Seeking Alpha
Long only, special situations, contrarian, research analyst
Profile| Send Message| ()  

Our desire to invest in companies that are not exposed to the vagaries of the global macroeconomic situation often leads us to invest in more "exotic" companies than we otherwise would. But none of the companies that we have ever invested in, or even come across, can match the uniqueness, the potential, or the risk of the company that we will be discussing in this article: Organovo Holdings (ONVO).

Overview

Organovo is a San Diego-based company that specializes in 3D bio-printing. The company was founded in 2007, and went public via a reverse merger earlier this year. The stock trades on the OTC, but plans are in the works to move up to the Nasdaq once the company's financials strengthen (more on that later). Organovo produces the NovoGen MMX Bioprinter, which was introduced in 2010 as the first commercial 3D bioprinter. For readers unfamiliar with bioprinting, it is the creation of living human cells and tissues via the use of 3D printing technology. Organovo really is creating human cells and tissues from scratch, and that alone lets the company claim the prize of truly being the most unique company that we have come across. Since they began trading this year, shares of Organovo have been on a wild ride, soaring to nearly $10 in June, before falling back to below $2. As of this writing, shares of Organovo trade at just over $2. So, is now the time to buy shares for the long-term (we are exploring Organovo's long-term potential and risk, not its short-term trading potential)? In this article, we will explore Organovo's potential, its risks, and its financial state, analyst coverage, and the competition the company faces.

Organovo Today and its Future Goal: Creating Organs from Scratch, and Making Apple's Returns After 1997 Seem Quaint

In investing, there are often key events that, in hindsight, were the buying opportunities of a lifetime. Apple (AAPL) in 1997 was such an opportunity. As Apple spiraled closer and closer to bankruptcy in 1997, its stock plunged as investors ran for the exits. Steve Jobs has stated that Apple was 90 days away from filing for bankruptcy when he returned to the company.

Investors who took a risk and bought Apple shares in 1997 and held them through today have made around 18,000% over the last 15 years, as Apple has made what many business historians see as the greatest business turnaround in history. And yet, it is important to remember one key fact: Apple has accomplished everything it has on the back of consumer wants, not needs. While Apple is our largest individual position, and we remain bullish on the company, it is important to keep in mind that aside from the use of iPads in the treatment of autism, Apple's products are, frankly speaking, not necessary to daily life. iPhones, Macs, and all of Apple's other devices do make life easier, but they are not necessities. Many people on this planet will go their whole lives without ever seeing an Apple product.

Organovo, however, has a product that, if successful, will be a true necessity. In the United States alone, 18 people die each day waiting for organ transplants that never occur because of a shortage of donor organs. Organovo, if it truly can begin creating organs, will be able to solve this issue, and make billions in the process. We do not think that the life-saving potential of this technology can be overstated. Organ donor shortages are among the most vexing healthcare problems for governments around the world, and Organovo has a real chance of fixing this issue. Furthermore, because Organovo's technology utilizes a patient's own cells to create tissues (and someday, organs), the risk of donor rejection is lessened dramatically. If Organovo can succeed, we think that Apple's 18,000% return will seem quaint by comparison. The unmet need here is enormous, and investors who are willing to hold Organovo stock for years (this is a true long-term bet; the ability to create organs could be something for the next decade) have a chance to double their money many times over. But, given the fact that the possibility of organ creation is years away, what is the company doing today? Can Organovo even survive long enough to have a chance at creating human organs? We believe that the company has a decent chance of survival.

As Organovo marches towards a future of organ creation, the company is not standing still. Its technology can do more than save the lives of organ transplant patients. Organovo has the potential to change the way that drugs are created and tested. Ideally, pharmaceutical companies would be able to test all compounds in humans, to determine if they are safe and effective. Given that 90% of drugs fail to make it to market, pharmaceutical companies waste billions each year moving drug candidates into human trials only to find out that they are either ineffective or unsafe in humans. For obvious ethical reasons, it is impossible to test drug candidates in humans at all stages of development. Enter Organovo. By utilizing its NovoGen technology, Organovo can create tissues for use in pharmaceutical research, thus allowing scientists to see how compounds affect real human tissue at any stage of the developmental process.

(click to enlarge)Organovo creates tissues by stacking layers of cells on top of each other. The concept of bioprinting relies on a central principle of cellular biology: that cells self-assemble via the binding of their surface proteins. Under the right conditions (as shown above), larger clusters of cells will fuse together to create more complex structures, and this process continues until a final sample of living tissue is created. Organovo's bioprinting technology is not limited to a single type of cell. As Zacks highlights in its report on Organovo (more detail on that later), Organovo can create multiple types of cells.

