By Jason Napodano, CFA
We are initiating coverage of Avita Medical (AVMXY) with a Buy rating and $4.00 price target (download report). We are big fans of the company’s ReCell® Spay-On Skin™ system. ReCell is an autologous cell harvesting, processing and delivery technology that enables surgeons and clinicians to treat complicated skin defects, including chronic wounds, scars, burns, depigmentation, and aid in rejuvenation or reconstruction procedures that uses a patient’s own skin cells to facilitate the regenerative process. Clinical experience generated by the company shows the system can be successfully used to promote healing and the formation of new skin structure after a severe injury, such as a burn or scald. Data also shows that ReCell can improve the appearance of acne scars, remove areas of discoloration and restore pigmentation in patients with vitiligo, and aid in the healing of chronic wounds such as venous leg ulcers and diabetic foot ulcers.
We like the system because it is simple, fast, safe, and effective. It’s the ideal product, in our view, to treat major burns or scalds in children because the biopsy area is so small in comparison to split thickness meshed skin grafting (STSG), the current standard or care. A 1 cm2 biopsy with ReCell can treat a severe burn at up to 80 cm2, with wound re-epithelialization rates similar to the gold standard STSG. This is an enormous leap forward in our view considering covering a severe burn or scald at 80 cm2 with a STSG might require the biopsy area to be as large as 50 cm2. Plus, the ReCell procedure is less painful and offers superior pigmentation and patient satisfaction on follow-up. Avita is currently conducting a U.S.-based phase 3 / PMA trial with ReCell in acute burns and scalds, with data expected in 2014.
The chronic wound market remains the Holy Grail for Avita Medical. The market is large and growing rapidly as a result of the growing elderly and diabetic populations in the develop world. The market is dominated by negative pressure wound treatment, but things like advanced dressings and skin substitutes are coming on strong. Products like Shire’s Dermagraft and Organogenesis’ Apligraf have sales exceeding $150 million worldwide. We think ReCell compares well with these products on a cost and effectiveness standpoint. The company is currently conducting a phase 2 / IND feasibility study in this area for the U.S. market.
In Europe, ReCell has been granted CE Mark for the “Intended to be used to disaggregate cells from a patient’s split-thickness skin biopsy and to collect these cells for reintroduction to the patient. The cells can be used for autologous application to the prepared wound bed as determined by the physician.” The company is currently conducting several post-market studies to help drive reimbursement in specific indications such as burns and scalds, vitiligo, scars, and aesthetics / reconstruction. We note that Avita is also investing in product development, with a next-generation product in planning. This will allow for improved economics, including a razor / razor blade model, and potential increased uptake from the market.
In the U.S., there are an estimated 250,000 emergency room visits each year for severe burns (source:National Fire Protection Association). Children under the age of five are 5-times more likely to have a severe burn than the general population. The majority of these burns are from non-firm contact burns or scalds. In roughly 20% of these cases, the patient will require admittance to the hospital for treatment. Standard of care, as noted above, is split-thickness meshed skin grafting. Avita's pivotal phase 3 trial noted above is designed to show non-inferiority to the standard of care, with secondary measures assessing potential superiority on measures of epithelialization, wound closure rates, pain, and appearance. In looking at the feasibility data and case study results, we are optimistic on the outcome of this pivotal trial.
Based on the simplicity of use, and the assumption that ReCell will achieve non-inferiority to split thickness meshed skin grafting on wound healing at the recipient site and superiority at the donor site, we believe the product can easily take 25% market share, with upside to as high as 40% market share based on the outcome of several key secondary endpoints, including pain, appearance, and patient satisfaction. Assuming an average cost per use at around $1,000 per treatment, we see ReCell as a potential $62.5 to $100 million opportunity in the U.S in burns and scalds alone. The opportunity in the rest of the developed world in burns and scalds easily eclipses another $100 million in our view.
