Artko Capital recently released its Q1 2019 Investor Letter, which you can track down here. In it, the fund reported its quarterly return of 10.3% and also shared its views on some companies in its portfolio. Among the stocks discussed was Recro Pharma, Inc. (NASDAQ:REPH), for which the fund wrote the following:
Recro Pharma (REPH)-We added an initial 2% position late in the 1st quarter to the $180mm pharmaceutical manufacturing company masquerading as a pharmaceutical drug development company. We generally have an aversion to investments in fields that are commodity based or where we lack a knowledge-based competitive advantage such as tech or pharmaceuticals. In particular,this case was an interesting event-based situation where Recro’s very valuable Contract Development and Manufacturing Organization asset (CDMO) was overshadowed by its costly investment in the intravenous meloxicam (IVM) pain management drug.
We have no strong opinion on the value of the drug,which has gone back and forth with the FDA on the agency’s desired results but were more excited when its second attempt at approval was rejected leading management to essentially suspend most of its cash draining R&D operations and to focus on its very valuable CDMO asset. Our view was that if the drug was approved at our $8 entry price, we would do well on the price adjustment, but were secretly hoping that it would not so we would have the opportunity to buy more at much lower prices just the CDMO asset. This is essentially what has transpired in recent weeks, and we started to add significantly more portfolio weight to this position at lower price levels as we believe both the incentivized management and board are looking for a lucrative exit. In the wake of the drug’s rejection the company has begun to lay off the rest of the IVM R&D staff, added a reputable activist investor to its board,and expanded its board seats signaling its shareholder friendly intentions and desire to realize significant value from its CDMO asset where it also meaningfully raised its 2019 guidance and expects to be cash flow positive by 2H19.
The CDMO asset has many of the characteristics we look for an investment: very sticky (95% renewal rate)customer base with long-term contracts; a strong moat where it can take up to two years for a pharmaceutical company to complete its due diligence on a potential replacement; complex intellectual property for manufacturing oral release drugs;and a hard to obtain Drug Enforcement Agency (DEA) license to manufacture controlled substances. As a result, the CDMO has almost 40% operating margins, industry growth tailwinds and a secular shift toward outsourcing drug manufacturing. While the company has some net debt and expected to burn more cash in the first half of2019 as it winds down its IVM venture, the future looks bright as the sub-$200mmenterprise value company expects its CDMO asset to generate up to $40mm in EBITDA this year,placing its run rate 2019 multiple around 5.0x. At the same time, in the last two years the multiples for transactions for similar assets are 16.0 to 17.0timessignaling significant upside even if the company is able to get a low double digit multiple on its asset in a sale scenario,though we would be just as fine with holding it for continued organic growth. Additionally, it’s likely the IVM drug has some value to other pharmaceutical companies with more FDA experience and larger capital bases to develop it, though we are not ascribing a value to this option in our thesis.
As a final point, to circle back to our original discussion of Valeant Pharmaceuticals, this situation -while not precise-is very similar to our original thesis in that stock in 2008: a mismanaged drug trial where the drug had more value to other industry participants, solid cash flowing operations masked by a bloated SG&A/R&D base;and an involvement with a reputable activist investor, Value Act, that was willing to monetize the assets and change the strategy to one with a clear path to value creation where one doesn’t need to have a PhD in biology to recognize.
Looker_Studio/Shutterstock.com
Recro Pharma is a clinical-stage specialty pharmaceutical company with a market cap of $185.38 billion. It mainly develops products for ambulatory care settings and hospitals. Year-to-date, the company’s stock gained 13.77%, and on April 25th it had a closing price of $8.43.
At Q4’s end, a total of 11 of the hedge funds tracked by Insider Monkey were long this stock, a change of -21% from the previous quarter. By comparison, 14 hedge funds held shares or bullish call options in REPH a year ago. So, let’s see which hedge funds were among the top holders of the stock and which hedge funds were making big moves.
The largest stake in Recro Pharma Inc (NASDAQ:REPH) was held by Broadfin Capital, which reported holding $14.5 million worth of stock at the end of September. It was followed by Newtyn Management with a $11.4 million position. Other investors bullish on the company included Alyeska Investment Group, Engine Capital, and Renaissance Technologies.
Warren Buffett never mentions this but he is one of the first hedge fund managers who unlocked the secrets of successful stock market investing. He launched his hedge fund in 1956 with $105,100 in seed capital. Back then they weren’t called hedge funds, they were called “partnerships”. Warren Buffett took 25% of all returns in excess of 6 percent.
For example S&P 500 Index returned 43.4% in 1958. If Warren Buffett’s hedge fund didn’t generate any outperformance (i.e. secretly invested like a closet index fund), Warren Buffett would have pocketed a quarter of the 37.4% excess return. That would have been 9.35% in hedge fund “fees”.
Actually Warren Buffett failed to beat the S&P 500 Index in 1958, returned only 40.9% and pocketed 8.7 percentage of it as “fees”. His investors didn’t mind that he underperformed the market in 1958 because he beat the market by a large margin in 1957. That year Buffett’s hedge fund returned 10.4% and Buffett took only 1.1 percentage points of that as “fees”. S&P 500 Index lost 10.8% in 1957, so Buffett’s investors actually thrilled to beat the market by 20.1 percentage points in 1957.
Between 1957 and 1966 Warren Buffett’s hedge fund returned 23.5% annually after deducting Warren Buffett’s 5.5 percentage point annual fees. S&P 500 Index generated an average annual compounded return of only 9.2% during the same 10-year period. An investor who invested $10,000 in Warren Buffett’s hedge fund at the beginning of 1957 saw his capital turn into $103,000 before fees and $64,100 after fees (this means Warren Buffett made more than $36,000 in fees from this investor).
As you can guess, Warren Buffett’s #1 wealth building strategy is to generate high returns in the 20% to 30% range.
We see several investors trying to strike it rich in options market by risking their entire savings. You can get rich by returning 20% per year and compounding that for several years. Warren Buffett has been investing and compounding for at least 65 years.
So, how did Warren Buffett manage to generate high returns and beat the market?
In a free sample issue of our monthly newsletter we analyzed Warren Buffett’s stock picks covering the 1999-2017 period and identified the best performing stocks in Warren Buffett’s portfolio. This is basically a recipe to generate better returns than Warren Buffett is achieving himself.
You can enter your email below to get our FREE report. In the same report you can also find a detailed bonus biotech stock pick that we expect to return more than 50% within 12-24 months. We initially share this idea in October 2018 and the stock already returned more than 150%. We still like this investment.
Free Report Reveals
Warren Buffet's Secret Recipe
Our Price: $199FREE
We may use your email to send marketing emails about our services. Click here to read our privacy policy.
Have You Heard of “America’s Nightmare Winter” Scenario?
Has gone public in recent weeks, with his “4th and Final Prediction”… about a scenario he calls: “America’s Nightmare Winter.”
You’ve probably never heard of Bill Bonner–but in addition to owning an interest in businesses all over the globe, he also owns more than 100,000 acres, with massive properties in South America, Central America, the U.S.,… plus three large properties in Europe.
Bonner has come forward today because he says we are about to enter, “A very strange period in America… which could result in the most difficult times we’ve seen in many, many years.”
Bonner has made three similar predictions in his 50+ year career… and each one proved to be exactly right, although he was mocked each and every time.