ENZO BIOCHEM INC ENZ
August 27, 2014 - 12:20pm EST by
repetek827
2014 2015
Price: 5.82 EPS $0.00 $0.00
Shares Out. (in M): 44 P/E 0.0x 0.0x
Market Cap (in $M): 256 P/FCF 0.0x 0.0x
Net Debt (in $M): -21 EBIT 0 0
TEV ($): 235 TEV/EBIT 0.0x 0.0x

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  • Royalties
  • Life sciences
  • Patents
  • Settlement
  • NOLs
  • New Product Launch

Description

Enzo Biochem was founded in 1976 and runs a ~$58mm year regional laboratory and and a ~$36mm/ year life sciences business that sells products to other labs and research institutions. The value of Enzo’s core operating business plus the value of a $61mm settlement with Life Technologies (expected in Q414) are less than the current enterprise value. The market has totally overlooked  Enzo’s novel gene detection platform , AmpiProbe, and the ten high profile patent cases Enzo has filed against some of the biggest names in molecular diagnostics.  John Desmarais, perhaps one of the most famous and successful IP attorneys practicing today, has taken all the Enzo cases on full contingency which represents a huge vote of confidence.  We think the risk/ reward in Enzo is asymmetric, with downside support and the potential to make multiples off current levels should AmpiProbe or any of their larger cases succeed.  


Margin of Safety: The Two Base Business and $61mm  Settlement from Life Technology expected in Q414


The Base Businesses

What does Enzo do? Enzo reports in two operating segments - Enzo Clinical Labs and Enzo Life Sciences (they have a third division that develops therapeutics but spending there has effectively ended).  Enzo Clinical Labs is a regional clinical lab serving New York, New Jersey, and E. Pennsylvania. Enzo offers a comprehensive range of clinical  laboratory tests  (40% of clinical labs segment revenue covers higher margin  esoteric tests) and maintains a clinical laboratory in Farmingdale, New York. Patients specimens are delivered to their laboratory  by their own logistics  department.

We know what you are thinking...why  in my right mind would I want to compete against Quest and LabCorp in a business where scale is so important? First of all, Enzo is the largest independent clinical lab in the state of New York and New York is the highest value clinical lab market in the  country. In fact, Enzo has a  bigger footprint in NY than Labcorp.  If Enzo’s clinical lab was solely focused on providing routine metabolic testing then one could reasonably expect them to lose share over time to their larger competitors but Enzo has positioned its lab as a Center of Excellence, akin to a kind of boutique in the industry.  Enzo has differentiated themselves as a technology and platform developer and as a valuable channel of distribution (they call on between 2-4k doctors).  As an example, Enzo created and then licensed Qiagen’s HPV test, which is the most used HPV test, and  Siemen’s viral load test. To give an indication of Enzo’s regional clout, Sequenom (NASDAQ: SQNM) partnered with Enzo to market Sequenom’s MaterniT21 test which is a leading non invasive prenatal test so in spite of its small size Enzo Clinical Labs has clout.




Their second business is called Enzo Life Sciences which manufactures reagents and products for drug development and clinical research customers. Life Sciences sells 7,500 of their own products and distributes over 30,000 products online at www.Axxora.com.     Enzo Life Sciences has an extensive sales and marketing infrastructure  to directly service end users (this will become important later on as we discuss the potential of Enzo most exciting new product Ampiprobe).  The products supplied by Enzo Life Sciences  include small molecules, proteins, antibodies, peptides, probes, assay kits, and custom services. Far from  commodity products, Enzo markets its products under its various brands - Enzo, Alexis, Biomol International, Assay Designs, Stressgen and is a leader in microarray analysis, gene regulation, and gene modification. Patented Enzo technologies are known  as key tools  in non radioactive gene and protein labeling.  This business generates ~50% gross margins and is profitable but sales are projected to be flat in the $34-$36mm range so we take a conservative approach and value the asset at 1x revenues or $.80/share .


