Cipher Pharmaceuticals: Write-Up Preview

Cipher is a potential multi-bagger Canadian microcap with two unpriced, near-term catalysts.

Thesis Summary

Cipher Pharmaceuticals (“Cipher”) is a specialty pharmaceutical microcap company listed on the Toronto Stock Exchange (TSX:CPH) and the OTCQX Best Market (OTCQX:CPHRF), the highest tier of the OTC markets.

Cipher’s current business (its “legacy business”) consists of three segments: the products segment, which is a portfolio of pharmaceutical products directly marketed and sold by Cipher in Canada; the licensing segment, which is a portfolio of products licensed to commercial partners for which Cipher receives product supply revenues and net sales royalties on products sold in North America and Latin America; and the development products segment, a portfolio of pharmaceutical products being developed either directly by Cipher or in collaboration with a commercial partner. 

The most important products for each of Cipher’s business segments are Epuris for the products segment, Absorica for the licensing segment, and MOB-015 for the development products segment. 

Epuris is a market leading prescription oral isotretinoin treatment for severe acne in Canada, which Cipher directly markets and sells in Canada and pays a single digit royalty on a perpetual, exclusive licence to its commercial partner, Galephar Pharmaceutical Research Inc (“Galephar”).

Absorica is a prescription oral isotretinoin treatment for severe acne, marketed and sold by Cipher’s commercial partner, Sun Pharmaceuticals Industries (“Sun Pharma”), in the United States, for which Cipher receives net sales royalties and product supply revenues. Absorica is an identical product to Epuris but is sold under a different brand name in the United States.

MOB-015 is a topical solution treatment for onychomycosis (nail fungus) which is being developed by Cipher’s commercial partner, Moberg Pharma AB (“Moberg”), for which Cipher has obtained the exclusive rights to market and sell in Canada. Cipher expects MOB-015 to become available in Canada in the second half of 2026.    

Cipher’s legacy business is a high-quality business that produces stable, high margin, free-cash flows with practically no need for incremental capital reinvestment and has many attractive financial characteristics. Such characteristics include high gross margins; high operating margins; high returns on invested capital without the use of debt; high margin royalty revenues that have the potential to grow without Cipher providing incremental capital reinvestment; a war chest of cash sitting on the balance sheet that represents a significant proportion of Cipher’s market capitalisation; high monthly after-tax free cash flows which continue to increase Cipher’s cash pile; and tax loss carry forwards available for use as a tax shield for future earnings.

Although Epuris is not protected by patent, it has a competitive advantage in the form of a niche; the drug has a high market share in a relatively small market and the costs for a new competitor of entering that market are very high in proportion to the potential attainable economic value, which acts as a barrier to entry for prospective competitors.

Absorica is no longer protected by patent. However, Cipher’s management is of the view that Absorica’s market share has stabilised following the expiration of its patent in the United States.

In addition to the highly attractive legacy business, Cipher has the potential for significant further upside from two near-term catalysts: the commercialisation of MOB-015 in Canada in 2025/2026 and a large acquisition relative to Cipher’s current market capitalisation slated for 2024.

MOB-015 is a topical treatment for onychomycosis. Cipher has obtained the exclusive rights to market and sell MOB-015 in Canada from its commercial partner, Moberg Pharma AB (“Moberg”). Cipher estimates the value of the market opportunity in Canada at approximately CAD $91 million. A single product, Jublia, currently has approximately 95% of the market share for onychomycosis treatments in Canada. Cipher anticipates that MOB-015 will quickly take market share away from Jublia. Furthermore, Cipher’s estimation of the market opportunity in Canada is somewhat understated because it assumes that treatment rates (that is, the proportion of patients affected by onychomycosis who seek treatment) will remain the same. Cipher’s true opportunity with MOB-015 lies in expanding treatment rates and thereby increasing the value of the target market in Canada. Onychomycosis has an estimated prevalence of 6.7% of the population in Canada. With an approximate population of 39 million people, the number of affected patients is approximately 2,620,172.082 people. If MOB-015 successfully increases treatment rates due to its superior efficacy and ease of compliance with its treatment protocol, then Cipher could potentially sell hundreds of thousands of units of MOB-015 in Canada.

Cipher’s second near term catalyst is a large acquisition. Management have indicated their intention to make an acquisition the value of which is significant relative to Cipher’s current market capitalisation. The criteria for Cipher’s prospective acquisition include legacy pharmaceutical products in the United States that have been on the market for a long time, that are producing stable revenues, and that require minimal commercial efforts; opportunistic purchases of product portfolios or entire companies with the objective of cutting costs and achieving positive EBITDA; and potentially acquiring a United States company with a NASDAQ listing and combining Cipher and the target, thereby attaining a NASDAQ listing for Cipher.

Cipher’s prospective acquisition will be significant given its indicated size and so it is important that management makes the right acquisition. There are at least two factors which indicate that management is likely to make a value accretive acquisition: firstly, there is a significant degree of insider ownership within Cipher. Secondly, management has a proven track record of value accretive share repurchases, which is demonstrative of effective capital allocation.

There is a margin of safety factored into Cipher’s current market price due to the value of its legacy business. If Cipher could simply maintain its TTM 2023 financial year operating income of USD $12,681,000 for the rest of its corporate existence, then at an assumed long-term interest rate of 7%, I estimate the value of Cipher’s legacy business to be CAD $225,658,384.25 before factoring in the value of either of the two near term catalysts. With a current market capitalisation of CAD $222,910,000 and a cash balance as at 31 March 2024 of USD $41,981,000 (CAD $57,454,566.88), I estimate Cipher’s enterprise value to be approximately CAD $168,203,817.37.

My estimate of the value of Cipher’s legacy business (CAD $225,658,384.25) compared to its current enterprise value (CAD $168,203,817.37) provides a margin of safety of approximately CAD $118,699,204.76. Expressed as per share values, Cipher’s current market price (on an enterprise value basis) is CAD $6.89, whereas the value of its legacy business is approximately CAD $11.64 per share before factoring in the value of the two near-term catalysts.

I don’t believe it is possible to accurately attribute value to Cipher’s prospective acquisition at this time, given the lack of quantitative information that is available, although one could make reasonable assumptions and speculate. I have chosen not to.

I estimate the value of Cipher’s business on a per share basis after factoring in the MOB-015 catalyst to be within the following range:

• Low range: $11.15.

• Medium range: $13.44.

• Medium-high range: $19.99.

• High range: $45.85.

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: the commercialisation of MOB-015 and an impending acquisition. 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.

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, 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 directly told Cipher and which Craig Mull has relayed on earnings calls. 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 in effect spending money that overwhelmingly belongs to him – 40% of Cipher’s cash balance is directly attributable to him. The fact that he is spending his own money strongly disincentives him from doing something silly. Now, that’s all well and good in theory, but what about in practice?  What if anything has Craig Mull done to demonstrate that his capital allocation is effective? It just so happens that Cipher has a recent history of value accretive, effective share repurchases at prices that are approximately half and one third of today’s current prices. So, there are some recent, concrete events which we can point to in order to take comfort that Craig Mull is a competent capital allocator, which in turn suggests that the impending acquisition might work out favourably. He certainly seems to know the value of his business based on historical repurchases, and hopefully that translates to him purchasing assets that are at least equal to or greater in 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. Please also keep in mind that valuations are always rough estimates, are not capable of precise calculation, and vary widely based on assumptions and their reasonableness and appropriateness. Please think critically about valuations presented here and decide for yourself whether they are appropriate or not. Thank you for reading and happy hunting.