January 06, 2021 - 9:13pm EST by
2021 2022
Price: 16.71 EPS 0 0
Shares Out. (in M): 35 P/E 0 0
Market Cap (in $M): 585 P/FCF 0 0
Net Debt (in $M): 56 EBIT 0 0
TEV (in $M): 641 TEV/EBIT 0 0

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In an overvalued market, HLS is a heads I win, tails I break even type of investment. A Canadian small cap pharma company, HLS currently has 1 main drug which generates substantial cashflow, and a blockbuster drug just being rolled out now. At todays pricing the stock is trading at my bear case DCF using estimates substantially below managements guidance, creating very little downside risk. On the base case I get a $24 target vs current trading levels of $16.75, good for a 43% return. My bull case DCF gets me to $32 or 91% upside. 


The situation exists as the US company that developed the blockbuster drug has lost their patent protection. As well the market is underappreciating the potential for the current cash flowing drug to grow whereas my channel checks show this to be highly likely. 


Even better, management has a high level of restricted stock that gets triggered next August based on a 3 month average closing price. If the stock is below $15 in that period they get zero. If its above $20 they get all of it, setting up a strong incentive for management to make the stock work over the coming months. 

(note: all numbers in this writeup are in USD except for share price and eps)




The blockbuster drug is Vascepa. It had been developed by Amarin in the US, with HLS in-licensing the Canadian rights in 2017 for $5mm. Then in late 2018 the Reduce-It trial results came out which showed that taking Vascepa leads to a vast reduction in cardiac events.


Based on these results and analysing the market of statin users, Amarin estimated peak sales in the US of “multiple billions” while some sellside analysts pegged the number at around $5 billion annually. HLS had hit the lottery with their 5mm spend. 


Amarin applied for a new expanded label for Vascepa incorporating these results and received it from the FDA in Dec 2019. In the mean time Vascepa sales were climbing as doctors saw the trial results and writing prescriptions off label. HLS applied to health Canada and got new drug approval at year end 2019. Everything was great and HLS stock went to $24 from a price of $10 before the Reduce-It trial results were released. 


HLS hired a sales force to start selling Vascepa in Feb and then things got derailed with Covid and the inability to go into doctor's offices. The timing was obviously unfortunate as HLS was just taking on this SG&A expense and then had to pivot to a virtual sales model. 


At the same time, Amarin stock was getting hammered, which also resulted in HLS share price weakness. Amarin lost a legal challenge to its patents as the courts rules the patents invalid based on obviousness (basically saying this is just another form of fish oil and thus not patentable). https://www.fiercepharma.com/marketing/it-s-confirmed-amarin-loses-patent-appeal-protecting-blockbuster-hopeful-vascepa-from


Its worth pointing out two things here. The first is this challenge is on the original patent of Vascepa to lower triglyceride levels , not the expanded label to help prevent adverse CV events. Thus generics can’t make that claim. However doctors are likely to prescribe the generic off label, significantly hurting the Vascepa franchise in the US. But in Canada, HLS never filed Vascepa as a triglyceride lowering drug, thus any generic manufacturer would have to run their own trial and demonstrate results that it can lower triglyceride levels before it could be approved and hurt Vascepa sales through the same off label usage.


The second thing to point out is HLS has data protection in Canada until early 2028. This makes it unlikely that HLS will face any generic competiton in Canada until 2030 (HLS also has patents that run well into the 2030’s but lets assume it goes generic in the early part of the decade).


Turning to the numbers, management has guided for peak market penetration of 8-10% 5 years post launch meaning on a year end 2024 runrate basis. This equates to 275mm-325mm in sales. Here’s how that break down. 7.4% of Canadians are on statins. Of that population Vascepa has been deemed beneficial for 71%. At a pricing of $1,900 annually you get above that guidance range. Management admitted these numbers get to a higher range than the official guidance, but they rounded down aggressively to get to 275mm-325mm. In reality based on management actual assumptions it would be 300mm-400mm using 8-10% penetration levels. This drug should have ebitda contribution margins of around 40% at scale which I model they reach in 2025. 






And here’s where I get my Bull/Bear/Base case DCF numbers. I run the same SG&A numbers throughout the 3 scenarios, but assume 11% 8% and 5% penetration. At 5% the DCF gets us to todays price. At 8% we have 43% upside, and at 11% its almost a double. These sales numbers also mesh up with the US guidance Amarin had given and sellside had modeled before the patent issues. 


How is the rollout going? Well so far it seems decent given the circumstances. As mentioned the timing couldn’t have been worse with a bunch of reps added in Jan/Feb. But the company switched to a digital sales model and worked on what they could control, getting private lives covered and submitting for public lives covered from the provinces (In Canada roughly half the population has private coverage and the other half is covered by the provinces). As of the November conference call, 50% of private payors were covered through their insurance with that number aiming to be over 80% in the next 6 months. The provinces should begin to add Vascepa to their formulary lists in H2 2021. So sales will be modest for now but should start to be significant in 2022. Last quarter the company included this chart in their presentation, which is helpful.






In my model I have Vascepa sales climbing to 22mm in 2021 and 113mm in 2022. There’s about an 20mm opex investment from 2019 pre launch to 2021 so the drug will start contributing in 2022 after being a drag on financials this year and next.




Clozaril and market expansion:



The Vascepa segment is the main part of the story but I think sellside does a good job outlining the opportunity. I think where this report creates value and differs from sellside is explaining the expansion opportunity of the existing drug Clozapine, after having spoken to a few psychiatrists who are prescribers.




