AXP - AirXpanders, Inc.

AirXpanders is a medical device company focused on the design, manufacture, sale and distribution of its AeroForm ® tissue expander, which is approved for sale in Europe and Australia. The company is expecting results from its pivotal trial shortly and anticipates that AeroForm will be reviewed for clearance by the U.S. Food and Drug Administration (FDA) this year. Subject to receiving marketing clearance, AirXpanders is aiming to commercialize AeroForm in the U.S. in early 2016.

Tissue expanders are used in breast reconstruction procedures following mastectomy to expand and stretch the skin and underlying muscle prior to the placement of a permanent breast implant.

It is anticipated that AXP will list on the ASX during June 2015.

http://www.airxpanders.com

Anyone else follow/holding these guys? Product in a nutshell: After a breast mastectomy, if a woman wants to have reconstructive surgery a cavity needs to be created behind the chest muscle in order to fit an implant. The current method of treatment is to insert a saline sack that is then slowly filled via injection with multiple trips to the surgeon over a period of months until the cavity is created. This process is considered to be quite painful for the patient, not to mention time consuming with multiple visits to doctors.

AXP's technology is to insert a "balloon" filled with a CO2 canister behind the chest muscle. The patient is then given a remote control and can slowly inflate the balloon over a period of weeks without having to make any trips to their surgeon for painful injections. There are fail safes built in that limit the amount of CO2 released. The tech is so simple, but to me it seems like a great leap forward. In the US of the 350,000 women who could receive reconstructive surgery only ~120k opt for it because of the discomfort of the procedure (in December in the US the Breast Cancer Education Act was also passed which makes it mandatory for breast cancer patients to be informed of reconstructive surgery options).

AXP predicts that its product will not only take a decent share of the current market but convince a fair portion of the 230k women/year who are not having the procedure to consider it. The rollout in Australia has taken 20% of the market in the first six months, dare I say it would be higher but it's taking AXP reps four months to get around to seeing surgeons, although the market here is very small (about 2% of the US market). Seventy surgeons have trialled the product, and most have moved on to pilot cases. Of the ones who have completed their pilot cases not a single one has dropped out.

The economics of the business are great, they're sitting behind patent protection and I reckon in steady state gross margins of 75%-80% are possible. Tbh I wouldn't be surprised if they get swallowed up by a bigger fish at some point. Stock is hard to come by though if you're trying to get any sort of volume.

Thanks for the write-up. Agree, it looks revolutionary and could transform this segment of the medical world.

How long do they have the patent protection?

In my experience, these medical device companies (the successful ones I looked at, for instance RMD, NAN on the ASX) end up in the 60-70% range with gross margin. Maybe I need to look at a few more but 75-80% is pretty high. Steady state R &D expenses is probably any where from 10-20% (IMO), selling & marketing & admin is usually around 25-30% in these types of companies ( again IMO). EBIT margin, I'd guess would be in the 20s.

Looks like the initial price for this product in Australia is $2,450 from the prospectus. Manufacturing is in Costa Rica (is this risky?), so the Aussie price is probably a bit inflated compared to the eventual US price due to proximity and/or scale? I guess it probably depends how much does the traditional method cost (incl. medical fees) vs. Airxpanders method + medical fees.

At a guess after running some numbers to justify the current valuation I came up with any where between a market share of 100,000 to 150,000 units sold each year. That's using a return on capital invested range of 25-40%. They won't need much PP&E if they are outsourcing the manufacturing, but they will need a fair bit of working capital (inventory + debtors). The funding cycle will need to account for government reimbursement (looks like it's entirely funded by the government in Australia and the USA) and the time that these take to process. Do you think an asset turnover ratio somewhere in the range of 1.6 to 2.5 is reasonable? At 100,000 units they'd need about $100m-150m in assets to support the sales if this was the case. They'll probably chew up another $50m-100m in op-ex to scale up the operation & promote awareness of the product.

That's probably gibberish! My main point is there's a lot of assumptions required here.

Also need to be mindful that they still need to get FDA approval in the USA (which I note seems to be behind schedule).

Competition post patent protection is also important. Can they build a moat in that time frame?

Government reimbursement of the patient's medical costs is also important. If it got cut, is this still procedure viable? (Mind you, it'd take a nasty minded government, you'd think, given this is a touchy subject).

Are there legal ramifications if something goes wrong?

Just some questions and initial thoughts.

Ves said:

How long do they have the patent protection?

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2031.

