Angiotech is so undeservingly and severely beaten down that it is bound to at least double its market capitalization in the next 3-5 years, providing annual returns in the neighborhood of 25%. We will try to explain how and why we believe that will happen in the next few paragraphs.
In the company’s own words, Vancouver-based Angiotech is “a global specialty pharmaceutical and medical device company that discovers, develops, and markets innovative technologies and medical products primarily for local diseases or for complications associated with medical device implants, surgical interventions and acute injury.” In other words, Angiotech takes usual medical devices such as needles and catheters, and utilizes its expertise in specialty pharmaceuticals to improve the therapeutical value of such devices by combining them with drugs that enhance their effectiveness.
Angiotech was originally a pure play on Boston Scientific’s paclitaxel-eluting Taxus coronary stent, on which it receives a net royalty of about 6% from licensing its coating technology. As a first step toward revenue diversification, in March of 2006, Angiotech paid $785 million to buy American Medical Instruments (AMI), which brought into the company over 5,000 specific products in its inventory of medical devices, including various biopsy devices, guidewires, hemostasis pads, specialty surgical knives, sutures, and microsutures, allowing ANPI to make and market its own specialty medical devices. Angiotech has identified more than 40 AMI devices that it wishes to combine with existing Angiotech drug technologies in the near future.
An interesting example of this combination is the 5-Fluorocacil coated anti-infective Central Venous Catheter (5-FU CVC). Central venous catheters are usually inserted into critically ill patients for extended periods of time to administer fluids, drugs, and nutrition, as well as facilitate frequent blood draws. One of the complications associated with CVC implantation is infection, which can occur when bacteria contaminate the catheter. Having shown in clinical trials that 5-FU on a CVC effectively interrupts the colonization by bacteria, the company filed in December 2007 an application with the U.S. Food and Drug Administration (FDA) to start marketing the 5-FU CVC in 2008.
THE BAD NEWS
As with almost any company that finds its shares in undervalued condition, Angiotech is not without trouble. At the risk of being left without readers, let us get the bad news out of the way first, so that those who can not manage to get around the company’s troubles will not spend their precious time to read the rest of the thesis.
- Debt Load: Strong execution in 2008-09 is central to ensuring Angiotech’s financial viability. The debt load incurred with the AMI acquisition and the approximately $50 million in annual interest payments put significant pressure on the company to deliver results. Nevertheless, the company still has $131 million in cash and investments on its balance sheet, and its financial flexibility is strong ($50 to $60 in annual spending, mainly R&D, could be cut off quickly) with no onerous debt covenants.
- Increased Competition for Taxus: New drug-eluting stents from Abbott and Medtronic are set to enter the U.S. market in 2008 and take share from incumbents J&J and Boston Scientific. We expect royalties from Taxus to decline and take that into consideration in our model (see valuation below), however, if the competitive scenario becomes overly aggressive and/or the DES market continues to shrink at the rate seen in 2007 (which we believe is unlikely), Angiotech will be even more pressured to quickly generate new revenue streams to offset declining royalties.
In order to assess the value of Angiotech’s business in the most adequate way possible, we have chosen to divide the company’s business in three distinct segments and subsequently sum the value of these three parts to arrive at an estimate of intrinsic value for the business as a whole.
1) Drug-eluting Stent (DES) Royalties
Since the release of medical studies that called into question the superiority of DES over bare-metal stents in the end of 2006, there has been an extreme amount of negative sentiment towards DES and coronary stents in general. This negativity has translated into sharply lower sales and, consequently, a 30% lower revenue stream for Angiotech in the first nine months of 2007 ($89.5 million) than in the comparable period of the previous year ($127.8 million).
While the market responded as if that was the end of the story for Angiotech by sending its stock down by more than 50%, there is still a large body of data that supports the efficacy of the Taxus DES and evidence on coronary stents is still inconclusive and conflicting. People may use the Taxus stent less in the future, but research indicates that the product is completely viable and will be in the market for a long time. Despite recent data showing that the market for DES has increasingly shown signs of stabilization, in order to conservatively account for the conflicting set of facts and for a more crowded DES market (with the entrance of competitors Medtronic and Abbott), we have chosen to model an annual decline of approximately 20% in Angiotech’s royalty revenue stream for the next three years and discount these figures at a 10% rate to reach a present value of approximately $250 million for this segment of the company’s business.
2) Existing AMI Products
This segment of the business accounts for the value generated by the more than 5,000 specific medical-device products acquired by Angiotech when it purchased AMI. It is important to note that these products primarily serve niche markets with high barriers to entry and low incentive for new competitors to enter, thus revenues are recurring in nature and quite predictable. Additionally, the company has been restructuring these operations by discontinuing non-strategic products and streamlining the manufacturing process.
