Medgenics: Overlooked Biotech Stock Could Be Good Risk/Reward Investment

Investors in the biotechnology sector probably don't need any antidepressants. Many biotechnology stocks are namely among the best performing across the stock market. Over the last 5 years, the biotechnology index trackers tripled in price. But did all biotechnology companies flourish? We discovered a small company that Wall Street has forgotten about but in fact is well positioned to become one of the greatest developers of medical technology that allows patients to produce, within their bodies and on a long-term basis, their own natural human protein therapy for the treatment of a range of chronic diseases such as anemia and hepatitis C. The industry in which they operate is worth billions of dollars. The company is Medgenics (MDGN) and this article explains why this stock is a must have for investors who are searching for a highly skewed risk/reward investment.

Company overview

Medgenics was founded in 2000 in San Francisco as a medical technology and therapeutics company which engages in the research and development of products in the field of biotechnology and associated medical equipment in the United States. The company develops and commercializes Biopump, a groundbreaking tissue-based platform technology for the production and delivery of therapeutic proteins using the patient's own tissue for the treatment of a range of chronic diseases, including anemia, hepatitis, hemophilia, and other chronic diseases. This pump technology is a platform for endless indications. Therefore the company plans to develop a pipeline of products based on this technology to target the broader large and rapidly growing global protein therapy market. R&D and manufacturing operates in Misgav, Israel and U.S. manufacturing operates in San Francisco.

Medgenics is managed by a team of biotechnology and biomedical device experts that include highly experienced figures in the healthcare industry, in healthcare finance, as well as influential figures from the medical community and academia.

Last week the company announced that its executive team has been replaced. Andrew L. Pearlman, PhD., the company's Founder and previously the company's President and Chief Executive Officer, has retired as of September 13, 2013 but is continuing to serve on the Board of Directors and as a senior advisor to the company.

The new executives are:

- Michael Cola, President and Chief Executive Officer

- John Leaman, M.D., Chief Financial Officer

- Garry Neil, M.D., Global Head of Research and Development.

In addition Mr. Cola joined the Medgenics Board of Directors.

Investors welcomed the replacement as the stock price rose upon the news.

What is Biopump?

So the company develops the so called 'Biopump' technology. It's a combination biological/device product, split in three different product candidates called EPODURE, INFRADURE and HEMODURE. How does it work? The next chart clarifies.

(A)

The first stage is the removal (harvesting) of a sliver of dermal tissue, called a micro-organ (2-3mm diameter x 30-40mm length), from beneath the patient's skin. This procedure is performed under a local anesthetic, is intended to be performed in a physician's office and is minimally invasive, so as to encourage rapid healing with little or no scarring. Generally, more than one micro-organ will be harvested from the patient (typically 4-5).

(b-e)

The micro-organ is processed outside the body using a non-immunogenic adenoviral vector to introduce the appropriate gene into the tissue's cells and cause the cells to produce the desired protein, thus converting it into a sustained-action Biopump.

(f-i)

Tests are performed during processing to determine the daily protein production from each Biopump. The appropriate number of Biopumps is thereby determined and then subcutaneously implanted back into the patient after one to two weeks. After implantation, Biopumps are designed to maintain protein levels in the blood within the therapeutic window for up to six months or more.

Management estimates that the Biopump technology could potentially be applied to many elements of the market, as the next overview explains.

Medgenics is not the only company though working on self healing medical technology. Competition in this area is fierce. But in our view this should not be a major hurdle for investors. Firstly the Biopump technology is unique in the sense that it addresses the key limitations of regular gene therapies, in knowing the dose, in the ability to increase or reduce it, and most importantly, in being able to effectively stop it if needed. The Biopump uses intact tissue at all times, so that the cells in the tissue never leave their natural matrix.

Secondly the growing protein therapy industry is worth approximately $120 billion as we speak. And according to RCNOS, a leading research company in this field, the growth is all but over. Even if Medgenics only is able to obtain a tiny percentage of the market, the company could be worth billions.

