Description

Organovo Holdings, Inc. (NYSE: ONVO) is an opportunity to short both 3D printing and a high-flying biotech stock with no revenue and no risk of a surprise FDA approval.  The stock trades 2-4 million shares per day, and if you call around there are a few shares available to short but at rates of ~30%.  Options are also liquid so I'm personally executing this with a short call spread and puts.  This is my application thesis for VIC and I am very excited to join the club!  As an FYI, I had also submitted this idea to another blog which will probably publish this week or coming Monday.  Moving forward, however, VIC will become my primary outlet for investment ideas.  Enjoy!

Short Organovo Thesis:  

ONVO is a reverse merger company that has grown to nearly $1 billion in market cap (and uplisted to the NYSE MKT) through a spree of spurious press releases and what I consider a cult-like investor following.  Its only assets are ~$114K of rights to two patents and $49.8 million of cash raised from selling stock. 

ONVO has not developed any products, and its 3D bioprinting “technology” is substantially slower and more expensive than traditional cell culture techniques.  ONVO has less than a 10% institutional investor base and the stock appears to be driven solely by press releases and PR hype.   Once the speculation inevitably subsides, I believe investors will realize there is no intrinsic value beyond reported cash in the bank of $0.65 per share - a downside opportunity of more than 93%. 

Additional Rationale:

• Promise of creating “3D bioprinted organs” for humans is a pipe dream decades away, and ONVO has neither the capital nor people necessary to succeed at such a venture
• ONVO’s 3D bioprinting technology is far too slow and expensive to deliver a viable product for drug toxicity testing – the only near-term market identified by management
• ONVO’s patent protection is weak and does not come close to claiming all of the methods necessary to “print” human organs in the future
• ONVO’s partnerships are questionable: both Autodesk and Knight Cancer Research are over a year old and neither has claimed any progress since announcement
• ONVO’s scientific co-founder, Gabor Forgacs, has left the company and is pursuing more viable opportunities (synthetic leather & meat) with notable venture capital backers
• ONVO executives are cashing out: the top three (Keith Murphy, Barry Michaels and Sharon Presell) have sold ~$7 million worth of ONVO stock and pay themselves nearly $1 million per year while ONVO has no recurring revenue and a burn rate of ~$12 million per year

Catalyst: 1) I think ONVO’s PR campaign is overextended and the speculative money has been made; 2) Management is both issuing and selling shares on the open market; 3) based on its own milestones the Company must prove it has a viable product by December 2014.

Macro Background: 3D Printing

Commercial 3D printing attracted Valkyrie’s attention in 2011 with the Economist’s feature “Print me a Stradivarius”.  At that time, total 3D printing revenues were ~$2 billion (primarily prototyping and some limited manufacturing) and cash flow earned by the market leaders, Stratysis and 3D Systems Corp, was a scant $70 million or so.  Fast forward to today and cash flow for these two companies has doubled to ~$140 million while their market cap increased to nearly $14 billion at the peak.

While commercialized 3D manufacturing may be revolutionary, we are in the very early days.  If the tech bubble taught us anything, it should be that 100x EV/EBITDA ratios are not good investments – no matter how promising the technology.  There is just too much risk associated with early stage ventures to pay exorbitant prices.

Nowhere in my research, however, did I find viable investments in 3D bioprinting of human organs.  To be honest, I first heard about Organovo through my wife because 3D organs were featured on Grey’s Anatomy.  It makes great television, but the technology is 10-20 years away at the earliest.  Regular 3D printing is in its infancy: 3D bioprinting of real human organs that can be implanted is still a pipe dream.

