I assume most of us are following the latest developments in the 3D printing industry. It all started roughly 5 years ago with bold statements that the 3D printing will revolutionize and transform the retail and biotech industries. At the peak of the hype, companies like 3D Systems and Stratasys reached multi-billion dollar valuations while barely covering their operating expenses. Soon, the stage got saturated and the investing public realised there is nothing proprietary in place to guard the first-movers. The last nail in the coffin, however, came a month ago when Hewlett Packard announced it is about to enter the race.
Logically, a wise investor might prefer to stay away from 3D printing at least until the dust settles and/or superior technology is introduced. Having said that, I want to present you a company developing and commercializing functional, three-dimensional human tissues.
Quick Overview of Organovo Holdings:
Although dated back to late 2014, the video is a neat presentation of the technologies implemented by Organovo Holdings (NYSEMKT:ONVO), their strengths over the alternative methods and possible future applications. As of today, the company is starting to realize revenues from its initial commercial product launched in November 2014 - exVive3D™ Human Liver Tissue while expected to introduce kidney tissue in the following two to three quarters. The company has also entered into various collaborations with academic and pharmaceutical partners - the most prominent of which are the skin tissue agreement with L'Oreal and the bio-ink deal with Merck. In addition, at the closing of the latest conference call, the CEO hinted about possible developments in the research of human therapeutic patches that will be announced in the next 12 months.
Moving to company's financials - due to its nature as an early-stage research company, Organovo has been burning cash since inception. The deficit has been mainly fulfilled by secondary offerings, as well as through various US federal grants. Similarly to the other 3D printing ventures, Organovo is 100% equity funded and currently sitting on substantial cash reserve of over $60m - sufficient to cover the operating shortfall in the following 1.5 to 2 years. Although not consistent Q-o-Q (due to revenue recognition principles), the top lines of the income statement are picking up, realizing three-digit growth that is expected to persist in the future.
Focusing on the management team - a hefty 13.2% chunk of the equity is currently in possession of insiders. Other significant owners include Vanguard, BlackRock and State Street among others.
Since 2007, CEO of the company is Keith Murphy who has a successful track record with other biotechs, namely Amgen and Alkermes. From educational perspective, Murphy's background is also impressive including a B.S. in Chemical Engineering from MIT and a degree from UCLA School of Management. His significant holding in the company combined with relatively young age are closely aligned with investors' best interest. The only concern to shareholders has been the extensive remuneration packages awarded to Murphy.
Recently, the second most-influential person - the CFO Barry Michaels, left the company. Typically, such move would have been be interpreted as a significant negative development as he is meant to have a superior understanding of company's current position and chances to achieve its demanding goals. On this occasion, however, rather than trading his seat for a more lucrative deal, Michaels went for a long time announced retirement while holding his Board of Directors position in Samsara - a subsidiary of Organovo. On the bright side - his salaries and bonuses were in excess of $1m last year; the CFO seat is empty for more than 2 months now which leads to operational savings and possibility of short-to-medium term positive catalyst in case of reputable successor.
Overall, Organovo is relatively small company with current headcount of 115 employees. As the company is shifting from pure research to commercial focus, an emphasis is needed on the sales efforts and representatives of the company. As noted in the past two conference calls, the company has moved to 8 to 10 sales people. At first glance, the sales force looks experienced; once the internally-generated capital starts flowing into the company, Organovo will be able to afford some rock stars and the cycle will be amplified.
