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Unilife: My Favorite Speculative Stock Pick For 2014
Jan. 16, 2014 9:55 AM ET | About: UNIS
Disclosure: I am long UNIS, . (More...)

Every investor should look to select at least one new speculative stock to add to their portfolio at the start of a new financial year. To sift through the various candidates, I've developed a list of ten top criteria that has served me very well. To qualify as 'my favorite spec.', a stock must score at least eight out of ten.

1. It's still relatively unknown (to maximize your bragging rights come end of year)

2. It's in a high-growth, well-followed sector (to ensure people will understand)

3. It's got disruptive, proven technology (to make it different, but not too different)

4. It's got decent analyst coverage (to ensure word gets out when the time is right)

5. It's got the talent and capabilities in place (to minimize the potential downside)

6. It's got potential to go cash-flow positive (to minimize risk of major dilution)

7. It's got multiple price catalysts (to maximize shots on goal and maintain attention)

8. It's been around a while and ready to go (to have the discount already built-in)

9. It's got big themes and broad trends on its side (to get people properly excited)

10. It's got real ten-bagger potential (to qualify as a true speculative stock)

Over the last few weeks, I've been looking at a variety of potential candidates. To meet criteria number two and nine, I've focused my attention on the healthcare, life science, IT and energy sectors. I tried to pick potential candidates that were small cap and had reasonable liquidity. Companies that caught my eye included Vertex Pharma, NPS Pharma, Mannkind, Sarepta Therapeutics , RenaSola and Trina Solar and Ameresco. But none of these scored as well as one dark horse that has 'epic 2014' written all over it. I was introduced to this company by a long-time friend who works in marketing for a very big pharmaceutical company. He told me about a new device company that's blitzing the competition for some very big drug contracts. That company is Unilife (NASDAQ: UNIS) - and it is my speculative stock tip for 2014.

1. It's still relatively unknown (to maximize your bragging rights come end of year)

Unilife is one of the rare finds - a company that looks ready to come out of nowhere and redefine an entire market. Unilife has a market cap of only $400 million and is competing against industry giants like Becton Dickinson and Medtronic. But while those companies cover many types of medical products, Unilife is a pure play stock. Their focus is injectable drug delivery devices, which are used by pharmaceutical companies to contain and deliver injectable drugs and vaccines. Think prefilled syringes, auto-injectors, wearable injectors, etc.

After a few bumpy years getting things together, Unilife looks like it turned the corner in 2013. The stock rose 90% for the year as it started announcing deals with pharmaceutical companies including Sanofi, Novartis and AstraZeneca. Yet it looks like the stock is only getting warmed up.

2. It's in a high-growth, well-followed sector (to ensure people will understand)

Medical device and life science stocks had a great run in 2013, and there's no reason to believe the trend will not continue through 2014.

Everyone has been to the doctor and received an injection. And nearly everyone knows at least one person with diabetes or some other acute disease that requires regular injections. Many of these drugs are approved with a pre-filled device in which they are pre-packaged and ready for injection.

Considering that a pharmaceutical company can't get their drug approved and successfully used without the device, the Unilife business model becomes quite compelling and rather unique. It means long-term contracts with each pharmaceutical customer for each drug. For example, a contract Unilife signed with Sanofi for Lovenox runs for 10 years. A contact they signed with Hikma for generic injectables runs for 15 years. That's a very long time to basically lock in recurring revenue.

On the flipside, all Unilife does is sell its devices to a pharma company . The pharma company has to worry about regulatory approval, sales and marketing. So there's virtually no S in the SG&A. That means that every $100 million a year deal, Unilife can generate some very nice operating margins (Unilife is targeting north of 40%, which is more than double most healthcare companies). This combination of incremental long-term contracts and strong operating margins should command a very healthy PE multiple.

3. It's got disruptive, proven technology (to make it different, but not too different)

Unilife does offer conventional devices…but with a twist. Pharmaceutical companies have billions of dollars invested in the drug manufacturing processes, so they aren't going to throw it all away and replace it in order to use a better drug delivery device. So Unilife's devices fit into standard processes to fill and package a drug.

Furthermore, because the drug may need to sit inside the device for two years, pharmaceutical companies don't want to introduce new materials that can damage or chemically interact with the drug. So Unilife's devices use the same materials from the same suppliers that pharmaceutical companies use now for existing devices and packaging. All of the innovation is built around these standard processes and design requirements. My colleague from the pharmaceutical company called it "Innovation within a Standard Footprint".