Today 3D bioprinting is almost exclusively performed as research, and I can’t find any information on a “market” for 3D bioprinting.  One group estimates a potential market of $112 million by 2020 and $307 million by 2023.  This is tiny and 6-9 years away.    Moreover, ONVO isn’t even the leader in 3D bioprinting or regenerative medicine (as is often claimed by investors).  A simple Google search up turns up several prominent universities doing more advanced work than Organovo:

• The Wake Forest Institute for Regenerative Medicine (which is moving away from bioprinting due to high cost)
• Princeton and Cornell have printed working human ears
• University of Pennsylvania is printing vascular networks
• Chinese universities are printing kidneys
• A Sunnyvale, CA MeetUp group known as BioCurious (yes, really) even created their own 3D bioprinter from scratch using, “a couple of old CD drives, an inkjet cartridge, and an Arduino”! 

Macro Background: Hepatotoxicity Testing is Intensely Competitive

Understandably, Organovo doesn’t pretend 3D organs are around the corner, but instead they focus on printing 3D liver samples for drug toxicity testing (known as hepatotoxicity).   Hepatotoxicity testing, however, is not a revolutionary new market; it is an intensely competitive niche of pharmaceutical drug development.

To better understand the opportunity in hepatotoxicity, I consulted Ph.D.s and academic research (the most important of which is available here).  The short story is that big pharma is spending more on drug development while receiving fewer FDA approvals (humorously referred to “Eroom’s Law in the pharma industry). 

Specifically, big pharma now spends almost 20% of revenue (~$70 billion annually) on drug R&D.  Only 5 out of every 10,000 compounds reach clinical trials and of these only 2-3 out of 10 recoup their cost.  In total, the average cost to develop a new drug (including failures) is $0.4 - $1.8 billion and can take 10-15 years from discovery to approval.  Hepatotoxicity is a major cause (estimated up to 1/3) of drug development failure.  Up to 50% of liver failure is caused by “Drug Induced Liver Injury (DILI)” and during 1995 – 2005, 34 drugs were withdrawn from the market due to hepatotoxicity. 

Due to the high cost of drug development and high likelihood of hepatotoxicity, it is crucially important for big pharma to test for hepatotoxicity early and accurately.  To-date, there have been two methods for testing a drug’s hepatotoxicity: in vivo (“in the body”) with live rats or in vitro (“outside the body”) with 2D or 3D liver tissue samples. 

It is important to note here that 3D liver test samples – considered the Holy Grail by Organovo’s management – already exist and are being supplied to most of the big pharma companies at low cost by InSphero.  InSphero can produce tens of thousands of 3D cultures in a matter of days compared to a full month required to produce 400 samples by ONVO. 

I questioned Organovo’s CFO and IR team via email about InSphero, specifically asking, “I've heard that 3D printing of liver tissue is substantially slower and far more expensive than traditional cell culture techniques employed by InSphero?  What do you view as Organovo's competitive advantage in hepatotoxicity testing?”.  IR’s reply is telling:

“In regard to 3D liver competitive positioning – we believe that the data that we have publicly described demonstrates superiority over the current market standard which dominates market share, the use of hepatocytes in traditional 2D cell culture.  We also believe that because we are actively working towards launching the world’s only 3D liver tissue that recreates human liver structure and activity, that if we reach that goal, our 3D liver tissue will offer characteristics superior to all potential competitor products.”

I love “actively working towards” and “if we reach that goal:” (I could say the same thing about winning the lottery)!  More importantly, Organovo does not even address their primary competitor, InSphero, or the higher cost and time it takes for Organovo to produce the same 3D product as InSphero.  Instead, they state the “data publicly described” (note it’s data not a product) is superior traditional 2D cell culture. 

In regards to 3D samples being superior, there isn’t yet conclusive scientific evidence that 3D samples are superior to 2D samples. 2D samples can be more easily measured for hepatotoxicity whereas 3D samples cannot be viewed in the same plane (which makes toxicity measurements difficult).  Moreover, in vitro testing (either 2D or 3D) will never fully replace in vivo testing with live rats, because even 3D liver tissue cannot accurately replicate the complexity of a living organ.   

