Senior Biotechnology Analyst Jason Napodano of Zacks Investment Research specializes in uncovering small biotech and medtech companies with good prospects for successful drug development. He relishes proven management capable of creative financing to move private equity into the public markets, and he does not shy away from tiny companies outside the U.S. that have extraordinary technology. In this wide-ranging interview with The Life Sciences Report, Napodano presents the elegant growth stories of small companies that could return magnificent gains to investors.
The Life Sciences Report: Jason, you follow some companies that are not domiciled in the U.S. Are there special considerations or concerns that investors should be aware of before investing in stocks outside U.S. markets?
Jason Napodano: I cover a number of Canadian companies, one Switzerland-based company and one Israel-based company. Listing and liquidity are probably the two biggest hurdles that investors need to overcome with regard to companies outside the U.S.
The readers of Zacks Investment Research reports are primarily retail investors. The first hurdle for retail investors is finding a broker who allows them to buy a stock that is trading on the Toronto Stock Exchange [TSX] or the SIX Swiss Exchange.
Then there are tracking stocks. Some are company-sponsored, but others are Pink Sheet stocks not sponsored by the company. Retail investors have to be careful. You might want to buy a foreign-listed company that you can't acquire on its primary exchange, but there may be a U.S. OTC-listed tracking stock available. You have to make sure that you're buying company-sponsored stock-either the American depositary receipt or the tracking stock-and that you're not buying a vehicle set up to follow the stock price that, in the end, may not follow the price at all.
The third issue is differences in accounting and reporting standards. The U.S. is one of the few countries using generally accepted accounting principles [GAAP]. There are different standards in Canada and Europe. Some European companies only report twice a year, as opposed to the U.S., which reports quarterly results. Financial statements may look a little different than what you see in the U.S. Investors need to be aware of how and when companies report. Those are nuances investors need to be aware of when they are looking at foreign companies.
TLSR: Are there arbitrage opportunities available when trading international stocks, or is this beyond the scope of the average retail investor? Can hedge funds do it?
JN: Hedge funds probably could do it, because they can get in and out quickly and they have access to information that could allow them to play that arbitrage. However, I'm a pretty big believer in efficient markets. Individual investors may or may not be smart, but the market as a whole is pretty smart. If you have a stock listed on the TSX.V and the last trade there is $5.25, while the U.S. OTC stock is $5.15, you might be able to play some sort of arbitrage. What makes it difficult is the liquidity of the OTC. Can you short a stock on the TSX.V and long the same stock on the OTC? Does your broker allow you to do that? A lot of retail investors are not going to participate in this type of trading, but I wouldn't doubt that there are hedge-fund guys out there who try to capture that arbitrage.
TLSR: Jason, what about a reverse merger? You're familiar with this mechanism. Tell me what it is and why it is done.
JN: In a reverse merger, a private company acquires a public company. In most instances the public company has failed-either filed for bankruptcy or gone out of business-and its assets are substantially gone. But the public company provides the private company with a way to go public via the ticker symbol. When these private companies do become public, they typically change the ticker symbol because they may not have acquired a company in their industry. A reverse merger may involve a failed real estate investment trust [REIT], Internet venture, retailer or oil and gas explorer. The deal is done, and the new company is trading on the OTC.
TLSR: Does the Securities and Exchange Commission [SEC] require an S-1 in a situation like this, when a private company is obviously just acquiring the ticker symbol that it's going to change?
JN: Yes, it does. There are some regulations, but fewer than in the typical initial public offering [IPO] process. You asked why a company would do this. It's a heck of a lot faster and less expensive. If you're a small, private biotech company and you don't have the capital-or maybe the trial data or the awareness-to do a fully marketed IPO with a big-name investment bank, you can get a reverse merger done in three to four months at significantly lower cost. An IPO may take 6-9 months or longer, and costs more money.
