2023). The Cogstate thesis remains on track. Original Write-up. Buy under 1.80

Copper Property Trust (CPPTL) paid out $0.30 per trust certificate on January 10, 2023. The distribution consists of $0.20 of net sales proceeds. The balance is from net income generated from rental proceeds. Copper Property Trust continues to look attractive. Original Write-up. Buy under 14.00

Currency Exchange International (CURN) had no news this week. It reported earnings on September 13. They looked great! Revenue increased 139% to $21MM, beating consensus expectations by $5MM. This was truly a massive beat. Revenue in the fiscal third quarter was 67% higher than 2019 FQ3 (pre-pandemic). The company’s Payments business grew revenue 65% to $3.6MM. Year to date, Currency Exchange has generated EPS of $1.15 or $1.53 on an annualized basis. As such, the stock is trading at just 9x earnings. The investment case remains on track. Original Write-up. Buy under 16.00

Epsilon Energy (EPSN) had no news this week. Epsilon reported an excellent quarter on November 10. Revenue increased 6% sequentially. In the quarter, Epsilon generated $9.6MM of net income and $11.2MM in free cash flow. This is quite significant for a company with a market cap of $170MM. The company continues to buy back shares and pay dividends. Due to the strong cash generation in the quarter, Epsilon currently has $40MM of cash on its balance sheet and no debt. The stock continues to look attractive. Original Write-up. Buy under 8.00

Esquire Financial Holdings (ESQ) had no news this week. It reported earnings on October 25. EPS increased 21% to $0.94. Return on assets and equity were 2.48% and 20.60%, respectively. Credit metrics remain strong with nonperforming loans of 0.67% and a reserve for loan losses of 1.24%. I continue to believe Esquire dominates an attractive niche and is set to grow nicely for the foreseeable future. Despite 21% EPS growth and strong credit metrics, Esquire trades at just 11x forward earnings. Original Write-up. Buy under 42.00

IDT Corporation (IDT) reported another good quarter on December 5. Revenue was down 13% y/y, mainly due to tough comps from last year. The two most important value drivers continue to chug along. NRS revenue grew 107% y/y to $17.6MM. Net2phone subscription revenue increased 33% to $15.5MM. During the quarter, IDT repurchased 203,436 shares (~0.8% of shares outstanding). Eventually, both of these divisions will be monetized (either through a spin-off or an asset sale). The investment case remains on track and my price target is 55 based on an updated sum-of-the-parts analysis. Original Write-up. Buy under 45.00

Kistos PLC (KIST: GB) had no news this week. The company reported first-half 2022 results on September 7. They looked great. The company reported revenue growth of 745% and EBITDA growth of 768%. It generated free cash flow of £93MM, or $186MM annualized. Kistos has pulled back due to falling natural gas prices in Europe. As such, Kistos is currently trading at 0.7x annualized EBITDA and 1.8x annualized free cash flow. This is too cheap. Another risk is that the EU is considering instituting a windfall profit tax on energy companies. While this would be a negative, I think it’s reflected in Kistos’ valuation. Further, Kistos generated $89MM of EBITDA in 2021. Thus, it’s trading at just 3.5x “normalized” EBITDA, not a demanding valuation. I continue to see at least 100% upside ahead. Original Write-up. Buy under 7.50

Liberated Syndication (LSYN) has had no news recently. Libsyn’s plan was to “go public” again in September. Obviously, that didn’t happen. It isn’t too surprising given the market volatility. I’ve reached out to Libsyn’s CEO and hope to catch up with him soon. Libsyn has posted several press releases in the past couple of months. I remain optimistic about Libsyn’s prospects. Once financials are re-filed, I’m looking forward to seeing: 1) How Libsyn’s core hosting business is doing. Podcasting conferences were a key way that Libsyn marketed. When COVID shut down in-person events, it negatively impacted Libsyn’s new customer acquisition. Now that COVID is behind us, I expect the core business to accelerate. 2) Revenue growth for AdvertiseCast. This is an exciting business opportunity. Revenue grew 50% in 2021 for AdvertiseCast, and I expect continued strong growth going forward. 3) The growth of Glow. Libsyn acquired Glow in 2021. Glow enables podcast creators to offer premium shows (think substack but for podcasts). I think this is a big market opportunity. While Libsyn has been a frustrating stock, I think (and hope!) our patience will be rewarded. Original Write-up. Hold

M&F Bancorp (MFBP) had no news this week. M&F is taking advantage of an interesting opportunity (Emergency Capital Investment Program) available to many small banks. As a result, I expect EPS to grow from $1.36 in 2021 to $4.74 in 2025. Assuming M&F continues to trade at its average P/E multiple of 9.3x, the stock should hit 44.00 by 2025, implying almost 150% upside. Original Write-up. Buy under 21.00