So while a company like BD has a standard commodity prefilled syringe that's like every other, Unilife has one with automatic, integrated needle retraction. And where standard auto-injectors are bulky and confuse users, Unilife's rival product is compact, intuitive to use and immediately tells you when the last drop of a drug has been injected. If you look at the diabetes ads on TV, you will note that they don't really market the insulin drug itself. It's all about the coolness and convenience of the device, and why it's better. I think Unilife's done the same thing in every other area for injectable drugs. They've created safer, simpler and more convenient devices than anything else out there. For a pharmaceutical company, that differentiation is the carrot on the end of the stick. Because they realize that if their drug is supplied in a Unilife device, then people are going to select it over the competition - which means more market share and more revenue for them.

Unilife has a very large portfolio of such products that appear to cover virtually every sector of the injectable drug delivery market (except insulin pens and insulin pumps which I imagine is either already well served or Unilife has just not entered yet). I tried to find a competitor that had more products for use with injectable drugs than Unilife and was surprised to find myself unsuccessful. The market for injectable drug delivery systems is fragmented, with most companies only specializing in one area such as prefilled syringes or auto-injectors. In my research, BD came closest to rivaling Unilife's range of products, but not even they offered wearable injectors or ocular delivery systems.

4. It's got decent analyst coverage (to ensure word gets out when the time is right)

As the saying goes, if a tree falls in the woods and no one nobody is there, did it make a noise? Same applies to stocks. A company needs to have some credible analyst coverage to ensure investors are going to hear about news when it is announced or immediately afterwards.

Unilife has pretty good analyst coverage for a company of its size, including Jefferies, Cantor Fitzgerald, Landenburg, Leerink Swann, and others. These investment banks have very good reach across the institutional desks. There is also upside, if 2014 unfolds the way I think it will, then every other device analyst worth their salt is going to initiate coverage on Unilife as well. This can only further help to increase investment demand for the stock.

5. It's got the talent and capabilities in place (to minimize the risk of screw-ups or delays)

Like most investors, I only invest in companies that can back up their words with actions. We've all seen companies that might have the greatest mouse trap in the world, but are too incompetent or early-stage to bring it to market. I really like the depth and experience of Unilife's management team. Their CEO seems to get a little excited at times, and has made some promises that the Company failed to meet on time. However, the most important thing is that they always seem to come through in the end. And he has real skin in the game with over 6.8M shares, including millions of dollars of stock he purchased in the open market. Behind him is a solid group of development and sales people that have decades of experience proving themselves at some of the leading companies in the device industry.

· From BD, they attracted the ex-global head of product development and North American head of pharmaceutical systems, the Director of Self Administration of Injectable Systems and some other rising stars.

· From West Pharma, they secured their Vice-President of Strategic Market Development, Vice-President and General Manager for Injection Systems Director and Strategic Market Development.

· From Medtronic, they hired the Leader of Advanced Engineering and Systems who brought all of these diabetes pumps to market.

You don't have this level of talent walk away from golden tickets with such established companies unless something very special was in the works at Unilife.

Furthermore, Unilife has already invested heavily to build all of the production facilities they need to meet customer demands moving forward. Their facility in Pennsylvania looks very impressive, as does videos of the production equipment they have inside. Given how risk adverse pharmaceutical companies are, it makes sense that Unilife had to build the infrastructure and attract the talent before it began to sign deals. Based upon recent deal flow, I think it's safe to say Unilife has qualified for the big league.

6. It's got potential to go cash-flow positive (to minimize risk of major dilution)

There's nothing I hate more than investing in a stock which then goes out and does a secondary capital raise that causes dilution and the share price to fall. When I first started doing research on Unilife, I'll be honest that a secondary offering was my primary concern. It almost caused me to walk away and pick a different stock. But after completing my research, I don't think a secondary capital raise is going to happen…at least not until the stock price is higher and offers a better valuation and less dilution.

While Unilife is low on cash, they have revenue coming in from some big contracts with Sanofi, Hikma, Novartis, AstraZeneca and others. These deals, combined with a couple more with some hefty upfront fees, should be enough to see them go cash flow positive.

In addition, the analyst at Jefferies says that a $40 million debt funding deal is coming up. And the Unilife CEO has now said a few times that he's not going to do a secondary raise now based upon the value of the deals he's got coming up, and the additional revenue that will come along with them.

