IPO Preview: Advanced BioHealing

| About: Advanced BioHealing, (ABHB)

Based in Westport, Connecticut, Advanced BioHealing (ABHB) is scheduling a $200 million IPO with a market capitalization of $597 million at the price range mid-point of $15 for Wednesday May 18, 2011. The full IPO calendar includes three others for the week of May 16.

SUMMARY: Advanced BioHealing acquired a regenerative medicine business from Smith & Nephew in 2006. In 2010, sales of $147 million were up 72% compared to 2009. March 2011 quarter sales of $44 million were up 47% compared to the 2010 March quarter.

Gross margins are in the 80% range. Adjusted net income for the March quarter was 10% of revenue. Advanced BioHealing shows very good growth, high gross profit margins and high net income margins. However, Advanced BioHealing's business is based in large part on patents. Several key patents are due to expire within the next few years. See ‘Patent Problems’ below.

VALUATION: Advanced BioHealing’s juicy 80% gross profit margins present a likely target for competitors once its key patents expire.

Advanced BioHealing’s price-to-earnings ratio is 35 on an adjusted basis, annualizing the March quarter. A P/E ratio of 35 is about double that of other, larger competitors mentioned in the S-1 filing, including Smith & Nephew (NYSE:SNN) and Kinetic Concerpts (NYSE:KCI). The premium might be justified if Advanced BioHealing did not have expiring patent issues.

ABHB Valuation Metrics

BUSINESS: Advanced BioHealing is a regenerative medicine company whose principal product, Dermagraft, has received premarket approval (PMA), from the U.S. Food and Drug Administration (FDA) for the treatment of diabetic foot ulcers (DFUs).

Dermagraft is a regenerative bio-engineered skin substitute that assists in restoring damaged tissue. From the commercial launch of Dermagraft in 2007 through December 31, 2010, Advanced BioHealing sold over 200,000 units of Dermagraft that have been used to treat an estimated 50,000 patients. DFU patients carry a one-in-seven lifetime risk of developing osteomyelitis, or an infection of the bone, and a one-in-five lifetime risk of amputation, which has an associated 50% five-year mortality rate

Advanced BioHealing acquired the business from Smith & Nephew in 2006. Smith & Nephew acquired the business in 2002.

MARKET: Based on industry sources, Advanced BioHealing estimates that DFUs affect nearly 900,000 people annually in the United States, of which Advanced BioHealing estimates 60% to 70% are slow healers that could be treated with Dermagraft based on its approved indication. As a result, Advanced BioHealing believes the total addressable market opportunity in the United States is approximately $3 billion.

CUSTOMERS & MEDICARE: Customers include hospital-based wound care centers, physician offices, surgery centers and government hospitals. Coverage of Dermagraft for the treatment of DFUs is currently provided by Medicare, more than 1,000 private plans and numerous Medicaid programs.

MANUFACTURING: Advanced BioHealing manufactures Dermagraft using proprietary cell-based techniques that were developed over a 20-year period with significant capital investment. The manufacturing of regenerative medicine products is highly complex and involves a number of regulatory challenges, providing a significant barrier to entry for potential competitors.

Advanced BioHealing manufactures its products in a state-of-the-art facility located in La Jolla, California that is registered with the U.S. Food and Drug Administration, or FDA, and is ISO 13485 (2003) registered.

PRODUCT PORTFOLIO: Advanced BioHealing is currently conducting a pivotal clinical trial to assess the efficacy and safety of Dermagraft in treating venous leg ulcers, or VLUs, and completed enrollment for this trial in November 2010. The company expects to report results from the clinical trial in the fourth quarter of 2011 and, if successful, submit a supplement to the existing PMA for Dermagraft to the FDA in the first quarter of 2012.

Another product, TransCyte, has received premarket approval, or PMA, from the FDA for the treatment of certain types of severe burns. Although Advanced BioHealing has not yet commercialized TransCyte, ABHB believes a potential opportunity exists to market this product through arrangements with state, federal or international government agencies.

