Unilife, Or: When A “Growth” Pure-Play Isn’t A Smart Play by Jordan S. Terry, Managing Director Stone Street Advisors LLC

I come from the school of fundamental value analysis/investing. So when a client asked me to look into Unilife Corp (NASDAQ:UNIS) a few weeks ago, naturally, my first reaction was to look at their SEC filings and financial statements. It became immediately clear (as it should to anyone who’s spent more than 60 seconds looking) that this was not a company on which one could perform a discounted cash flow (DCF) valuation or any other traditional fundamental valuation, since their financials are an absolute and utter disaster of the highest order. DCF won’t work – it’d just be adding an enormous degree of false precision/certainty to an extremely uncertain and unpredictable set of financials – and comps are only useful insofar as they not only exist, but have similar activities, capital structures, etc. Option valuation is just another exercise in futility, especially considering the firm’s financial and operating history is all over the place, making any assumptions/inputs useless.

So how then are we supposed to value this company?

Frankly, I think attempting to value the company is jumping about 50 steps ahead, without taking the preceding 49. We must learn to crawl before we can walk (let alone jump!). Similarly, we must understand this company, the industry, sources and extent of demand, and other factors before we can even begin to throw darts at a board and value this firm. I’m not here to reinvent the wheel by parroting the same arguments made by others (see the many preceding Seeking Alpha etc. articles on the company). Rather, I’m going to try to point out some new ideas, or present existing facts in a new light.

Paging Professor Porter, Professor Porter to the Front Desk!

For the uninitiated, part of fundamental analysis is getting to know the company and the various forces that act upon it, or with which it interacts. Don’t be so quick to dismiss this type of analysis as academic or ineffective. Unless you’re the type of person who prefers the “see no evil, hear no evil” method of investing. (If this is new to you, please pay attention, for your own sake):

Using the 5-Forces framework, it doesn’t take a rocket scientist to realize that Unilife Corp (NASDAQ:UNIS) isn’t exactly in the best position.

Threat of New Entry: It operates in an industry with low barriers to entry. In fact, I can outsource design, manufacturing, distribution, etc to China, build a website and cold call pharma companies for not very much money at all.

Competitive Rivalry: The market for its products is intensely competitive and Unilife Corp (NASDAQ:UNIS) is among the weakest if not the weakest of the bunch. They can claim their products are differentiated enough that end users can market them to patients to differentiate themselves, but after speaking to a few doctors, that’s a load of nonsense, to put it gently. Their products aren’t that different from competitors and while they’ve worked with some big pharma companies, those firms have much bigger contracts with – and loyalty to – the entrenched players in the market (Becton Dickenson, etc). Several others have commented on this in depth, pointing out that the market for prefilled syringes is “oligopolistic in nature and is dominated by a few key players.” Besides Becton, there are other extremely similar (in end-users’ eyes) products from the likes of other, still much larger & established competitors such as Nipro, and West Pharmaceutical Services Inc. (NYSE:WST), which also makes a wearable product in case anyone was under the impression I’m just talking about prefilled/safety syringes.

Buyer Power & Threat of Substitution: Unilife Corp (NASDAQ:UNIS) is tiny. Its buyers (customers) are massive. Even if Unilife had the greatest syringe technology ever conceived by man, they couldn’t come anywhere close to satiating their customers’ needs. That’s a moot point since, as I mentioned, their products aren’t substantially different enough for a customer/end user to really care, and their customers hold all the negotiating power, anyway. Also, and I think this is a key point missed by almost everyone long the stock, why would a huge company do business with a tiny, unreliable, unproven supplier that can’t produce at scale? The answer is, they wouldn’t. The only reason Unilife gets a taste is because $40 million here or there for a big pharma company (on the chance their primary supplier screws up somehow) is literally a rounding error to them. Sanofi’s cost of sales last year was ~$15 billion (at current EUR/USD rate). $40mm is less than 1/3rd of 1% of that! No one at Sanofi is getting fired for doing a small (for them) run of prefilled syringes with Unilife. For those of you who still can’t grasp what I’m getting at here: Just because a few big pharma companies have done business with Unilife, it hardly means that Unilife is on the same level as the incumbent players.

If you disagree, please explain to me why Becton does over $4.3 billion in medical device revenue/year while Unilife is struggling to get a few million. Unilife is not a startup making syringes out of a garage; their products are just not significantly unique, their scale not sufficiently large, nor are their prices substantially low such that their target market is jumping at the chance to work with them. You’re welcome to hold on to the pipe dream that one day Unilife may get to that point, but you’re tying up your (presumably) hard-earned money until – IF – that day comes, you’re bearing a large opportunity cost by not putting your money into higher quality investments. Whether you’ve been following this company for years or you’re new, it matters not; the results thus far speak for themselves, and they are far from stellar.

Timing is Everything

As Unilife notes on its website, its products are not approved by the FDA. This is not a problem in and of itself since all of its products would be treated as Combination Products by the FDA, which are considered for approval by their Primary Mode of Action, which is not the device, but rather whatever drug the device holds/delivers. This is not to say the device is irrelevant in the approval process; the device is still part of the review. The FDA aims to review & act upon applications for generic drugs (like the ones Hikma makes) within 30 months. Unless the products are fast tracked for one reason or another, that means no real product sales for 2.5 years, minimum. I may be wrong here, but somehow I doubt, based on Unilife’s history, Hikma Pharmaceuticals Plc (LON:HIK) is going to take ownership of anywhere close to 175mm units/year in 2014, or 2015. Maybe, possibly 2016, so minimal revenue from the deal until then. Remember, Hikma is only paying Unilife $5mm upfront (per press release), which they recognize over the 15-year term of the agreement, not all at once, per thenotes to the financial statements in the last

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