'I never thought I'd pick a pharmaceutical'

But free money is . . .well, free money!

By AllStarPortfolio Oct 30, 2009 1:05AM
"Bold words" is what I thought when I first read Chris Graley's note to me on CAPS for AllStarPortfolio, but then I read the rest; and he had plenty to say.

KV.A has currently has 3 major brands that they sell.

The Ther-RX brand is devoted to women's health care. It has 3 major products. Gynazole and Clindesse are both anti-infectives and Evamist is used for estrogen therapy. These 3 products provide about 40% of KV's renenues and revenue growth for these products was 15% in fiscal year 2008 and 30% in fiscal year 2007.

The Ethex brand handles KV.A 's generic products and makes up about 57% of KVA's revenue. They have a ton of different products in different catagories, but 64% of their generic sales come from their cardiac drugs. Metroprolol is probably the most well known. Revenue growth in this brand was up 16% in 2007 and 56% in 2008

The Product Dynamics brand markets a few trade-marked ingredients to the pharmaceutical and nutrition industries. It is currently about 3% of revenues and a growing but currently negligible part of the company.

In August of 2008, FDA seized $24M worth of unapproved drugs from KV-A after an earlier inspection revealed that the ingredient guaifenesin was still being manufactured by KV A in a time released format after the FDA released a statement that using the drug in a time released format would first require further FDA approval. The drug is used to thin mucus and is found in common in cold and flu products such as Mucinex or Theraflu. The FDA required companies to stop manufacturing the affected products before Aug. 27, 2007, and to stop shipping the products before Nov. 26, 2007.

In November 2008 KV.A neglected to file it's annual report stating that the pending government action would adversely effect it's future earnings.

In January of 2009 a class action lawsuit was filed by share holders against KV.A. At about the same time, KV-A voluntarily suspended manufacturing and shipment of all of it's products.

In February 2009 KV.A reduced it's workforce by 700.

In March 2009, the company agreed to an injunction from the FDA to stop manufacturing and shipping all drugs until they receive approval from the FDA on good manufacturing practices. The injunction binds the company's executives to remain in FDA oversite for a period of 5 years. It also delays all other drugs that they have in the FDA pipeline.

There's lots of other stuff in between, but I'm going to switch to September 2009 now. KV.A has rehired their workforce and received approval from the FDA on good manufacturing practices. They are starting up manufacturing and just sold the ACNE cream ANDA to Perrigo for $14M plus $2M in milestones. The agreement also transfers the responsibility for litigation with Glaxo Smith Kline to Perrigo. This allows KV.A to remove expenses related to this litigation from it's balance sheet. GSK makes Duac which ANDA clones in the generic version.

Ok now my analysis...

This company is currently priced at 0.3 price to book value and it's priced that way for a reason. The company itself pondered it's ability to continue to do business when the FDA swooped in. It fired it's former CEO, and it's CFO just stepped down recently. If it would have filed it's last annual report on time, there is a big chance that it would be in bankruptcy right now. All that being said, this company has turned the corner. You've seen the previous growth rate that I posted above. They also have a some drugs that were delayed in the FDA pipeline that are now being considered as well. They should see a surge in growth as these drugs get approved. They got caught doing what most drug companies have been doing to a lesser extent at a time that the FDA wanted to prove a point that they were cracking down. They will now have the best manufacturing processes for the next 5 years.

OK, so we have a $27 stock that was quickly headed to $50, That stock got caught with it's pants down. It paid a price. A very big price! It's making the same drugs that were very popular before. Fortunately, it managed to melt down right before the economy tanked. If it went bankrupt today, you'd still make money. The play on this is an old fashioned Benjamin Graham type purchase.

OK, now a couple of negatives...

First, the class action suit is still out there. I'm not as worried about it though, because even if the shareholders win, a penalty will be assessed based on the current valuation on judgment and not the future valuation. The previous CEO has a big threat of errors and omissions or negligence in a civil trial, but that doesn't effect the stock. The second thing that bothers me is that the former CEO is still the board chairman and in control of the majority of voting shares of the class B stock. He's responsible for the short cuts in the past, but he's also responsible for some shrewd business decisions that caused the KV.A growth in the past. He is currently jockeying for position to get a little of the control that he had as CEO back as chairman. The only thing that worries me is that he will continue to take the same short cuts of the past to cut production costs. Thanks to the FDA, I don't have to worry about that for the next 5 years.

This is a little more of an involved pitch Solaris, but this pitch should really only be 2 words.

"Free Money!"

I hope that you approve.

Well as i told Chis, back on September 22nd, "That is a great pitch".

Chris Graley is a contributor to AllStarPortfolio on The Motley Fool
Visit wallstreetsurvivor.com to track AllStarPortfolios picks!

SolarisKing
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AllStarPortfolio
Tags: CAPS
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