Per the scientific paper by van Tonder, Steenkamp and Gulumian:

“The ultimate goal of predictive toxicology would be to develop techniques that can be used in vitro. However, it should also be noted that it is highly unlikely that animal studies will be avoided altogether, at least not for the foreseeable future, which leaves room for in vivo profiling technologies as adjuvants to conventional safety pharmacology testing. In fact, it may help justify the use of animals for safety pharmacology testing. It is not impossible to employ these technologies using in vitro platforms, but more research is necessary to develop and establish effective methodologies and biomarkers.”

Hepatotoxicity testing is an important decision milestone in drug development, but Organovo’s potential product (if developed) will not be a silver bullet.  It will be too expensive and too slow and face intense competition from InSphero (backed by RedAlpine), Hurel (backed by Sanofi-Aventis), Vivo Biosciences and heavyweights like Sigma-Aldrich (SIAL) and Thermo Fisher Scientific (TMO). 

Intellectual Property and Patent Protection is Weak

As outlined above, Organovo isn’t the only company (nor even the first) to create a 3D bioprinter.  Of note, EnvisionTEC, a German company, has been selling its 3D Bioplotter since 2001 – more than 10 years before Organovo!  Second, Organovo didn’t even create its own “NovoGen MMX Bioprinter” in house: development was outsourced to an Australian company named Invetech.  Anthony Bozza, of Lakewood Capital Management, also found the NovoGen MMX to be something of a joke in this article:

“We were lucky enough to have found one university professor (and prominent tissue researcher) who had evaluated Organovo’s machine for purchase…she pointed out that it was cheaper to build the machine in-house with ‘a few grad students.’ Surely, a machine made by ‘a few grad students’ would never match up against the revered product of a $1 billion market capitalization company like Organovo,” his letter notes, setting up the punch line.  “We asked the professor how much they had to sacrifice in terms of quality by making it themselves. She responded, ‘Oh no, our machine is better.’”

Third, and most importantly, investors hoping Organovo’s patents will claim all rights to 3D organ printing are going to be disappointed: 

1.)    The Clemson patent (US Patent No 7051654) only claims a method for forming viable cells, “wherein at least about 25% of said cells remain viable on said substrate after incubation for 24 hours at 37 degrees C in a 5% CO.sub.2/95% O.sub.2 environment” – hardly an all-encompassing claim on 3D organ printing (who wants a 25% alive organ that only survives for 24 hours?!). 

2.)    The Forgacs patent (US Patent No 8241905) only includes one claim covering “A method of producing a three-dimensional biological engineered tissue” which does not clearly describe all the methods and processes required for entire organ fabrication. 

3.)    Organovo has another 5 applications into the USPTO (see patent application numbers 20140012407, 20130345794, 20130190210, 20130164339, 20120116568), but all the application dates are within the past 1-3 years.  For those unfamiliar with patent law, an invention must be statutory, useful, non-obvious, and new.  Both EnvisionTEC and Dr. Anthony Atala at Wake Forest have publicly discussed and demonstrated 3D bioprinting technology more than a year before Organovo existed, so I think ONVO has a very slim chance of receiving additional patents on its 3D bioprinting process.

More importantly, the intellectual property required to engineer living human organs will likely require hundreds or thousands of patents claiming every method of fabrication.  Claiming that a single company (especially one with just 2 patents and 5 long shot applications!) owns the rights to the entire 3D bioprinting process is absurd.  It’s like claiming a single company owns all the rights to manufacturing motor vehicles or smart phones. 

By comparison Cellular Dynamics has over 700 patents+applications for the manufacture of human cells.  At a $235 million market cap, ICEL trades at $335,714 per patent vs ONVO’s outrageous $114 MILLION per patent.  Yes, that means ONVO is 340 times more expensive than ICEL on a per patent basis!  And as a prelude to my next post, ICEL also has a bigger market opportunity and a far more credentialed and experience management team. 

