Companies: ATD    CEL    LID    LPX    MEDG   

On AIM and the Full List, 110 health and medical companies are capitalised at less than £100 million following valuation falls across the sector. Yet companies at the smaller end of the sector can offer fertile ground for stock pickers, with many companies offering the potential for new blockbuster drugs, as well as a degree of insulation from slowdown, since people become ill in fair economic climes or foul.

Over the past six months, shares in the aforementioned firms have declined by an average of 21 per cent (see graphs below), following a flight to companies perceived as being more defensive or resilient, rather than ‘blue sky’. However, this space potentially offers investors rich pickings, with a raft of multinationals with deep pockets having lately picked off small UK players for healthy premiums. BBI was acquired by US-based Inverness Medical, Gyrus by Japanese giant Olympus and Tissue Science Laboratories by New York-based Coviden. And analysts including Numis’ Brett Pollard consider recent falls overdone, arguing that the sector’s dynamics remain healthy, underpinned as they are by demographic change and the need for so-called ‘big pharma’ to operate far more efficiently.

Lipoxen sticks close
For many up and coming companies, fostering links with big pharma represents a cute business strategy. If they can manage to tie up lucrative licence deals with the giants of the sector, their market capitalisations can quickly feel the benefits.

One entrepreneur with a list of US big pharma contacts as long as his arm is former American investment banker Scott Maguire, chief executive of London-based small-cap Lipoxen, whose market value is a lowly £26 million. ‘No one has even heard of us,’ he concedes, although broker Landsbanki has set a 42p target for the company’s 26p shares and forecasts that the business will break even in two years.

Via two platform technologies, which enable therapies to be circulated in the body for longer, the company has two products currently in clinical trials. These appear to be anything but pie-in-the-sky. Three large sector players have signed up licence deals, including Schering-Plough and Baxter, while evaluations are ongoing with others.

Milestone payments from reaching certain stages of development boosted the AIM-listed group’s cash levels to £1.8 million by March, which Maguire says is enough to be going on with in light of a monthly burn rate of £100,000. He also expects to sign another licence deal this year.

Smaller peer Medgenics, the US-Israeli venture valued at less than £6 million, floated on AIM with a £3.3 million fundraising in December which was designed to fund the conclusion of a ‘Phase I/II’ trial for its delivery system for anaemia. While both businesses could prove successful over time, Lipoxen’s commercial deals lend it more immediate weight.

Coombs coming to AIM
Serving big pharma directly is Asterand, one of the smallest companies on the full list and set to move to AIM shortly under new chief executive Martyn Coombs. The company is valued at only £7 million, despite the fact that its customers include each of the top 30 largest pharmaceutical players and its target market is estimated at $700 million (£350 million).

Asterand’s business is in the ethical sourcing and supply of human tissue for use in clinical trials. Saying that ‘over 70 per cent’ of its competition currently comes from universities, Coombs believes customers would prefer to deal with a professional organisation like his. Having restructured the business and reduced the cost base by an annualised £700,000, he promises profitability is ‘close’. With £2.2 million of cash in the bank and its own £3 million depository of assets, the company offers speculative appeal for the bold.

Californian concerns’ cost-cutting allure
Two Californian providers of services to big pharma are Celsis and Entelos, both offering different ways for their clients to save time as well as money. Jay LeCoque, ambitious chief executive of Celsis, stresses that ‘Now, possibly more than ever, big pharmaceutical companies are under immense pressure to reduce their costs.’ Celsis’ products and services, which include microbial monitoring services, laboratory outsourcing services and time-saving kits for drug discoverers, help them to do just that.

LeCoque says the company’s core businesses enjoyed ‘a very good’ year to March and results due for release this month could provide a kick to the shares, sold down from a 244p high to below 160p. Trading on a prospective price-to-earnings ratio (p/e) of less than ten times, the shares are worthy of further investigation at current levels.

Entelos’s approach is more esoteric. Its complex ‘virtual patient’ software is designed to save drug discoverers millions in development costs and the company has already inked agreements with Pfizer, Johnson & Johnson and even the US medical regulator. In 2007, the group’s losses were cut to $100,000 on $21.8 million sales and house broker KBC Peel Hunt forecasts profitability this year – with some confidence, since 80 per cent of 2008 revenues are already booked. A prospective p/e of 19.2 dropping to 7.8 in 2009, based on forecast earnings of 1.3 and 3.2, implies the shares are worth following.

Going it alone
Although viewers of TV hospital drama Casualty may unknowingly be familiar with cardiovascular monitoring expert LiDCO’s machines beeping in the background, its business model eschews big-name connections. The company has steadily increased sales and cut losses in recent years on the back of a single product. Last year it lost £2 million from sales of £4.1 million, but its cash balances at the January balance-sheet date were a healthy £2.2 million and a new product to address the surgery market could lead the company into profit. A European roll-out is underway, with broker Panmure predicting it will add over £1.3 million of revenue this year alone. The shares might repay a speculation.