|How to Profit from Australia's Healthiest Biotechs: Wilson HTM's Shane Storey|
|By George S. Mack of The Life Sciences Report|
|Thursday, 16 April 2015 12:51|
Australia will always be known as a trove of natural resources, but its most precious treasure is the abundance of entrepreneurs who are all too happy to develop the country's intellectual assets.
Shane Storey, head of research at Australia-based Wilson HTM Investment Group, observes that as the market value of resource commodities declines, investors are diverting investment capital to healthcare stocks, especially in the medical technology sector. In this interview with The Life Sciences Report, Storey presents three names that don't come close to their long-term fair valuation potential. The upside, he believes, could be quite dramatic.
The Life Sciences Report: Shane, does Australia have a new natural resource?
Shane Storey: I would like to think that. At the moment, healthcare technology—medical devices in particular—is one of our most successful industries. If you measure the total revenue from the best devices, we've had some terrific successes. We have companies from Australia that have become global names, like ResMed Inc. (RMD:NYSE) and Cochlear Ltd. (COH.ASX).
A lot of innovation and good, high-tech manufacturing is going on in this country. In the last 5 to 10 years Australia has had too many disappointments in biopharma, and in drug development specifically, so the investment focus has shifted toward devices, which investors see as less risky. Devices can find their way into the market faster than drugs, and investors get rapid and authentic market feedback as to whether the technology is any good.
TLSR: With the declining price of commodities and natural resources, do you see investors shifting capital from natural resources into healthcare?
SS: Yes. I'm fortunate enough to have covered the sector for a long time. I remember 10, 15 years ago, around the time when the medtech industry in Australia was really in its infancy, the risk profile of early-stage life science investment was seen as similar to the risk profile of an early-stage resource company. At the time, I thought that because medtech companies were fairly risky ventures, they'd be seen as having no worse a risk profile. But there is a difference. Although commodity development is very risky, the end markets weren't as risky because commodity prices were good—until recently. But even if a life science company developed a product that worked, people had no feel for what the end market would be like. They didn't know whether demand would be there.
TLSR: Now the demand is not so hot for resources. Where is the investment capital going?
SS: The tables have turned 180 degrees. Even though there is still uncertainty about the ultimate market demand for medical devices, they have almost switched places with resources in the minds of many. Having spoken to institutional investors and other investors in the sector for more than 10 years, I have always known there was a general level of interest in devices. Although that level of interest has increased only modestly, it's nonetheless still there. Developers will find investors interested in the sector.
TLSR: How does financing look for companies in Australia? Is capital available?
SS: We know what key success factors to look for now. It has been a long process of education, but we are in a reasonably good position, where we can see companies go to the market and raise $20–40 million ($20–40M), whereas that was very difficult 10 years ago.
The other thing that's changed is the investment experience of people looking at the sector. What's really nice to see is that a lot of the guys who were investing 10 years ago are still at it, and they are, of course, more successful now. Their holdings have grown and they are managing larger funds, so it's more difficult for them to play, particularly, in the smaller names. Nonetheless, they are still investing in medical devices, and now we have some clear examples of who got it right, who got it wrong, and what has made the difference.
TLSR: As you note, investors find it difficult to play in the small- and micro-cap realms. But what about venture capital? Is that available?
SS: The capital markets for early-stage technology have been a consistent problem. If you look at venture capital, it's very thin. Companies can raise money publicly at an early stage, but it's difficult to raise meaningful amounts early as a private startup.
What we often see are companies falling into the trap of being serial capital raisers. That, of course, is an incredible distraction from running a business and delivering a project. You can get attention here in Australia, but the problem is you're raising very small amounts of money, like $5–10M, maybe $15M, which isn't enough usually. But companies must cope with that, and we've had some survive. The ones that survived are good.
TLSR: Shane, you earned your Ph.D. as a biochemical engineer. Do you take a scientific, quantitative and even qualitative approach to understanding a platform or a technology? Do you apply an engineer's mindset to due diligence?
SS: Inevitably, I think my training does read into my diligence.
A key skill taught in engineering is to be OK with not knowing the answers. I think you learn to have a level of comfort with making decisions without complete information. It boils down to defining the three or four really important concepts that tell you whether an opportunity has a chance. Can these guys pull it off? Will it work? Will it stack up to the competition?
"A lot of innovation and good, high-tech manufacturing is going on in Australia."
An engineer's discipline also trains you to kill off projects early. When I started working as a sellside analyst, I focused a lot on the science. These days I focus on that less because I've seen so few examples where that has proven to be the decisive element for the investors' outcome, particularly in an early-stage investment. Let's be frank about it, investors are more likely to earn a return on an early-stage technology long before that technology is actually in the marketplace.
TLSR: What would be the single most important characteristic you would like to see in a medtech, device or drug company?
SS: The best companies are the ones where everybody gets something out of it. The patient gets the benefit, the physicians get to add a revenue stream and feel better about their clinical practices and, importantly, the payer saves money. ImpediMed Ltd. (IPD:ASX; IPDQF:OTCMKTS) is a great example of that kind of company.