Organovo’s Partnerships are Questionable at Best

Organovo’s lack of in-house technology or valuable patents probably explains why they can’t find a long-term research partner or acquirer.  Investor presentations and press releases hype up “partnerships” with pharmaceutical (like Pfizer, Harvard and UTH here) but the only one I can verify with the actual partner is Knight Cancer Institute, and when I called, Knight said there was nothing new they could report and they couldn’t provide further info without approval from Organovo.  I ran into similar walls with Autodesk and Invetech, both whom had to “check with the company first” and then never followed-up or couldn’t comment.  Interestingly, L’Oreal (which ONVO claims as a partner) lists its research partners for toxicity testing online: “Private Sector Partnerships” refers to for-profit enterprise and Organovo is not listed (but most of its competitors are there).

I also called multiple departments at L’Oreal, Pfizer and United Therapeutics.  No one at those companies knew of a partnership with Organovo.  These are all large companies, so it’s possible I didn’t find the right department or person.  Given the importance of these partnerships, however, I think investors should demand more information from Organovo’s management than a press release that says, “Organovo Holdings, Inc. has entered into an agreement with L’Oreal exploring the use of 3D skin for testing skin care products. Terms have not been disclosed.”

Moreover, management hasn’t provided any progress on other partnerships, many of which are several years old but still touted in public investor presentations.  When I questioned IR about the partnerships, they refused to provide an update, responding: “you noted that ‘I've already reached out to contacts at Invetech, Autodesk and Knight Cancer Research (all of whom declined to provide an update) and I've been unable to identify the key people at United Therapeutics, Pfizer or L'Oreal.’  We are not trying to be overly harsh or reactionary in saying this, but we think it’s entirely appropriate for these partners to decline to update you, and entirely inappropriate that you reached out to them directly.” 

Ok: “we are not trying to be overly harsh or reactionary”, REALLY?  I’ve spoken with many management teams, and this is the first that DID NOT want me to speak with their business partners and/or clients.  Most companies love to make introductions to their customers and business partners.  Sure, they’ll cherry pick the best ones, but every other management team I’ve spoken with will provide contact information and introduction to clients who can verify said company’s services.  Organovo has no real customers to speak of, and they refuse to provide contact info or updates on their partnerships?  So in essence they are unable to find one partner they trust enough to speak positively about the company? 

Gabor Forgacs, the Scientific Co-Founder, has Left the Company

In my view, however, the most telling sign of Organovo’s weak competitive position is the exit of its scientific co-founder, Dr. Gabor Forgacs.  Dr. Forgacs left the company in 2013 to pursue what we believe is a more viable business model in 3D bioprinting: synthetic leather and cultured meat.  His new company, Modern Meadow, is built on the same intellectual property as Organovo and is backed by Peter Thiel’s Breakout Foundation, Artis Ventures, ULU Ventures, the Singularity University, the USDA and the National Science Foundation. 

None of these notable venture investors have backed Organovo.  In fact, Organovo has never had any big venture capital investors –  even its first $3.5M “angel” round included 57 people! 

Organovo’s Management Team is Cashing Out

The R&D team may be researching real challenges in 3D organ printing, but the management team looks like it’s using the high share price and public financings to cash out personally.  Keith Murphy, the CEO, even warns investors to ignore “false short and distort” articles.  Blind adherence is rarely a good investment strategy.  

While asking its shareholders to ignore the short sellers, Organovo’s management team is selling $7.4 million worth of shares, with CEO Keith Murphy unloading $1M per month since November 2013.  The salaries of the top three insiders combined (CEO Keith Murphy, CFO Barry Michaels and CTO Sharon Presell) are more than $800k per year – this is multiples of what Organovo paid to license its hyped-up patent rights!  Management should not get rich while burning through shareholder cash. 

Management’s historical performance doesn’t help either.  There is no demonstrated record of start-up success and CFO Barry Michaels prior two stints as a public company CFO at Cardima Inc. and Lipid Sciences ended as zeroes, as did Sharon Presnell’s last job at Tengion.  

