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A stock that could double before the end of the year



July 20, 2010 – Comments (7) | RELATED TICKERS: CPD.DL2

Thanks to the fine folks over at Above Average Odds Investing, I recently became aware of a company called Caraco Pharmaceuticals (CPD).  The following is a link to post that AAOI (who plays CAPS btw) recently made on this company.

Caraco Pharmaceuticals (CPD): A Generic Misunderstood Pharma

CPD is a fascinating situation that anyone who is interested in special situation investing should check out.  If nothing else, it's an extremely interesting story.

Apparently Caraco Pharmaceutical is a distribution and manufacturing subsidiary of an Indian generic pharmaceutical manufacturer called Sun Pharma.  It was humming along, growing at 20% per year, and not even having to spend any of its own money on R&D (Sun does all of the heavy lifting) when WHAM in late 2009 it was forced by the FDA to temporarily closed its manufacturing facility in Detroit, Michigan and seized some of its drugs because the plant failed to comply with its Good Manufacturing Practice (cGMP) requirements.

While I don't know the details of the specific violations, this sounds much like Johnson & Johnson's recent problems at its PA plant. Unlike JNJ though, CPD doesn't have any other plants to shift its production to so it had to circle the wagons, clean house, outsource additional production, and work on straightening out the issues at its plant. This incident caused the company's stock to fall from $15 pre-incident to the $4.80 that it sits at today.

I'm still looking into this story, but it intrigues me enough that I'm doing so pretty thoroughly today. At first glance, one would think that this stock would be an easy double in a rough market if the FDA gives it the green light to reopen its Detroit plant.

Here's what I have been able to find out by doing some independent research on this situation this morning.  Many people believe that Caraco is close to re-opening its Detroit production facility.  It at least has slowed its cash burn by outsourcing production of its licensed drugs while its plant was down. While its plant was closed CPD is supposedly modernized it and it supposedly has been bringing employees back as needed.

Here's one potential sign that an FDA decision on the closed plant could be arriving in the near future.  After Caraco ran into trouble with the FDA it appointed Jitendra N Doshi as its interim CEO to fix the situation (on 7/28/2009). Mr. Doshi is essentially a representative of Caraco's parent company. From 2006 through this appointment he was the Executive Director of Sun Pharmaceutical Industries, Inc., a generic pharmaceutical company and wholly-owned subsidiary of Sun Pharma. Clearly Sun wants to get things fixed at its U.S. subsidiary.

Anyhow, here's the interesting part, Mr. Doshi has 45,000 in CPD stock that is currently worth $203,000. It appears as though on June 15th, he filed to sell his shares. If I am not mistaken, officers who file to sell shares must do so within 90 days. 

This could mean that either Mr. Doshi expects CPD to receive FDA approval to reopen its Detroit, Michigan manufacturing facility at some point between June 15 and September 15 and he will sell his shares at a significant profit once the stock pops on the news. OR it could mean that he has failed and wants to get out of the stock before news hits the street and it implodes. IMHO, the former seems more likely than the latter. Of course, it's always possible that he just needs money and that I'm looking into this planned sale way too deeply. 

Another problem with the Company, unrelated to the issues with the Detroit plant, is Caraco just had an independent member of its Board of Directors resign on July 6th.  This resignation put it in violation of the rules of the NYSE Amex, which requires companies to have three independent board members.  CPD has stated that it will replace the outside Board member within 180 days which is the legal time allowed.  Should it not do so theoretically the company could be delisted, but I don't foresee this being an issue.

Anyhow, this is one of the more interesting situations that I have seen out there lately. Here we have what was once a rapidly growing company that ran into a huge, but fixable problem that cause its stock to fall off of a cliff.  Despite the problems at its manufacturing facility, Caraco still has a solid pipeline of generic products and the support of Sun Pharma out of India.  

Obviously (since I'm talking about it) I have not put any real money to work here yet, but I did add CPD in CAPS a week or two ago at a starting price of $4.95/share.  

I am trying to find out as much about this company and situation as possible before committing any real money to this idea (which I am seriously considering).  Is there anyone out there in CAPS who is familiar with Caraco or Sun Pharma?  How about anyone from Detroit that has heard about this story or might know someone who has?

On a side note, stories like this are one of the things that I love about investing in situations. Every company has a unique, fascinating story. I love reading about them, trying to figure out the outcome, and whether the odds justify investing in them.  If CPD receives approval to re-open its Michigan production facility its stock will absolutely explode, regardless of what the overall market does.  This is just the sort of alpha-generating returns that special situations can create in a world where individual stocks are consistently trading more and more in tandem with each other.  


7 Comments – Post Your Own

#1) On July 20, 2010 at 3:06 PM, Tastylunch (28.51) wrote:

i'll definitely check this one out Deej. if I find anhything useful to you I'll post it here.

I guess the question I have is what if they don't get FDA re-approval ?

I know they have quite a bit of cash and "cash" assets.But that doesn't matter if they never cash out.

do they have plans to liquidate the US unit if things go awry? or fold back into Sun Pharma?

