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Company Overview

SOHM, Inc. (SHMN) is a pharmaceutical manufacturer that produces and markets generic drugs for all major treatment categories. In March, 2009, the Company obtained a direct manufacturing license under Current Good Manufacturing Practice (CGMP) and World Health Organization (WHO) regulations to produce generic pharmaceuticals. This authorization provides the Company with manufacturing capability for a wide variety of products. SHMN has private label license agreements with two companies to produce pharmaceuticals and surgical products.

The Company’s manufacturing facility, located in India, enables low production costs without compromising quality. SHMN has the ability to develop, manufacture and market generic pharmaceuticals in various dosage forms, including tablets and capsules, creams and topicals, ointments, liquids and injectables. At present, SHMN has global licenses to manufacture 30 products and approximately 300 generic drugs and product formulations for distribution.

SHMN markets and sells its offering globally but focuses primarily on emerging markets in Africa, Latin America, Southeast Asia and the European Union. The Company’s global headquarters is located in North America and it has offices in China, India and the U.K.

The Company signed a distribution agreement with a country in the Far East in May 2009 and has received order confirmation for seven products and trial orders totaling 1.5 million tablets. Another order for 1.5 million tablets is being finalized which will add approximately $400,000 to annualized revenues. SHMN forecasts revenues from sales of generic pharmaceuticals approaching $1.8 million in 2009 and anticipates annual revenue growth exceeding 80% through 2011.

Investment Highlights

Generic drug manufacturing expertise

SHMN’s proprietary processes and formulation capability allow it to develop generic formulations of brand name drugs that don’t infringe on valid patents relating to the brand-name product. Demand for generic pharmaceuticals is increasing as a result of increasing awareness and acceptance of generics by consumers, physicians and pharmacists globally. In addition, government agencies and private managed care/ insurance programs encourage the substitution of generics for brand-name pharmaceuticals as a cost savings measure.

Significant market opportunity

Sales of generic drugs reached $90.7 million in 2007, growing at a three-year 12.1% CAGR. Generic drug sales rose 14-15% in 2008, as compared with 6-7% growth for branded pharmaceuticals. Patent expirations of blockbuster drugs are the primary growth driver for the industry[1]. Drugs representing approximately $20 billion in annual sales have patents expiring in 2008, similar to levels seen over the past two years. Patent expirations will help drive growth of generics by 14-15 % next year. In 2008, more than two-thirds of all prescriptions written in the U.S. were for generics.

According to a DDB Health survey, consumers prefer medicines that have been around a long time to the latest pharmaceuticals, and over half prefer generics to branded drugs. Asked whether they would prefer the latest medicine or one that has been around for years, 70% said they prefer the tried-and-true drug over the latest and greatest, and 54% said they prefer generics to branded.[2]

Focus on emerging markets

The Company plans to distribute its offering in fast growing, underserved emerging markets in the Far East, Africa, the European Union and Latin America. SHMN has already registered its offering in these countries and plans to begin exporting from its India manufacturing facility in Q2 2009. Despite the challenges of the current economic climate, a large percentage of the world’s population needs basic pharmaceuticals but can’t afford branded drugs because they are either too expensive or not available due to high prices. SHMN’s distribution network was recently expanded to include emerging pharmaceutical markets in Indonesia, Thailand, the Philippines, and Malaysia.

Infrastructure to support manufacturing and export

By consolidating its pharmaceuticals assets in India, the Company establishes a generic drug manufacturing hub where it can capitalize on low prices, strong marketing and global recognition of Indi’s emerging role as a leading drug manufacturing center. In October 2008, SHMN obtained pharmaceutical drug licenses that enable it to sell in Africa, Latin America and Southeast Asia. In February 2009, SHMN obtained a direct manufacturing license for generic pharmaceuticals. This license completes the needed infrastructure development for its India manufacturing hub.

Aggressive growth strategy

SHNM is aggressively marketing its offering and establishing a global distribution platform. In January 2009, the Company signed an exclusive private label and development agreement with an India-based generic pharmaceutical manufacturer. In May 2009, SHMN signed a distribution agreement with a country in the Far East, received initial orders for seven products and trial orders for more than 1.5 million tablets. Another trial order for 1.5 million tablets is being finalized which will add approximately $400,000 to the Company’s revenues.

In addition, SHMN is planning acquisitions to expand its operating capacity and bargaining power. According to management, acquisitions could add up to $3 million to annualized revenues and extend growth opportunities in the Indian pharmaceutical market.

