June 27, 2018 - 11:45am EST by
2018 2019
Price: 3.98 EPS $-1.75 $1
Shares Out. (in M): 5 P/E n/a 4X
Market Cap (in $M): 21 P/FCF n/a 3X
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): -2 TEV/EBIT n/a n/a

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Given the growing market for capsule endoscopy and C-Scan’s unique ability to sustain its efficacy without bowel preparation, I believe the company could generate $60 million in sales and attain a $480 million market cap in 2020.  This would imply a share price of $54, more than 13X CHEK’s current price.  Utilizing the more aggressive price/sales multiple of its competitor, Exact Sciences Corporation (NASDAQ:EXAS), CHEK could trade to in excess of $200 per share by 2020 if it were to generate $60 million in sales.

I believe that Check-Cap is a compelling acquisition candidate for a host of companies, but Medtronic plc. (NYSE: MDT), a $117 billion company that acquired Covidien and its competing PillCam systems, may be particularly interested in acquiring Check-Cap to protect its leadership position in the capsule endoscopy market.  While PillCam is an effective solution for colon cancer screening, unlike C-Scan it requires bowel preparation, which is one of the primary deterrents for patients. 

Colon Cancer Market Overview:

Colon cancer is cancer of the large intestine, which is the final segment of the human digestive tract.  It is the second leading cause of cancer deaths in the United States and the third most common cause of cancer worldwide. The Journal of the National Cancer Institute characterized colon cancer as “the most preventable, yet least prevented form of cancer”.  Most cases of colon cancer begin as small, noncancerous clumps of cells called adenomatous polyps. Over time, these polyps can become colon cancers.  Polyps may be small and produce few, if any, symptoms.  As a result, doctors recommend regular screening tests to facilitate early detection of colon cancer by identifying and removing polyps before they turn into cancer.

The colon cancer screening market is $25 billion annually, involving 35 million patients a year.  Screening for colon cancer has been rising rapidly in the United States, yet a large portion of the population is still reticent to go for screening and unsatisfied with the currently available alternatives.  In 2000, about 40% of Americans who were in the appropriate age group for screenings underwent the tests. This figure has increased to approximately 65% today, resulting in a 30% decrease in the past decade in colon cancer’s mortality rate for people older than 50.  Despite this progress, however, about 42% of eligible adults are not up to date with their colon cancer screening according to the American Cancer Society.  Studies indicate that certain requirements of colon testing, such as laxative preparation, fasting requirements, pain and embarrassment are troubling for prospective patients.

There are several tests that detect colon cancer, but all of them have significant drawbacks.  Colonoscopies are the most common screening test for colon cancer and involve the insertion of a flexible tube, or colonoscope, into the rectum.  The tube is guided by a physician through the colon, and a camera at the end of the colonoscope enables visualization of polyps.  There are challenges associated with the perception of colonoscopies as being invasive and painful procedures. 

Colonoscopies also have a risk of major complications.  Patients are sedated and need to take a day off from their usual activities.  Some patients cannot tolerate colonoscopies, or they may be at higher risk for sedation.  Colonoscopies can be expensive and involve higher risk of bowel tears or infections compared with other tests.  For these reasons, colon cancer screening uptake is low, especially compared with the high attendance rates of other cancer screening programs (i.e. breast and prostate cancer).  

While observational studies suggest that colonoscopies can help reduce colon cancer incidence by about 40% and increase mortality by about 50%, the quality of colonoscopies is variable and influences these benefits.  Colonoscopies can miss some polyps, especially those that are flat, referred to as sessile adenomas, from which 20% to 30% of colon cancers are thought to originate.  Also, poor bowel preparation can result in failed colonoscopies that must be redone.  According to a French epidemiological survey, 5% of 1.12 million colonoscopies performed in 2008 had to be redone because they were incomplete.  In 40% of these cases, inadequate bowel cleansing was responsible for the failures.

Stool screening tests can also be effective in detecting colon cancer.  Such tests identify microscopic amounts of blood in the stool.  Fecal Immunochemical Tests (FIT) are a common screening choice in many areas of the world.  FIT’s use antibodies to detect blood in a patient's stool that cannot be seen with the naked eye.  Such tests involve the possibility of false positives, however, from hemorrhoids, anal fissures, or menstruation.  While the FIT is covered by most insurance companies and is a low-cost option, it needs to be repeated every year. 

