Let’s face it, we all love a mystery box.
You’ve probably noticed by now that I am a bit of a pop culture junkie and sometimes when I am looking at ASX-listed med/biotech companies, it feels to me a bit like a MasterChef Mystery Box Challenge. You suspect there is something tasty in there – and eventually when it all gets cooked it will turn out alright – but your initial reaction is holy crap. Of course, we are instinctively attracted to the allure and risk of the “mystery box”, which is what makes the whole concept so much fun. When I was a kid you couldn’t keep me away from a lucky dip at the Royal Show.
I should note that I am still a kid, just with a penchant for vintage whiskey and power tools (sometimes even at the same time).
I’ve wanted to write a piece about Admedus (ASX : AHZ) for a while now but there are so many components to this company that it takes a lot of fossicking around to try and understand the pieces. Then when one has “fossicked”, it’s necessary to take a step back and ponder whether the resulting understanding of the landscape looks cohesive, or whether it looks more like a dogs breakfast. Notwithstanding that Australian analyst reports are mostly bullshit designed to drum up business for brokerage firms, I think part of the reason why AHZ has a lot of confused punters and generally convoluted analyst coverage is precisely because it is tough to grasp and has a lot (too many?) moving parts.
It certainly challenged me.
As I understand the business, there are three segments. The first part is a fairly boring medical device portfolio that consists of a mixture of small devices and consumables. This part of the business doesn’t really warrant a whole lot of analysis – it either sells or it doesn’t. I actually don’t mind health service and distribution businesses provided that they have some sort of a differentiated strategy and can show growth without sacrificing profitability to just being “price competitive”. In the case of AHZ, the scale of this business segment isn’t enough – at least at this stage – to either get wildly excited or overly critical.
The second part of the business – the tissue engineering part – doesn’t leap out with controversy either. If anything it is a bit humdrum. Objectively, the “ADAPT” technology (process) has almost no discernible scientific oomph and sounds more like the love child of a research project and a creative branding exercise than anything else. All of the publications I have been able to find focus on the performance and applications for the technology, and tend to be quasi-marketing pieces in low-impact journals, rather than providing meaningful detail on the actual science and why it produces superior products, though I do understand (and respect) that sometimes for process technologies putting less information into the public domain is commercially necessary. As best as I can tell it is glycerol-based tissue processing of collagen scaffold in order to reduce intracellular crystallisation.
Yawn … but ok (incidentally, if someone wants to post a detailed scientific explanation of ADAPT, I would be most grateful).
Regarding the CardioCel product itself, there is nothing wrong with the idea. There is a market for it, and a need. I think it is also fair to say that there are a lot of competing products out there and a general recognition that we need more than just a quality collagen ‘patch’. Whether an ADAPT-modified TEP really delivers on this or not, is not possible to ascertain from what I have been able to read. What I do know is that there is a huge amount of effort being spent on smarter ways to build tissue matrix / scaffolds (in my reading, one of the best reviews I found was a recent MIT Ph.D thesis if you have a bottle of something that needs to be killed one evening).
Is CardioCel cutting edge? No. Can it sell? Probably. More on that in a minute.
So the first two parts of AHZ’s business neither offend me or turn me on. If the company has a solid commercial strategy and the products are competitive – at least within a certain pricing tier – there is no reason why it can’t be successful. However the third pillar of the business – the vaccine business – doesn’t resonate with me at all. Although there is no doubt that a HSV-2 vaccine would be a great product with mega potential, Prof. Frazer’s technology platform probably isn’t going to deliver it. The clinical experience with Garadsil has been generally positive and we should all take our hats off to Prof. Frazer’s accomplishments. However HSV has a completely different set of immunology challenges than HPV, ranging from the way the virus maintains its dormancy, to antibody recognition, to achieving durable immunity through enhancing certain specific T-cell responses. Even the scant (although one very nice) publication around the HSV work demonstrates that the strategy isn’t a slam-dunk and notwithstanding the nice data, the published pre-clinical study didn’t have an effective control to benchmark efficacy.
If AHZ’s HSV and HPV (“second generation”) vaccines are based on the Frazer ubiquitin-conjugated DNA vaccine concept, then there is no reason to doubt that these therapeutics will be safe and well tolerated. This is the intrinsic advantage of this platform technology (and so, incidentally, press releases that shout “safety” from the rooftop are probably a bit overstated and unnecessary). I’m not really going to comment on the potential HPV product because there isn’t yet enough information and it is just too early to say if there is something there. Not withstanding critique to the contrary, I prefer to make a more fact-based analysis rather than make too many inferences.
However for the HSV-2 product, there are basically two red flags for me. Firstly, given all the experience with Prof. Frazer’s platform technology, if there was an opportunity in HSV you would have thought we’d already see commercial momentum given the size of the market opportunity. Considering that Prof Frazer’s enforcement of his IP rights were essentially retrospective, pharma has been working on this concept for a long time. Secondly, a vaccine that confers immunity for HSV-2 is probably insufficient unless it also treats HSV-1. For example, some recent developments around ADCC-mediated immunomodulation for HSV that can handle both strains looks very promising, especially since antibody-directed strategies for gD glycoprotein targeting have not traditionally worked. Therefore the product that AHZ is developing probably doesn’t cut it, a least in terms of a product “vision” for HSV.