Robust management outlook

The Company estimates 2009 sales approaching $1.8 million in 2009. Based on management’s outlook and our understanding of SHMN’s business model, we expect Company revenues to rise to $4.5 million in 2010 and $7.6 million in 2011. Assuming a 20% share dilution, we forecast EPS at $0.003 in 2009, $0.017 in 2010 and $0.26 in 2011. Over the longer- term, we expect SHNM to maintain double-digits growth rates for both revenue and earnings, driven mainly by strong organic growth and acquisitions.

Business Model

SHMN develops and commercializes generic pharmaceuticals, utilizing its controlled-release and other in-house and formulation technologies. The Company focuses on developing generic versions of brand-name products for which the patents are near expiration or expired and requiring a proprietary formulation expertise. The Company’s proprietary processes and formulation skills allow it to develop generic versions that replicate the brand-name products’ physiological effects but don’t infringe on any valid patents.

Through research and development, SHMN expands its range of generic pharmaceuticals. Its generic drug development strategy is two-fold:

1. Introduce generic versions on the patent expiration date of the equivalent brand-name pharmaceutical; and
2. Achieve market introduction at the earliest possible date.

The Company actively reviews pharmaceutical patents and seeks opportunities to challenge patents it believes are either invalid or would not be infringed by a generic version. SHMN also enters into alliances and partnerships to acquire rights to pharmaceuticals it does not own and to share development costs or resolve patent barriers to entry. Overall, the Company’s generic product development strategy leverages a legal strategy predicated on non-infringement of established brand name pharmaceuticals and speed to filing.

The Company’s manufacturing facility is located in Ahmedabad City, India, in an area considered one of the safest in India and perfect for pharmaceutical operations. The facility is approximately 10,500 sq ft and the entire land area is approximately 15,000 sq ft. There is additional space available for future growth and storage requirements. In February 2009, SHMN’s manufacturing facility was licensed by the India FDA. The license indicates compliance with Current Good Manufacturing Practice (CGMP) Regulations: Division of Manufacturing and Product Quality and World Health Organization (WHO) regulations.

The manufacturing facility provides complete technical support for production activities and houses the following:

• A quality control laboratory with instruments to provide, chemical and microbiological analytical support;
• A spacious raw materials storage area which provides separate storage facilities for incoming materials, quarantine materials, released materials and a separate section for sampling under controlled environment and isolated areas for dispensing of raw materials;
• A finished goods warehouse for storage and distribution of finished goods.

Corporate strategy

The Company’s produces premium-quality, affordable pharmaceuticals and meets the changing needs of the drug market with a continual flow of new products, broadening its product portfolio, optimizing a global supply chain, helping customers more efficiently manage their inventory and customizing distribution and shipping based on specific customer needs. SHMN plans to grow by extending its leadership position in emerging generic pharmaceutical markets in Africa, Latin America, Southeast Asia and other important international markets.

Key aspects of the Company’s strategy include:

• Increasing generic R&D capabilities and production capacity;
• Establishing a high level of operational oversight and quality control;
• Providing high-quality products in markets that are currently under served, poorly served, or under-subscribed by existing suppliers;
• Using cost-effective, up-to-date instruments and equipment and machineries;
• Employing advanced electronic and information technology to reduce staffing and other operational costs;
• Continuing to actively seek and evaluate potential acquisitions, collaborations and other business combinations;
• Avoiding head-to-head competition with an established business in regions that already are well served.

Sales and marketing

The Company’s customers are drug wholesalers, mass merchandisers, warehousing chain drug stores, and mail-order pharmacies. SHMN markets its products both directly and through partner alliance agreements. SHMN focuses on fast growing, under served emerging markets in the Far East, Africa, newly added European Union states and Latin America. Despite the challenges of the current economic climate, much of the world’s population has a great need for basic pharmaceuticals, but these drugs are either too expensive or not available to vast populations in these regions. The Company recently expanded its generic drug distribution to address emerging pharmaceutical markets in Indonesia, Thailand, the Philippines, and Malaysia.

The Company’s marketing effort focuses on:

• Identifying, through careful market research, un-served or underserved niche markets;
• Combining the core pharmaceutical business with ancillary marketing concepts, activities and operations;
• Identifying, negotiating, and entering into partnerships with larger, more established distributors;
• Utilizing advanced electronic and informational technologies in sales and marketing;
• Accommodating special and ethical products when and where sufficient demand exists.