An increasingly popular option is Multitarget Stool DNA (MT-sDNA) testing. The only commercial product in this category is Cologuard, which is FDA approved for screening of asymptomatic persons at average risk for colon cancer.  Cologuard is produced by Exact Sciences Corporation’s (NASDAQ:EXAS), which has a monopoly in this specific arena.  In a large multicenter study with almost 10,000 participants, Cologuard was compared with a FIT. The sensitivity for detecting colorectal cancer was 92.3% with DNA testing versus 73.8% with FIT. For pre-cancer, however, the results for both tests were disappointing, as the sensitivity for detecting advanced precancerous polyps was 42.4% with DNA testing and 23.8% with FIT.  

A novel screening procedure involves swallowing a video capsule, which allows for direct visualization of colon polyps.  A patient who undergoes conventional capsule endoscopy must do the same bowl-cleansing preparation as a patient undergoing a colonoscopy, but unlike a standard colonoscopy, the pill capsule system is painless and requires no anesthesia.  Patients do not have to take a day off work or arrange for someone to drive them to and from the test.

In 2001, Given Imaging Ltd. revolutionized gastrointestinal (GI) diagnostics with the launch of PillCam COLON (PillCam), a vitamin-sized capsule endoscope that is taken orally and directly visualizes the colon for the evaluation of polyps in patients who are at major risks for colonoscopy or moderate sedation.  In February 2014, Given Imaging was acquired by Covidien plc, which was subsequently acquired by Medtronic plc (NYSE: MDT).

The Pillcam device was initially cleared by the FDA for visualization of the colon and the detection of colon polyps in patients following an incomplete colonoscopy with adequate preparation where a complete evaluation of the colon was not technically possible.  In 2016, however, the FDA also cleared PillCam for an expanded indication in patients who are at major risk for colonoscopies or moderate sedation. 

A patient in need of diagnostics swallows the Pillcam, which safely travels through the patient's digestive tract and is naturally excreted.  The pill contains a power source, light source, and two tiny cameras.  It transmits up to 35 frames per second for approximately 10 hours to a recording device worn by the patient. A leading study published in the New England Journal of Medicine reported no serious adverse events among 320 subjects.  The study concluded that use of the device was “a safe method of visualizing the colonic mucosa through colon fluids without the need for sedation or insufflation”.  At around $500, the PillCam costs less than a colonoscopy, which can run $800 to $4,000 or more. 

Unfortunately, however, PillCam fails to address what is arguably the most significant impediment to colon cancer screening, the requirement for bowel preparation.  A clean colon is necessary to accurately explore the patient’s colonic mucosa, and PillCam does not have the ability to suck or wash the mucosa.  

In its November 2012 presentation, Given Imaging projected that its annual global market opportunity for PillCam COLON was $1.7 billion, comprised of 3.3 million procedures, as a complimentary solution to a colonoscopy.  A superior capsule endoscopy solution for colorectal cancer with expanded indications relative to PillCam, however, could potentially capture a much larger share of the $25 billion market. 

Check-Cap Ltd.

Check-Cap Ltd. (NASDAQ: CHEK) is a clinical-stage medical diagnostics company engaged in the development of C-Scan, the first preparation-free ingestible capsule for colon cancer screening.  The company was founded in 2005 and completed an IPO in the US in 2015.  Check-Cap has offices in Israel and Boston, and it employs an R&D team of world-class experts in a range of fields including physics, algorithms, software, hardware and clinical science.

The C-Scan capsule uses ultra-low dose X-ray and wireless communication technologies to generate information on the contours of the inside of the colon, which it passes through naturally.  A patch is worn on patient's back to facilitate capsule control, tracking and data recording.  The information generated by C-Scan is used to create a 3D map of the colon, allowing physicians to look for polyps and other abnormalities. 

C-Scan’s uniqueness revolves around the removal of many frequently-cited barriers to screening, such as laxative bowel preparation (which is required for existing video capsule technologies on the market), invasiveness and sedation.  It also could be particularly effective at detecting precancerous polyps, which subsequently may be removed by a colonoscopy. 

