Regenerative medicine has grabbed the world's attention of late, with the promise of curing - instead of simply treating - debilitating and life-threatening diseases. The field is undoubtedly progressing with three stem cell therapies now approved for commercial purposes, and the long-awaited first human clinical trials using embryonic stems cells by Advanced Cell Technology (OTCQB:ACTC) well underway. Despite the hard fought gains on the clinical front, however, I show in this initial article on the Stem Cell Sector that investors, by and large, have not been lining up to take part in this medical revolution. In fact, a key point of this article is that the sector is absurdly undervalued compared to its potential market value, and current developmental stage.
Therefore, I will discuss three issues over a series of articles to appear in Seeking Alpha. Specifically, I will provide investors with an overview of the sector, show why the sector is beginning to make a rapid turnaround in investors' minds, and finally, give recommendations on how to best profit from the coming stem cell revolution over the course of this series. This first article provides an overview of the general scientific and economic trends within the sector.
There are over 50 public companies claiming to be active in the stem cell sector today. However, the vast majority of these companies have market caps significantly less than $20 M, and a number of companies have no clinical activities to speak of. As such, I compiled a final list of 18 publicly traded companies (MSB.AX, OSIR, OTCQB:NVIV, PSTI, CYTX, ACTC.OB, TIG.BR, NBS, ATHX, FCSC, EHP.L, CUR, STEM, OTCQX:CMXI, BCLI, ASTM, OTCQB:ISCO, and OTCPK:RCLL; arranged in order of descending market cap) that should be of interest of investors as a means of gaining exposure to this sector. I choose these particular companies because they all have significant ongoing clinical activities, and the market caps that didn't fall below my predefined level of "patently absurd risk" (i.e., $20 M).
General Trends within the Stem Cell Sector
The lead clinical candidates across the sector were centered on either cardiovascular diseases (44%) or CNS disorders (28%) (Figure 1). The remaining lead indications were essentially evenly divided amongst cartilage regeneration, dermatology, GVHD, oncology, and retinal diseases. Coupled with the lead clinical indications, the most popular sources of stem cells are adult bone marrow/blood and neural tissues (Figure 2). Interestingly, embryonic sources are only being used by one company (Advanced Cell Technology), which is undoubtedly linked to the ethical concerns surrounding human embryonic stem cells in general. Even so, ACTC has gone out of its way to assuage ethical concerns regarding its use of embryonic sources with its patented single-cell blastomere technology. Nevertheless, it is worth noting that all other stem cell companies have decided to forgo dealing with the ethical problems associated with embryonic stem cells, despite the fact that they are the most potent.
To gain insight into the developmental stage of the sector, I combed through each company's clinical pipeline and noted the stage of their most advanced clinical candidate (Pre-clinical, Phase I, II, III, or approved by a regulatory body). Of these 18 companies, three were still bogged down in pre-clinical work before progressing to human trials, and only one company had a single ongoing Phase I trial. Nevertheless, the considerable clinical progress of the sector in general is clearly illustrated by the fact that ten companies have now pushed their lead therapies into Phase II trials, and another three have therapies in Phase III (one is suspended due to inadequate financing-see below). Moreover, three therapies have now been approved by regulatory bodies in recent years, showing the marked development of the sector as a whole. It is also important to note that the vast majority of these companies have multiple ongoing clinical trials, and I am simply noted their most advanced stage. I expect the industry to see a wealth of Phase III trials over the next few years, along with more regulatory approvals.
Another intriguing finding is that the combined market cap for these 18 companies stands at a paltry $3.6 B. To put this number in context, the three public anti-obesity drug companies (ARNA, OREX, and VVUS) alone have a market cap of approximately $3.4 B. Even more surprising is that the stem cell sector actually has three therapies (ChondroCelect, laviv, and Prochymal) approved by Western regulatory bodies, whereas the anti-obesity space only has two (Belviq and Qysmia). Moreover, a single stem cell company (OTCQB:ACTC) places the potential market value of its retinal program alone somewhere close to that of the entire obesity space in 2012 (i.e., $30 B), showing a marked mismatch between the sector's market cap and its potential value.
In order to gauge the "health" of the sector, I regressed company market cap (x-axis) versus its current PPS (y-axis). A sector in good working order should exhibit a positive relationship between these two variables, i.e., market cap and PPS should be coupled. Nevertheless, no relationship exists between these two variables within the stem cell sector (slope = 0, r-squared = 0.00427). This lack of a trend between market cap and PPS is likely due to a combination of two factors: 1) Companies within the sector relying on a high degree of dilutive financing to fund their daily operations, and 2) Strong resolution among shareholders to hold in spite of the dilution, thus holding the market cap steady. Overall, the market cap of many stem cell companies hasn't changed much due to outright selling pressure; rather share counts have increased dramatically over the lives of these companies. I believe this is a clear general trend within the stem cell sector (e.g., ACTC, PSTI, etc.), and explains the next major trend within the sector.
Namely, 44% of clinically active stem cell companies trade on exchanges with either low reporting requirements ("OTC") or non-American exchanges with much lower liquidity. This trend becomes overwhelming skewed when including the plethora of stem cell companies with market caps below $20 M. Even more problematic is the fact that a handful of the companies currently on major exchanges, such as Nasdaq, are currently failing to meet listing requirements, and may therefore have to perform reverse splits to avoid a delisting. As such, it's entirely possible more companies will slip off of major exchanges into the OTC markets, where it is undeniably harder to raise capital.
Taken together, I believe all of these trends point to the fact that the sector as a whole is tremendously underfunded and undervalued, especially by institutional investors (i.e., many of these companies have effectively zero institutional support). The reason for this under appreciation in my view has been the utter reliance on dilutive funding by stem cell companies. Pluristem, for example, ran into serious trouble with its shareholders after initially reporting positive trial results, diluting shareholders upon the subsequent spike in PPS, and then failing to report the death of a 7-year old girl treated in the trial months later. The company reported that she initially improved and they viewed this as a "success" for their cell therapy. Nevertheless, many investors viewed this as a reporting violation, leaving a stain on the sector as a whole.
Unfortunately, the lack of broad retail investor, institutional support, and private investments is having a detrimental effect on the sector. Specifically, Aastrom Biosciences, Inc. and Athersys have therapies in advanced stages of clinical development, but have had to curtail their business and clinical activities for financial reasons. Advanced Cell Technology has literally had to shelve multiple potential therapies, and instead focus solely on retinal disease due to a sheer lack of funding. That is indeed disappointing for patients suffering from debilitating diseases such as ALS, Acute Myocardial Infaction, Critical Limb Ischemia, among a host of others.
In conclusion, the stem cell sector is growing rapidly on the clinical front, but investor sentiment has remained lukewarm. The investors that got in early have generally remained loyal to their companies, but the sector has failed to attract a broad base of investor support thus far, evinced by the absurd market cap of these 18 companies combined.
In the next article in this series, I will discuss how non-predatory private and institutional investors alike are just now becoming more active in the sector, and hence, why the sector should start to outperform over the next few years.