Cipher Pharmaceuticals: A High ROIC Legacy Business at a Fair Price with a Free Call-Option on Two Unpriced Catalysts
Cipher offers a stable, cash-generative legacy business; able, well-incentivised management; and two near-term catalysts with the potential for additional significant upside.
Introduction
The way that I conceptualise the investment opportunity in Cipher is that for the money you pay today, you receive value in the form of a stable, cash-generative, high margin, high return on invested capital business with no debt, lots of cash that’s increasing at a rapid rate, and an able and honest management that is strongly incentivised to act in your best interests as a shareholder. Along with all that value, you also receive what is effectively a call option on two near term catalysts: a large, impending acquisition in 2024 and the commercialisation of MOB-015 in 2025/2026. Either or both of those two near-term catalysts could provide significant upside in addition to the value you already receive from purchasing the legacy business, which acts as a margin of safety mitigating the risk of permanent loss of capital.
What are the probabilities of those two near-term catalysts turning out favourably? Well, on the one hand, the dynamics of the Canadian market for onychomycosis treatments is such that MOB-015, a treatment that is ostensibly superior to all currently available treatments globally based on efficacy, ease of use, and safety, is entering a market where a single incumbent product has almost the entire market share. So, effectively, in the Canadian market, MOB-015 has a single product to overcome in order to become the market leader. Not only that, but the market incumbent, Jublia, is not a good product, which is something that prescribers have communicated to Cipher. In other words, MOB-015 is entering a market with a single, weak competitor. As Warren Buffett once said, the secret to life is weak competition. So, the odds of MOB-015’s commercialisation in Canada turning out well seem favourable.
On the other hand, the ostensible probability of a large acquisition turning out poorly seems high. Most corporate acquisitions are value destructive, especially when the acquirer already has a good business. In effect, if the acquirer cannot purchase a business that is even better than its current business, then it is effectively lowering the quality of the overall business by purchasing the lower quality target. For example, if a conglomerate of businesses whose average return on equity is 25% purchases an additional business with a return on equity of 20%, then the average return on equity across the entire conglomerate has been diminished. So, what if any factors are present here which militate against the acquisition turning out poorly, especially in light of the company’s history of poor acquisitions.
Well, for one thing, Craig Mull, Cipher’s CEO, is a 40% shareholder of the company. The significance of this is that he is essentially spending money that overwhelmingly belongs to him – 40% of Cipher’s cash balance is directly attributable to him. The fact that Craig Mull is spending his own money strongly incentivises him to ensure that the acquisition is value accretive. That’s all well and good in theory, but what about in practice? What if anything has Craig Mull done to demonstrate that he is a competent capital allocator? It just so happens that Cipher has a recent history of value accretive share repurchases at prices that are approximately one-third and half, respectively, of today’s current price (CAD $9.25). So, in practice, there have been events that demonstrate Craig Mull’s competence as a capital allocator. Based on previous share repurchases, Craig Mull certainly seems to know the value of his business. Hopefully, that translates to him purchasing assets that are of equal or greater quality than Cipher’s legacy business. All that to say, I think the probability of the acquisition turning out well is also favourable, given management’s strong incentives and recent track record of competent capital allocation.
As always, this write-up is not a recommendation or financial advice and is merely intended to pique your interest and to act as a starting point for you to begin your own research. I, of course, have endeavoured to ensure that the facts presented here are accurate. But at the end of the day, you must do your own due diligence and verify the facts for yourself so that you have the satisfaction of knowing that any investment decision that you may choose to make is based on your own knowledge and understanding and not based on blindly following others. Always do your own due diligence. Thank you for reading and happy hunting.