Clinical Labs have been selling over the last couple of years for a minimum of 2 to 6x revenues  (GE bought Clarion for 5.7x and Novartis bought Genoptix 2.4x)... In the most recent and perhaps relevant  comp for Enzo, Fresenius Medical Care AG  bought Shiel Medical Laboratory, Inc located in Brooklyn for ~ 2x revenue last year.  Similar to buying a piece of real estate, the price of a lab largely depends on  scarcity value and location --and Enzo is the largest, independent lab left in NY which is an important consideration given all the consolidation that has been going on in the industry.  At a minimum, it’s not unreasonable to value this asset at 2.5x current  revenues  which is $145mm or $3.29/share.  Add the $.80/ share for Life sciences to the $3.29/share for the lab and you get a total of  $180mm or $4.09/ share.



$61mm Damages award from Life Technology Case in US District Court for the District of Connecticut

The second prong to the margin of safety relates to Enzo’s case against Life Technologies (this is separate from the Desmarais cases in Delaware). In 2004 Enzo filed suit in District Court in Connecticut against Applera Corporation, now Life Technologies (NASDAQ:LIFE) for alleged infringement of  six patents relating to DNA sequencing, labeled nucleotide products, and other technology.  In November 2012 a jury in New Haven found that one of these patents (US Patent No. 5,449,667) was infringed and valid and  awarded $48.5mm in damages.  Life Technologies appealed the decision and on August 5, 2013 the appeals court upheld the jury verdict and also awarded Enzo prejudgment interest of $12.4mm, bringing  the total award to in excess of $61mm.  It’s critical to understand the context and history of the case because the district court judge had previously ruled against Enzo on two motions for summary judgement, seemingly trying to punt the case to the appellate level, and both times the appeals court overturned the lower court’s ruling. In the latest ruling, the Judge denied the defendant's laches argument to limit damages and denied their request for a new trial. Currently we are awaiting Life Technologies final appeal but  our thinking / observation is that each successive appeal is weaker than the previous appeal because defendants tend to argue their strongest arguments first in the hopes of getting the case dismissed. Should the appeals court hear the case, we expect the oral hearing in the next couple of months and the final verdict ninety days later.  Enzo has $105mm in NOLs and there is no contingency associated with this litigation so we expect to receive the entire payment of $61mm or  or $1.38/ share.

So as relates to our downside protection we have two operating businesses valued under conservative assumptions at $4.09/share and the  damages award from Life Technologies worth $1.38 for a total of $5.47/ share vs. today’s price of $5.82.




Two Huge Shots on Goal: AmpiProbe and The Ten Delaware Patent Cases


AmpiProbe: Leveling the Molecular Diagnostics Playing Field

Continuing its decades-long tradition of technology leadership, Enzo has developed a novel, proprietary nucleic acid detection platform called AmpiProbe. The current market for  nucleic acid-based tests is $2 billion, and AmpiProbe has the potential to disrupt this market by providing substantially greater sensitivity than conventional PCR based tests for a fraction of the cost. One of the hardest hit areas in health care reimbursement has been diagnostic testing, to the point where many labs cannot even make a profit on certain routine tests.  As one industry expert told us, United Healthcare reimburses $48 for a  HepC test which is less than the cost to run the test using conventional PCR .  AmpiProbe uses a novel amplification technology that can cut the costs  by up to ~50%. AmpiProbe requires less sample and reagent ,is compatible with the open sample processing systems already in modern labs, and is not subject to PCR royalties.

Enzo expects to make its first commercial sales of AmpiProbe in Q115.  AmpiProbe will be offered through Enzo Clinical labs. Enzo becomes a reference lab  by offering lower priced tests to other labs. Alternatively, Enzo will sell reagents  directly to labs so they can create  their own lab developed tests, which should help turn things around in the Life Sciences Division. How fast AmpiProbe ramps will be a function of how the product is priced but management indicates that they have very low cost of goods and will be able to make an extremely compelling case to an industry that is suffering from deflationary pressures.