FDA product approval

Dealing with the FDA can be a lengthy and complex procedure. The following chart shows a brief overview of the necessary steps.

procedure regulatory approval from secfilings.nasdaq.com

What are the chances their 3 product candidates are allowed to be sold? Let's assess:

EPODURE:

The companies announced last month this product candidate continues to be on target to carry out its first US clinical trial of its Biopump technology. This is according to step 7 from the chart above after it attained clearance from the FDA for the phase II trail in treating dialysis patients in the United States. Earlier this year, Medgenics reported interim data from its Israeli phase IIa clinical study of EPODURE to treat anemia in end stage renal disease patients, and the US trial will be thus the phase II study of the technology in similar patients. Former CEO Andrew Pearlman said the first half had seen progress and Medgenics was now positioned for "important near term milestones".

Our assessment is that EPODURE indeed is near important milestones and we think it is likely that Medgenics is allowed to proceed with phase III testing. Historically, products that have successfully passed the phase II stage have namely a 60% chance of actually being approved to go on to the market. Medgenics could commence next year as Phase III trials are an important turning point in general (step 8). The purpose of phase III trials is to gather even more information about the effectiveness and safety of the new medicine from large numbers of patients (likely to be several hundred to several thousand patients), comparing the medicine's effectiveness with standard treatments. At this point the product has better than a 70% chance of being approved and getting on to the market.

INFRADURE:

This one stands for sustained production and delivery of interferon-alpha for use in the treatment of hepatitis, which has received approval for two Phase I/II trials in hepatitis C from the Israeli Ministry of Health with the first slated to commence in Q4 2012; and has received Orphan Drug Designation from the FDA in June 2012 for the treatment of hepatitis D. Orphan Drug Designation carries multiple benefits, including the availability of grant money, certain tax credits and seven years of market exclusivity, as well as the possibility of an expedited regulatory process.

According to management:

"....We will continue to evaluate and update our plans for the regulatory and clinical pathway for the INFRADURE Biopump with a view to determine whether there would be an advantage to seek regulatory approval of one of those product candidates in the United States, or possibly first in markets outside the United States, in light of the fact that hepatitis D is a relatively rare disease in the United States, but is more widespread internationally, with an estimated 15 million patients or more worldwide with the disease. In addition, we plan to identify other rare diseases with orphan designation which affect less than 10,000 people worldwide, in which the sustained therapy potentially offered by our Biopump Platform Technology could represent a major clinical advantage. According to the National Organization of Rare Diseases, there are thousands of such diseases, and we are exploring these to identify those most promising for our Biopump technology...."

An important validation of this product was given by renowned experts during the recent annual conference of the American Association for the Study of Liver Disease (AASDL) in Boston late November 2012.

Based upon this information, we think it is more likely than not that this product will reach the last step (9) in a few years from now.

HEMODURE:

This product is now being developed to produce and deliver clotting Factor VIII therapy for the sustained prophylactic treatment of hemophilia. The company was granted $4 million by pharmaceutical company Baxter to co-develop this product. In November 2010, Medgenics took control of the preclinical development as part of an extension to the agreement, while yields were improved. Although the agreement expired in September 2011, Medgenics has confirmed that Baxter remains interested in HEMODURE and indicates it will seek to move forward with the next stages of collaboration once further technical performance improvements are demonstrated by HEMODURE Biopumps in vitro and in animal models. Once target levels are reached, Medgenics could commence a phase I/II trail in humans.

Given this information, we think this product is still in its early stages. Therefore it is too early to tell whether it's likely this product will reach the last step.

Summarizing: We conclude that Medgenics appears to be far advanced in the process of getting final approval for product sales of EPODURE and INFRADURE. Given the historical rates of success and validation by experts in the industry, we think it is likely that a final approval will be obtained. We cannot say the same for HEMODURE (yet), as this product is still in its early stages of development.

Insider trading

source: nasdaq.com

The insiders seem to have a significant stake in the company and are on the buy side since the stock hit the $4 mark. No insider selling, so no red flag here.