In addition to cashing out personally, management has filed a shelf registration to issue shares “at-the-market”.  Their investor presentation (page 29) claims it is less dilutive than a marketed public offering, but I strongly suspect it is considering their inability to attract institutional investors to anchor another share raise.  So, they are selling shares directly to retail buyers in the open market.  The investor presentation continues with the following slide justifying “the importance of sufficient capital”.  “7.5% dilution would double opportunities” (dilution isn’t bad, it’s great!) and that Organovo needs to raise capital now to “Avoid more significant dilution during market downturns or when cash on hand is low” (aka we gotta sell this sh*t while it’s hot!).  Best of all is page 31 warning investors to, “remain on guard against spurious information”.  That’s good advice in general – does it also apply to Organovo’s investor presentations?

Summary and Valuation

Given all of the above information, it’s interesting to take a look at “Organovo Highlights” from the Investor Relations section of the website:

• Statement number one, "Organovo develops the world's first commercial 3D bioprinting technology platform" is just false: as best we can tell EnvisionTEC developed the world’s first commercial 3D bioprinting technology
• Statement number two, "Organovo reported in April 2013 on the creation of the first fully cellular 3D bioprinted liver tissue" might technically be true, but InSphero creates “fully cellular” 3D liver tissue (and sells it for profit!) faster and in greater quantities than ONVO – adding the bioprinter just takes longer; it’s like bragging about building a house behind schedule and over budget
• Number 3: "Organovo named to MIT Technology Review’s 2012 TR50 List of World’s Most Innovative Companies" - Should I invest because they were written up in MIT’s tech review?
• Number 4: "Organovo’s NovoGen MMX Bioprinter named one of the “Best Inventions of 2010” by TIME Magazine" - TIME?  Really?  Not even technical validation there…
• Number 5: "Organovo partners with Autodesk Research to develop 3D bioprinting software" There is no timeline, no financial details were release (I bet ONVO is paying ADSK) and ADSK hasn’t confirmed they are actually doing anything!
• Number 6: "Organovo has been featured in leading publications and media outlets, including: The Wall Street Journal, The Economist, The New York Times online, Nature, Science, TIME Magazine, Businessweek, Fast Company, Inc. Magazine, WIRED, Forbes, MIT Technology Review, CNBC, Discovery Channel, ABC News, and CBS Sunday Morning" - This is the real kicker – they list 15 media outlets but no customers or partners!

Since inception, Organovo has earned a paltry $0.04 of revenue per share, spent $13.5 million on R&D, issued 29 press releases and raised $77 million in capital.  In a best case scenario ONVO is only worth the $0.64 per share of cash on its books (and even this will probably be paid out to lawyers and liquidators). 

Organovo has minimal institutional shareholders combined with stock uplistings, large insider ownership and exciting new technology.  It reminds me of the Poseidon Concepts hydraulic fracking pool scheme that blew up last year.  POOSF (CN:PSN) was listed on the TSX 500, made it to the $1 billion valuation mark and even had a big 4 auditor!  Its management team owned more than 10% of the outstanding stock.  The company was constantly in the media and even picked up equity analysts from large Canadian banks (Organovo hasn’t even done that).  Everyone was in love with Poseidon Concepts: then it collapsed.   

Risks

1. ONVO’s share price trades on hope and dreams and the milestones are set by the company, so management could continue the charade for a while.  I think the PR campaign has run its course and, take my cue from management: now is the time to sell.  They’ve set December 2014 as their milestone for delivering a viable liver toxicity assay, and I think a lack of progress and/or sales will disappoint before then.  (Also, a long position in ICEL should hedge against any irrational bull run in biotech stocks.)
2. The US government is increasing its funding for 3D printing and Organovo could get a significant research grant.  There are dozens of universities developing this technology with better teams and credentials than Organovo, but never underestimate government ineptitude.
3. Organovo could be acquired by a larger pharmaceutical or biotech company.  We think this is extremely unlikely.  Organovo has been shopping its ideas around for two years now without any serious suitors or institutional investors. 
4. Short Squeeze.  This is always possible, especially in a bull market.  However, the stock is very liquid with ~2 days to cover and there aren’t any large Carl Icahn’s who might corner me on this, so I think the likelihood of a deliberate short squeeze is quite low.

Catalyst