A study conducted by the Mayo Clinic determined that patients consider laxative preparation to be the most troubling aspect of colon testing for patients.  Also in approximately 20% of cases using existing colon cancer screening tests, the standard bowel preparation is sub-optimal, potentially compromising optical diagnosis.  Since Medtronic’s PillCam uses video camera technology that requires a clear image of the wall of the colon, patients are required to have standard bowel preparation. Unlike optical imaging, however, C-Scan’s capsule uses X-rays that penetrate the colon contents, enabling it to map the inner topography of the colon surface while seeing through stool in the colon.  Hence C-Scan patients do not require bowel preparation.  This key differentiator of C-Scan could enable Check-Cap to significantly accelerate screening rates globally by appealing to a large portion of the population that is deterred by bowel preparation.



I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


C-Scan Results and Commercialization Path

Check-Cap has come a long way towards commercialization, and sales are on track to commence in the first half of 2019.  In the interim, there are a host of upcoming catalysts over the remainder of 2018 that could significantly bolster the company’s valuation.

On January 9, 2018, Check-Cap obtained the CE Mark approval of its C-Scan System.  CE marking is a certification mark that indicates conformity with health, safety, and environmental protection standards for products sold within the European Union.  The company will now need to obtain applicable regulatory approvals or clearances to market its products in each country within the European Union.

In September 2017, Check-Cap completed a multi-center study of the C-Scan system in support of CE Mark submission. The objective of the study was to assess safety and clinical performance of the system in detecting polyps. The three-center trial enrolled 66 patients, and no bowel preparation, sedation, or change in diet was required.  The study demonstrated a 44% sensitivity, which is the ability to identify polyps accurately.  Very encouragingly, however, sensitivity strongly correlated (R-squared = 0.98) to the percentage of the colon scanned.  In 12 procedures for which scan imaging density exceeded 70%, sensitivity was 100%.  Even in 19 procedures where scan imaging density was greater than 50%, sensitivity was 78%.  Strong safety data was also recorded, as safe passage of the capsule from mouth to rectum was confirmed and radiation exposure was very low (equivalent to that of one chest X-ray, or 1/200th of a CT scan).

In the fourth quarter of 2017, Check-Cap commenced a clinical study for the purpose of introducing C-Scan system Version 3, which incorporates the latest algorithms and system optimization. Importantly, C-Scan Version 3 tailors scanning of the colon to the patient’s natural colonic movements in order to maximize the amount of the colon that is tracked and imaged.  Based on the study’s evaluable results, C-Scan Version 3 demonstrated significant improvement in average colon imaging coverage compared with the C-Scan version used in the study that supported the CE Mark approval received in January 2018.  The company expects interim results for the study in the third quarter of 2018.  This could be a very significant imminent catalyst for Check-Cap’s stock.   

Given C-Scan’s meaningful relative benefits and positive safety results, if the sensitivity results released in the third quarter of this year for the C-Scan Version 3 in the ongoing EU post approval study yields significantly higher sensitivity levels, I believe it could be a game changing catalyst for Check-Cap; C-Scan could emerge as the only high sensitivity screening procedure for both cancerous and pre-cancerous polyps that does not require bowel preparation and is essentially hassle free.

Check-Cap reported interim clinical study results of C-Scan Version 3 in March 2018 with evaluable results of 21 patients showing average colon imaging coverage of 64%, a 40% improvement over 46% average colon imaging coverage in the CE Mark study.  As demonstrated in the CE Mark study, sensitivity is strongly correlated with colon imaging coverage.  Given that sensitivity was 78% (p<0.05) for subjects with greater than 50% colon imaging coverage and 100% (p<0.05) for subjects with greater than 70% colon imaging coverage, it seems highly likely that the impending sensitivity results will be very positive.  This could position Check-Cap to ultimately displace Medtronic as the market share leader in the rapidly growing capsule endoscopy market.  It could also draw suitors like Medtronic or Exact Sciences to attempt to acquire Check-Cap.

