Why Barron’s Article on Opko Health is Myopic

Submitted by Mike Anthony as part of our contributors program.

The feature story in this weekend’s Barron’s magazine regarding Opko Health (NYSE: OPK) is superficial and parrots an elementary argument that has been unpersuasive for years. I will justify my argument in the article that follows, explaining to readers why shorts will likely get squeezed in Opko Health, just as they have been squeezed in every major company led by its CEO, Dr. Phillip Frost.

Arguments coming from Barron’s automatically receive the benefit of massive distribution, an affluent readership, and the “steamroller effect” of Wall Street’s most powerful weekend publication. Barron’s circulates to over 300,000 households holding an average net worth of $3 million each. According to a 2010 survey, 96% of readers take action after reading Barron’s (many by buying or selling securities featured in the magazine).

As we all know, however, might does not make right. To the contrary, in Sweating Out the Results of a Blood Test, author Bill Alpert abuses the marketing influence of Barron’s while failing to justify his conclusion. Below, I explain that his article makes an intellectually disappointing argument that has been parroted for many years.

Alpert’s Article Is Superficial

The depth of Alpert’s analysis reflects the self-evidently brief amount of time he spent reflecting on Opko Health. This is not a personal attack- to see the shallowness for yourself, search online for “short Opko.” You will effortlessly retrieve thousands of essentially identical analyses. Search and see for yourself. What is the most publicized argument for shorting Opko Health? I have heard it repeated so often that I could recite it backwards: Opko Health has a high price-to-sales ratio. In other words, if you evaluate Opko Health shares as you would for a typical business, basic analysis will show that it is overvalued in proportion to near-term revenue.

Of course, this makes me want to slam my face into my palm.

This mantric conclusion inexplicably causes no less glee for shorts even upon its thousandth repetition. Honestly, I almost do not care to correct them anymore. Facepalms are easier. Here is why.

Why Skimming the Surface Is So Alluring

In his analysis, Alpert provides a glib overview of Opko Health and its CEO, Dr. Phillip Frost. Quickly glossing over the largest systematic insider buy program in stock market history and the 68-fold rally in Dr. Frost’s prior company (among other trivial factoids), Alpert then presents the meat of his article by evaluating technical problems within a couple of Opko Health’s products.

I will spare you the paragraphs of analysis and jump to the conclusion (spoiler alert!): some Opko Health products have been discontinued and others might have marginally lower sales than had been originally forecasted. Alpert concludes by insinuating that investors should pass on Opko Health until revenues increase: “prospective investors might want to wait for the validation that comes with real fundamentals.”

So, why is my face in my palm?

Simple. Any college freshman can look at an income statement and note that $40 million in annual revenues with a $1.25 billion market capitalization equates to an overvalued share price by conventional metrics. This calculation requires no more than 30 seconds of thought.

If the college student were to reflect for a while, however, he or she might realize that Opko Health cannot be appropriately analyzed using a price-to-sales ratio.

Indeed, the vast majority of Opko Health operations are in research and development. Why should an analyst therefore rely on current or near-term revenues when calculating fair value? No competent analysts are forecasting revenue numbers for 2013 or 2014 that would satisfy a conventional price-to-sales ratio for Opko Health. Perhaps, then, the student might look ahead in the textbook to more advanced valuation methods?

Opko Health is a multinational conglomerate with over 220 employees. It generates about $40 million in annual revenues despite the vast majority of its operations focusing on research and development. Cash flow is healthy, burn rate is minimal, debt levels are nominal, and insider buying consistently tops the charts. So although the share price seems high based on a traditional analysis, the company does not have any threats from internal finances.

Moreover, the company’s structure is not hierarchical and does not align with typical operating structures. Instead, it functions more as a bank of businesses- a holding company.

Aha. Opko Health Is a Holding Company. There It Is.

Alpert’s article in Barron’s began and ended with the same, superficial perspective: If Opko Health’s shares traded like a traditional company, they would trade at a lower price per share. Thank you, Alpert. Thank you for telling us, again, that Opko Health shares have a high price-to-sales ratio. If it were not for your article, we would only have had a thousand other articles with the exact same conclusion.

Alpert failed to analyze Opko Health as a holding company. This would have required a complete rewrite of the article. A holding company cannot be analyzed like an operating business, just as a bank cannot be analyzed like a mining company.

Conclusion

* Alpert failed to reflect on the implications of Opko Health’s corporate structure as a holding company, which would have fundamentally altered his entire perspective on the valuation of long-term opportunities to serve human health versus his near-term revenue estimates.
* Alpert inappropriately chose sensational valuation metrics for persuasive effect rather than useful analysis.
* Alpert failed to address the years of real market prices that have disproved his theory of “it’s not possible through fundamental research to say that Opko Health is worth more than a billion dollars.”
* Alpert failed to look beyond superficial financial statements and valuation theories.
* Alpert focused on marginal revenue reductions for a few of Opko Heath’s products while neglecting dozens of other multi-million dollar opportunities (and some billion dollar opportunities) incubating at Opko Health.

Ultimately, Alpert did little more than parrot an elementary argument that has been unpersuasive to the market for years. Opko Health is a health sector holding company that is currently trading at $1.25 billion. It is not trading at that valuation because of current or near-term revenue. It is trading at that level because investors vote with real money (not commentary) that Opko Health owns and is building long-term value.

Opko Health is the final life work (and likely gift to the world) of one of the world’s most successful pharmaceutical entrepreneurs who is quite pleased with prevailing market prices, happily buying tens of thousands of shares every day and shrinking the supply for shorts. As he approaches retirement, perhaps Alpert should recall those trivial factoids about Dr. Frost’s long-term executive performance. What if Dr. Frost decided to buy all the shares he was planning to buy over the remainder of his lifetime in the course of a few weeks?