James Faulkner on WatsHot in the small cap market: Plethora Solutions, Pressure Technologies and ASOS

Plethora Solutions (PLE)

The lack of share price response to this week’s news from Plethora (PLE) is surprising given that it holds out the prospect of this company generating significant profits. Perhaps the whole subject of premature ejaculation is a turn-off for investors? I don’t know. What I do know, however, is that once the numbers start rolling in the market will have to sit up and take note, whatever its reservations.

For the uninitiated, Plethora owns a majority stake in PSD502, a topical spray for the treatment of premature ejaculation. In two large Phase III studies PSD502 showed a highly significant and clinically meaningful effect increasing mean intravaginal ejaculatory latency time at baseline from 0.5 minutes to 3.2 minutes at week 12. 87% of the patients in the studies were considered as responders with the product being well tolerated with no significant safety issues. PSD502 also showed positive effects across a wide range of other parameters including partner satisfaction, and the product was approved by the European Commission in November 2013.

On Tuesday, Plethora entered into a license agreement with Recordati, an international pharmaceutical group, granting Recordati the rights to commercialise PSD502 in Europe, Russia, the Commonwealth of Independent States (C.I.S), Turkey and certain countries of North Africa. In return, Plethora will receive an upfront payment of €5 million, a payment of €6 million upon grant of variant approval from the European Medicines Agency for a new six dose can, a payment of up to €10 million upon first commercial sales in France, Germany, Italy, Spain and Portugal, up to €25 million in aggregate in sales-based milestones, and tiered percentage royalties on net sales (ranging from the mid-teens to the mid-twenties for 10 years from first commercial sale, and thereafter at a single digit percentage royalty rate).

Even setting aside the royalties, which are the key ingredient of this cocktail, that’s €46 million in various milestone payments from this deal, which looks significant against a current market cap of just £56 million.

The market seems to be taking a very dim view of this, as it has done of the entire Plethora story in recent years – with various wake-up calls along the way. I believe another one of those wake-up calls could be around the corner.

It may be a slightly embarrassing issue, but premature ejaculation is a real-life problem, for which there is currently no globally approved pharmaceutical treatment. For example, epidemiological studies conducted in the US and Europe indicate that between 20-30% of men of all ages suffer from premature ejaculation. Based on an assumption of 1-in-4 men with the condition, the potential patient group could be in excess of 24 million men in the US alone. Following its meeting with the United States Food and Drug Administration (FDA) in March, Plethora “unambiguously defined the path to a successful submission of the New Drug Application for PSD 502”. With the US offering a the potential for a large homogenous market for PSD502, approval here would surely drive a re-rating for the shares.

Earlier this month the firm conducted a fundraising that will enable it to acquire the minority royalty interests in PSD502 held by Shionogi, Paul Capital and the Original Patent Holder, thus taking its stake in PSD502 to 100%.

That’s a 100% stake in a product that Plethora’s own internal estimates suggest could generate peak sales of up to $1 billion per annum. Even if we assume a relatively low overall 5% royalty on sales, that’s $50 million per annum to Plethora, most of which will go to the bottom line given that these are royalties (i.e. Plethora outsources manufacturing and sales & marketing operations).

Perhaps the market just isn’t convinced that this is a product that will sell in the quantities that Plethora and others are predicting. But then again, I’m sure plenty of people thought the same thing about Viagra…

Pressure Technologies (PRES)

The re-rating of Sheffield-based Pressure Technologies (PRES) looks set to continue after what looks like a very savvy acquisition this week. The firm has bought New Zealand based Greenlane Biogas Holdings Limited, a leading developer and global supplier of patented technology for upgrading raw biogas to high purity biomethane, for a maximum total consideration of NZ$25 million (£12.4 million).

With Pressure Tech’s Chesterfield BioGas division already well integrated with Greenlane technology, this looks like a propitious acquisition for Pressure Technologies. Greenlane had been suffering from a lack of finance, which is a problem that should be overcome as part of a larger group. With Greenlane and its partners having recently commissioned the world’s largest biomethane plant in Montreal that can process 16,000 m3/hour of biogas, its capabilities are unquestionable. Hopefully, Pressure Tech will provide the platform Greenlane needs in order to grow what is already a very exciting business.

The deal could not have come at a better time for the firm’s Alternative Energy segment, which has gone from a standing start to being a major pillar of growth for the group. In the recent interims, Chesterfield BioGas recorded order book growth for biogas upgrading equipment of £11 million since last July, with orders on hand for four projects with four new customers. Although the division reported a small loss during the first half, enquiry levels are said to remain high and management is confident of winning follow-on projects with existing customers further down the line. Indeed, in addition to today’s acquisition the firm revealed that it had recently signed a contract and a letter of intent for new biogas projects totalling £3.4 million, all of which use Greenlane’s patented technology.

As a result of the acquisition, house broker Charles Stanley has upgraded its FY16 normalised pre-tax profit forecast by £0.5 million to £10.1 million. On current estimates, the shares trade on a prospective earnings multiple of 16.5x for FY14 (ending September), 13.5x for FY15 and 11.1x for FY16. However, with Pressure Tech already in the midst of an upgrade cycle, I wouldn’t be surprised to see forecasts hiked even further as the acquisition is bedded down. In any case, the current valuation looks conservative vis-a-vis the wider engineering sector, despite the stronger rates of growth being posted by Pressure Tech. The firm is gaining an excellent reputation as an astute acquirer of businesses that are in need of a wider growth platform, and it would seem that this story has some way to run.

ASOS (ASC)

How the mighty fall! Back in June I urged caution to readers looking to ‘bottom-fish’ erstwhile wonder stock ASOS (ASC) after the profit warning:

“Profit warnings come in threes, as the saying goes, and I wouldn’t be surprised to see ASOS continue to be bogged down in its international markets for the remainder of the year. Consumer confidence in Australia has fallen off the edge of a cliff, and Russia is also in a mess for obvious reasons. ASOS may be forced to ‘invest’ in (i.e. cut) prices in some of its weaker markets if it wants to see the top-line progression it is hoping for, which would put further pressure on margins and profitability. The shares have been hammered in recent months, but I still wonder whether the outlook for ASOS is positive enough to support a still-toppy earnings multiple in excess of 50 times.”

Well, since then the shares have fallen by around a third, as the transformation from Paragon to pariah continues…

It seems to me that the journey from 7,000p to 2,000p has been brought about by the market’s realisation that ASOS cannot have its cake and eat it – i.e. it cannot maintain margins AND achieve its ambitious revenue growth targets. But there could be more pain to come. Broker N+1 Singer notes that while it has put through downgrades of 30% for FY15 and 38% for FY16, the shares only fell by a comparatively modest c.7% on the day. Even now, with earnings expected to fall in FY14 and be relatively flat in FY15, the shares still trade on a stonking PE of around 50x.

This still looks like wishful thinking, especially given that Singer admits that to achieve its revised forecasts, “c20% sales growth is required in both years [FY15 and FY16] as well as a near 5% EBIT margin in FY’16 (i.e. a 100bps improvement).”