In February 2018, Check-Cap submitted an application to register the C-Scan system for marketing and sale in Israel, and the company expects to commence sales in the second quarter of 2019.  Following a commercial launch of C-Scan in Israel, Check-Cap anticipates launching its C-Scan system in Europe during 2019.  Check-Cap has also been setting the stage for a launch in the U.S.  In December 2016 and February 2017, the company conducted pre-submission meetings with the FDA.  Utilizing the FDA’s feedback on the regulatory pathway for C-Scan, Check-Cap intends to initiate a pilot study in the U.S. this year.  The company is also considering commencing clinical trials in Japan and China next year in parallel with a pivotal study in the U.S.  

Check-Cap’s collaboration with General Electric is a testament to the company’s credibility and provides confidence in its ability to scale production.  In November 2017, Check-Cap entered into an agreement with GE Healthcare, which involves GE’s final assembly, packaging and shipping of C-Scan capsules, initially to support the company’s U.S. pilot trial that it expects to initiate during 2018.

Check-Cap also has an exciting pipeline of potential products utilizing its existing technologies.  Depending on its ability to consummate strategic partnerships, it may seek to pursue the following potential new applications for C-Scan:

·       Localized drug delivery capsule

·       Gastro intestinal motility diagnostics capsule

·       Small bowel video capsule combined with C-Scan tracking system

As of December 31, 2017, Check-Cap had 30 granted patents, 2 allowed patent applications and 23 pending patent applications worldwide relating to various elements and functions of its products and related enhancements.

Downside Protection & Upside Potential

After a successful $20.2 million public offering in May 2018, Check-Cap’s pro-forma cash balance was $22.6 million, providing in excess of two years of runway at the current cash burn without any revenue.  Amazingly, the market cap of Check-Cap is only $21 million, less than the company’s last reported cash position.  The company has an additional 3.67 million Series C warrants outstanding, each of which strikes at $5.50 per share and has almost 5 years of remaining maturity.  While the exercise of these warrants would increase the outstanding share count to 8.96 million, it would also increase the company’s cash balance by in excess of $20 million.

PillCam’s success since launch in 2001 (primarily in small bowel screening) has resulted in capsule endoscopy having become a common screening option for doctors to use on patients.  Also, Medicare and Medicaid have substantially increased average physician payment for in-clinic capsule endoscopy and the number of U.S. patients with reimbursement coverage for capsule endoscopy has grown significantly since then.  It is likely that C-Scan will have favorable reimbursement coverage if it is approved by the FDA (just as Cologuard has).  The increasing acceptance of capsule endoscopy could enable Check-Cap’s C-Scan to scale much more quickly than Given Imaging, which was founded in 1998 and started selling PillCam SB for visualization of the small bowel in 2001.  At that time, capsule endoscopy was a brand new field with very limited awareness. 

Check-Cap is following a similar trajectory to that of Given Imaging.  In 2001, Given Imaging received Ministry of Health approval to market the PillCam SB (then referred to as the M2A Imaging Capsule) in Israel.  The company was also granted approval that year for marketing in the EU and Australia.  Given Imaging had $7.4 million in losses on no revenue for the six months ended June 30, 2001, yet it was able to raise $60 million in an IPO in October 2001, a very difficult period for the capital markets following the 9/11 terrorist attacks.  In the latter half of 2001, Given Imaging generated its first sales, and in 2002 the company grew revenues exponentially to $29 million.  In 2014, Covidien acquired Given Imaging for $860 million net of cash, 4.78X the $160 - $200 million in annual sales Covidien expected to gain from the acquisition. 

As a result of the much more established market and reimbursement paradigm for capsule endoscopy, in conjunction with C-Scan’s unique ability to circumvent the bowel preparation requirement and detect precancerous polyps, it is conceivable that Check-Cap could scale more than twice as quickly as Given Imaging did since it launched its first product.  This implies potential sales for Check-Cap of more than $60 million in 2020.  Check-Cap believes that the global market opportunity for C-Scan is $4.76 billion annually, comprised of a global population at age 50 of greater of 710 million, an average procedure cost of $600, and a screening frequency of once every 10 years.  Hence $60 million of sales contemplates only minimal penetration relative to the aggregate market opportunity.  To demonstrate the potential revenue ramp of C-Scan, investors could also study the sales trajectory of Exact Sciences’ Cologuard.  Cologuard generated $26.5 million in sales during the first four quarters since the product launched, and within 8 quarters, it exceeded a $100 million annualized run-rate. 