Products

SHMN produces and markets generic drugs covering all major treatment categories. Its product list includes anti-arthritic/analgesics, anticancer drugs, antifungals, anti-infectives, cardiovascular agents, central nervous system, dermatological, gastrointestinal and respiratory drugs, biotechnology products, hormones, anesthetics, antidiabetics, antiemetics, dermatologicals, immunosuppressive agents, ophthalmic drugs, and treatments for benign prostatic hyperplasia.

Source: Company website.

SHMN’s manufacturing facility is licensed by the India FDA to manufacture:

• TABLETS: uncoated; coated; chewable; dispersible;
• CAPSULES - hard gelatin capsules; dry syrup;
• ORAL LIQUIDS - syrups and suspensions;
• OINTMENT - external creams & gels;
• β - LACTUM: tablets; capsules; dry syrup;
• INJECTABLES.

Industry Outlook

IMS Health forecasts 4.5% to 5.5% growth in the global pharmaceutical market during 2009, with dollar amounts exceeding $820 billion. The global pharmaceutical market is forecast to grow to $929 billion in 2012, an equivalent CAGR of 5.5% over the next five years[3]. The increase will result from rising worldwide demand for medicines as the world’s population ages and chronic conditions and infectious diseases tied to global warming.. According to a PricewaterhouseCoopers report, the global pharmaceutical market could reach $1.3 trillion by 2020[4].

Pharmaceutical Market Worldwide ($ billion)

Source: www.vfa.de/en/statistics/pharmaceuticalmarket/

The U.S. is the world’s largest and wealthiest pharmaceutical market, accounting for around 40% of the total. France, Germany and the U.K. together account for almost 50% of European pharmaceutical sales. However, emerging markets such as China, India, South Korea, Brazil, Mexico, Russia, and Turkey are predicted to show the most growth next year, with spending increasing 14-15% to $115 billion. These countries will account for 40 to 50% of annual market growth over the next five years.

India’s pharmaceutical market

India has had a strong domestic pharmaceutical market and a growing population which already exceeds one billion. Pharmaceutical is one of the fastest growing sectors of the Indian economy. India has the fourth largest pharmaceutical market by volume (8% of global total) and the thirteenth largest by value (less than 1% of global total). Between 1996 and 2006, nominal sales of pharmaceuticals rose 9% annually. Demand in India is growing faster than the global market due to the country’s rising population, increasing number of seniors and growing personal income.

India is emerging as a competitive outsourcing hub and already plays a major role in the global pharmaceutical industry as a manufacturer of Active Pharmaceutical Ingredients (APIs) and intermediates for drug makers. As a production location, India is attractive because of its educated population and low wages. Global pharmaceutical companies are establishing long-term relationships with manufacturers and contract research providers in India. Since the end of the 1980s, India has exported more pharmaceuticals than it imports.[5]

India’s pharmaceutical industry has been in transition for several years now as a result of changes to drug patent legislation in 2005. Current industry focus is on developing drugs and contract research and/or production for Western drug companies. India’s government has taken steps to increase the country’s attractiveness for drug researchers by eliminating import duties on studied drugs. ICH Good Clinical Practice regulations are now mandated, and protocol approval times have been cut to approximately 12 weeks.

Indian companies manufacture drugs for overseas clients, in addition to marketing pharmaceuticals for their own sales networks. There are also new drug development programs by Indian companies with planned international market launches. Outsourcing to India has proven an effective way to reduce costs and developmental time. [6]

According to Crisil Research, the Indian pharmaceutical industry was valued at $13 billion in 2006-07. Of this, the domestic formulation segment accounted for almost 48%, the formulation export market accounted for about 25%, and bulk drug exports represented 27%. Pharmaceutical sales are forecast to reach $20 billion by 2015 and position India among the world’s top 10 pharmaceuticals markets[7].

Despite the global recession, Fitch Ratings expects demand for Indian pharmaceuticals to remain largely stable, driven by the inherent stability of demand for core pharmaceutical products and the lower cost of Indian generics relative to Western branded counterparts.