(click to enlarge)The NovoGen printer can create layers (example A), tubular cells (example b), cells with custom thickness, size, and shape (example C), or even branched structures (example D) in 5-7 days. Organovo's technology solves 2 of the major problems in tissue creation. The first is that the cells it creates are surrounded by other cells, which means that this 3D structure allows them to behave as if they were in a real body. Secondly, because Organovo uses natural cellular material to generate tissues, cells are not exposed to foreign materials, thus allowing them to build their own extracellular support matrices.

In its research report, Zacks argues that the advances in tissue creation that Organovo has achieved allow the company to revolutionize two markets. Zacks writes that Organovo has the potential to:

"Produce highly specialized three-dimensional human tissues that can be utilized to model a specific tissue physiology or pathophysiology. The company has demonstrated the ability to create human blood vessel constructs and to create fully human tissue containing capillary structures. This has the potential to broaden the scope and scale of 3D tissues that can be generated, and to facilitate the development of disease models in such areas as cardiovascular disease, oncology, and fibrosis."

Furthermore, Zacks says that Organovo can:

"facilitate biological research through absorption/distribution/metabolism/excretion (ADME) testing used to determine which factors enhance or inhibit how a potential drug compound reaches the blood stream. For example, distribution of a compound can be affected by binding to plasma proteins; age, genetics, and other factors can influence metabolism of a compound; and the presence of certain disease states can have effects on excretion of a compound. Many companies perform ADME studies utilizing various cell-based assays or automated bioanalytical techniques."

Organovo's technology holds a great deal of research potential. And that potential is already being realized. In 2010, Organovo struck a partnership with Pfizer (PFE), under which the company is set to earn $450,000 in revenue. The deal is set to run through the end of 2012, and most observers expect the deal to be extended and enlarged to include more milestone and royalty payments to Organovo. The company has a second corporate deal with United Therapeutics (UTHR), which was inked in October 2011, and is set to last for 30 months. Under the terms of that deal, Organovo will utilize its bioprinting technology to conduct research on treatments for pulmonary hypertension. So far, Organovo has recognized $618,000 in revenues from its deal with United Therapeutics. In addition, "Organovo granted United Therapeutics an option to acquire from a worldwide, royalty-bearing license in certain intellectual property created under the research agreement solely for use in the treatment or prevention of pulmonary hypertension and all other lung diseases. If enacted, the license would provide for certain milestone payments and minimum annual royalties and sales-based royalties to Organovo."

Organovo may be unprofitable today (all early-stage biotechnology companies are), but this is not a company with some "pie in the sky" idea. The technology here is real, and Organovo is already generating revenues from the use of its NovoGen bioprinters. As time goes on, we expect more collaborative deals to be signed, giving the company the financial strength it needs to move itself closer to the promise of organ creation. Organovo is growing to meet the needs of today and tomorrow. Its newly built headquarters in San Diego has three times the capacity of its old headquarters, giving the company room to expand its research and development efforts. Organovo's first major leap occurred in 2010 when the NovoGen printer was created. Its next major leap forward is set for 2015. By that point, the company expects clinical trials on the use of its artificially created blood vessels to be complete, thus allowing them to be used as grafts in bypass operations. That would represent an incremental step towards the company's long-term goal of organ creation. As we stated earlier, an investment in Organovo is likely one that will truly pay off in the next decade, for it will take years for the company to advance its bioprinting systems to the levels needed to create something as complex as human organs.

Organovo may be small. It may be unprofitable. And it may be early in its corporate life. But we have seen few, if any, companies that hold as much promise as Organovo. If the company can create human organs from scratch, it will save countless lives, both here in the United States and around the world. And Organovo's technology is already being used in pharmaceutical research, where it has the potential to save companies billions of dollars, by allowing them to know early on which drug candidates to invest in, for Organovo's artificial tissues are as close to human testing as pharmaceutical companies can get to true human testing. We do believe that if Organovo is successful, its investors can, over the long run, see returns that can easily rival that of Apple over the past 15 years. But, investors should not let this cause them to forget a crucial fact: that, at this moment, Organovo is a very speculative, very risky stock.

The Risks: Is Organovo the Webvan of 2012?