Ves said:

In my experience, these medical device companies (the successful ones I looked at, for instance RMD, NAN on the ASX) end up in the 60-70% range with gross margin. Maybe I need to look at a few more but 75-80% is pretty high. Steady state R &D expenses is probably any where from 10-20% (IMO), selling & marketing & admin is usually around 25-30% in these types of companies ( again IMO). EBIT margin, I'd guess would be in the 20s.

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CPAP machines are off patent aren't they? RMD seems to be in a fair few other business lines. For a single device manufacturer with patent protection 80% doesn't seem that far fetched. I don't know enough about NAN to comment. Your R&D expense looks pretty high, IMO. Unless AXP are trying to develop new products it's hard to see where they could be putting more than a couple of million/year in R&D.

Ves said:

Looks like the initial price for this product in Australia is $2,450 from the prospectus. Manufacturing is in Costa Rica (is this risky?), so the Aussie price is probably a bit inflated compared to the eventual US price due to proximity and/or scale? I guess it probably depends how much does the traditional method cost (incl. medical fees) vs. Airxpanders method + medical fees.

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The Australian price is at the very bottom end of the price charged for the existing technology in the US. The US price is US$1,700-US$2,200. I don't know but would assume that the medical fees would favour the new tech as there are fewer follow-ups to the surgeon during the expansion process. As a superior product I'd expect them to at least be able to price in the upper of the current price range.

I wouldn't classify Costa Rica as risky. It actually has a very active medical device industry with plenty of big names already established down there.

Ves said:

At a guess after running some numbers to justify the current valuation I came up with any where between a market share of 100,000 to 150,000 units sold each year. That's using a return on capital invested range of 25-40%. They won't need much PP&E if they are outsourcing the manufacturing, but they will need a fair bit of working capital (inventory + debtors). The funding cycle will need to account for government reimbursement (looks like it's entirely funded by the government in Australia and the USA) and the time that these take to process. Do you think an asset turnover ratio somewhere in the range of 1.6 to 2.5 is reasonable? At 100,000 units they'd need about $100m-150m in assets to support the sales if this was the case. They'll probably chew up another $50m-100m in op-ex to scale up the operation & promote awareness of the product.

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How did you come up with that WC number? With a base assumption of 70% margin and 2x inventory/rec turn (which seems low IMO) at 100k units that would require a cash investment in inventory of ~$65m. Receivables will be high, but won't need to be funded by shareholders beyond what is required to pay staff, marketing, taxes etc (the benefits of a high margin business!).

In Australia it is rebatable which means it is on the Federal Government's Approved Prosthesis List, once a device is added to this list all insurers must pay for the device. The process would be that the hospital purchases the device from AXP, or wholesaler, and then seeks to be rebated by the patient's health fund. It gets a bit fuzzier when it's done in the public system (I think ultimately the state government would end up footing the bill), but the overwhelming majority of reconstructions will be done on insured patients. I'd be surprised if private hospitals were working with 180 days credit; RHC for instance is on a maximum 60 days with trade creditors. In the US the private health system will be the largest rebater, not the US government. Again I'd be surprised if they were working on 180 days credit.

Ves said:

Also need to be mindful that they still need to get FDA approval in the USA (which I note seems to be behind schedule).

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I'd be very surprised if the TGA has approved something and the FDA knocks it back. The reverse can happen but generally if the TGA says safe and effective the FDA will say the same.

Ves said:

Competition post patent protection is also important. Can they build a moat in that time frame?

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That's a good question, and one I just don't know. But with 15 years to patent expiry there's enough time for things to play out. One thing worth remembering is that surgeons will be the ones who push their patients toward a suggest device. They are a pretty sticky group of customers. Once they are comfortable using a product, and remembering that they aren't paying for the product, they won't likely switch just because a generic version is available for a few hundred dollars less.

Thanks, 2031 does make sense - if I recall patents are 20 years in the US.

It's possible that I am being overly conservative with some of my numbers here.

Your comment re R&D seems reasonable. Although, it may increase a fair bit once the patent lapses. It's hard to find a long-term medical company that isn't trying to develop new product lines. But for the purposes of valuing the company as a currently known single product entity, you're right 10-20% is too high.

I can't remember which patents Resmed still has open, but given the original mask was patented in the early 90s, it's probably expired.