Financials

Let's look at some basic financials. Medgenics is still in a pre-revenue and pre-profit stage, so it is important to analyze, just like with other biotech companies in their early stages, whether the cash balance can cover the cash burn for a long period.

source: finance.yahoo.com

Given the net cash available and low cash burn, they can fund their operating activities without an urgent need for a dilutive stock offering in the near future. This is mainly thanks to a large public stock offering of $32 million completed in February this year.

According to management:

"...Without taking into account any revenue we may receive as a result of licensing or other commercialization agreements we are pursuing, we believe that cash on hand, will be sufficient to enable us to fund our operating expenses and capital expenditure requirements through 2014..."

But what about revenue?

"..Although we have not yet generated revenues from product sales, we have generated income from partnering on development programs and we expect to continue to pursue partnering activity... If our product development efforts result in clinical success, regulatory approval and successful commercialization of any of our products, we would expect to generate revenue from sales or licenses of any such products....We do not anticipate that we will generate revenue from the sale of products for at least five years; however, we do intend to seek licensing or other commercialization agreements similar to our agreement relating to the development of our HEMODURE Biopump. We anticipate that the funds received as a result of such agreements may be sufficient to fund our operations in the future...".

Because direct product sales are not to be expected in a few years from now Medgenics focuses on a diverse mix of income streams so that the company attracts cash inflow till their physical products can hit the market. A few months back the Israeli government awarded a $1.9 million grant. Other grants like these could follow in the near future.

Summarizing: we regard the current financial situation as very healthy and although the foreseeable future of income is (of course) uncertain, we expect management being capable enough acquiring even more non-dilutive funding till product sales start.

Valuation

So what could Medgenics be worth tomorrow?

Experts forecast that the protein therapy market will be worth about $150 billion in 2017. To be very conservative, let us assume that Medgenics will obtain a 0.5% market share. That makes $750 million. Biotech stocks are generally valued at high price-to-sales ratios but again let's be conservative so no multiplier. We set the discount rate, since this is a risky business, at 15%. Discounting gives 750/1,15^4 = $429 million.

Shares outstanding totals 18.4 million so a stock price of 429/18.4 = $23 can be derived.

The stock market currently values Medgenics at just above $6.

Technical analysis

source: stockcharts.com

The stock price just broke through the resistance of MA200 on high volume. This MA200 is now a short-term support level. Medgenics is a buy from a technical point of view.

Risks

This is a biotech small cap. Investing in this stock is obviously not without risks. Investors should bear in mind:

- A new dilutive stock offering is a (remote) possibility. We do not expect this in the short term, considering the sizeable war chest and low cash burn. However, we won't rule this out completely in the long-term since investing in biotech stocks brings an above average dilution risk.

- The whole process with the FDA is lengthy and complicated. A setback in the timeline is not unthinkable. We think however this is not likely, given the diverse portfolio mix and advanced status in the FDA timeline.

- Expectations set by management do not necessarily have to materialize. As management themselves indicate, the nature of the business is highly uncertain and forecasting is therefore complicated.

Conclusion

Medgenics offers a very attractive risk/reward ratio. Left aside by WallStreet for a long period, investors are just starting to notice the potential value.

Insiders are on the buy side. Medgenics is cash-rich while cash burn is low. The company is able to generate other streams of income such as licensing, royalties and grants before their products will hit the market. This makes downside risk very slim while upside potential is huge. Based on this alone the stock should be trading much higher. Their Biopump technology is unique and likely to enter a massive multi-billion industry. The FDA timeline goes according to plan and any step forwards could drive the stock price up significantly. As soon as product sales start, the market capitalization could be a multifold of what it is today.

Recommendation: Speculative Buy, Price target $23.

Ticker code: MDGN

Listing: AMEX

Market capitalization: $116 million

Average daily volume: 49K

Next earnings date: November 2013, no exact date planned yet

Disclosure: I am long MDGN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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