Webvan was one of the most spectacular failures of the dot-com bubble, and was actually named by Cnet as the biggest flop of that era. Webvan, for readers unfamiliar with it, was a San Francisco based company that promised same-day delivery of consumer products. The company went public in 1999, raising $375 million, and was worth $8.45 billion on its first day of trading. Webvan's IPO was the largest offering that occurred during the fourth quarter of 1999. Webvan was never able to attract enough customers to its platform. That, combined with a massive spending spree, including $1 billion worth of warehouses, caused the company to file for bankruptcy in 2001, costing its investors everything (the Webvan brand was resurrected by Amazon in 2009).

Could Organovo be the next Webvan, a company with a great idea on paper, but one that costs investors everything? It is certainly possible. Organovo is unprofitable, and there is no clear timeline for profitability. Unlike traditional early stage biotechnology companies, there is no clear pathway to profitability. There is no drug candidate whose approval and market launch will bring cash in the door. Profitability will depend on when Organovo's technology is at the stage necessary to create organs that can live inside the human body, and that is something that cannot be truly timed. Creating "simple" tissues is already a complex process, and while artificial organs have been created from scaffolds before, full human organ creation has never been done via bioprinting (however, Wake Forest University is using bioprinting to create prototype kidneys). Bioprinted organs are years away, and there is no certainty that Organovo will survive long enough to see the day when artificially produced organs are a reality.

Compounding the risk of investing in Organovo is the fact that there are no options available for the stock, which means that investors are unable to hedge themselves via puts. Organovo's stock, while active for an OTC stock, is still thinly traded, with average daily volume over the past three months coming in at just under 224,000 shares. It is possible that should investors find it necessary to sell their shares, they will be unable to do so. While Organovo's SEC filings state that it has enough capital to fund its operations for the next 12 months, there will come a point in time when Organovo will need to dilute its stockholders to raise more capital. Investors need to be prepared to have their stakes diluted, likely more than once, as Organovo works to build its technology.

An investment in Organovo is a speculative one, and while we do believe that the potential gains are large, there is a real chance that investors will lose their entire investment in Organovo. No one can say with certainty that Organovo will be able to create fully functioning, transplantable organs, and as such, this stock must be treated as a speculative investment. No investor should commit capital to Organovo that they are not prepared to lose completely. No amount of technological promise can mitigate the risks of investing in this company. Investors considering buying shares of Organovo need to keep that in mind, as well as the fact that it will take years to realize meaningful profits in Organovo. For some investors, the time period necessary to profit will simply be too long.

The Financials: More Than Meets The Eye

As a reminder, Organovo went public via a reverse merger earlier this year, and the company does file full financial statements with the SEC. Organovo is unprofitable, but the company is growing its revenue, even if it is off of a small base. In Q2 2012, Organovo posted $258,975 of revenue, an increase of 49.373% over Q2 2011. The increase was due to revenues from the United Therapeutics deal. For the first six months of 2012, revenues grew by just 1.151% over the first six months of 2011, due to the fact that Organovo recognized $100,000 in product revenue during the first six months of 2011. As Organovo signs new collaborative deals, its revenues should continue to grow.

Organovo's GAAP income statements are essentially useless when it comes to evaluating the company's financial state, due to the warrants it holds on its balance sheet. As part of its financial restructuring and public market debut, Organovo issued warrants to its investors for 16.75 million shares, with a life of five years and a strike price of $1 (these warrants are callable if the company's stock trades above $2.50 over a consecutive 20-day period). The liability that Organovo puts on its balance sheet for these warrants rises and falls alongside Organovo's stock price. In Q2 2012, as Organovo's stock rose, its warrant liability rose by almost $34 million (Organovo values these warrants using a Monte Carlo options model), causing Organovo to post a loss of 82 cents per share (or $35.385142 million), even though the company's operating loss came in at $1.449569 million. The methodology for valuing these warrants also means that Organovo will post a GAAP profit for Q3 2012, as its stock has slid down to around $2, therefore requiring a readjustment in its warrant liability. Investors are better served tracking Organovo's cash flows to determine its financial state. Organovo burned $5.414181 million in operating cash flow during the first six months of 2012, and over $8.7 million since the company was founded in 2007. We should note that Organovo will receive $16.75 million in cash if/when its warrants are exercised.