Based on Angiotech’s initiatives to rationalize the existing AMI business, we have modeled 8% annual revenue growth from the approximately $171 million expected in 2007 ($127 million in the first nine months) to reach revenues of approximately $185 million in 2008. Currently, comparable industry valuation multiples (from a universe of 19 companies) average 12.2 times 2008 EBITDA and 3.7 times 2008 Sales. It is important to note that these are products that, even without the added value of a drug coating, carry high gross profit margins on the neighborhood of 45-50%. By applying a reasonable multiple of 3.2 times to 2008 revenues, we arrive at approximately $600 million of intrinsic value for this segment of the company’s business.
3) New Products / Pipeline
Valuing a pipeline of medical products, be they medical devices or drugs, is always a difficult task that may easily lead an investor to incur in significant misjudgment towards the impact of this business segment to the intrinsic value of the business as a whole. In Angiotech’s case, the market has facilitated our mission by completely wiping out the value of the company’s upcoming products from the company’s current stock price.
It is our opinion that, at current prices, investors are receiving a free option on Angiotech’s pipeline. Mr. Market doesn’t want to wait any longer for the new products to start generating profits, yet we believe that the payoff makes the wait significantly worthwhile. The three leading candidates in the pipeline (Quill SRS, Vascular Wrap, and 5-FU CVC) are products that have proven themselves in clinical trials and have true therapeutical value. Through our probability-weighed model, we believe that the company’s lineup of more than fifteen new products to be launched in the next five years may be worth from a minimum of $350 million to multiples of the current market cap.
(+) DES Royalties $250 million
(+) Existing AMI Products $600 million
(+) New Products / Pipeline $350 million
Total Value $1,200 million
(-) Net Debt ($444 million)
Intrinsic Value $756 million
Shares Outstanding 85 million
Intrinsic Value per share approximately $9 per share
PRICE VS. VALUE– The Second Half of 2007 for Angiotech
We have chosen the six final months of 2007, a period marked by deepening woes in the global credit markets and, consequently, strong fear in stock market participants, in order to illustrate the central point of our idea with the behavior of Angiotech’s stock price in comparison with our estimate of the company’s intrinsic value. Below, you will find entries from our notes that form a timeline which will help understand the facts that have driven changes in both our estimate of intrinsic value and the company’s market price.
July 2007: Angiotech Completes Enrollment in CVC Study – Angiotech announced the completion of enrollment in its CVC Pivotal Study. The company expects to have preliminary data results compiled in the fall, and present the final data results in early 2008 at a major scientific symposium. Pending trial results and all necessary approvals, Angiotech will prepare to launch the commercial product line in 2008.
Market Price: $6.90 Intrinsic Value: $12.00 Expected Return: 73.9%
Our Take: We understand this as positive news for the investment. It goes in favor of the investment thesis and, although not material enough to change our estimate of intrinsic value, it does increase the probability of approval in one of the key products in the company’s pipeline.
August 2007: Angiotech Reports Second Quarter Results – Angiotech reported good quarterly results and provided interesting insight into the company's long term goals. The company aims to improve its productivity from current annualized revenue per employee of $177,000 to $500,000, and has established a series of margin targets which should dramatically boost profitability. The company has been making steady progress in the development and launch of its new products, and expects to see a modest revenue contribution from Quill and Vascular Wrap already in 2007.
Market Price: $7.19 Intrinsic Value: $12.00 Expected Return: 66.9%
Our Take: This is positive news for the investment. Although in favor of the thesis, the results reflect the estimates in our model and do not change our estimate of intrinsic value.
September 2007: Angiotech Settles Patent Dispute with Johnson & Johnson – Angiotech reached a settlement with Johnson & Johnson subsidiary Conor Medsystems over that company's CoStar drug-eluting stent. The company said it was involved in lawsuits with the company in the U.K., the Netherlands and Australia. The dispute centered on Angiotech's patents for the cancer drug paclitaxel to coat stents.
Market Price: $6.36 Intrinsic Value: $12.00 Expected Return: 88.7%
Our Take: This is slightly positive news for the investment thesis as it removes a litigation risk that hung over the company. There is no change to our estimate of intrinsic value.
October 2007: Angiotech Meets Goal in CVC Study – A pivotal study of Angiotech's 5-Fluorouracil-coated Central Venous Catheter met its primary goal for effectiveness, according to the company. The primary endpoint involved comparing the 5-FU CVC to another anti-infective catheter to evaluate the prevention of bacteria growth. Angiotech said it plans to file a pre market request with federal regulators in the fourth quarter of 2007 based on the positive trial data.
