A Stock that Discovers More than Just Profits

Monday, May 17, 2010 - 3:43pm

by Frederick M. Steier

As investors, we are inundated with so much information that great ideas sometimes get lost amid the noise. Sometimes we become so intrigued by a company that we completely ignore the fact that there may be other entities supporting the company that may be even better investments.

Even if an investor examines a product or service that isn't particularly good, it is always worth digging one level deeper to see if some other opportunity exists beneath the surface. For example, you may love the car you drive, but the stock of that car company may be too expensive. The stock of the company that provides the computer system, however, may be an overlooked gem.

Pharmaceutical Product Development Inc. (Nasdaq: PPDI) fits this bill exactly. The company handles all the work that goes into clinical trials for major pharmaceutical companies. In essence, big pharma outsources its clinical trial work to companies like PPDI. Now that may sound interesting on the surface, but there are so many different aspects to biosciences that a company better be competent in a wide range of services if it wants to be a big player in the market. That's where PPDI excels.

The company has conducted regional, national and global studies across all kinds of therapeutic areas and in 102 countries. These include preclinical programs, Phase I-IV clinical trials, vaccines and laboratory services. PPDI also provides support for drugs and devices that are going to market by offering product launch services, medical information, patient compliance programs, patient and disease registry programs, product safety, Phase IV monitored studies and prescription-to-over-the-counter transition programs.

In order to stay competitive, the company must stay ahead of the curve. PPDI has been in business for 24 years, and continually wins contracts from major pharmaceutical companies. As of 2008, it had served 49 of the world's top 50 pharmaceutical companies.

Up until recently, PPDI engaged in the discovery of new drugs as well. This made the company a particularly interesting play, as it provided diversification for investors and the possibility of mega-revenue should it discover a blockbuster drug. The advantage was that, unlike other biotech or pharma companies which need to eternally refill their drug pipelines while living off the cash flow from a current drug, PPDI would always have a significant underlying business. Any discovery would be gravy, especially since PPDI spreads risk by partnering in compound discovery with other companies.

Now, management has decided to spin-off the Discovery Sciences segment through a tax-free, pro-rata share of stock in a new company. After the spin-off is complete, investors who want to own PPDI's Development segment but also give themselves access to the Discovery segment should consider buying both stocks.

So where is the risk in this investment? There are two. The first is competition. PPDI must fight to maintain its position among other players like Covance Inc. (NYSE: CVD) and Parexel International Corporation (Nasdaq: PRXL). The second is the overall health of the economy and regulatory attacks on pharmaceutical and biotech firms. These are tough times, remember, and everyone has been cutting back and PPDI has not been immune.

The company had $284 million in contact cancellations in the most recent quarter, which was 60% of new authorizations. This is certainly not good news, but PPDI also has $3 billion in backlogged authorizations. Yes, these could be cancelled as well, but unless the company starts seeing even larger and more frequent cancellations, there is little cause for alarm.

The other reason not to panic is PPDI's extremely robust balance sheet. The company sits on $600 million in cash and has no debt. On top of this, it generated $200 million in free cash flow during the trailing twelve months and $134 million in profit. While business is lackluster, with revenue and earnings down this quarter compared to last year, the company's balance sheet is so rock solid that it would take a meltdown in the health care sector to knock it off its game. Investors can also take heart in the fact that the Executive Chairman owns 6.5% of the company himself, indicating his interests are aligned with shareholders.

While times are tough, PPDI is a good story with a good future ahead of it. Analysts see earnings struggling this year, but roaring back in 2011, with a 5-year annualized growth rate of +13%. Earnings will be propelled by pharma companies reinstating their R&D budgets back to pre-recession levels. There is always risk, of course, but this seems like a good time to get in.

Frederick M. Steier does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.