For me, the issue with AHZ is sort of fundamental and basically commercial rather than scientific. At a superficial level, it irritates me that company doesn’t clearly report its revenues attributable to the different product segments and so we don’t know whether their 2014 revenues come from catheters or engineered pig* patches. I did note the forecasted revenues in the most recent Edison report, but it would be nice to start seeing a more regular breakdown by product segment so we can understand how and where AHZ’s portfolio strategy is delivering value. At this time, it looks like about 1/3 of AHZ’s near-term revenue is attributable to CardioCel and the rest to its generic device/consumable products. This is really important to understand because if most of the valuation equation comes down to generic products, then this company is hugely overvalued at its current $120m-odd market cap.
I don’t mind the tissue engineering business because I see it as just a higher-value extension of the device/consumable business, and as a product portfolio strategy it is fine. I don’t really buy the “proprietary” or “performance” aspects of ADAPT/CardioCel – it looks like a nicely prepared collagen scaffold and that’s about it. But if it is a solid product with an articulated differentiation, quality manufacturing and good marketing (and price point!), it can be highly successful. By all accounts, clinicians like using it, the company has successfully pursued marketing clearance in a bunch of meaningful territories and if the growth forecast for CardioCel is even half-accurate, then it will be a nice little earner. A company doing $50-60m in sales from a product like this (which has good margins, I am sure) would enjoy a valuation contribution from that product of at least $300-400m. AHZ is not there yet, and initial sales are a bit sluggish but time will tell.
Of course none of the analyst reports on AHZ talk about competition, but let’s leave that one on a high note.
The dog for me is the vaccine business. I don’t like it. The products don’t jump out at me as being particularly innovative or leading-edge. The HSV-2 strategy is fundamentally flawed. The HPV strategy is too early and comes across as little more than a way to capture and direct a little Ian Frazer star-power. Gardasil has had plenty of controversy relative to Prof. Frazer’s public profile, but there is no doubt that his (deserved) reputation has huge marketing clout, and AHZ harnesses this on just about every web page and press release. Frankly, the way AHZ positions the “immunotherapy” business looks more like the exploitation of a personality cult than something grounded in science that has the potential to produce a market-leading product. I don’t want to be too petty or unkind about it, but it doesn’t turn me on.
However, what I really don’t like about the vaccine business isn’t the slightly squiffy marketing veneer, it is the resource utilisation relative to the other business segments. Here we have a potentially nice little company that is actually making some money (FY2015, maybe $10-12m?), has a few novel products that it is (arguably) successfully selling. It has a decent bit of cash on the balance sheet, it has the potential to bring in other products (particularly devices) either for late-stage development or as a regional manufacturer/distributor. But then the company turns around and takes all that value creation and cash flow, and sinks it into a product development activity that is extremely expensive, high-risk, probably undifferentiated and a poor fit with a medical device company.
If I were a shareholder, I would be asking “why?”
Personally, I would spin-out the vaccine business into a private company where the development doesn’t sit so strongly in the public domain, and where every little wart and blemish needs to get reported. I’d probably drop the HPV program and focus on HSV-2 (that is if you really think a HSV-2-only vaccine is a commercially competitive gameplan). By all means AHZ should remain a shareholder, perhaps even capitalise the company by taking the distribution rights (i.e. there is a bit of a financial engineering opportunity there), and possibly even have a preemption right to take it back. But let other capital – if AHZ can find it – share the risk of a product development exercise that doesn’t match the rest of the portfolio whatsoever. If Prof. Frazer really does bring scientific star-power to this program, then there will be no problem accomplishing this.
BUT if AHZ can’t cornerstone a round of financing for that separate company – i.e. bring in other investors to share the risk – then this is a meaningful signal that the asset(s) aren’t all that interesting. That being the case, I would then prefer to see AHZ focus on using its financial resources and accomplishments to date, to build a more evolved device/tissue portfolio where it could possibly be a strong niche player. Especially around AHZ’s investment in manufacturing (not having visited the AHZ site, I can’t attest how “state-of-the-art it really is, but it’s a sexy story).
To conclude this rather long-winded analysis, I would say that I see potential in AHZ. There are some interesting accomplishments there, and at least the company is generating some revenue that seem to have good margin. Cash is king and if the management team could focus on a device/tissue play (combined with the manufacturing capability) they could really build a nice business that would be worth investing in. I personally wouldn’t put a dime into this company until it distances itself from the vaccine activities because right now, all the company is doing is directing all that “good” value creation into something that is not only speculative, but underwhelming.
I would rather AHZ built value through revenues and product focus, than spruiking the hypothetical valuation contribution of a massive but unlikely opportunity.
*erratum: I note that the patches are bovine, not porcine.