GROWTH PLAN: Advanced BioHealing believes the addressable patient population for treating DFUs and VLUs outside the United States is significantly larger than the addressable patient population in the United States. If Advanced BioHealing successfully completes the VLU clinical trial and related one-year follow-on study, Advanced BioHealing intends to file a marketing authorization application with the European Medicines Agency for a VLU indication in 2013. If successful, this approval would grant marketing rights in 30 European countries.

PATENT PROBLEMS: Issued patents are expected to expire on various dates between 2012 and 2021, including two of key patents covering three-dimensional cell, skin and tissue culturing, which Advanced BioHealing uses in the manufacturing of Dermagraft, that are expected to expire in 2012. In addition, a key patent covering production of a temporary living skin replacement, which Advanced BioHealing uses in the manufacture of TransCyte, is expected to expire in 2012

Outside of these key patents, Advanced BioHealing also has eight other supporting patents that acquired from Smith & Nephew related to the manufacturing and shipping of living cell-based products, such as Dermagraft and TransCyte.

Of the remaining supporting patents, Advanced BioHealing expects that two covering a three-dimensional cell and tissue culture system will expire in 2013; two generally covering naturally secreted extracellular matrix will expire in 2015; one covering growth and packaging of three-dimensional cell and tissue culture systems will expire in 2015 and one related patent will expire in 2016; one covering cells or tissues with increased protein factors will expire in 2018 and one covering shipping and storing frozen products will expire in 2021. (See S-1 page 83)

HISTORY: Dermagraft and TransCyte were originally developed by Advanced Tissue Sciences, Inc., a company founded in 1987. TransCyte received a PMA from the FDA for the treatment of certain types of severe burns in 1997 and Dermagraft received a PMA from the FDA for the treatment of certain types of DFUs in 2001.

Smith & Nephew acquired Dermagraft and TransCyte and all related assets from Advanced Tissues Sciences in 2002. In 2006, Advanced BioHealing acquired Dermagraft and TransCyte and all related assets from Smith & Nephew in an asset purchase transaction. The primary consideration in such asset purchase transaction was the assumption and performance of Smith & Nephew’s existing contractual obligations related to the Dermagraft assets, as well as entering into sublease agreements with Smith & Nephew for office, manufacturing and warehouse space in La Jolla, California and payment of a cash purchase price upon closing of the transaction. The acquisition had no effect on the FDA clearance of the acquired products, and Smith & Nephew transferred ownership of the FDA PMA’s for Dermagraft and TransCyte, effective as of the closing of the transaction. Advanced BioHealing holds all worldwide commercialization rights to Dermagraft and TransCyte.

TRADE SECRETS, PATENTS: In addition to trade secrets, know-how and other unpatented technology, Advanced BioHealing also relies on patents to protect its products. Advanced BioHealing acquired most of its key patents related to Dermagraft from Smith & Nephew, which acquired those patents from Advanced Tissue Sciences, Inc.

Thus, most of the patents were not written by Advanced BioHealing or counsel engaged by Advanced BioHealing , and Advanced BioHealing did not have control over the drafting and prosecution of these patents. Therefore, Advanced BioHealing cannot be certain that key patents were properly prosecuted in their respective jurisdictions or that the patents provide proper protection, or any protection, for its products and processes.

COMPETITION: Direct competitors with regenerative medicine products are Organogenesis, Inc., which markets Apligraf, and Systagenix Wound Care Limited, which markets Regranex.

Also, there are alternative diabetic foot ulcer treatments, including advanced mechanical treatments marketed by Kinetic Concepts, Inc. and Smith & Nephew, and traditional 510(k)-cleared wound dressings marketed by, among others, ConvaTec Inc., Johnson & Johnson (NYSE:JNJ), Healthpoint, Ltd., Systagenix Wound Care Limited, Smith & Nephew, Mölnlycke Health Care and The Coloplast Group.

USE OF PROCEEDS: Shareholders intend to sell 5 million shares. Advanced BioHealing plans to sell 8.35 from shares to net $113 million, and plans to allocate the proceeds as follows:

  • $50.0 million to $60.0 million to develop & complete a second manufacturing facility.

  • Balance for working capital and other general corporate purposes.

  • Advanced BioHealing may use a portion to repay the outstanding balance on its term loan in full, which as of April 2, 2011 was $13.3 million.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.