There are days when the news that comes out of the stock market makes you want to rip the router out of the wall and just forget about stocks for a couple of days. Thursday, August 8th was one of those days as the FDA delivered a sharp kick to the collective groins of Wright Medical (NASDAQ:WMGI) shareholders with a nearly impossible-to-justify rejection of the company's application for the Augment orthobiologic product.
If there was any good news, and that's a big "if", it was that most analysts were not fully incorporating Augment into their numbers for Wright Medical. Consequently, the rejection is not devastating from a numbers perspective. Moreover, it's still at least theoretically possible that the company can find a way to get this product on the market eventually, where it could still be a multi-hundred million dollar product. For now, though, investors would do well to think about Augment on par with getting included in the will of a wealthy uncle you didn't even know you had - the FDA has made it clear that that Augment will reach the U.S. market more or less over its dead body.
A Shocking Decision, But Then Again It's The FDA
Things were going pretty well for Wright Medical. The company had reached an agreement to sell its sub-scale major joint recon business to MicroPort and was gaining share on the likes of Tornier (NASDAQ:TRNX) in the fast-growing lower extremity space. Augment was going to be the cherry on the sundae, giving the company a highly valuable product to penetrate the approximately 45,000 annual ankle fusion procedure market, to say nothing of follow-on applications.
All of that was scrapped Thursday night, as the FDA not only issued a "non-approvable letter" to the company, but in it stated that the company included the wrong patients in the study and would have to conduct a brand new full-scale clinical trial before obtaining approval.
This decision is shocking on multiple levels. Remember, the original study of Augment (a recombinant protein) was launched over four years ago, with the FDA having significant input into the study design. While the FDA has now tried to claim that the study was too low-risk, nearly 50% of the patients receiving Augment were obese, one-quarter were smokers, more than 20% had had a prior surgery, and more than 10% had diabetes. The average age was north of 56 years, the mean BMI was just below 31 (the cut-off for clinical obesity is 30.0), nearly one-third had primary arthritis, and more than 8% had rheumatoid arthritis.
This was the largest-ever study done of ankle fusion procedures, and while I'll acknowledge that this patient population was not a "train wreck" group, it was hardly a low-risk population or unrepresentative of the intended market. Perhaps the FDA wanted the study done with only obese smokers aged 70 years or more, but the agency had the opportunity to insist on that more than four years ago, at the 2011 panel meeting, and with the first rejection in 2011. Instead, the FDA has chosen to wait until August of 2013 to complain about the trial population - a suspicious delay in my book.
It's also well worth noting that the FDA's own panel of experts thought Augment was good enough in 2011. All three votes (efficacy, risk/benefit trade-off, and safety) were in Augment's favor (10-8, 10-8, and 12-6) and while there were some concerns about the chosen endpoints and the efficacy of the product, the panel still gave it the thumbs up.
The FDA Clearly Has A Problem With Augment
All of that said, it has been equally clear to me that the FDA has it out for Augment. The FDA's representative at the panel meeting, Nona Colburn, went so overboard in her criticisms of Augment that she was actually chided on the record by one of the panelists (this doesn't happen very often at panel meetings). Moreover, the company (BioMimetic, at that time) publicly stated that she had been uncooperative and uncommunicative in their dealings.
Once again, consider the nature of the objections raised back in 2011 when the FDA rejected Augment despite the favorable panel vote. The FDA tried to claim that CT scans were unreliable and the readings needed to show consistency between the original reading and a third-party radiologist (but refused to specify how much consistency was needed). The FDA wanted cell-based assays to detect neutralizing antibodies and stratification by patient population. Last and not least, the FDA wanted ALL secondary surgeries labeled as Augment failures - even when the surgery was due to the need for a completely unrelated event like a screw removal or screw failure.
If the FDA wants to count screw failure as failure for Augment, it's pretty clear that the FDA is out to screw Augment and Wright Medical. I would assume this is due to the embarrassing post-approval problems with Medtronic's (NYSE:MDT) Infuse. Not only was Infuse used widely off-label, but it turns out that there were numerous significant side-effects in company-sponsored trials that were not reported to the FDA. All told, it doesn't appear that Infuse works much better than a bone graft, but carries potentially significant side-effects. Suffice it to say, this has been a huge black eye for the FDA and it looks like Wright Medical now has to pay the price, even though the products are different.
The argument for Augment has always been that it was just as effective as a bone graft taken from the patient (autograft), but would spare the patient the pain and risks tied to that surgery. Thus far, every clinical study has backed up that conclusion, and the company was intending to price Augment on par with the autograft procedure - basically meaning that patients would be spared the pain and infection risk of the procedure, and doctors could save the time of the procedure with no loss in revenue.
Now it's highly uncertain that Augment will ever see the light of day. There is an appeals process that the company can use, and management said during the conference call that the agency "encouraged" them to explore this avenue. Appeals seldom work, but it's worth a shot. It's less clear that the company will launch another pivotal study - it would require tens of millions of dollars and multiple years to complete, and I have little doubt that it would change the FDA's mind.
In the meantime, Wright Medical is flush with cash ($500M-plus on hand) and has a strong and rapidly-growing lower extremity orthopedics business. That gives the company ample scope to acquire more businesses/products, including perhaps some already-approved biologics. With large rivals like Johnson & Johnson (NYSE:JNJ) and Stryker (NYSE:SYK) more focused on the trauma side of extremities, there is room to gain share in reconstruction (organic or through M&A) and Wright could still find itself as a M&A target itself.
The Bottom Line
Stripping out Augment still leaves Wright with the potential to grow at a double-digit rate on both the top line and free cash flow line for the next decade. Removing Augment does take about 10% to 15% out of my fair value, but that still leaves the stock about 10% to 15% undervalued today, with further downside to Augment hard to imagine. As an aside, the value of the contingent value rights (NASDAQ:WMGIZ) does imply that the market still sees a roughly 20% chance of approval for Augment.
It's certainly unfortunate that the FDA has rejected Augment, but it doesn't destroy the bull case for Wright Medical. While losing Augment takes away one of the marks of distinction relative to a rival like Tornier, Wright Medical is still worth watching for its ongoing sales force restructuring/improvement and double-digit lower extremity growth.
Disclosure: I am long WMGI. 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.
Additional disclosure: I am long WMGI and WMGIZ