ImpediMed has a system that detects subclinical lymphedema, which is a swelling in a limb that is a consequence of cancer surgery or radiotherapy, or both. Those therapeutic modalities cause a lot of damage to the lymphatic system, and lymphedema occurs in a surprisingly large number of people. If you don't diagnose and treat lymphedema correctly, and early stage, it may develop into an irreversible condition, and there's terrible morbidity associated with that.
ImpediMed has this wonderful bioimpedance technology that picks up changes in extracellular fluid in the tissues maybe three to six months before it is clinically observable. The idea is that if you can pick the condition up well before you see visible swelling, and before the patient is experiencing symptoms, you can treat the problem preemptively. These patients can be treated quite successfully.
TLSR: What about reimbursement? Is that in place?
SS: Just last year, ImpediMed got its CPT1 code from the American Medical Association. It got nice pricing for tests from the Centers for Medicare & Medicaid Services (CMS). Its reimbursement code became active in January. So we're excited to see the first quarter of sales, driven by a new reimbursement status. It's really an exciting time for this company. ImpediMed is probably my favorite device company.
TLSR: This bioimpedance technology is being marketed as the L-Dex system. It's used in the oncologist's or surgeon's practice when the patient presents for follow-up, correct?
SS: Yes, that's right. Originally, this story developed around breast cancer in women, although subsequently it's been extended for use in the lower extremities of women and men for other indications. In the breast cancer patient, the idea is to get a baseline measurement of the lymph fluid in the patient's arm, because that's where you get swelling after the lymph vessels and nodes are dissected out or irradiated. If the lymphedema advances past a certain point, often what happens is that the swollen limb can't get free of the accumulated fluid. It's a self-perpetuating problem, in that proteins and other elements start to precipitate out and get into the tissues, and then you get fibrosis and cystitis and infections. It never goes back to normal.
"Investors are likely to earn a return on an early-stage technology long before that technology is in the marketplace."
Patients are monitored, perhaps quarterly, for the first couple of years, and then maybe twice annually after that. Patients probably end up getting 14–15 L-Dex tests. Once a patient is five years post-surgery, he or she is out of the high-risk category and can probably just move on, and not worry so much about monitoring for lymphedema. This program is designed to be embedded into the clinical practice of postoperative follow-up.
TLSR: ImpediMed's market cap is up dramatically over the last six months, and now it's at about AU$225M (US$180M) in market valuation. In Australian dollars, it's up more than 85% since the beginning of October. Do you see a lot more upside here?
SS: Yes, I see a lot more upside. If you look at the revenue opportunity that's ultimately available to ImpediMed, you are talking in the hundreds of millions of dollars. Its business model is one we know and love, where most of the revenue comes from consumables, which in this case includes the single-use electrodes used in the test.
I think the incidence of breast cancer in America alone is about 250,000 patients per year. Based on that, there is a lot of pure gross profit that's available in ImpediMed's consumables business model, and a lot of latent interest to be tapped. The idea of being on top of lymphedema risk in this incident population, and given its recent pricing advantage, there is a lot of upside in this company.
TLSR: Shane, the company has announced the launch of a couple of pilot programs in some large U.S. physician practice management groups. These offices are treating thousands of patients a year. Are the clinicians in these practices intended to be key opinion leaders (KOLs)? Are they going to go out to talk about the L-Dex system?
SS: The pilot programs are in place to learn about the value proposition. As for KOLs, I think physician input will be valuable. With CMS reimbursement available, the pilot programs are more about understanding utilization, understanding the right way to incorporate the system into clinical practice, and homing in on the right sequence of L-Dex tests that physicians should order.
TLSR: Could we move ahead and talk about another name you like?
SS: I'd like to touch on SomnoMed Ltd. (SOM:ASX), a really interesting company. Although it's small, with only an AU$129M market cap, it is the first group with a global capability to sell an oral appliance treatment for sleep apnea. This market has largely been dominated by continuous positive air pressure (CPAP), and by companies like ResMed and Respironics Inc. (a Philips Healthcare/Koninklijke Philips N.V. [PHG:NYSE] company). But a lot of apnea patients are intolerant of CPAP. Many patients, when offered CPAP therapy, either don't want to adopt it or, having tried it, find that they can't continue the therapy. They just can't get used to sleeping with a mask with air flowing into their airways.
TLSR: What is different about SomnoMed's oral appliance solution?
SS: It's called the SomnoDent. It's a little bit like the mouth guard you might wear playing football or to prevent bruxism (teeth grinding), but it's more sophisticated. SomnoMed's device brings the mandible forward a couple of millimeters, which opens the airway and alleviates the apnea.
"Everything I read about the American healthcare system tells me it is headed toward multidisciplinary settings, accountable care organizations, people coming together to treat patients in a most cost-effective way."