Given Imaging’s sales slowed from a CAGR of 43% from 2001 – 2011 to about 10% by the time it was acquired.  Similar to Given Imaging, Check-Cap’s growth is likely to be much higher in the early years after launch of its first product, implying a significantly higher multiple than Given Imaging was able to attain from Covidien in 2014.  If Check-Cap were to be ascribed an 8X revenue multiple on 2020 sales of $60 million, it implies a $480 million valuation and a two year price target of $54 per fully diluted share (assuming full exercise of the Series C warrants).  Successful capsule endoscopy products deserve a lofty multiple as a result of their high margins and strong growth prospects.  Given Imaging, for example, generated ~78% gross margins for PillCam.  At these gross margins, I believe that Check-Cap could generate ~$3 per share of EBITDA in 2020 assuming $60 million in revenue and a 100% increase in the company’s OPEX to $20 million annually.

To demonstrate the extreme upside potential of successful colon cancer diagnostics companies, the extraordinary story of Exact Sciences is instructive.  EXAS sells a non-invasive stool based DNA test called Cologuard for early detection of colon cancer.  The FDA granted premarket approval (PMA) for Cologuard in August 2014.  In 2014, Exact Sciences generated $1.4 million in sales.  Two years later, the company generated $39 million in sales and in 2017 sales jumped to $266 million as Cologuard traction surged.  On June 15, 2018, EXAS closed at $68.53, yielding a market cap of $8.4 billion.  That’s a whopping price/sales multiple of >31X, which if applied to my 2020 sales projection for CHEK could imply a two year target price in excess of $200 per share.

Compelling Acquisition Target

There are a plethora of multi-billion dollar companies in the colon cancer diagnostics industry that could be interested in acquiring Check-Cap.  Manufacturers of equipment for optical colonoscopy and sigmoidoscopy include Japanese companies like Hoya and Fuji Film. Manufacturers of equipment for CT colonography (CTC) include General Electric Healthcare Systems, Siemens Medical Solutions, Philips Medical Systems Ltd. and Toshiba Corporation. Manufacturers of equipment for optical capsule endoscopy includes Medtronic plc.  Companies that have developed or are developing non-invasive technologies based on stool, serum, or molecular diagnostics include Exact Sciences, Illumina, Inc. and Quest Diagnostics.

Check-Cap would be a particularly compelling acquisition candidate for Medtronic plc., a $117 billion market cap company that acquired Covidien and its PillCam systems.  Assuming that C-Scan’s sensitivity and specificity in the soon to be released EU post-approval study results are as encouraging as I expect, Medtronic could soon conclude that C-Scan is vastly superior to PillCam.  Medtronic’s leading position in the capsule endoscopy market could ultimately be threatened by Check-Cap.  Medtronic generates approximately $4 billion in annual net income, and if the company decided to spend just one month of net income to purchase Check-Cap as a defensive measure today, it would imply a price per share in excess of $37.

Very interestingly, Exact Sciences actually mentions Check-Cap’s C-Scan as a primary competitor to Cologuard in its 2017 10-K: 

Our Cologuard test faces competition from procedure‑based detection technologies such as flexible sigmoidoscopy, colonoscopy, and “virtual” colonoscopy… and newer screening technologies such as pill-based imaging solutions like PillCam COLON, cleared by the FDA in February 2014, and C-Scan, which recently obtained a CE Mark.

This makes it evident that Check-Cap is on EXAS’ radar screen, and it wouldn’t be surprising if the company decides to diversify into the capsule endoscopy market.    

Risk Factors & Disclaimer

While I believe CHEK’s risk/reward profile is compelling, it is a pre-revenue company and hence there are many risk factors to consider.  If, for example, the company fails to execute in commercializing C-Scan while burning through its cash balance over the next two years, the stock could decline from current levels.  CHEK is an extremely volatile small cap stock, and we advise investors to conduct their own due diligence before investing.  I have an ownership interest in CHEK at the time of this write-up that could change at any time without notice.  The information set forth in this analysis represents the opinion of the author as of the date of this report. This report contains certain forward-looking statements, which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “could,” “estimated,” “potential,” “outlook,” “forecast,” “plan” and other similar terms.  All are subject to various factors, any or all of which could cause actual events to differ materially from projected events.

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