Marijuana & Antidotes: GSK & CEMP Nursing Pulmonary Diseases

With the recreational legalization of marijuana in Washington and Colorado, there has been an influx of investment based on skyrocketing revenues. I think there is a group of investors that would like to profit from this, but have ethical reservations. Three possible concerns might be: 1) the stigma from investing in a predominately illegal substance; 2) a concern regarding federal restrictions (U.S.C. Schedule I); or 3) other personal dispositions regarding drugs. An alternative investment would be the antidotes associated with smoking marijuana.

What is often underreported are the collateral expenses of smoking. Data for marijuana use had been conventionally excluded from these studies, but its increase of use and legalization will slowly push it into the statistics. It is likely to be a drastic multiplier for risks in pulmonary disease due to several factors, some of which are listed below.

The idea that these emerging vice sectors are pure profit to our economy is a misnomer. Dating back to the repeal of Prohibition, a record has been kept of the comparisons between taxation and the cost of collateral expenses. This goes to show that for every dollar gained in revenue and then captured by local government taxation; there is a greater expense (revenue for someone else) occurring in other sectors. For example, alcohol related health and incidents cost fifteen times more than the profit from its sales tax. (see The Public Health Consequences of Marijuana Legalization). The CDC reports we are spending an annual average of $133 billion for smoke related illnesses.

Chronic Obstructive Pulmonary Disease (COPD) and other interim respiratory conditions are the focus of the following pharmaceutical companies due to increased cases, severity and current antibiotics losing effectiveness from evolution of antibiotic resistance.

COPD & Pneumonia

The American Thoracic Society has tracked high mortality rates caused by COPD compared to other leading diseases. On average, a smoker may take anywhere from 20-30 years to have the full onset of COPD. It is estimated that 20% of COPD cases are caused by cigarette smokers. Tobacco smoke contains more than 4,000 chemicals and marijuana smoke contains a greater amount of carcinogens than tobacco smoke. “[W]hen equal amounts of marijuana and tobacco are smoked, marijuana deposits four times as much tar into the lungs.”

COPD is just one of the many pulmonary diseases that can be caused by smoke from marijuana and tobacco. Medical studies also link tuberculosis, pneumonia, and chronic bronchitis to smoking. “In 2009, it was estimated that 9.9 million Americans reported a physician diagnosis of chronic bronchitis…” The most common cause was cigarette smoke. With the increase in legalized marijuana, there will be an increase in need to treat the spectrum of these respiratory/pulmonary conditions.

Cigarette smoking from 1965 to 2012 had decreased from 42% to 18% of the population, but from 2010 to 2013, the rates have plateaued and cigar smokers have increased 2x-3x historical figures. (see Surgeon General).

GSK Antidotes

The data shows that GlaxoSmithKline (NYSE: GSK) has had a major presence in development of drugs that address COPD. Their pharmaceutical and vaccine portfolio is vast in addition to OTC products, but the focus on respiratory disease is on point. The outlook of GSK’s respiratory endeavors is positive according the Q2 2014 release.

[C]ontinued momentum in new product launches in respiratory…new sales growth expected from Breo, Anoro and Incruse…

Their Q1 and Q2 sales in 2014 have consistently been led by their respiratory portfolio with it accounting for more than half of all pharmaceutical sales.

(click to enlarge)

The EPS was down at 22.8 cents for the quarter, but the dividend increased by 6%. As of September 6th, the stock was trading at a modest P/E ratio of 14.80 and at approximately 4% above its 52week low of $46.01. I consider the current price a buy for a long-term hold through the 2015 and 2016 year.

CEMP Antidotes

For a cheaper entry price into pulmonary antidotes, Cempra Inc. (NASDAQ: CEMP) was trading at $10.25, approximately 26% above its 52week low. They have several drugs in the pipeline between Preclinical and Phase III, but the most promising to me are: 1) Solithromycin for pediatric pneumonia in the United States; and 2) Solithromycin via Toyama Chemical Co. in Japan. Both applications have provided revenue for Cempra Inc., which is an accomplishment for a company that has not completed all U.S. clinical trials.

The pediatric application is utilized via Biomedical Advanced Research and Development Authority (BARDA) contracts 1 2. It allows patients to use the drug outside of the test populations. Being under the U.S. Department of Health and Human Services, this is similar to FDA’s “compassionate use” and “expanded use” exceptions of investigative drugs. Toyama realizes Solithromycin as an opportunity due to its “efficacy against respiratory tract infections” and the “great need for new macrolide antibiotics.” (see Toyama Press Release).

For the time being, I see CEMP as a hold. This is based on two factors. First, I have found various quotes on its book value, and only after some cautionary adjustments can I find a matching calculation. After using deferred revenue from Toyama licensing and removing significant R&D costs; I start to approach a 9x-10x price to book value. In a September 9th press release, the Toyama deferred revenue was realized and at twice the anticipated amount; a $10 million milestone payment. I estimate the projected book value to be closer to $1.30 from the previous $1.17. This might be bearable for the shareholder of a clinical-stage pharmaceutical company, if not for a second factor: future stock offerings.

CEMP’s Note Activity & Dilution Concerns

The company had lowered their “current portion of long term debt” to 1/5 that of the previous six months. This gave them a momentary victory in assets vs. liabilities. However, with small revenue streams and plenty of R&D to accomplish, they needed new financing. Cempra Inc. adjusted the note at the last minute with Hercules (Capital & Trust). They took on $3 million more in debt and increased the future limit by $10 million. Indications were given that they may utilize the $10 million by mid-2015.

We will need to obtain additional financing … prior to the commercialization of any of our product candidates. [W]e may use our available capital resources sooner than we currently expect…

In June 2013, the public offering issued 8,273,938 shares at $7.00 per share. At that time the book value per share was approximately $2.98. The common stock was offered at approximately 2.35x book value. They currently have 4,125,622 more common stock reserved for future issuance.

(click to enlarge)

Cempra Inc. does not have a vast portfolio of products on the market like GSK. Their net loss requires them to take out loans and issue more common stock. The following is a chart of their pipeline that requires additional financing to see it through:

(click to enlarge)

If a public offering takes place again in Q2 2015, there is a risk the offered price will be much lower than the current trading price of $10. If they take on the remainder $10 million in debt, it will only add to this disparity.

Conclusion

The political climate and straw polls suggest that more states will legalize marijuana for recreation and medicinal purposes. The addition of marijuana smoking, a consistent rate it cigarette smoking and increased use of cigars correlates to an increase in pulmonary disease. GlaxoSmithKline is prime for a long term investment at the current stock price. Cempra Inc. is a great response to pulmonary disease too, but the stock price may significantly decline as it nears Q2 2015. I will be watching for further indications regarding a public offering.