Besides burns and scalds, we believe ReCell has meaningful potential to capture market share in acne scarring (25+ million Americans), vitiligo (~200,000 Americans), and aesthetic and/or reconstructive procedures (~1 million Americans). On a global basis, we see ReCell, conservatively, as a potential $250 million product. Approval for use in chronic wounds has the potential to double that peak sales number to $500+ million on a global basis.
Avita has a direct sales model in parts of Europe (two sales reps in the UK, one in France and one in Germany). In these countries, the company is working closely with a select group of influential surgeons and centers willing and able to serve as training and reference sites, conduct clinical and economic studies, present results in publications, congresses, case reports and white papers and support application of ReCell for reimbursement in each country. Reimbursement is the key to driving sales of the system in our view, so we are pleased to see the company tackling this issue head-on by partnering with key opinion leaders and fostering open communication on the device.
In other areas outside of Europe, such as China and Turkey, the company is partnering with distributors. The company currently has one major relationship in each country. These distributors provide a lower-cost alternative to direct channels, but at the cost of decreased margin, lack of control over performance, multiple non-aligned product sales and no direct customer contact. Distributors also require significant training and supervision, particularly for a disruptive product like ReCell. Still though, the opportunity to enter a market like China is too big to pass up for Avtia. The company signed up a Chinese distributor in June 2012 that has completed 125 procedures to date. We expect Avita to seek additional distributor relationships and joint ventures around the world in the next several quarters. Key to these relationships will be watching for initial stocking orders and tracking the performance and sales milestones.
…Listing and Liquidity Are Our Biggest Concerns…
For a small biotech company with a market capitalization of only $32.5 million, Avita Medical is surprisingly well capitalized. The company held $12.3 million in cash as of March 31, 2013, and reported nearly $15 million in positive working capital and $14.5 million in positive shareholder equity. We see the current cash position as sufficient to fund operations for the next three to four quarters.
The stock trades on both the Australian Securities Exchange (ASX) under the ticker symbol AVH and the OTCQX market under the ticker symbol AVMXY. The company reports financials according to International Financial Reporting Standards (IFRS). Full financial results are posted only twice a year (vs. quarterly for all U.S. NASDAQ & NYSE listed names). Some investors, including the bulk of institutional buyers, have an aversion to buying foreign-listed companies that trade on the U.S. OTC market, even if listed on the highest tier OTCQX. The average 3 month trading volume on the AVMXY listed stock is only 8,500 shares. U.S. institutional ownership is listed as N/A. We suspect it is below 10% of the total float. We believe, given the OTC listing, IFRS reporting, and extremely low trading volume that it is difficult for a large institution to establish a core position in Avita Medical.
In this regard, we would like to see the company make an effort to move its listing to a major exchange in the U.S. The balance sheet and stock price qualifies the company for the NASDAQ-CM. This move would do wonders for the perception and credibility of the company, and in turn drive increased liquidity and institutional ownership. In the meantime, U.S. retail investors, amenable to the OTC listing and favorable on the story – as we are – have the advantage of being able to scoop up AVMXY shares on the cheap before the big institutions either take notice or are able to buy in. We have seen this scenario before (see: Organovo, Inc., InVivo Therapeutics, or Canadian-based Cipher Pharmaceuticals). It’s a very attractive opportunity for retail investors, assuming the company delivers on both the data and the listing.
The market capitalization at only $32.5 million is far too low and highly attractive for long-term investment in our view. Based on the projected sales opportunity of the ReCell device in potential indications such as burns and scalds, vitiligo, scars, and chronic wounds, we see the shares at meaningfully under-valued. We have built a discounted cash flow model to value the shares and arrive at a market capitalization of approximately $70 million. This equates to a target price of $4.00 per share. We believe the shares are set for a major re-valuation on the pending phase 3 / PMA data from the burns and scalds trial currently being conducted in the U.S., with data expected around the middle of 2014.
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