Product pipeline and recent developments
exVive3D™ Liver Tissue is company's first commercial application of a series. The product addresses the unmet need for more predictive tissue for toxicology and other preclinical drug testing. Unlike Organovo's competitors, the current service offered is executed and supervised by company's technicians on Organovo's site. A report is submitted to the client once the results are ready. The contract cost is averaging $150k. According to Organovo's presentation attached below - the size of this particular market is $1.3 billion and expected to grow. Advantages of the technology include its ability to capture complex series of interactions with multiple cell types which can be missed by standard 2D or animal models. Other factors to be considered include the longevity of the test as well as its relatively low price compared to the alternatives. The following result from Troglitazone - a failed diabetic drug reiterate the superiority of Organovo's product when compared to the other alternatives:
The second product from the line - exVive3D Kidney Tissue, hit the functional validation milestone back in October 2015 and is projected to be launched three quarters from now. The lack of existing alternatives, particularly effective 2D cell models is even more acute in the kidney than the liver business, which leads to higher forecasted pricing of $250k per contract. The adoption rate of the technology is expected to be similar to the one of the liver tissue.
As indicated in the patent section below, the company is also continuing work in skin tissue development. In addition, in the middle term management hinted about possible development in the therapeutic application that will be revealed in the following 12 months.
Expanding on the long-term, I see the exVive3D series as a transitionary step in company's strategy. I believe Organovo will quickly diversify its tissue portfolio, adding heart and other material to its series. Once these projects start bringing enough capital, considerably more resources could be allocated to development of tissue patches or even whole organs. This market is significantly bigger and underdeveloped compared to the drug testing, with a huge and rising gap between supply and demand. Advancement in the field will revolutionize the medicine and reshape the way we look at and treat various diseases.
The patent war - do not touch my margins
Back in the introduction of this article, I made a parallel between the unfolding struggle of the commercial 3D printing companies and the future course of Ogranovo's revenues and margins. The only factor that can prevent the bioprinting industry from the same miserable fate is a strong patent portfolio.
Here is the comprehensive list of patents held by Organovo. I am neither a lawyer nor having the technical expertise of how these patents can possibly be bypassed by company's competitors, but what I understand is that Organovo has exclusive rights to create engineered tissue with no scaffold present. In addition, the company has obtained the exclusive rights of using ink-jet printer technology to dispense cells and creation of matrices of bioprinted cells on gel materials. These two points are summarizing the underlying technology behind 3D tissue printing and hence should prevent newcomers from entry.
Quoting Organovo's most recent 10K
We own or hold exclusive licenses to 12 issued U.S. patents and 22 pending U.S. patent applications. Outside of the U.S… 15 issued patents and over 90 pending applications…
...meaning company's competitive edge will be clearer once the pending applications are either approved or rejected. Before drawing general conclusions about company's ability to defend its first-mover advantage, let's consider some other risk factors, competitive pressure and possible superior technologies.
Risk factors, competition and technological advancement
Continuing the previous section, a major challenge Organovo is facing is to adequately protect its intellectual property and limit the number of new entrants in the field. The worst possible scenario would be if the company improves its technology through several modifications and once optimization is achieved, a big player, say Pfizer, taps into the market.
Another possible danger is coming from abroad. Considering the importance and vital applications of the technology, competing projects could quickly grab the attention of foreign investors and governments, secure excessive funding in the form of grants and premium debt.
Cutting-edge technologies like tissue-on-chip are also in sight, jeopardize the adoption of the exVive3D series. Universities and companies are working on the idea with prime application - a better drug tester. Due to the early stage of development of both 3D printed tissues and tissue-on-chip, it is hard to compare and evaluate the advantages and disadvantages of the two as both products are dynamically evolving. It is clear, however, that one will be a substitute for the other.
The next major issue is existing competitors producing similar, if not identical, product. As a main rival of Organovo, I identify Insphero AG, a Swiss-based start-up that is attracting attention worldwide. At first glance, Insphero is offering a wider range of products; while working on alternative solutions at a considerably lower price (taking into account the EU-funded grant alone is bigger than all the grants received by Organovo over the past 5 years). Moreover, Insphero has already sealed deals with majority of the leading pharmaceutical companies. Based on the information from various forums and websites, I conclude that Organovo's product is slightly superior when compared to Insphero, but still not good enough to compensate for the significant price difference between the two. Moving to the UK, the publicly listed Cyprotex (OTC:COTXF) is offering 3D microtissue models in addition to a full range of other solutions. Compared to Organovo, Cyprotex's $37m valuation is conservative at least, considering company's robust financial results. In summary, the market is large enough to accommodate all participants if the pharma industry adopts the 3D printed tissues and no better substitution emerges overnight. However, a severe competition might lead to excessive R&D costs and lower selling prices.
