AP Pharma, Inc. APPA
October 16, 2001 - 12:44pm EST by
2001 2002
Price: 1.95 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 40 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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AP Pharma is a micro-cap drug delivery company whose value appears to be well protected by its cash reserve and by the value of its existing royalty streams. At the same time, the company has significant potential for appreciation because of likely growth in the royalty streams and because of the potential of new products under development. Recent leadership changes increase confidence that the company can successfully commercialize new technologies.

Though the company’s market cap is only $40 million, management of AP Pharma has estimated that the present value of cash flows from its current product lines is $100 million. Adding the $20 million of cash on hand at June 30 would yield a value of $120 million – attributing no value to the company’s development-stage technologies.

Management’s $100 million estimate is arrived at using a single-digit discount rate and assumptions about product line extensions. Far more conservative assumptions yield values of at least $35 million which, with the company’s cash, are more than enough to protect the current market cap. These estimates of value could rise significantly in the next 12-24 months.

Following is a summary of some of the company’s key revenue streams:

Retin-A Micro Royalties – AP Pharma has been receiving roughly $2 million per year in royalties from Johnson & Johnson for sales of a patented formulation of Retin-A used in treating acne. Given that the patent on this product extends to 2016, it seems conservative to value this royalty stream at $10 million, which is five times current cash flow. Royalties from Retin-A Micro are likely to expand in coming years due to a recent approval in Canada and, more significantly, to expansions into Europe and into the market for lower-dose Retin-A products. These expansions have the potential to more than double the current royalty stream.

Carac Royalties – AP Pharma first began receiving royalties from Dermik Labs (Aventis) in the first quarter of 2001. This product treats sun-induced skin lesions known as actinic keratoses. Carac competes directly with Efudex, a drug that is generating approximately $50 million per year for ICN Pharmaceuticals. In the first few months of sales, Carac is reportedly taking more than 20% market share. Due to the significant advantages of Carac’s time-release formulation, it seems reasonable to believe that Carac will grow to at least $25-30 million of annual sales ($2.5-3 million of royalties for AP Pharma) and that this royalty stream is worth at least $15 million.

R.P. Scherer Earnouts – In July 2000, AP Pharma sold part of its operation to Scherer (Cardinal Health) for $25 million in cash plus earnout payments that could total $26.5 million over three years. Up to $5 million is due this year based on performance in the first 12 months since the sale. Management has indicated that they believe sales of the divested products have been satisfactory and that at least some of the earnout payments will be received in 2001. It may be reasonable to value this cash flow stream at $10 million.

Development-Stage Technologies – AP Pharma is focusing on development and commercialization of its Biochronomer polymers for time-release delivery of drugs that are implanted or injected. The new Chairman, Dr. Paul Goddard, has referred to these polymers as “Holy Grail” products that the pharmaceutical industry has been seeking for many years. The goal is to be able to deliver a drug such as a painkiller in a polymer that would release the drug over a sustained, predictable period of time and which would leave no residue in the body. A surgeon, for example, could apply painkillers in a wound before closure, thereby reducing or eliminating the need for subsequent applications of painkillers. AP Pharma has successfully completed toxicology tests on the Biochronomer polymers and is planning to file an application this year to initiate Phase I human studies. Discussions are ongoing with pharmaceutical companies who may enter into cost-sharing and royalty agreements on these products.

AP Pharma’s prospects were almost certainly enhanced in November 2000 when Dr. Goddard assumed the role of Chairman and the management team was restructured. Dr. Goddard was Chairman and CEO of Neurex from 1991 to 1998 and managed the successful sale of Neurex to Elan Corporation for more than $800 million. He also has senior management experience with SmithKline Beecham and served as President and CEO of Elan for two years after the merger with Neurex. Another key employee is Dr. Jorge Heller, the company’s Chief Scientist. Dr. Heller has been working with controlled release polymers for more than 15 years and is recognized as a leader in this field.


Events that could cause AP Pharma’s stock to appreciate in the next 12 months include: announcements regarding partners for the Biochronomer products, increases in royalties from Carac and Retin-A Micro, receipt of earnout payments from Scherer, and approvals for product line extensions for Retin-A Micro.
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