Gamble of the week: promising biotech firm

This week's gamble is a science-rich company with solid long-term prospects in a niche sector, whose present downtrodden valuation does not reflect its potential.

This company supplies human tissue and other biomaterials, such as blood and DNA, to the pharmaceutical and biotechnology industries. The group collects these products from hospitals and medical premises around the world, stores them in specially controlled conditions and then sells them to healthcare firms for use in their research. These substances typically fill the gap between preclinical (animal) and Phase I (human) trials, with the aim of shortening drug development times and weeding out ineffectual treatments earlier in process.

Asterand (LSE:ATD)

Growth in this niche sector is being driven by increasing research into biomarkers and the trend for customers to outsource this service to specialists. Currently, in-house operations account for about 75% of the tissue-supply market, but this is steadily falling as research staff struggle to cope with tighter laws and the need to test tissues from a wide variety of ethnic backgrounds and disease types/stages.

Encouragingly, the company was awarded a prestigious $2.9m contract in October 2007 with the US Department of Defence to review its massive tissue repository, which is the largest biobank in the world.

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The group's finances also look healthy. Turnover (at constant exchange rates) was up 9% to £7.6m in 2007, despite a temporary supply disruption caused by a restriction on Russian exports of human materials. This year Asterand is aiming to move into profitability for the first time with Edison Research forecasting 2008 sales and normalised earnings per share of £10.9m and 0.4p respectively, rising to £12.4m and 0.8p in 2009. Moreover, as at 31 December the group had net cash of £2.2m, along with potential carried-forward tax losses of £41m (subject to approval by HM Revenue & Customs), equating to a deferred tax asset of up to £10.5m.

Fine so far, but what are the risks? Well, if growth is slower or takes longer than envisaged, then fresh equity may need to be raised, potentially diluting shareholders. The company is also exposed to tissue-supply issues, foreign-exchange fluctuations and government regulation, and, due to its small size, liquidity in the shares tends to be thin.

But if Asterand can achieve Edison's targets, then the shares look undervalued, particularly for such a science-rich company operating in a niche sector with solid long-term prospects. Chief executive Martyn Coombs seems to agree as he purchased 200,000 shares in April at 5.25p each. Finally, it is worth noting that 12 months ago Asterand received a takeover approach from a consortium of its shareholders, pitched at 7.75p per share. Although the bid was rejected as being too low, it should help underpin the present downtrodden valuation.

The next trading update is scheduled for 7 May.

Recommendation: SPECULATIVE BUY at 5.75p (market cap £6.3m)

Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments

Paul gained a degree in electrical engineering and went on to qualify as a chartered management accountant. He has extensive corporate finance and investment experience and is a member of the Securities Institute.

Over the past 16 years Paul has held top-level financial management and M&A roles for blue-chip companies such as O2, GKN and Unilever. He is now director of his own capital investment and consultancy firm, PMH Capital Limited.

Paul is an expert at analysing companies in new, fast-growing markets, and is an extremely shrewd stock-picker.