When a company goes public via a reverse merger, management typically controls the process and doesn't give up ownership to the public markets immediately. The reverse merger allows management to bring the company public and then decide the terms and timing of the S-1 filing and the initial financings, as opposed to coming public via an IPO, where ownership of the company is offered on day one. Many private companies go public via a reverse merger with the founders, management and bankers owning 90% of the shares; they only float whatever they need to acquire the company, which may be less than 10% of the shares. Typically what happens is the stock begins to trade, and then management files an S-1, registers the rest of the shares and raises capital.
TLSR: I surmise that these reverse merger deals are vehicles that private equity people use to create shareholder value more quickly in the public markets. Is that indeed the case?
JN: Absolutely. Sometimes reverse mergers get a bad rap because there is not a lot of information available to investors, and not a lot of liquidity. I sift through the murky water that surrounds reverse mergers and try to pick out the gems. Investors may have to look at 20 before they find one worth investing in, but if they can find one, they can get in early on what is potentially an enormous opportunity.
TLSR: Let's go ahead and talk about some of your ideas. Go ahead.
JN: Since we're talking about reverse mergers, I'll talk about two that have been successful. I'll start with InVivo Therapeutics Corp. (NASDAQ:NVIV), which I started covering in Q3/11 at $0.64. It is now about $5.50/share. InVivo has a biodegradable scaffolding for patients who have experienced acute spinal cord injury. The company came public without a lot of fanfare. It had private equity backing, and it had a lead investor. I got involved with the story and loved it.
TLSR: The reverse merger, in this case, saved time and was capital-efficient. Is that part of the story here? What made InVivo a candidate for reverse merger?
JN: The reverse merger was a value creator here. InVivo was a good candidate for the technique because it had preclinical data but didn't have a data package that would generate interest among big investment banks for an IPO. The company needed to come public to raise money more efficiently. After its initial financing, InVivo was able to generate additional data and control that process better. New data have come out since the merger, and that has sent the stock up six-fold. A lot of investors would shy away from a situation like InVivo's, but there was incredible value and opportunity here, and it's proved out a winner.
TLSR: InVivo Therapeutics' technology platform is a biodegradable polymer scaffold that you can seed with human neural stem cells. You could also put medication, like a corticosteroid, into the scaffold. Where are we now in this project's development, and what are the catalysts?
JN: The company just received U.S. Food and Drug Administration [FDA] approval to begin its first human clinical study with the device alone. It will not be seeding the scaffold with cells, and no drug is eluting off it.
This trial should start sometime in Q3/13. It will be a small pilot study-a humanitarian use device [HUD] study, which means that if the company can generate good safety and feasibility data, it could get its device on the market with just that study. Acute spinal cord injury patients are a small population, and nothing is available for them. If the study goes well, the company can file a humanitarian device exemption [HDE], which is essentially the medical device equivalent of an orphan drug designation.
For medical devices, you don't do phase 1/2/3 studies, as you would in drug development. You do what's known as an investigational device exemption [IDE] or a pilot study, which is the equivalent of a phase 1. Next is a premarket approval [PMA] study, which is essentially the equivalent of a phase 3 trial. InVivo is doing the equivalent of an IDE; it's called an HDE because of the orphan indication. The company could get to market with the scaffold platform for the orphan indication if results are positive. To expand the label into much larger populations, InVivo would have to go back and do a PMA trial.
TLSR: With this HDE, there has to be some clinical benefit derived from the scaffold, even without seeded cells or a drug-eluting process. What possible efficacy could come out of just the scaffold alone?
JN: Under the HDE guidelines, you must demonstrate safety, no harm. There's not a lot to demonstrate in terms of efficacy.
In terms of what the device can do by itself, the company talks about the body's response to acute spinal cord injury, inflammation, which gives rise to scarring. This can push on the spine, causing long-term damage and paralysis. InVivo's procedure involves stabilizing the spinal column with pedicle screws, and then the customized scaffold is cut and placed over the wound in the spinal cord. Cutting and placing the scaffold takes only a few minutes and is done by the spinal surgeon during the stabilization procedure. It's very efficient, and so far looks to be very safe.