India pharmaceutical industry expansion

Source: Sources: Global Insight, VCI; Forecast: DB Research

Generic demand

According to a DDB Health global survey, most consumers prefer medicines that have been around a long time to the latest pharmaceuticals, and over half of consumers prefer generics to branded drugs. Asked whether they would prefer the latest medicine or one that has been around for awhile, 70% of consumers said they would take the tried-and-true drug over the latest and greatest, and 54% said they prefer generics to branded. Of the U.S. respondents, 69% said they prefer generics. It is not uncommon for branded products to lose almost their entire market share to generic drugs within just a few months after patent expiration.[8]

The global generics market was valued at $ 77 billion in 2006, split 60:40 between emerging and regulated markets. The global generics market reached $90.7 million in 2007, growing at a three-year CAGR of 12.1%. Sales of generic drugs increased by 14-15% in 2008, as compared with 6-7% branded pharmaceutical growth. Patent expirations of blockbuster drugs drive generic market growth. Patents on drugs with approximately $20 billion in annual sales expired in 2008, similar to levels seen over the past two years. Leading products such as Risperdal, Fosamax, Topomax, Lamictal and Depakote are expected to lose market exclusivity in one or more major markets around the world this year. In 2008, more than two-thirds of all prescriptions written in the U.S. were expected to be for generics. New government contracting initiatives in Germany, and educational programs in Japan, Spain and Italy, will drive greater generics use in those markets.[9]

World generics market growth ($ billions)
Source: http://pharmalicensing.com/public/articles/view/1144147543_44324e57b031f

India has achieved a strong position in the global generics market. Generic drugs produced in India are increasingly accepted worldwide. While in 2002 Indian companies accounted for less than 7% of all generic drugs approved in the U.S., they accounted for over 20% in 2006. India's share of total DMF filings has increased from 14% in 2000 to about 50% in 2007. In terms of ANDA approvals as well, India's share has grown from 15% in 2005 to 25% in 2007[10]. Indian companies are expected to grab around 30% share of the increasing generic market in the future.

Financial Analysis

SHMN expects to generate revenues from sales of generic drugs. The Company’s generic pharmaceuticals are exported globally with a focus on distribution in emerging markets in Africa, Latin America, and Southeast Asia.

SHMN plans to begin exporting product from its India manufacturing facility in Q2 2009. The Company’s historic revenues consist of accrual of interest earned on the tax lien certificates owned, as well as liquidating revenue from properties sold that the Company received through settlement of unredeemed tax lien certificates.

Income statement, $

Source: Company’s financial reports

The Company has a weak liquidity position and has relied on external financing for funding. SHMN must continue to raise funds to implement its 2009 business plan; however there is no assurance that management will be able to raise the necessary capital.

Balance sheet, $

Source: Company’s financial reports

Outlook and valuation

SHMN plans to sell generic pharmaceuticals in emerging markets in the Far East, Africa, the European Union and Latin America. The Company has already registered its offering in these countries and is likely to start the export from India already during Q2 2009.

The Company is already starting to build sales momentum. In January 2009, SHMN signed an exclusive private label and development agreement with an India-based generic pharmaceutical manufacturer. The two companies have formed a global platform for introducing SHMN generic medicines in African, Latin American, and Southeast Asian markets. Generic pharmaceuticals sourced through this agreement are likely to be labeled under the SOHM brand and be distributed directly under the Company’s manufacturing license in India.

Also in January 2009, the Company received a purchase order for various chemicals and chemical products with a cumulative value of approximately $1 million. In May 2009, SHMN received orders from a Far East customer for seven products and trial orders of more than 1.5 million tablets in the initial shipment. Another trial order for 1.5 million tablets is being finalized.

Based on management business outlook and our understanding of SHMN’s business model we expect the Company to report revenues of $1.8 million in 2009, $4.5 million in 2010 and $7.6 million in 2011. Assuming 20% annual share dilution from equity sales, we forecast EPS of $0.003 in 2009, $0.017 in 2010 and $0.26 in 2011. Over the longer- term, we expect SHNM to maintain double-digits growth rates for both revenue and earnings, driven mainly by strong organic growth and acquisitions.

Revenue and earnings forecast, $

Source: Analyst estimates

Comparative valuation

SHMN competes in the global specialty pharmaceutical market. Its industry peers were recently trading at forward Price/Sales multiples of 1.13 times revenues and forward Price/Earnings multiples of 11.16 times earnings.

Peer valuation

Source: Yahoo Finance

We value SHMN at 20 times our 2010 EPS estimate, given its solid growth outlook, low revenue base and rapidly expanding distribution network. As a result, we are initiating coverage of SHMN with a Speculative Buy rating and a $0.33 price target. However, we strongly advise investors to consider the risk factors mentioned below since a Company at this early development stage faces many challenges in attaining its revenue goals.

Risk Factors

Inherent business risks

So far the Company has been successful in building its operating capabilities and developing its global distribution platform. However, there is no guarantee that SHMN can complete targeted acquisitions, establish an efficient generic drug manufacturing hub in India and leverage its infrastructure, sales channels and management expertise for consistent growth.