Medexus Pharma (MEDXF) had no news this week. It reported fiscal Q2 results on November 8. The report was excellent! Revenue grew 55% y/y and EBITDA was $4.2MM, a y/y improvement of $6.3MM. The company generated positive free cash flow and is actively exploring options to refinance its convertible debentures which come due next fall. The stock’s valuation looks cheap at 1.1x revenue and 7.6x adjusted EBITDA. The investment case remains on track. Original Write-up. Buy under 3.50

NexPoint (NXDT) had no news this week. It filed its 10-Q to report earnings on November 14. The results looked good. Operating cash flow is healthy. NAV as of September 30, 2022, is $28.17 (I miscalculated NAV earlier) so the stock is still trading at a big discount to fair value. The company generated $0.55 of funds from operations in the quarter. As such, it’s trading at ~7x, a discount to peers who trade closer to 12x. The company was also recently added to the MSCI index. As such, there will be index fund buying throughout the rest of the month. Original Write-Up. Buy under 17.00

P10 Holdings (PX) announced on December 27 that it increased its share repurchase authorization by $20MM (2% of its market cap). P10 is fairly limited in how much stock it can buy back given its low float (high insider ownership), but I view this announcement very favorably. The company is growing like crazy yet trades at just 12.5x adjusted earnings. The investment case is on track. Original Write-up. Buy under 15.00

RediShred (RDCPF) announced good quarterly results on November 27. Revenue grew 50% y/y to $14.7MM CAD (47% constant currency growth). EBITDA increased 27% to $3.6MM CAD. On an organic basis, EBITDA grew 13% y/y. Organic growth is being driven by increased demand for shredding by businesses. Higher fuel costs and driver costs hurt margins. However, the company plans to pass through price hikes which will help offset these headwinds. RediShred is also active on the acquisition front. On November 2, the company announced that it had acquired ProShred Philadelphia for $7.3MM to $8.3MM (depending on earn-outs). I estimate the acquisition took place at a 6x EV/EBITDA multiple. This is a good deal. The stock continues to look incredibly cheap at a 5.1x EV/EBITDA multiple and a 7.4x price to free cash flow multiple. 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. It disclosed its quarterly earnings on November 10. The sale of the joint venture (JV) has closed, and Transcontinental reported that it intends to use $182.9MM of the proceeds to “invest in income-producing real estate, pay down debt and for general corporate purposes.” The company hasn’t disclosed what it intends to do with the second installment of proceeds from the JV sale ($203.9MM). The company continues to look attractive with 96% of its market cap in cash. Insiders own 86% of the company and could make an imminent move to buy out remaining shareholders at a large premium to the current stock price. Original Write-up. Buy under 45.00

Truxton (TRUX) reported Q3 earnings on October 20. They were very good. Net income in the quarter of $1.49 grew 11% y/y. Net revenue also grew ~11%. Credit metrics remain excellent with $0 in non-performing loans. On an annualized basis, Truxton is generating $5.96 in EPS. It is trading at 10.4x annualized earnings. Historically it has traded at 13.5x. 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) announced a capital return program. It will pay a special dividend of $10 per share to shareholder on January 31 to shareholders of record on January 20. Unit will also start paying an initial variable quarterly dividend. The initial quarterly dividend will be $2.50 per share and be paid in the second quarter. The investment case for Unit Corp remains on track. The stock is dirt cheap, generated tons of cash, and is returning it to shareholders. Original Write-up. Buy under 65.00

Zedge, Inc. (ZDGE) reported Q1 2023 earnings on December 13. Revenue increased 14.5% y/y. However, EBITDA decreased 71% y/y to $1.0MM and operating cash flow decreased 60% y/y to $1.1MM. The decline was due to lower advertising revenue and expenses related to the integration of GuruShots. The quarter was disappointing, but management commentary suggests that advertising rates have already improved. Further, the stock is ridiculously cheap. It trades at 3.0x annualized EBITDA and 9.5x FCF. Further, it has 66% of its market cap in cash. Original Write-up. Buy under 6.00

Watch List

Enhabit (EHAB) remains on my watch list. It is a 2021 spin-off that has performed poorly. It is focused on the home health and hospice space. Revenue is currently declining slightly due to health care worker shortages, but eventually, I expect revenue to reaccelerate. The stock looks very cheap, trading at 6.0x free cash flow. Meanwhile, insiders have been aggressively buying shares. The stock chart looks horrible, but this stock probably has significant upside looking out 2-3 years.

Harbor Diversified (HRBR) remains on my watch list. It is the holding company for Wisconsin Airlines, which has a capacity agreement with United. HRBR trades at a cheap valuation because there was uncertainty regarding whether United would extend its contract with Harbor. However, the company recently disclosed that the contract has been extended for five years. No terms have been released yet, but the stock should re-rate higher over time.

**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 February 8, 2023.