Skin in the Game: This Dermatology Market Stock Is a Good M&A Bet

Dermatology is a health care market sub-sector with positive demographic tailwinds including an aging population that is living longer, more people moving to the sun belt, an increasing desire to look younger and pay for it, and even a climate change aspect because of the thinning ozone layer. 

A number of new dermatology-oriented stocks have surfaced in the past several years and have fared better than other health care sectors, with an average stock decline this year of just 6%, compared with a 25% drop in the overall biotechnology group and a 37% loss for Allergan, one of the leaders in dermatology product sales.  

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Yet, one company's shares are trading below book value and even below cash value, despite a slew of new products launched over the past 12 to 18 months, solid revenue growth both in the U.S. and internationally, a new revenue stream from royalties and a bolstered balance sheet.

That company is Oculus Innovative Sciences (OCLS) , which this week signed a $19-plus million cash upfront deal with the holding company of former partner Laboratorio Sanfer for the sale of its dermatology and wound care products in Mexico and other Latin American markets.

In addition to the cash payment, Oculus Innovative Sciences was able to keep its Brazilian territory and will get a 3% royalty on sales in Latin America outside Mexico, with a guaranteed annual minimum for 10 years. 

Oculus Innovative Sciences provides prescription dermatology products in Asia, Europe, the Middle East and the U.S. The company's product line includes gels, solutions and sprays to treat atopic dermatitis, burns, dermatitis-related itching, seborrhea, scars and wound care management.

Sales for the fiscal year ended in March were $15.1 million, including $4.4 million in the U.S., more than double from fiscal 2015, $3.7 million in Asia, Europe and the Middle East (up 27% from a year earlier), $5 million in Latin America sales (flat from fiscal 2015), and about $1 million from other areas, including royalty and service streams.

With its newfound cash, Oculus Innovative Sciences plans to increase its domestic dermatology sales force, continuing its new product research and development, with a target of one new product per quarter, and also potentially adding to its product portfolio through acquisitions or in-licensing. Near-term catalysts for Oculus Innovative Sciences investors are expected to revolve around new product approvals and launches, potential acquisitions, and reaching operating break-even sometime over the next 12 to 18 months.

So far this fall, Allergan has been spending the proceeds from the sale of its generic assets to Teva Pharmaceutical Industries, including acquisitions in dermatology, gastrointestinal treatments, gene therapy and the liver disease market as well as with share buybacks and a new dividend.

Nevertheless, plenty of cash remains from this timely divestiture given the recent fall in generic-drug stocks caused by a Department of Justice investigative letter this week for Allergan to make more purchases. Dermatology-related revenue comprises more than one-third of Allergan's sales, a proportion that might attract more merger and acquisition activity.   

Or could Laboratorio Sanfer, which already has shown a preference for Oculus Innovative Sciences' products in Latin America, take a bigger bite from this apple and acquire more territories from the company or even the whole company?  Alternatively, could clinical-stage dermatology companies such as Derma Sciences, Dermira, Foamix, NeuroDerm or Revance, which have plenty of cash but lack established sales teams, get a leg-up on marketing their potential blockbuster drugs with the purchase of an already up-and-running and growing dermatology company such as Oculus Innovative Sciences?   

Only time will tell concerning a potential buyout for Oculus Innnovative Systems, but in the near term, these shares might warrant a look for value-oriented investors.

This article is commentary by an independent contributor. At the time of publication, the author held shares of TEVA.

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