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CIGX upgrade today and really explains their potential quite well
ICM Capital Markets Ltd 888 Seventh Avenue, 17th Floor
New York, New York 10105 (646) 833-4914
Otis T. Bradley
April 25, 2011
Star Scientific, Inc.
( Nasdaq – CIGX – 3.64 )
We continue our Buy Recommendation on CIGX shares. There are four major reasons:
1) A likely licensing agreement for Star's BDL (Below Detectable Levels) Modified Risk (i.e. Safe or at the very least much Safer ) Tobacco Products (of ALL kinds – cigarettes, chewing tobacco, alternatives, etc.). This could occur any day and would probably include an upfront payment and future royalty stream. Star would then have immediate profits, recurring revenue and recurring profits, and per share earnings upon which to value this aspect of the story. Our estimate, as discussed under "BDL" immediately below, is that CIGX could be earning $1.00 per share (untaxed but per fully diluted 170 million shares) in a year from this BDL technology alone.
2) We expect the Federal Appellate Court to rule on Star's suit against Reynolds American (RAI-36.28) within two months (possibly one). If that ruling is as favorable as we believe it could/should be, Star might (eventually) win trebled damages of $2 billion or higher from Reynolds. Philip Morris (Atria – MO – 26.06) would be next in line for a substantially higher amount. Substantially meaning a multiple of $2 billion.
3) A new and very aggressive posture from Star against Reynolds (maybe MO and others in the Tobacco Industry as well) will likely follow the Appellate ruling -- maybe leading to settlements, a friendly acquisition of a part of Star's Technologies (the Patent Litigation aspect) and/or unfriendly takeover attempts. We believe that as soon as a favorable opinion comes down from the Federal Appellate Court – probably in May or June – this part of the Star story will become very active and exciting. A Jury Trial could be scheduled for sometime late this year.
4) And finally, Star seems to have developed what appears to be a patented Technology Platform which could be a treatment or even a cure for many serious diseases – such as Alzheimer's, Thyroid, Arthritis, Heart, Stoke and important others. That really seems too preposterous for many to believe. However, unlikely as this may seem to some/many/even most (including a heavy weighting of Shorts), evidence of this possibility continues to arise from various sources. If true, CIGX shares would seem to have pretty much open-ended potential on top of the significant BDL and Litigation potentials.
Closest at hand of the four potentials above is Star's BDL Technology. A decade ago, when Star (that is, Jonnie Williams) discovered a Tobacco Leaf Curing Process that essentially prevented the loss of oxygen, which in turn prevented the creation of nitrosamines, which in turn carry the worst of smoking's cancer causing carcinogens, the Technology was relatively crude (primarily varying air flows via fans). That is what the Reynolds Tobacco suit has been all about – infringement using that early technology – but now, infringing upon the technology for over a decade. During that decade Star/Williams and co. have created a far more sophisticated technology and have been able to lower the nitrosamine content in the tobacco leaf to a level that is not detectable whatsoever. That means that ANY tobacco product cured with Star's technology will enjoy 100% (or at least 99%) fewer nitrosamines and thus none of the bad carcinogens.. In plainer English, Any Tobacco Product made Star's way will be SAFE. All others will not be safe. Rephrased again, that is to say ALL other tobacco products will be harmful, or very harmful. How valuable, therefore, is that that (BDL) technology?
The U.S. Tobacco Company that would benefit most from partnering with Star's BDL Technology is Lorillard
(LO – 99.21). LO has a very small Market Share of U.S. cigarettes – probably 6% or 7% versus maybe 30%+ for Reynolds and 60%+ for MO. That's pretty much the entire U.S. Industry. Lorillard has no chewing tobacco/snuff business at all and no lozenge or alternative smoking products either. Both of these are $4 billion markets. The "Smokeless" Market is growing maybe 4% a year, whereas the Alternative Product Market is probably not growing at all, because its products are not really any good (i.e. they don't work – that is have much success stopping people from smoking). Philip Morris probably has close to 90% of the chewing tobacco/snuff market, having paid $10 billion+ for U.S. Tobacco (3-times revenue). Glaxo (GSK – 41.38) probably has a similar market share in the smoking alternative market, which as stated is also $4 billion.
We do not believe Star will deal with Reynolds. There is far too much bad blood after 10 years of litigation and Reynolds obvious desire to eliminate Star. The same is probably true of Philip Morris, who many believe has been working alongside Reynolds. Lorillard does not seem to have any of the same problems. It has much more market share to gain in all of these markets. And, Mr. Kessler, the CEO of Lorillard, was CEO of U.S. Tobacco when acquired by Philip Morris. He obviously knows the "Smokeless" business inside out.
If Lorillard could gain only 1%-2% of the U.S. Cigarette Market (which we believe runs some $75 billion a year), introducing a "Safe" product could thus equal $750 million - $1.5 billion of new revenue. (Obviously they might gain 3% or who knows?) If Lorillard was to pay Star 10% of that (a modest number considering that Lorillard would not really have any other large additional expense – just slap the name Newport or Kent on its new "Safe" products), CIGX would earn $75 - $150 million before tax (which with large tax-loss carry forwards they would not owe a while).