The device is designed to act as a shield and protect the spinal cord from the body's own inflammatory process. As the body's inflammatory response subsides, the scaffold degrades, and you don't get that secondary scarring and injury that InVivo believes is the cause of the majority of the paralysis.
TLSR: Who will be the patients? What is their status coming into this study?
JN: Patients have what's known as an AISA-A [American Spinal Injury Association classification] injury-complete paralysis with no motor or sensory function at or below the injury. Safety will be the primary endpoint, with ASIA impairment score data as secondary endpoints. If paralysis and loss of sensation are complete, any improvement should be attributable to the device, because typically these patients do not progress. If the company can say, "We protected that patient from further damage," or is able to show touch sensation on pinprick testing, improved bladder function, or improved lung function, it will be attributable to the scaffold device. That will have to be confirmed in PMA pivotal trials, but the orphan indication allows the company to expand on that initial ASIA-A population by selling the product on the market. One final thing worth noting: The trial is with only five patients and open-label in design, so we should start to see data shortly after the trial starts.
TLSR: Jason, there was another reverse merger company that you wanted to talk about. What is it?
JN: It's Organovo Holdings Inc. (NYSEMKT:ONVO). The reason I like to talk about InVivo and Organovo together is because the same private equity team, banking team and lead investor brought both companies public.
Organovo is developing a three-dimensional [3-D] bioprinter. It came public in early 2012, which is when I started coverage, and it was trading at $1.55/share. Today, it's more than $6.30. The business development team has another home run, a fourfold win, with Organovo. On July 12 the company uplisted from the OTC to the NYSE.MKT. This listing on a major exchange allows for greater visibility and credibility with institutional investors. The stock nearly doubled on this news. This is the ultimate kind of success for a reverse merger.
TLSR: Anywhere you turn today, you hear about 3-D printing. What is Organovo doing with it?
JN: Organovo is developing a bioprinter to create 3-D biological structures for use as bioassays. Other companies are collaborating to see what can be accomplished with these 3-D bioassay structures.
TLSR: The company is developing a 3-D liver model as a hepatic toxicity screen, presumably for drug developers. Is that its lead development project? Is the idea that a 3-D liver structure will have more of a liver organ phenotype than hepatic cells floating in suspension or in a dish?
JN: Yes. When you plate what's known as two-dimensional [2-D] liver cells in a dish, they begin to stop functioning as liver cells within 24 hours. You start with a dome-shaped cell in the dish, and within 24 hours it begins to flatten out and lose interaction. If you're a large pharmaceutical company and want to test a drug for liver toxicity, you only have the ability to test on viable liver cells for those 24 hours. With Organovo's 3-D liver cell assay, you can build structures that are 20-25 cells high. Because of this more phenotypic shape, the liver cells still behave like in vivo liver cells at five days. Because they are surrounded by each other, they build connective junctions and work in concert to produce enzymes and perform other normal functions of liver cells.
TLSR: This sounds like a premium-priced product line. What is the value proposition for the pharma customer?
JN: Organovo's process is to create a simple assay kit built in tiny microwell plates, ranging from 24, 48 or 96 wells per kit. Each microwell will contain little 3-D livers, which it then sells to pharmaceutical companies. Drug developers can use Organovo's product to get up to 144 hours of data, and not just the 24 hours that 2-D assays allow.
Using Organovo's product, a pharma could protect itself from spending a lot of money to bring a drug to phase 3 only to have the drug fail because of liver toxicity-or worse, bring a drug to market and then have it pulled off the shelf because of toxicity. From a pharmaceutical company's standpoint, it's a risk-reward calculation. It may cost more to buy these assays from Organovo, but one phase 3 trial could cost $25-50 million [$50M]. There is a real value proposition here, and I think Organovo can start generating revenues as soon as next year.
TLSR: What about using different cell types to build other organ models as toxicity screens?