I'd be concerned that Sun Pharma would reacquire CPD at a steal... And that may be also why they are trading so cheaply.


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#2) On July 20, 2010 at 3:50 PM, TMFDeej (97.45) wrote:

Thanks Tasty.  I'm definitely in the information gathering stage on this one.  That's the great thing about posting ideas here on CAPS. Hopefully it will attract comments from people who are familiar with this or similar situations.

Of interest, the stock has soared over 9% since I began writing about it earlier today.  I wonder if it's related.  The markets have improved over that time period as well, but a nearly 9% move on no news is pretty large, even for a small stock.

Also, I just came across something curious about the company that might give me pause on investing real money in this situation.  More on that to come. 


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#3) On July 21, 2010 at 2:25 AM, iceman9999 (< 20) wrote:

Hi Deej

Caraco is my largest holding right now. As you note the upside here is pretty clear. Caraco was growing very quickly before the shut down, has very strong backing in Sun, and has a great business model of letting Sun do all the R&D.

What made this a high conviction pick for me is what I see as the downside protection. If you look at their revenues over the past year they have shifted to being a majority from US distribution of Sun drugs and not from drugs produced in house. The distribution products are much lower margin (8-10%) but large volume. As they have still been able to keep the distribution side going the cash burn has been minimal despite the manufacturing shut down (and management brought costs in line very quickly). So worst worst case scenario if they can't figure out how to reopen the plant (which I think is extremely unlikely at this point) they sell it and just become purely a distributing and marketing arm of Sun in the US. 

I think it is almost a lock that the plant will reopen (I would guess within the next 6 months). As far as I can tell management has made all the right moves in response to the FDA action.  

I think a bit of pressure on the stock recently has also been due to Sun losing a lawsuit on a big seelling generic launched at risk where Caraco might be on the hook for clawback liability as well as losing sales going forward. But the actually liability to Caraco will be pretty limited and they have a great pipeline of both in house and distribution drugs. 

Interesting theory about the Doshi sale. However, I could not find an official SEC filing. Only came up on AOL so I am wondering if it is a mistake. Do you have a link?

I have also thought about the risk that Sun might just try to buy out the remaining portion they don't own. I read somewhere that the Sun CEO was asked about this and said they wouldn't do it because it would look bad to mess over Caraco shareholders. Not totally reassuring, but they have been involved with Caraco for quite a while and I would think if they are interested in owning them outright they would have made a bid by now. 

Interested to hear what your reservations are. 


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#4) On July 21, 2010 at 6:23 AM, TMFDeej (97.45) wrote:

Hey Iceman.  Thanks for the fantastic feedback.  I'm glad that someone else who is familiar with the situation chimed in.

The specific issue that I was concerned about turned out to be nothing.  My only major concern with this situation is the FDA's recent crackdown on pharma plants in the U.S.  The FDA seems to be even tougher today than it was when it originally closed down the Caraco plant.  If I knew someone in the FDA, or who was at least familiar with how difficult it currently is to re-open a closed plant or had someone on the ground in Detroit that was familiar with the situation I would be much more comfortable putting real money into this idea.

I came across the Doshi sale on AOL as well.  You're right, it could very well be a mistake if there's no actual SEC document floating around out there.


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#5) On July 21, 2010 at 10:55 AM, iceman9999 (< 20) wrote:

It is clear that the FDA has gotten tougher in terms of plant shut downs in the last year or so. Hadn't thought about whether that also means tougher standards on reopening them. Historically from what I could gather must plants that get shut down reopen eventually, although the shutdown period can be quite long (years not months). 

Sun has stated that the Caraco remediation plan has been approved by the FDA, which appears to be an important milestone:\s-work-plan-approved-by-usfda-sun-pharma/95497/on

Caraco is also rehiring workers:

On the Yahoo board there has been some good sleuthing which has found Caraco posting job opening ads for QC jobs. So it sure looks like things are headed in the right direction.  

I think this is a great example of an instance where the distinction between risk and uncertainty (emphasized by Monish Pabrai and others) is useful. I agree it would nice to know more about how close they are to reopening, but then we wouldn't have the investment opportunity we do now. There is uncertainty as to exactly when the plant will reopen but I would argue the downside risk is quite low. There is very little risk to Caraco as a going concern as their balance sheet is solid and their operations should be at about break even cash wise due to the distribution income (especially with all the recent PRs about new drugs they will be distributing for Sun). 

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#6) On July 21, 2010 at 2:24 PM, AAOI (97.68) wrote:

Deej, Great Post. I have been meaning to reply and just got around to it. As far as my thoughts, Iceman hit the nail on the head here, and his commentary mirrors my thinking on essentially every point. Regarding your point about talking to someone on the ground in Detroit, one of our clients was in the industsry for over 30 years and he happened to have a good friend in the business from Detroit who ended up doing some scuttlebutt for me if you would like to talk about his findings (or him for that matter).  

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#7) On August 19, 2010 at 10:16 AM, charlie0217 (< 20) wrote:

For what it's worth, CEO Jitendra Doshi sold 48,000 shares in early August. The insider sale was filed on June 16th.

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