The current main drug is Clozaril, which is a form of clozapine, an antipsychotic. Clozapine is prescribed to schizophrenics who do not respond to more traditional medication. Roughly 30% of the schizophrenic population could be benefitting from Clozapine. However there can be serious side effects to the drug, therefore the federal government requires patients to tested weekly (to ensure normal white blood cell count) and for this data to be kept in a federal database. Because this test requires a blood draw and given the difficulty with getting this specific patient population to adhere to routine intravenous blood draw appointments, the actual rate of patients receiving clozapine is only 6% of the possible 30%. This is an opportunity.







Clozapine has been generic for years, and Clozaril is the non-generic brand owned by HLS. HLS has 55% market share of patients currently on some form of Clozapine. How? The national registry is incredibly painful to use. When a patient is on the generic, the doctor must upload all the test results themselves. When a doctor prescribes Clozaril, HLS staff will handle this for them in the CSAN patient care portal. The psychiatrists I spoke with explained that if they specifically prescribe Clozaril that’s what must be dispensed. Given they would much rather spend their time performing billable tasks than entering data, there’s a strong preference to prescribe Clozaril. This edge over the generic should be durable as given the severity of the side effects this portal is needed in perpetuity.


 This drug is currently doing about $44 million in sales and is growing slowly (with the patient population) however that will soon change. The company recently introduced the CSAN pronto. This is a finger prick blood draw, not an intravenous. Patients will be much more likely to come to their weekly appointments for a finger prick test, and this has the potential to expand the market from the 6% of 30% currently taking Clozapine to a much higher level. HLS should capture 100% of this expanded market as their product is the single factor driving the expansion. The psychiatrists I spoke to confirmed that since the CSAN pronto devices were placed in their hospitals this summer it has been easier to convince new patients to agree to the medication and make their appointments


On my numbers that 6% of 30% reaches 9% of 30% by 2024 with this growth entirely attributable to HLS. This drivers total Clozaril sales from 44 million in 2020 to $67 million by 2024 with very little incremental costs. The street is missing this nice boost to revenue, instead modeling in a 3% growth CAGR vs my 10%. 



Valuation = Downside protection:


My bear case assumes only 5% penetration of Vascepa, but the same cost structure as my bull case. My DCF uses a 10% discount rate, and after 2030 my FCF goes into 10% terminal decline. Therefore very little value is ascribed to the terminal calculation. 


At these bearish numbers, I get to a $16.45 target price, or effectively todays trading price. But what if Vascepa is a complete flop? Well, the company functioned just fine before Vascepa. Using my 2025 Clozaril numbers and a slightly higher cost base than 2019 (pre Vascepa salesforce ramp) we would be at a 40mm standalone ebitda vs an EV today of 513mm. If Vascepa is a complete flop and management throws in the towel in 3 years we still wouldn’t lose more than 20%.



Odds and Ends:




Historically management has done a decent job of acquiring drug portfolios at reasonable prices. Recently they spent 41mm (with another 18mm possible) to acquire 10mm of ebitda from a seller who had reached out to the company directly. The CFO told me they estimate the IRR on this acquisition at 20%. The strategy is to round out the portfolio with drugs they can market to the same practitioners they are calling on anyways (psychiatrists and cardiologists).


Balance sheet is reasonable with 86mm of debt and adjusted ebitda climbing to 57mm in 2022. Cash flow is positive in this trough year at 11mm, but will climb to 119mm in 2025 (or $4.35 per share) meaning the stock is trading just under 4x peak earnings.




Management incentive:



Another reason to buy now; management has a funny RSU structure and needs to get the stock above 20 next summer. There are 600k RSUs tied up to this plan. The trigger is based on the VWAP for the 90 days preceding the 3 year anniversary of the grant which was August 18th 2018. They get all the units at $20 or above and none below $15 (with it being pro rata if VWAP falls between those numbers). The payout here could be substantial for the 3 founders who are part of the plan ($25 base case x 600k units means $5 million each). 


The company just initiated its first buyback last month,and given right now is the period where the company is investment mode, it makes no sense until you realize this RSU plan is in place for next summer. See text below:


  The Board adopted the HLS Therapeutics Inc. Performance Share Unit Plan (the “Performance Share Unit Plan”) on May 22, 2018. Under the Performance Share Unit Plan, a maximum of 600,000 Performance Share Units (each, a “PSU”) may be granted. Unless otherwise determined by the Board, the Performance Share Unit Plan will be administered by the Compensation and Governance Committee. Unless otherwise determined by the Board or the Compensation and Governance Committee and set out in a grant agreement, PSUs will vest based on performance metrics tied to the volume weighted average price of the Common Shares over the 90 Trading Days prior to the end of the 36th month following the grant date, provided that, on or before the vesting date, the Common Shares become listed for trading on the Toronto Stock Exchange or another stock exchange that permits the vesting of employee compensation awards based on the price of the Common Shares. The PSU performance multiplier under a grant may range from 0% to 100% depending on actual performance. The PSU payout will be zero if performance is below the minimum threshold. The Performance Share Unit Plan provides that the Compensation and Governance Committee may make proportionate adjustments to the PSUs in the event of certain changes in the capital of the Company. 



Outside of that RSU plan, the 3 founders who are still with the company own about 10% of the shares.





The rest of the shares are controlled by the street, with Stadium Capital (sometimes activists) owning 18%, Athyrium Capital 14% and Mawer 10%. I assume with this lineup if the stock stays cheap for too long they’ll run a process and sell the FCF stream to the highest bidder.




HLS will perform based on the success of the vascepa rollout. If the drug hits the high end of my forecast, the stock will likely double in the next 24 months. If the rollout is disappointing, you likely will not lose much as the growth in Clozaril will keep the valuation reasonable. In an overvalued market, here’s an attractive, uncorrelated way to have decent risk adjusted returns. 



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.


Vascepa sales ramp

Clozaril CSAN pronto growth

Management incentivized to get stock above 20 in next 5 months

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