Two Speculative Health Care Plays

01/20/2010 10:09 am EST

Focus: STOCKS

Michael Shulman

Editor, Short-Side Trader

Michael Shulman, editor of ChangeWave Shorts, says two money-losing health care companies look good no matter what happens with health care reform or the economy.

No matter what happens with health care reform, the primary focus for most institutions is cost effectiveness and cost cutting. Two of our picks in health care that are accomplishing that are Cepheid (Nasdaq: CPHD) and Cerus (Nasdaq: CERS).

These companies can significantly help hospitals and blood banks reduce costs. CPHD and CERS are still unprofitable, but they are very solid product-driven companies and market dominators, in narrow market segments. We can expect them to outperform in any market environment short of a crash.

Cepheid is in molecular diagnostics using genetic testing, and dominates the rapid-response market for several important diseases, notably MRSA (the killer staph infection) and other hospital-acquired infections (HAIs). Starting this year, Medicare will not pay for the treatment of HAIs—imagine that!—except MRSA. Hospitals must diagnose patients before they are admitted and quarantine them, so they don't spread the disease.

Thanks to CPHD's equipment, this is now standard practice in the US Department of Veterans Affairs' hospital system, and that in turn has reduced MRSA by 75%-plus where the machines were first installed. Many states are now either mandating, or considering mandating, MRSA testing at admission.

There are two [possible] catalysts in the next 12-18 months. The first is the company’s receiving approval to market its equipment to smaller users, such as clinics, nursing homes, and doctors' offices. The second is a possible acquisition of CPHD.

At [above] $15, the company is selling for less than half its all-time high, and if it is taken out it would be worth north of $20. The open position I chose for Cepheid is the CPHD Jun 15.00 Calls (QHYFC), because it was the latest available expiration date. I'm raising the Buy Under [on the options] to $2.10.

Cerus is the only maker of systems that perform "pathogen inactivation." Its Intercept System kills virtually all pathogens in donated blood before that blood is processed into platelets.

With Cerus's technology, blood banks in Europe are already moving on from worrying about the quality of the donors' blood in many large European countries like Germany and France.

CERS management is very conservative, [but] that conservatism is winning more and  more institutional investors who can see Cerus' s path to both profitability and market dominance during the next one to three years.

Short-term upside catalysts include approval of a new trial in the United States. The company is negotiating with the Food and Drug Administration for a new trial, and [if that happens, I expect the company] will then negotiate a marketing agreement with a major player in the blood industry.

Cerus should be cash-flow-positive late this year or early next, and that, too, will lift the stock. When longer-term option positions are available, we will move from the stock to calls. The Buy Under [is] $2.50, [and the stock closed Tuesday above $2.00—Editor.)

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