Market Price: $6.67 Intrinsic Value: $12.00 Expected Return: 79.9%
Our Take: This piece of news confirms a previously expected outcome and lends credence to the company’s business plan, although no change is made to our estimate of intrinsic value.
October / November 2007: Angiotech Announces Preliminary / Actual Third Quarter Results – 3Q2007 Revenues of $68 million came 11% below our estimate of $76.5 million. Royalty revenue was in-line with what we estimated ($26.6 million). Existing product revenue came in 9% below our estimate of $45.5 million. Worse, the company also guided 4Q2007 existing product revenue 11% below our estimate of $48.5 million and full year revenue 11.7% below our estimate. While original management expectations were that new products would generate between $10 and $30 million in revenues in 2007, the company now does not expect any of these revenues. Our estimate for 2007 new product revenue was $14.5 million. The revenue shortfall generated disappointing adjusted EBITDA of $7.2 million and adjusted net loss of $3.1 million.
Market Price: $4.53 Intrinsic Value: $9.00 Expected Return: 98.7%
Our Take: Quarterly results were obviously frustrating. In face of the stomach churning 30% intraday drop in the stock price, we proceeded to analyze what impact these new facts had in our estimate of the company’s intrinsic value. The company’s explanation for the poor performance among revenue from existing products was, in sum, that they had to cut some product lines that were showing no or limited profitability, and suffered with the timing of shipment and production of surgical needles due their decision to close a facility in Syracuse, NY. The reasons given by the company for the revenue shortfall among new products were the longer regulatory review times in the EU for the Vascular Wrap, pushing launch from 3Q2007 to 1H2008, and for Quill the originally forecasted initial “time to first order” was 3 to 6 months, which has proven too optimistic and is now at 9 to 12 months.
There are several nuances to the analysis of Angiotech’s third quarter results (which we will be glad to discuss with interested parties), but the overarching element of the analysis is that the main issues generating the operational shortfall were of temporary nature rather than a matter of permanent impairment in the value of the business. Of course time has a direct impact in the present value of the business, so when accounting for the new timing for the development of the investment thesis we reduced our estimate of Angiotech’s intrinsic value from $12 to $9 Dollars per share. Nevertheless, in face of the haircut imposed by Mr. Market to the company’s stock price, the expected return on the investment still made it an attractive risk-reward proposition.
December 2007: S&P Removes Angiotech from Toronto Stock Exchange (TSX) Composite Index / Angiotech Submits Application to FDA for its 5-FU CVC – Standard and Poor’s announced that, as a result of the quarterly S&P/TSX Index Review, Angiotech, among other companies, was deleted from the index. In other news, Angiotech announced that it has submitted a 510(k) application to the U.S. FDA for its innovative, anti-infective 5-FU CVC. Pending the receipt of all necessary regulatory approvals, Angiotech anticipates launching the commercial 5-FU CVC product line in 2008.
Market Price: $3.23 Intrinsic Value: $9.00 Expected Return: 178.6%
Our Take: This piece of news only served to put further downward pressure on Angiotech’s stock price, strengthened by a good amount of tax loss selling. As a result of the exacerbated drop in price, the risk-reward equation has turned drastically more favorable for those who appreciate the value of the underlying business. The piece of news on 5-FU CVC simply confirms a previously announced event and helps advance the company’s business plan. No change is made to our estimate of intrinsic value.
Indeed, the impression that one gets from the events above is that the market has all but forgotten Angiotech. The next quarterly results (to be released on February, 19) might not yet show much progress in the final quarter of 2007, yet we are sufficiently confident that the company's progress in 2008 will bring it back to investor's radars.
1) Quarterly results show any revenues from new products and/or improved AMI results. 2) Regulatory approvals for Vascular Wrap and 5-FU CVC (1H2008). 3) Increased visibility of the company’s pipeline. 4) Return to profitability. 5) Eventual Taxus surprise.
|Entry||06/24/2008 02:55 PM|
|We have recently started looking at ANPI and I wondered if you still were involved and if you still saw the same upside.|
|Subject||RE: Still involved?|
|Entry||06/25/2008 05:15 PM|
|Yes, we are still very much involved and believe that the company has been achieving important operational landmarks with Quill, the 5-FU line, and the streamlining of the AMI business. Nevertheless, the suspension of the Vascular Wrap program was a setback and should delay this important pipeline item. All in all, we see an even better risk/reward proposition today than 6 months ago.|