So if they raise any cash at these current levels, it's probably going to be only one or two % dilution to raise a few million through their At-the-Market facility. If the ATM is used a little bit, I can live with that. But they didn't used the ATM when the stock hit $5 off the back of their recent deals, so I don't see them doing it now at $4.

Here is their most recent 10-Q. Crunch the numbers, and you can see what I'm talking about.

7. It's got multiple price catalysts (to maximize shots on goal and maintain attention

To me, THE most important factor in picking a speculative stock is their target milestones for the year. If it's a biotech stock awaiting the results of a phase III trial, then that's a lot of slow days with heavy speculation. I like to invest in companies that should have a steady flow of good news for the entire year, and the news can come from several avenues. In this regard, I've not come across a company to rival Unilife in a very long time. Here's a selection of what should happen based on my take-aways from recent earnings calls, investor conferences, analyst reports and reading Seeking Alpha:

· Several deals that were initially expected in 2013 got delayed, and are now expected in early 2014;

· Additional deals always targeted for 2014 that the Company says are on track;

· A debt funding program (probably around $40 million as I mentioned above);

· Expansion of production capabilities to meet demand for some very large supply contracts with Sanofi, Hikma and others;

· Sequential growth in quarter-to-quarter revenue;

· Start of provision of earnings guidance; and

· Development of new products

Rolled together, I think there's strong potential for one or two quality announcements every month. That should be more than enough to keep investor attention focused on Unilife. More importantly, because no one will be able to guess the timing of the next blockbuster deal, many investors will be more inclined to hold the stock for the long-term.

8. It's been around a while and ready to go (to have the discount already built-in)

I like to invest in companies that have been through the hard times, overcome adversity and emerged victorious. It means management won't go down without a fight. More so, it means that there is probably a fairly large discount already built into the stock price. I think that's the case with Unilife. It's been a target of the shorts,it's been attacked by Forbes in the media, it's had an ex-employee launch legal action, and it lost some credibility due to delays in signing deals through 2011 and 2012. But I think all this negativity has been swept away by the quality deals that have were announced during the second half of 2013.

As a new investor to Unilife, I simply say thank you very much for giving me such a nice discount to what the stock should probably be. And while I am not banking on it, I am also aware that a short squeeze might occur that would trigger a massive price upswing. To me, such a short squeeze event would be gravy on top of an already great investment.

9. It's got big themes and broad trends on its side (to get people properly excited)

To me, the truly great stocks are those that you can slip effortlessly into big national themes and emerging trends that people like to debate around the dinner table. In 2013, healthcare has been right up the top of the national debate. Unilife falls nicely into any healthcare conversation. Its products can help take healthcare out of hospitals and into the home, reducing costs and improving patient quality of life. Many of the hottest new drugs in development for oncology, auto-immune diseases, cholesterol reduction and pain relief are also injectables, which can benefit from delivery in Unilife devices.

10. It's got real ten-bagger potential (to qualify as a true speculative stock)

Any speculative stock pick should have the potential to generate a return of at least five, and preferably ten times your investment. Otherwise, what's the point? Unilife looks like a clear contender for potential ten-bagger status. Here's a few reasons why this should not be ruled out:

· Unilife has already announced major deals with major companies. There is no reason to expect this won't continue throughout 2014 as promised by management.

· Most of these contracts are expected to have upfront and recurring revenue that will take concerns about cash off the table. Unilife is forecasting sequential quarter-to-quarter growth moving forward, with an expectation of guidance to begin in the near future.

· I expect that as additional deals are signed, investors will begin to build into the stock price some value for future deals in the pipeline that are yet to be announced

· A typical medical device stock has a PE multiple of around 15-20X. With incremental deals for each drug generating minimum recurring annual revenue over ten years or more, and operating margins of 40%, Unilife should be able to command a high PE multiple.

· Looking at analyst reports, Unilife has a score of only 3.7X for Market Capitalization / 2014 target revenue. Unilife peers such as Insulet, Heartware and Nanosphere are more than double that. As Unilife's credibility continues to improve, we should expect existing and new analysts to increase their price targets.

· While there are some quality healthcare investors already in Unilife (like Frontier and JP Morgan), many others are still missing. As these investors begin to accumulate large positions off the back of additional deals, demand for the stock should drive strong liquidity.

· With 40% of U.S. registered shares now short, the potential short squeeze is real. In a perfect storm of strong institutional buying and short covering, the impact on the stock could be dramatic.

I look forward to coming back onto the Seeking Alpha board in late-December 2014 to exercise my bragging rights.