There aren't many ASX-listed companies operating in the far north of Australia, but TFS Corporation Limited (ASX: TFC) is one such company that grows tropical sandalwood and today confirmed guidance for a 10% increase in full year cash earnings, compared to the prior year.
The group reportedly owns and operates sandalwood plantations equivalent to the area of Manhattan and today announced it sold 1,500 hectares of new plantations in financial year 2015, more than ever before.
Sandalwood trees take around 15 years to grow before harvest and the business said it has recently completed the harvest of 35 hectares of sandalwood plantations. The trees owned by growers will be sold this financial quarter, while those owned by TFS will be processed into pharmaceutical grade sandalwood oil.
TFS operates sandalwood processing and oil distribution facilities in Albany, Western Australia and currently has a 50% interest in US pharmaceuticals business Santalis Pharmaceuticals Inc. It's via this ownership interest that TFS recently entered into a sandalwood oil supply agreement with US dermatological and healthcare giant Galderma.
The deal to supply Galderma sandalwood oil for use in its latest Benzac acne treatment clearly excited TFS's management to the extent that it recently agreed to buy both its US-based pharmaceutical partners, Santalis and ViroXis.
TFS's justification for the purchases is that they will allow it to capture all future product royalties, earnings and license fees generated by ViroXis and Santalis in supplying sandalwood oil-based products to big pharmacy operators or others.
That is of course if either Santalis or ViroXis generate much in the way of future revenues.
Currently only Santalis has a revenue-generating sandalwood related product and TFS has agreed to pay a minimum price of US$23.4 million for the two businesses.
The big surprise though is that TFS has also agreed to milestone payments to both businesses just for enrolling patients in Phase III trials among other things, while final earn out payments could take the total purchase price to a whopping US$244.9 million.
No wonder the ViroXis CEO said he was "delighted" to reach agreement with TFS a feeling likely shared by his counterpart at Santalis who may think Christmas has come early.
In my opinion this looks an extremely generous deal for the pharmaceuticals, while TFS shareholders (myself included) are forced to wear all the risk around funding clinical trials and still share future earnouts to the potential tune of US$244.9 million.
The forestry business still retains some attractive fundamentals but the left-field decision making is likely to be an issue for many investors and the stock has dropped around 13% to $1.52 since the announcement.
Of course if either of these companies does develop some profit-spinning products I'll be forced to eat my words and TFS stock will likely zoom far higher and that's why small caps can mean big returns.
