How the Seeds of Conflict Spur Growth

Robert Maltbie |

According to the Brookings Institute the overwhelming majority of classic theologians’, jurists and specialists in the hadith, which are the teachings of Mohammed, understood the obligation of a Jihad in the military sense stating that there is a consensus among Islamic scholars that the concept of jihad will always include armed struggles against wrong doers.

The origins of nearly all the 20th century Islamic extremist movements developed during 17th & 18th century, emanate from Muhammad bin Abd-al Wahhab . Anyone who did not profess to this new ideology was considered outside the realm of Islam and an apostate thus making the shedding of their blood and confiscation of their wealth permitted.

In a 2007 speech Abu Bakr al-Baghdadi, a Wahhabi trained scholar, proclaimed, "the end to which fighting the unbelievers leads is no Idolater remaining in the world". Offensive jihad, which he defended as going after the apostate unbelievers by attacking them in their home territory in order to make god’s word most high.

The Creation of a Megatrend

How many Muslims are Jihadi’s? Estimates average around 7% of the world’s populations are engaged in some form of terror activity. If we discount that number by 80% to 90% that still leaves a number by order of magnitude which is enormous, approximating 10 to 15 million Jihad i’s globally. As we have seen the act of capturing and killing figureheads and leaders has not derailed this megatrend. The central issue of conflict of cultures is not easily remedied.

Modern governments have proven unable to protect citizens. Armed terrorists and crazies are praying upon the masses of a largely un- armed citizenry. Recent terrorist activities in Egypt, Africa, France and San Bernardino, as well as over 274 domestic incidences thus far in 2015 of homegrown violence underscore this point.

Jihadi’s in Paris stormed the Bataclan theater and chanted "this is for Syria, God is good" stated a survivor “they came in with what looked like Kalashnikovs” and fired blindly on the crowd "they were shooting at us as if we were birds." In the US, citizens are increasingly concerned about open and porous borders and the proposition of admitting 10,000 Syrian refugees. In fact 54% of those surveyed are against this idea.

Gun sales have doubled over the last five years yet still only 5% of the population has a permit to carry a concealed weapon. Recent trends pre-Paris have been positive. Driven by Obama overtures to restrict access to guns, increased terrorism, domestic violence, combined with a new uptrend in sales to women, have created a strong backdrop over the last several years.

More women are purchasing guns as a means for self- defense. Retailers estimate that 20% of their shooting and hunting related sales were attributed to women.

The Long: Smith & Wesson Holding Corp. (SWHC)
Current price: $18.36
12- 18 month target price: $34

Smith and Wesson (SWHC) is well positioned to be a prime beneficiary of these trends. . Smith & Wesson is the largest domestic manufacture of guns and is known for the classic 357 and 44 Magnum's. A survey by the Pew Research Center shows a secular decline in gun ownership in the US from 1970 where it stood at 29%, to 2010 where it dropped to 22%. The recent uptick in gun industry sales in the US has taken this percentage up to approximately 24%. Post Paris momentum is picking up, evidenced by, record black Friday sales exceeding 185, 000 background checks. A mere return to 1970 levels of 29% would have a significant impact on Smith & Wesson stock. It is not difficult to foresee that gun sales can increase penetration to another 5% to 7% of the US population over the next 2 to 3 years. Accessories and ammo sales will also experience an incrementally large increase.

Smith & Wesson manufactures and sells firearm products in the United States and internationally. The company operates in two segments, firearms and accessories. It offers handguns, including revolvers and pistols; long guns, such as sporting, bolt action, and single shot rifles; hunting rifles; black powder firearms; handcuffs and restraints; and firearm-related products and accessories. Analysts have been bullish on the stock over the last sixty days. Two analysts raised their earnings estimates for the current quarter, current year and next year. The recent bullish sentiment is following yet another quarterly earnings beat for Smith & Wesson. The streak the company has been on is impressive. Smith &Wesson has beat estimates a whopping 17 quarters in a row. The last earnings beat saw earnings come in at 32 cents versus consensus Estimate of 22 cents.

Smith & Wesson has a degree of operating leverage of approximately 2 x. Therefore, an increase as projected by recent trends will double sales and increase EBIT by a factor of four, rendering pre-Paris estimates too low. I project this will increase revenues to approximately $18 per-share, increase cash flow to approximately $3.60 per-share and increased earnings to approximately $2.50 per-share by 2017. Given Smith and Wesson's historical PE multiple of 17 should give a two year target price of $42, discounted back by two years of risk premium equals 20% and that renders my 12-18 month target price of $34.