We further assume that over a year or so Lorillard might gain a 10% share of the "Smokeless" (chewing/snuff) market and 10% also of the alternative tobacco market (with Star contributing its CigRx product to Lorillard as a part of the deal), gaining $400 million of revenue from each of those markets and paying Star 10% of that or $40 million each. Star's grand total would thus be $155 million to $230 million – untaxed. Rounding that arbitrarily to $170 million, fully diluted that equals $1.00 per share. That will be our estimate for the BDL part of the Star story in 2012 – IF such a partnering occurs. As stated, as a part of such a partnering, it would seem logical for Star to include its CigRx product, which would explain why there has been such a deafening silence concerning CigRx since its limited introduction in August. (It would also indicate that Star has far higher hopes for its Anatabine Technology in Inflammation Reduction/Elimination applications than it does for marketing CigRx.)
No one can really argue with the numbers above, as we have made them up -- without any conversation with Star management whatsoever. While our numbers may well be challenged, we believe they are reasonable and much more likely low than high. In fact, over a several year period all of these numbers could be very much higher. In summation, therefore, if any relationship between Star and Lorillard does come to pass, we will start with that estimate of $1.00 per share in 2012 for CIGX from BDL, growing nicely thereafter.
In its last quarterly Conference Call Lorillard's management stated that they would discuss their long-term strategies in various markets – such as Smokeless Products – soon. What better time than tomorrow's Conference Call at 8:30 A.M. (888-239-6824), with further discussion following at an Analyst Meeting May 5. This could be a Major Positive for CIGX (and Lorillard too) if a partnering is announced, but therefore a disappointment if it is not.
Star's second closest potential (in time) is the upcoming (probably May or June) Federal Appellate Court pronouncement of another Jury Trial for Star's suit against Reynolds American.. To simplify this Litigation:
The questions seem to be only a) Did/does Star own pertinent patents? The Patent Office recently, and quite emphatically, ruled they did. b) Was there infringement? There seems to be evidence, which Judge Garbis did not allow in the Baltimore Jury Trial, that Reynolds own lawyers told Reynolds management that there was infringement. c) Was the infringement intentional? An internal Reynolds communication indicates that it was. d) Should a damages royalty be 1%, 2% or 3%? Could be any of those numbers. e) Should it be placed on the end product's value or the tobacco leaf only? Any value would seem to have to be only the end product, not the simple leaf which has no value per se. f) Triple damages or not? Can't think of any reason why not. g) Will the Jury Trial be under Judge Garbis again? If it is, that is a very serious negative for Star. If it is reassigned to another Judge, that is a clear victory for Star and we believe the Stock Market will respond very favorably.
We should know all/most of the answers to these questions within a month or two. Our bet is that those statements to be pronounced by the Court will be highly favorable to Star. Obviously if they are not, that would be just as much a negative to this part of the Star story.
Reynolds will then undoubtedly Appeal to the full body of that District. Last time the Court's verdict was a 3-0 unanimous one, followed by a full body of the 16 judges (including the 3 originals) that was unanimous as well. We expect the same to happen again. Reynolds may then try to have our Supreme Courthear their case. We see no reason that will not be turned down as it was before. The sequence of Reynolds trying to prolong the Litigation will continue, but time is finally running out. We hope that all of this – including a new Jury Trial and its decision -- could be over before the end of this year.
The numbers are so staggering that the Market should/must begin to discount at least some of those numbers beforehand. Last time Star (symbol STSI then, CIGX now) reached 6. (Although on fewer shares, the Damages are much larger now as the meter has been running.)Reynolds has probably done about $5 billion of U.S. revenue (concerned within this suit) annually for 10 years. 1% of that is $500 million – tripled, $1.5 billion. 3% (obviously) comes to $1.5 billion and $4.5 billion. Any of those numbers would cause serious financial damage to Reynolds. In Maryland the award would be escrowed.
Philip Morris U.S. cigarette sales probably ran 3 or even 4-times the Reynolds numbers over this decade. Potential damages there could obviously then range, mathematically, 3-4-times the Reynolds numbers. Such numbers are so staggering, however, as to be unthinkable. (Nonetheless, that is the way they calculate.)
For sanity's sake, cut them back to only a couple of billion, or several billion or some number of billions of dollars. Any of the possibilities are big enough to wound Reynolds severely and smart MO more than just a little.
Incidentally, each $1.5 billion increment is 8.82 per CIGX share, fully diluted, but before any tax or lawyer fees.
#3 – Settlements or What ?
Quite clearly, in our opinion, such numbers as discussed above would amount to the largest U.S. patent damage award ever (which Reynolds lawyers boasted when they won the Garbis Bench Trial several years ago). The looming threat of such numbers would/at least should precipitate settlement overtures, friendly acquisition attempts and/or unfriendly maneuvers. Therefore, once the Federal Appellate Court pronouncements are released – assuming they are viewed as highly favorable to Star – we expect ACTION, including aggressive new actions by Star, such as an attempt to enjoin sales of alleged infringing products. The quiet, passive Star Scientific – beaten up constantly by Shorts and Enemies – may change its spots quickly.