Need for additional capital

The Company has modest cash, negative working capital and a cash flow deficit. Additional acquisitions and significant marketing efforts are planned during 2009, which may require SHMN to sell stock or take on debt to raise capital. There is no guarantee that the Company will be able to raise the necessary capital for business development on acceptable terms, if at all. Lack of financing may hinder further growth and slow the implementation of the business plan.

Competitive market

India has a significant share in the global generics market. In recent years, this segment has been facing stiff competition, which makes the scale of production important to improve profitability. SHMN competes with established players with greater financial resources and better visibility and market position. Competition is fierce and price-cutting to attract customers is eroding industry profits. There is no assurance that SHMN will succeed and develop a competitive business.

Pharmaceutical companies try to limit generic competition

Pharmaceutical companies are using state and federal legislative and regulatory means to delay generic competition. If pharmaceutical companies succeed in limiting the use of generics, demand for generic drugs may decline, diminishing SHMN’s business prospects.

Management

Swati Shah, Chief Executive Officer and Chairman of the Board

Swati Shah was named Chief Executive Officer of SHMN in April 2008. With broad experience in customer service, financial accounting and international law, Mrs. Shah brings a wealth of knowledge to SHMN’s key leadership position. She has served various leadership roles at financial, commerce and law firms over the years and created the pharmaceutical and international trading organizations at SHMN by combining all of the Company’s resources under one umbrella. She was involved in the Company going public and also led initiatives to improve customer satisfaction and raise SHMN’s visibility in the public market. She was also a key member of the leadership team during the development of the Company’s India based pharmaceutical manufacturing plant.

Mrs. Shah is experienced in cross-border trade and investments and skilled in international trade, corporate infrastructure development, finance, taxation, investment, environmental, regulatory, intellectual property, and real estate matters. Mrs. Shah grew up in India, and earned a Bachelor of Law Degree and Bachelor of Commerce Degree from Gujarat University, Ahmedabad, India.

Shailesh Shah, Vice President and Secretary

Shailesh Shah is Vice President and Secretary of SHMN. Mr. Shah has over twenty years experience in IT consulting, human resource management, and international trade. He had multiple successes in leading and managing new business initiatives which integrate people, process, and technology. He has successfully assisted prospective importers and exporters with evaluating import-export potential, identifying target markets, developing market entry strategies and building distribution networks and the "mechanics" of international trade. Mr. Shah has built an extensive network of contacts with foreign and domestic companies/organizations for setting up channels of distribution overseas. He has a Bachelor of Science and graduate degrees in International Business, Marketing, and Sales, Post graduate Diploma in International Business Management Post Graduate Diploma in Marketing and Sales Management

Mr. Shah has worked effectively with regional development centers, state and federal agencies, legislators, U.S. and foreign trade offices, chambers of commerce, and other international economic development organizations to promote exporting through jointly sponsored programs. He developed and implemented a consulting program for the Company’s new International Trade Division to provide one-on-one consulting services to prospective clients in India, the U.K. and Africa. He has extensive experience in international market research, formulation of marketing programs, international distribution, quality control, international credit and shipping procedures and other activities necessary to effectively service a critical manufacturer in India and Africa.

Professional Membership:

• Certified Management Consultant (CMC), IMC, Washington, DC
• Senior Member, AATCC, NC
• Rotary Club of Buena Park, CA
• Life Member of Ahmedabad Management Association, India
• Member of All India Management Association, New Delhi, India
• Buena Park Chamber of Commerce
• California Chamber of Commerce, Sacramento, USA
• The U.S. Chamber of Commerce, Washington DC, USA

[1] www.piribo.com/publications/generic_drugs/top_10_generic_pharmaceutical_companies.html

[2] www.mmm-online.com/Consumers-prefer-generics-worldwide-says-study/article/137800/

[3] www.piribo.com/publications/general_industry/pharmaceutical_market_trends_2008_2012.html

[4] www.fiercebiotech.com/node/7238

[5] www.dbresearch.com/PROD/DBR_INTERNET_EN-PROD/PROD0000000000224095.pdf

[6] www.bioportfolio.com/cgi-bin/acatalog/The_Indian_Pharmaceutical_Market_Analysis_and_Forecasts_2008-2023.html

[7] www.financialexpress.com/news/domestic-pharma-market-to-hit-20billion-mark-by-2015/468164/

[8] www.mmm-online.com/Consumers-prefer-generics-worldwide-says-study/article/137800/

[9] www.pharmamanufacturing.com/industrynews/2007/384.html

[10] www.expresspharmaonline.com/20080131/indianpharmain202008.shtml