Derma Sciences: A Not Well Followed Growth Company With Solutions For Diabetic Foot Ulcers

| About: Derma Sciences (DSCI)

Investment Perspective in Brief

Derma Sciences (NASDAQ:DSCI) presents an unusual and attractive biotechnology investment situation. We are all aware of the binary outcomes of critical phase III trials in which a successful outcome usually leads to a dramatic increase in stock price (perhaps several fold), but failure can lead to a 50% or greater decrease in price. As there tend to be more failures than successes, it is always difficult to make a risk adjusted decision to buy a stock facing a binary outcome.

DSCI will report critical phase III results for its wound healing drug DSC-127 in mid-2015 or early 2016. The upside potential is substantial in the event of success, but the downside risk if it fails is enormously reduced. Why? Because the Company has an attractive business based on advanced wound healing products that should achieve sales of $45 million in 2014 and has the potential for long term growth of perhaps 30+% based on its current product line. Key to this business segment are some innovative products sold by an effective and steadily expanding sales force; this makes DSCI an attractive partner for smaller companies looking to sell or license their products. Because of this I believe that advanced wound healing could grow faster than the projected growth of 30+% based on current products.

Treatment of Diabetic Foot Ulcers Drives the Company

Derma's advanced and traditional wound care products can be used for all types of wounds such as ulcers resulting from diseases, surgical procedures, burns and injuries resulting from trauma. However, its greatest focus and opportunity lies in the treatment of difficult to treat diabetic foot ulcers. In the US, over 20 million people have diabetes and the annual incidence of diabetic foot ulcers is about 1.3 million. Derma estimates that its advanced wound care products are applicable to 300,000 to 500,000 cases annually which develop into serious conditions for which the cost over the course of one to two years of treatment can be $20,000 to $40,000.

Diabetic foot ulcers cause significant morbidity and can potentially be life threatening conditions if they become infected. It is estimated that they cause 100,000 amputations per year. The five year mortality rate following amputation can be 45% to 55%. This compares to a five year mortality rate of 35% for metastatic colon cancer.

Derma Sciences may offer the most comprehensive line of products used for treating diabetic foot ulcers of any US company. The legacy business that was the original basis of the Company was based on commodity bandages sold through distributors. However, about seven years ago, the Company switched strategies and began to develop more innovative and proprietary bandages and also decided to set up a direct sales force (this was a critical decision) which made the Company an attractive partner for smaller companies looking for a marketing partner. This has led to the addition of three highly innovative products in the last six years: Medihoney wound dressings, TCC-EZ total contact casting and the recently in-licensed AmnioMatrix skin substitutes.

DSC-127 is a High Potential Product in Phase III

So one part of the investment story is advanced wound care business and the strategically important direct sales and marketing effort. The other is DSC-127, a novel biological drug for the treatment of wounds. DSC-127 is an analog of the naturally occurring protein, angiotensin. The role of angiotensin in controlling blood pressure is well known and has been the basis for the development of major drug classes involved in treating hypertension and congestive heart failure. More recently, it has been found somewhat unexpectedly that angiotensin is also involved in wound healing. A key aspect of DSC-127 is that it can enhance the wound healing effects of angiotensin without affecting blood pressure. Derma Sciences in-licensed DSC-127 and technology on which it is based from the University of Southern California.

Clinical studies have suggested that DSC-127 upregulates mesenchymal stem cells at the site of injury, which plays a significant role in wound healing. DSC-127 increases keratinocyte production, the predominant cell type in the epidermis or outer layer of the skin. It also increases the extracellular matrix in the underlying dermis which provides structural support for cells and is important in communications between cells. It also increases the deposition of collagen the main protein (the glue) in the extracellular matrix by six-fold. It affects multiple biological functions.

The aim of DSC-127 treatment is to start the process of healing; it is used acutely rather than chronically. In clinical trials, it is given topically for four weeks and is then followed by standard of care. DSC-127 is being developed initially to treat diabetic foot ulcers. It is also being studied for scar prevention, radiation dermatitis, and radiation exposure due to nuclear attacks (under a BARDA grant).

Price Target Thinking

DSC-127 is a very novel approach in an area with great unmet medical need; the phase III clinical results for DSC-127 should be available in mid- 2015 or early 2016 and, if successful, the product could be launched in early 2017. As with most biologicals, this is a binary event that provides huge upside if it is successfully developed, but is a high risk development project. The differentiating aspect of DSCI as an investment is that the wound care products business, in my opinion, makes DSCI an attractive long term investment even if DSC-127 fails.

This note is a summary of a much more in-depth report that appears on my website. In that report I argue for a 2018 price target of $20 to $27 under the assumption that DCC-127 fails in phase III and development is abandoned. I further suggest that with success in the phase III trial that the stock could sell at $31 to $45 in 2018. The reason that I focus on this somewhat distant year of 2018 is that by then we will know if DSC-127 is commercially successful (or has failed) and the price will reflect whichever of these two outcomes emerges. This is based on detailed sales models that I have built.

Disclosure: I am long DSCI. 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.