Star's Disruptive Science
The most exciting part of the Star Story is the Company's Technology Platform. From the relatively humble beginnings of a better way of Curing Tobacco and then a Smoking Alternative, this Technology is a moving, growing opportunity that may become a mindboggling potential. The magnitude of the use of an Anatabine to lessen or even completely eliminate Inflammation is only unfolding, but the combination of the Roskamp Institute's announcements concerning its testing on neurological diseases – particularly Alzheimer's, the fact that Johns Hopkins is researching applications for other diseases, and now studies in Michigan regarding the effect of various anatabine dosages on inflammation generally are creating a mosaic of possibilities. We will probably learn a great deal more here over the next couple of/several months.
In an April 6 news release Dr. Michael Mullan, Roskamp Institute's chief scientist and 1990s leader in the discovery of a unique genetic that produced the theory that a small protein called B-amyloid is central to the Alzheimer's disease process, commented "We will soon begin clinical trials of RCP-006, a natural compound found in tobacco that inhibits inflammation and the accumulation of amyloid in the brain. Our scientists are also working with researchers at the Johns Hopkins School of Medicine for other applications of RCP-006."
We believe those "other" applications include thyroid and possibly arthritis. Roskamp itself is concentrating on neurological diseases such as Parkinson's,schizophrenia and depression – but most particularly on Alzheimer's.
We have expected more definitive news from Roskamp Institute and Johns Hopkins sooner, but believe it may not be until June or July. Findings from studies in Flint, Michigan could be announced in that timeframe as well. However, as a nutraceutical Star could introduce some form of an Anatobine Blocker pretty much when it wants (certainly after June-July results from Flint, Michigan regarding dosage), dependent only on how they advertise the product. We expect something here by Labor Day. Meanwhile, suffice to say, how many billions of dollars or even tens of billions would a treatment for Alzheimer's (alone – forget the other diseases) be worth? How much a cure?
We will obviously follow this Disruptive Science very closely and report upon news as it is released. Meanwhile, we will monitor BDL and Litigation closely, as they seem the closest developments over the near future (i.e. tomorrow through Memorial Day).
Any reversal of the above potential positives.
1) For example, if Lorillard says nothing tomorrow and May 5, that would be very disappointing. Even more disappointing would be Lorillard's describing their own internal efforts without any mention of Star.
2) Similarly, if the Federal Appellate Court remands the Jury Trial back to Judge Garbis, God help us.
3) CIGX has a Market Capitalization close to $500 million on the 130 million shares currently outstanding, over $540 million on the 150 million (first leg) diluted and $620 million on the 170 million fully diluted. Going up to 150 mm and then 170 mm shares does bring in a great deal of cash, however. Nonetheless, it is dilutive. Much of that is from the decade long fight for survival against Reynolds.
4) The Company still has no revenue and is running at a $4 million burn quarterly.
5) Internal management Investor Relations needs significant improvement. For example, our report has far more speculation than we would wish. Explanations for this problem are that management is thin, particularly considering how much they have on their plate, and there is still a competitive concern -- and we agree that a number of the disruptive things Star is doing could be very damaging to a number of companies – such as Reynolds, Philip Morris, Glaxo and other Big Pharmas). We hope, and expect that this story will blossom soon, however.
6) There is a very large Short Position of more than 14 million shares – over 10% of the outstanding and over 20% of the float. That number increased as last reported, in the face of enormous good news. Shorts can be right, or still dangerous when completely wrong.
CIGX shares are Highly Speculative in a sense, although we rate them as a (Plain) Buy due to our perception of the values of Star's BDL Technology, Star's Patents, Litigation potentials and most importantly its Technology Platform.
Having more than tripled from 1.60 to 5.12 in 6 weeks, CIGX was extended and then corrected over 40% back below 3 on fallacious rumors of first a delisting and then second warrant dumping. Both Short plants were totally untrue and, hopefully, will be punished. We believe this current move will be to new highs (the All-Time High near 6), but that such a move will require positive news – such as a Lorillard partnering. Hold your breath tomorrow.
We still believe that Calls should be bought for positive leverage. The May calls, which I own, are probably too short of time, and should be rolled over into August calls, which I intend to do over the next 2 or 3 weeks as they approach their expiration date of 8/20.
I, Otis T Bradley, certify that all the views expressed in this market commentary accurately reflect my personal views of the subject company(ies). I also certify that I have not and will not receive compensation with respect to the issuance of this report.
This analyst, and members of his immediate family, own shares of the following companies mentioned in this report: CIGX shares and May calls
Analyst Stock Ratings
Buy The stock should outperform its industry or peer group by 20% or greater within a 12-18 month time frame.
Sell The stock is expected to under-perform its industry or peer group by 20% or greater within a 12-18 month time frame, or where fundamentals of a company have deteriorated significantly and the stock is expected to materially depreciate.
Hold The stock does not have enough upside or downside potential to rate a Buy or Sell. The stock is either fairly valued or has too much uncertainty to have a Buy or Sell rating.
Otis T. Bradley
ICM Capital Markets, Ltd 888 Seventh Avenue, 17th Floor
New York, New York 10105