This has been a cottage industry for many years. The device is something that a dental technician, in conjunction with a dentist, will fit for a patient. SomnoMed recognized the opportunity and understood that there was a significant untreated market for people failing on CPAP. Those apnea patients have no other option until the apnea gets so severe that they must have surgery or they have a heart attack. We are starting to see some nice success with SomnoDent in America now, which has been the hardest market to crack because the market channels are very complicated there.
TLSR: I'm sure it's complicated, because CMS does not like the idea of paying dentists to perform services. It does not want alternative healthcare providers to drain the budget from Medicare and Medicaid patients.
SS: That's right. So it's been difficult. The other difficult structural element in the U.S. market is the fact that this is, ultimately, a multidisciplinary therapy, in that you need a dentist to help with the fitting of the device, and you also need a sleep physician to coordinate referral and take ownership of the patient. As short as five years ago, dentists and physicians didn't have many opportunities to talk to one another, and really they still don't.
SomnoMed is doing pilot programs with HMOs in America, and these programs are embracing a more multidisciplinary approach to the treatment of sleep apnea, with dentists and sleep physicians coming together to offer the SomnoDent as opposed to the traditional CPAP route. In some cases this is being offered as a first-line therapy for sleep apnea. These pilot programs began in mid-2014, and now we are seeing a model take shape. It's becoming quite interesting—even encouraging—to monitor.
The growth volume in the American market is now stable, in the 20–30% range per year. That is being driven largely through reorganization of the market channel. It's hard to get a sense of this from Australia, but everything I read about the American healthcare system tells me it is headed toward multidisciplinary settings, accountable care organizations, people coming together to treat patients in a most cost-effective way. I think that trend is here to stay.
TLSR: Are you talking about the American healthcare system going to an outcome-based system?
SS: Absolutely. Just taking the case of sleep apnea alone, outcomes for poorly treated or untreated patients are terrible, and those outcomes might be easily and cheaply avoided with a device that costs $300–500 per unit, depending on which version you get.
TLSR: Shane, you also follow drug development. I know you have a drug development company to talk about today. Tell me about it.
SS: Sirtex Medical Ltd. (SRX:ASX) has a product that has been on the American market for more than a decade. It sells a selective internal radiation therapy (SIRT) product called SIR-Spheres, which is similar to the brachytherapy that some men receive for prostate cancer treatment. Microspheres of resin are impregnated with an isotope, yttrium-90, and the indication is metastatic colorectal cancer. The metastases are in the liver, and so the company is also going for primary hepatocellular carcinoma (HCC).
The therapy has been used in a salvage setting, in the sense that folks who have been diagnosed with metastatic colorectal cancer have gone through first-line chemotherapy, and perhaps treatment with some biological agents. SIR-Spheres has been a "third- or beyond-line" therapy, and has been an extraordinarily successful application. It has made great inroads penetrating the market, and it's been seen as pretty safe and effective in this clinical setting.
TLSR: Why do you think the company's first Phase 3 trial, SIRFLOX, did not meet its primary endpoint?
SS: Sirtex was going for progression-free survival. It did the trial very bravely, on an all-comers basis. If you look at the 530-odd patients enrolled, I think 40% of them had extrahepatic metastasis. Whether in the lung or lymph nodes or wherever, the metastes were also outside the liver. Keep in mind that this is a liver-directed therapy, administered almost directly into the tumor in the liver. The microparticle resins get trapped inside the tumor vasculature and effectively irradiate the tumor from inside out. The therapy did achieve progression-free survival in the liver cancer patients, so it worked in the manner it was intended. I'm looking forward to seeing the full data at the American Society for Clinical Oncology (ASCO) meeting this year, but I think the inclusion of those folks with extrahepatic tumors may have complicated the picture.
TLSR: The FDA won't allow a retrospective analysis for a subpopulation of patients—in this case to eliminate the extrahepatic liver cancer patients, will it? Will the company have to design another trial to eliminate those extrahepatic patients?
SS: The FDA won't allow a retrospective study, so yes, more trials are planned. The Phase 3 that failed the primary endpoint was the first of three trials designed to be prospectively combined to measure the more significant endpoint of overall survival. The first Phase 3 failed on the primary endpoint of progression-free survival, but the data on overall survival are still ongoing. Ultimately, we have another two trials reading into overall survival in 2017, and so all hope is not lost.
TLSR: You have a target price of AU$50/share on Sirtex. The last price I saw was more than AU$25/share. I'm thinking this has to be very speculative, doesn't it?
SS: Sirtex's current market price discounts any chance that SIR-Spheres will progress into first-line therapy, either in metastatic colorectal cancer or in primary liver cancer, not metastatic liver cancer. That has another set of safety and efficacy trials, from which we won't learn the data until the end of 2016. The current market price in the AU$20s is absolutely wiping out all of that upside, and only valuing the salvage business. I think it's too early to write Sirtex off.
TLSR: It's been a pleasure, Shane. Thank you.