The Short: Retrophin, Inc. (RTRX)
Current price: $21.84
12-month target price: $14

Retrophin had a spurious inception, founded by Biotech Sith Lord Martin Shkreli, whom is better known for egregious price gouging with privately held Turing Pharma. Recently exposed with Valient Pharmaceuticals (VRX). Hedge fund managers have been gaming the biotech industry, combining price gouging after acquiring niche drugs with tax inversion schemes to drive eps and share prices. This egregious behavior and wanton greed has caught the eye of the Senate Special Committee on Aging. Some feel it is a form of domestic financial terrorism for the deleterious effect it is having on the American public’s cost of health insurance.

Shkreli’s last chapter of price-gouging involved Daraprim, a 62-year-old generic drug used to treat malaria and toxoplasmosis, a parasitic disease often found in HIV-positive individuals and others with weak immune systems. The drug is on the World Health Organization’s List of Essential Medicines, which are the most important medications needed in a basic health system. Shkreli’s current company, Turing Pharmaceuticals, acquired Daraprim in August, and boosted the price shortly afterward from $13.50 a pill to $750, an increase over over 5000%!

Shkreli is current entangled with some issues with Retrphin , his predecessor company, that Shkreli appropriated cash from Retrophin and used it to settle litigation from institutions and individuals who were investors in his hedge fund, and then illegally classified them in the company’s books as consulting payments. In essence, if the allegations are true, Shkreli stole money from the company to resolve lawsuits that had nothing to do with Retrophin, then lied about what he did in filings to the Securities and Exchange Commission by misrepresenting how and why the cash was spent. Government investigators have obtained data showing more than 612,000 shares of Retrophin and a total of $400,000 from the corporate coffers were distributed to former investors who had sued . As a large insider shareholder, Shkreli has threatened to sell his stock possibly as an offset to settle these charges.

Going public in late 2014, Retrophin entered into a trademark license and supply agreement with Mission Pharmacal for Thiola (tiopronin). Thiola is a FDA approved drug used for treating Cystinuria. Cystinuria is a rare disease that affects 20,000 patients in US. Cystinuria is characterized by formation of cysteine stones in kidneys, ureter and bladder.

Subsequently, Shkreli And Retrophin increased the price of Thiola 20 fold, from $1.50 to $30 per pill.

Thinly traded nano cap, Imprimis Pharmaceuticals (IMMY) recently announced the availability of a customizable compounded formulation of pyrimethamine and leucovorin for physicians who are prescribing Daraprim. Its offering, available in oral capsules, starts as low as $99 for a 100-count bottle ($0.99 per capsule). Express Scripts (ESRX), our nation’s largest PBM, indicated that it will make the $1 per pill alternative to Daraprim available in its formulary. This will give a huge boast to Imprimis and provide needed relief to its seriously ill users. With the help of Express Scripts, the $1 pill will become available on a massive scale. Similar efforts could easily be applied to developing generic versions of Thiola and Chenoda, with similar pricing, thus imploding revenues for Retropin.

A U.S. Senate panel will convene on Dec 9th. Launching a bipartisan probe into pharmaceutical pricing, seeking documents from four drug makers including Valeant Pharmaceuticals and Turing Pharmaceuticals, companies embroiled in controversy over price hikes on lifesaving drugs, the Senate's Special Committee on Aging also requested information from Retrophin Inc and Rodelis Therapeutics, according to a statement from the panel's Republican Chairwoman Susan Collins and Claire McCaskill, its top democrat.

These pressures could force Retrophin to roll back drug pricing, causing its revenues to plummet. Retrophin could drop to $14 per share, its next level of technical support, indicating about 30% downside risk. Eventually, without any new products, Retrophin could plummet to $4, its net tangible equity.

It is amazing that the largest customer of global pharma, Medicare, has no power to negotiate prices for its “customers”, while Europe, a market with nearly identical demographics, averages only 2-3% annual price inflation vs. the recent 11% annual price level hikes we American’s are forced to swallow.

DISCLOSURE: Maltbie’s firm currently is long Smith & Wesson Holding Corp, and is short Retophin, Inc. Robert Maltbie is a principal of California-based Millennium Asset Management.

Companies

Symbol Name Price Change % Volume
RTRX Retrophin Inc. 21.07 0.53 2.58 58,332
SWHC Smith & Wesson Holding Corporation 20.87 -0.07 -0.31 1,052,772

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