A.P. Pharma, Inc. APPA
November 25, 2002 - 8:35pm EST by
2002 2003
Price: 0.76 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 16 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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At the risk of ridicule, I'll recommend another look at a company I wrote up more than a year ago -- at a substantially higher price. APPA certainly fits with the latest VIC trends of: 1) analyzing micro-caps, and 2) revisiting old names.

In reviewing my previous write-up, I see that I had some hits and misses. On the plus side, the royalty streams have developed nicely. Carac has become an established product that, according to management, is capturing nearly 30% market share and is gaining on ICN's Effudex which reportedly still has about 50% market share. The low-dose version of Retin-A Micro has been introduced and, according to management, is running ahead of the forecasts of the marketing partner, Johnson & Johnson. Total royalty revenue increased more than 30% in the first nine months of this year and is expected to top $4 million for the full year.

Also a plus: APPA now has eight paid feasibility studies in process with pharmaceutical company partners. Among the opportunities being studied are opthamology applications -- where the chemical characteristics of the Biochronomer polymers are reportedly more favorable than competing products -- and antibiotic coatings for cardiac stents.

On the negative side, the earnout payments from R.P. Scherer were disappointing, totaling only about $4 million vs. my $10 million expectation. Also, APPA had a setback in August when it was forced to delay Phase II trials for APF112, its first proprietary pharmaceutical. The FDA raised some questions about irritation levels in both sample and control populations of animals in the Phase I studies. APPA management believes that some additional Phase I work -- along with comparisons of irritation levels in various FDA-approved products -- will enable the Phase II studies to move forward. However, the delay was disappointing and has contributed to significant pressure on the stock.

Nonetheless, the current valuation suggests that this may be a good time to revisit APPA. With a market value of $16 million and no debt, the company is trading for only slightly more than the September 30 cash balance of $15 million. The company is consuming cash, but only about $1.5 million per quarter, which gives it quite a while to generate positive developments or pursue strategic alternatives. The current valuation gives little credit to either the royalty streams or the drug delivery technologies.

If APPA was valued at cash plus five times next year's royalties, the value might be estimated at $40 million or nearly $2 per share. That estimate still gives no explicit value to the drug delivery technologies, but does assume that the company is creating value as it spends on R&D. With patents extending out as far as 2016, the royalty streams are likely to have long lives.

From a somewhat technical point of view, it is clear from recent volume that one or more large holders has decided it's time to take an exit from APPA. The stock has been under heavy selling pressure but seems to have found buyers at 75-80 cents. If the overhang of discouraged sellers is cleared out, there may be an opportunity for APPA to move higher while further developments are pending.


The stock price could increase if one or more of the following occur: 1) positive news regarding Phase II protocols for APF112, 2) announcements regarding development partners for new Biochronomer applications, 3) depletion of the overhang of sellers, or 4) initiation of a stock buyback plan.
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