For valuation purposes, I will be using Discounted Cash Flow to Equity and a 10 year projection of company's financials. In addition, I will provide you my valuation model so you can do the math based on your assumptions.
My revenue projections are as follows:
- The company will barely meet its revenue guidance for the upcoming financial year of $4-6m; the liver penetration will be limited to 20 contracts; the kidney tissue will be introduced by the end of the year and 2 sales will immediately be recognized
Moving forward, given the relative saturation of alternatives for liver toxicity test, the company will not reach its goal of $100m in annual sales for the product; on another hand, given the higher price and lack of substitutions, the kidney tissue will be significantly more successful, bypassing the initial targets in 7 years
Considering company's numerous projects and potential for future earnings, I included a line "Expected value of a new project". The line reflects the possibility of a breakthrough in either other type of tissues, organ patches or even printing of complete organs. It also reflects possibility of discovering an unknown technology. It is a relatively conservative estimate corresponding to the high level of uncertainty involved
The collaborations are expected to continue in foreseeable future, providing vital capital to Organovo; the federal grants will decay overtime
Moving to the expenses, both lines will increase as a function
- costt + (costt - costt-1)*(1+growth rate)
The model reflects executives' guidance that the growth in expenses will slow down in near future as the R&D for the liver product are already spent, while the kidney project is almost released. The growth in spending is expected to accelerate from 2020 onwards, reflecting the "expected value of a new project" revenue line.
Before moving to the equity calculation, I want to bring to your attention to my Cash Flow Statement projection:
Based on my income statement projection, expected employees compensation scheme and capital expenditure/depreciation of the fixed assets, it appears the company will need two more rounds of funding. The first and cheaper option is debt. However, my base-case scenario is that the management will prefer the equity issuance once again, diluting the equity holders. The suggested share price below is used for dilution calculations only and should not be used as a guideline.
Finally, let's focus on the DCF:
- The company won't pay taxes up to 2025 due to accumulated losses; afterwards, the tax rate is assumed to be 34% flat
- The CapEx is higher than the depreciation reflecting inflation and expansion of operations. However, neither spending on fixed assets or current assets/liabilities is expected to be significant for company's valuation
- The number of shares outstanding reflect 1) the dilution due to employees compensation; 2) the dilution following two consecutive secondary offerings expected in 2018 and 2020
- The discount factor is in excess to the 7.49% implied by the current market conditions (company's beta is 1.17, the bond yields are at record lows, and the implied market equity risk premium is 5.04%)
- The perpetual growth is expected to be negative; the assumption behind is that once optimized, the technology will attract new comers. Moreover, new, more advanced technologies will be introduced in 10 year period
As shown, even based on relatively conservative assumptions, the share price of the company appears depressed, offering 34.7% upside potential. This time I will skip the sensitivity analysis as the model will be uploaded.
Possible short term catalysts that could potentially unlock the value of the company include updates on the kidney tissue development, the advancement on the therapeutic application or other factors causing a short squeeze due to the relatively high level of short flow in the stock.
To wrap it up, Organovo is an exciting company, offering game-changing technology with numerous applications. At the same time, the level of uncertainty an investor is facing is considerably higher compared to an average small cap company. If you find such level of risk suitable for your portfolio, inclusion might be a good idea. However, considering the lifespan of company's projects coupled with the dynamic developments in the field, the deviation from intrinsic value could persist for an extensive period.
Disclosure: I/we 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.