The Ten Delaware Patent Cases

Back in the early 80s, a mere twenty years after the work of Watson and Crick, Enzo filed IP relating  to the modification  of nucleic acids at their sugar and phosphate sites and  labeling of nucleic acids for the purpose of generating a signal. This work dates back to a time when the primary mode of clinical diagnostics involved using immunoassays or physically growing cells in a petri dish. With advances in genome science and  the ability to recognize  pathogens at the cellular level, doctors embraced cellular approaches but the first methods used radioactive markers to identify DNA.  Enzo invented methods for detecting nucleic acids without the use of radioactive isotopes, which has subsequently become the de facto standard for molecular diagnostics.   Enzo was able to file a broad range of IP and add to their original patents through continuations of the original application as science and clinical practice developed.

In 2012 Enzo hired John Desmarais from the law firm Desmarais LLP (http://www.desmaraisllp.com/lawyers/john-m-desmarais) to represent them in ten different patent suits against Gen-Probe (HOLX), Life Technoloiges, Roche Molecular Systems, Abbott Laboratoreis, Becton Dickinson, Hologic, Affymetrix, Agilent Technologies, Illumina, and Siemens Healtchare Diagnostics. The significance of retaining Desmarais on full contingency (the split is not public but we’ve been told it is better than the standard 60/40) is that it demonstrates that one of the most prominent names in IP litigation is willing to risk millions of dollars of his own money to pursue these cases. For those that follow the industry, Desmarais is one of the most recognized IP litigators on both the plaintiff and defendant side.  Recently, on the plaintiff side, he represented Alcatel-Lucent against Microsoft in 2007  ($1.5 billion judgement for the plaintiff) and on the defense side he defended Cisco against Virnetx in a high profile case in the Eastern District of Texas.   A recent Wall Street Journal Article sheds some more light on Desmarais although the article discusses Non Practicing Entities whereas Enzo created all of its IP:

http://online.wsj.com/news/articles/SB1000142405297020375040457717340244268128


Clearly, Desmarais is one of the most prominent litigators in the field and only takes on very significant cases.  So what could this all be worth to Enzo and how long will it take to collect? Last week the parties met in Delaware District Court for a consolidated Markman hearing wherein the parties argued over the definition of the most important  claim terms in the patents.  We expect the judge to get back with his ruling in a couple of months at which point there will be more briefing back and forth. All case dispositive motions are due in April 2015 and the case should follow within a couple of months assuming there are no delays.  Enzo is asserting three patents and numerous claims against the various defendants. At this point in the litigation we can only make rough estimates of the aggregate value of the the infringing products across the various defendants.  For illustrative purposes, the patents cover all the genetic amplification products using PCR like Roche’s TaqMan product which sells $3-4 billion on an annual basis. That is just one of ten defendants! Unlike the case against Life Technologies in District Court in Connecticut which involved expired patents and past damages, the current patents don't expire until the mids 2020’s so a  positive outcome would entail payment for past damages and an ongoing royalty.


What’s this all worth? We are confident that the value of Enzo’s two operating businesses combined, along with the high probability of receiving  $61mm in damages from Life Technologies is worth at least close to  the current market cap of $256.  Enzo has $21mm in cash on its balance sheet ($14mm as of April 30,2014 +$7mm from PerkinElmer on June 23, 2014) and expects to be profitable in the next two quarters, especially as all its legal activity becomes full contingency with the resolution of the Life Technologies case by the end of the year.  Success with AmpiProbe and any one of the ten Desmarais cases have the potential to increase value multiples above the current stock price but should events not work out as we hope, we are at least left with two operating businesses with real value.
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

-favorable Markman ruling and positive briefings around pre trial motions / settlement discussions
-further stabilization of base business
-launch of AmpiProbe
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