I was digging through a few of those "industry reports" (you often find on google) on the Medical Device industry and the industry average gross margin was around 60%. Perhaps, as you said, the patent protection will allow them to get into the mid 70s. Do you know if there are any pricing controls applied to patent holders? It seems to me that the medical fraternity and customer won't care, because the government or insurer foots the bill?

It sounds like you're expecting a profit margin (before tax) of around 35-40% during the patent protection period. Correct?

Good point re the relationship between the TGA approval and the FDA approval.

McLovin said:

How did you come up with that WC number? With a base assumption of 70% margin and 2x inventory/rec turn (which seems low IMO) at 100k units that would require a cash investment in inventory of ~$65m. Receivables will be high, but won't need to be funded by shareholders beyond what is required to pay staff, marketing, taxes etc (the benefits of a high margin business!).

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Can you clarify why shareholders won't have to fund the debtors?

My figure is a total asset figure (PP&E, debtors, provisions, inventory etc. ) I basically just multiplied the 100,000 units by $2,450 (AU) and divided by an estimated asset turnover of 2.5 (lower figure) and 1.6 (higher figure).

I'm basically just bouncing scenarios off you, mate. I'm definitely not heavily researched in this area so it's most likely crap.

It's probably one of those cases where you need to value the PP period and then the period after it lapses.

Ves said:

Can you clarify why shareholders won't have to fund the debtors?

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For some reason I got in my head that you had said they would need to raise an additional $150m. Jet lag.

Let me get back to you on the other questions.

McLovin said:

The Australian price is at the very bottom end of the price charged for the existing technology in the US. The US price is US$1,700-US$2,200. I don't know but would assume that the medical fees would favour the new tech as there are fewer follow-ups to the surgeon during the expansion process. As a superior product I'd expect them to at least be able to price in the upper of the current price range.

That's a good question, and one I just don't know. But with 15 years to patent expiry there's enough time for things to play out. One thing worth remembering is that surgeons will be the ones who push their patients toward a suggest device. They are a pretty sticky group of customers. Once they are comfortable using a product, and remembering that they aren't paying for the product, they won't likely switch just because a generic version is
available for a few hundred dollars less.

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The product is clearly good for the patients but is it actually financially good for the surgeon? I can imagine it being good for the insurer as well if the overall cost of care is reduced. I just hope that most surgeons will have enough moral and ethics to suggest this product to their patients.

Or may be there'd be less visits per patient, but overall more patients electing reconstructive surgery.

Ves said:

My figure is a total asset figure (PP&E, debtors, provisions, inventory etc. ) I basically just multiplied the 100,000 units by $2,450 (AU) and divided by an estimated asset turnover of 2.5 (lower figure) and 1.6 (higher figure).

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$2450 is the price of the product... actual working capital would be some fraction of that in terms of COGS.

skc said:

$2450 is the price of the product... actual working capital would be some fraction of that in terms of COGS.

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Aren't asset turnover ratios calculated on revenue and not COGS?

Ves said:

Aren't asset turnover ratios calculated on revenue and not COGS?

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I don't know... but you are concerned with actual $$ required to support the working capital.

Say they need to hold 25,000 units in their inventory. The accounting entry is whatever the accounting rule says, but the cash needed to produce and hold these is 25k x COGS (or ~30% of 25k x $2450 per unit using a gross margin of 70%).

Or did I have one gin and tonic too many?

Ouch! AirXpanders have imploded. From $1.40-ish 18 months ago to 20c today.

A quick look at the most recent financial results shows a US$29 million quarterly loss on US$3.9 million revenue. Today the company announced the resignation of their President and CEO.

I'm guessing a capital raising can't be too far away?

I was in this until about a year ago, but lost interest because of the lack of revenue. My targets were so far ahead that I couldn't justify the price, and the continuing delays meant getting meaningful growth kept being pushed out 12-18 months. They've got a problem that the quality of the product isn't ending up as top line growth. Dodson's expertise seems to be in product R&D/regulatory not commercialisation. In that sense his resignation seems to be a mid-term positive.

When you've got a product like this at some point you need a few big years where sales go ballistic to prove you're on to a winner. They haven't reached that point nor do they look close to it, despite burning $100m or so, and I don't think it's a product failure. Frankly, flat q-on-q revenue growth is unacceptable. With zero visibility as to when this might actually turn a profit it's a very hard investment case to make.

If a cap raising comes, it's going to be very heavily discounted, especially with that debt. With a MC of ~$60m (plus ~$20m in debt) I do think there is a good chance of a t/o. If you can plug a product like this into an established sales channel then good things should happen.