JN: Liver toxicity is the No. 2 largest reason for drug failure. The No. 1 cause is cardiovascular toxicity. But this first development project at Organovo makes sense, because liver tissues can be grown, and liver is the only organ that can regenerate itself. Starting with liver, the company can map out the process and gain traction with its first product offering. Then it makes sense to create 3-D lung, kidney and cardiac assays.
In recent conversations, the company has talked about building oncology models as well. It has been expanding its research capabilities in this area, having signed collaborations with ZenBio Inc., the Knight Cancer Institute at Oregon Health and Science University, and even software maker Autodesk Inc. I can't tell you what the next product will be, but I know Organovo wants to create a suite of biological toxicity and oncology assays that it can take to large pharma. It will definitely expand once it qualifies the process.
TLSR: Your next thought?
JN: I have mentioned the banking team, the private equity group and the investors who brought Organovo and InVivo public. What I didn't mention is that this team brought another company public, Prolor Biotech Inc. (NYSEMKT:PBTH), which I do not cover. Just to give you a sense, Prolor was less than $1/share in 2009, and it was recently acquired for more than $6/share, more than $500M. These guys know what they're doing. I've found a banking team and a private equity group that is three-for-three in grand slams.
TLSR: We talked about foreign investment earlier, and you seem very comfortable with it. I know you follow Canadian companies too. You've done quite well with one called Cipher Pharmaceuticals, Inc. (CPHMF.PK) [DND:TSX], haven't you?
JN: Yes. Cipher is based in Mississauga, Ontario, and I initiated coverage on it at $0.96 two years ago. The stock is at around $6.60 today. I'm up almost 650% on this small Canadian pharmaceutical company. I'm the typical U.S. investor-skeptical of any company that is not in the U.S.-but I dug into this name and found it sitting on a potential gold mine.
Cipher has an improved formulation of isotretinoin, which is the most commonly used prescription acne medication. It licensed the drug to Ranbaxy Laboratories Ltd. (OTC:RBXLY) [RANBAXY.NS], which markets the product as Absorica. Cipher markets the product as Epuris in Canada. The sales are unbelievable, and it has only been on the market for a couple of months. Every time I see the IMS Health numbers, they exceed my expectations. I just put out a note to Zacks investors and titled it, "Yes, I'm Raising my Estimates on Cipher Again." It has been a wonderful growth story-a true diamond in the rough.
TLSR: Jason, this has been terrific. Thank you.
JN: I appreciate that. Thanks a lot, George.
This interview was conducted by George S. Mack of The Life Sciences Report and can be read in its entirety here.
Jason Napodano is senior biotechnology analyst for Zacks Investment Research. In 2009, Napodano was promoted to managing director of research for Zacks' Small-Cap Research division, which focuses on writing high-quality institutional research on underfollowed or undervalued small-cap stocks. Prior to his tenure at Zacks, Napodano spent three years on the buyside with Eastover Capital in Charlotte, N.C., where he focused on large-cap equities and specialized in healthcare, energy and technology. Prior to joining Eastover, Napodano worked as a research scientist for TechLab Inc., a biotechnology company focused on developing diagnostic kits and vaccines for infectious diseases. He also spent a year working in a lab at the Fralin Biotechnology Center, and a year working for a cancer researcher in Virginia. Napodano has a bachelor's degree in biochemistry from Virginia Tech, with an additional bachelor's degree in chemistry and a minor in math. He has a master's degree in business administration and finance, with a concentration in securities analysis, from Wake Forest University. Napodano is also a Chartered Financial Analyst [CFA].
1) George S. Mack conducted this interview for The Life Sciences Report and provides services to The Life Sciences Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Life Sciences Report: None. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
3) Jason Napodano: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. Zacks has or seeks to have a financial relationship with the following companies mentioned in this interview: InVivo Therapeutics Holdings Corp., Organovo Holdings Inc., Prolor Biotech Inc., Cipher Pharmaceuticals Inc., Ranbaxy Laboratories Ltd. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.