Organovo's balance sheet, however, is relatively healthy. The company has almost $8.5 million in cash & equivalents on its balance sheet, and no interest-bearing debt. Organovo's warrant liability currently stands at $80.577088 million, but that figure will drop when the company posts its Q3 results. Organovo recorded a $32.53 million charge when these warrants were issued in Q1 2012, and investors need to keep in mind that these warrant adjustments are non-cash in nature. Organovo will likely have a secondary offering within the next 12 months to strengthen its financial profile, and while that may be dilutive, investors in early stage medical companies need to accept that as a fact of life in this sector. Organovo ended Q2 2012 with 43,722,483 outstanding shares, and 75.4 million fully diluted shares, after taking into account the company's warrants and equity incentive plans. We believe that Organovo's financials are similar to that of other development stage medical companies. The company is burning cash, yet it has no interest-bearing debt, and it will likely finance itself with further stock offering until profitability. In this regard, Organovo is not a unique company.

How Many OTC Companies Can Claim Analyst Coverage?

Organovo trades on the OTC, yet it already has one research firm covering it. Zacks initiated coverage of Organovo in August with an outperform rating and a $3.25, which implies upside of 58.537% from current levels (this target reflects the company's fundamentals today, and should rise considerably if Organovo demonstrated that it can create viable human organs). Zacks' price target is based on a DCF model that stretches out to 2022, with profitability set for 2018. According to the DCF model used by Zacks, Organovo's revenues will grow at a CAGR of 57.95% over the next 10 years. Zacks expects that Organovo's first commercial product will be a liver toxicology assay kit, set to launch in 2014, and the firm notes that new assays add "tens of millions in potential." Zacks' estimates do not take into account the potential of transplantable organ creation. Were those to be included in the DCF model, we believe that the results would be quite different.

The fact that Organovo already has analyst coverage shows that the market, at the very least, recognizes that this company has a great deal of potential (but also a great deal of risk). As the company receives more press coverage, it is possible that more analysts will assume coverage of the stock, and that could, on its own, cause the company's stock price to spike.

Competition?

We should note that Organovo is not the only company working on creating transplantable organs. Tengion (OTCQB:TNGN), based in Winston-Salem, North Carolina, is developing a neo-urninary conduit for patients who have had their bladders removed due to medical necessity (usually due to bladder, abdominal, or pelvic cancers). Currently, patients who have their bladders removed receive new ones made of their bowel tissues. Tengion's goal is to instead create and produce a bladder via artificial tissue that will then divert urine away to a disposable bag outside the body. Tengion specifically lists organ creation for transplants as a long-term opportunity for the company. However, Tengion uses traditional scaffolding, not bioprinting in its "manufacturing" process, which could give Organovo the long-term advantage. That being said, Tengion's neo-urinary conduit is already in Phase I trials, and it has a neo-kidney augment in the preclinical stage of development. It would seem that Tengion is farther along in the process of creating artificial organs than Organovo. But, in business, being first is not always what matters. Having the financial strength to survive matters just as much.

Tengion was founded in July 2003, yet has never had a single dollar of revenue. Organovo, has posted revenue of over $2 million since its founding in April 2007. Tengion does have $10.323 million in net cash on its balance sheet, as opposed to almost $8.5 million for Organovo, but it burned $12.64 million in operating cash flow during the first six months of 2012, and almost $167 million since 2003. And while Organovo is making plans to move to the NASDAQ, Tengion was de-listed this month, and began trading on the OTC exchange on September 6. Companies are supposed to move up from the OTC, not to it. That being said, investors need to watch Tengion closely to see what the company is doing, for we do not think it is appropriate to write Tengion off at this point in time, even if its financial state is weaker than that or Organovo.

Conclusions

We have never come across a company with as much potential or risk as Organovo. If it can begin creating human organs, Organovo will revolutionize the medical industry, and save the lives of patients all across the world. And Organovo is already making an impact in the world of pharmaceutical research. Organovo's opportunities are vast, but so are the risks. There are no options available to hedge an investment in this company, and the pathway to profitability is uncertain. And Tengion is a factor that investors should not ignore. Over the next few days, we will be taking an even closer look at Organovo to see if there is a place for it in our portfolio. Investors who have room for speculation in their portfolios, and are prepared to hold the stock for years, should also consider adding to or initiating positions in Organovo. At this time, we do not know whether or not we will be buying shares of Organovo. But, we do know this: we will be following Organovo closely in the months and years to come, for we have never seen a company as unique, or as potentially life-changing as Organovo. This company has a chance to solve one of today's great medical challenges, and we hope that Organovo is successful, so that someday, no one will have to wait for an organ transplant.

Source: Organovo: Like Buying Apple In 1997, Or Like Buying Webvan In 1999?

Additional disclosure: We will be conducting more research into Organovo over the next several days to determine whether or not we will invest in the company.