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Expert Financial Analysis and Reporting

Cadence: A Post Mortem on a Successful Investment and What to Do with the Proceeds (CADX, $14.00)

Mallinckrodt (MNK) announced that one of its subsidiaries will start a tender offer to acquire all of the outstanding shares of Cadence for $14.00 per share. This represents a

32% premium to the trailing 30-trading-day volume weighted average price of $10.62 per share for Cadence Pharmaceuticals, Inc. The transaction is expected to close in mid to late March. Mallinckrodt expects the acquisition will be immediately accretive to its fiscal year 2014 adjusted diluted earnings per share, and significantly accretive to its fiscal year 2015 adjusted diluted earnings per share.

So what should we do with the stock? This is a very good deal for Mallinckrodt and I can’t envision any reasonable scenario in which they would walk away so I think that the downside on the stock is $14.00. The upside may also be $14.00 but there has to be some chance greater than zero that Mallinckrodt sweetens the deal or someone else emerges. Since the deal should close by April, there is not much time cost for money tied up until then. I’m just going to sit tight with my stock.

I deal in high risk stocks and have my share of failures. Because of this, I have humility when an investment thesis is correct. My philosophy is on to the next. However, if you will grant me a small exception, I would like to take a victory lap on Cadence and do a brief post mortem. The reason is that the Cadence situation gives you a good insight into my investment style.

I published most of my early research reports on Seeking Alpha before my website SmithOnStocks got up to speed. Since December 2012, I wrote seven Seeking Alpha articles on Cadence all of which were reiterations of my buy recommendation. During that time, there was only one other article (March 23 or 24, 2013) on Seeking Alpha and it recommended selling the stock. On this stock, I clearly stood alone. This resolve reflects an important aspect of my approach. I am an investor in companies. I am not a trader of stocks.

Because of my long history in biotechnology, I had known Ted Schroeder, CEO and Bill LaRue CFO for some time. This was very important to me because I had a clear channel of communication with the Company and I also trusted that I would be provided with balanced views when issues arose with the Company and stock. Of course, I clearly understood that they could be wrong on some issues. As I faced what seemed to be an unending stream of bear arguments over the past two years, I always felt that I understood the issues although the outcomes were not always clear. With all of my companies, I must have this level of communication if I am going to stick my neck out.

There were some key issues to deal with on the stock:

  • The biggest misunderstanding of the bears was that they thought that Ofirmev was nothing more than Tylenol. They didn’t understand that the IV form of acetaminophen (Ofirmev) has a very different medical use than Tylenol which is oral acetaminophen. My checks with hospitals came back with some extremely positive feedback, some of the most positive I have encountered on a product.
  • They didn’t appreciate that Ofirmev was a major innovation as the pharmaceutical industry had been unable over a course of 40 years following the introduction of oral acetaminophen to develop a stable intravenous dosage form of acetaminophen; this was the art behind Ofirmev. They looked at Ofirmev as a routine product line dosage extension.
  • New product launches have become much more complex and slower because of the reimbursement hurdles put in place by managed care. The Ofirmev launch was disappointing to most investors and perhaps even the Company before it blossomed into a spectacular success. This aspect of product launches is important to keep in mind for the future.
  • Generic companies challenge the patents of almost all new products and especially those that cover products that are based on generic active ingredients Not appreciating the skill and art involved in developing Ofirmev, bears beleived the patents covering Ofirmev were not defendable. Even after Cadence prevailed in the patent litigation, I was still getting tweets claiming that the court was incompetent and the patents would be overturned on appeal.

I think that these factors and others illustrate how my research is differentiated from many other people who write their own blogs or write on Seeking Alpha. I am not just rewriting press releases in an effort to get page hits. My reports are much more in-depth and balanced than most other reports that I have seen and I believe that this enables me to respond to the inevitable uncertainties that arise with stocks with more knowledge, balance and confidence. I also disdain trying to trade for 10% or 20% moves in stocks. I focus on my investment thesis and as long as it is unchanged and the price appears attractive relative to where I think that the stock could sell in a year, two years or more, I don’t try to catch every up and down price swing. In my experience, this is a losing strategy.

So what should you do with the money? I have a number of recommendations, but the two I am suggesting at this time for switching the Cadence money into are Antares (ATRS) and Derma Sciences (DSCI).  I have been writing on Antares for more than two years, but I have just introduced coverage on Derma. My thinking is that they have the same risk profile as Cadence. Antares is just launching Otrexup which I am quite positive on and Derma has a commercial business in place and is ramping up sales of TCC-EZ total contact cast and will launch its AmnioMatrix skin substitute in 3Q, 2014. In terms of risk/ reward profile they approximate Cadence as it was two years ago. Most of my other recommendations are based on clinical trial outcomes and are more binary. They have a different character.

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