NovoCure: Losses Continue To Cause Dilution Overhang As Optune Has Long-Term Potential

| About: NovoCure (NVCR)


NovoCure has developed Optune, a very promising and growing treatment for patients suffering from GBM.

Additional domestic coverage gains and overseas opportunities result in solid growth, yet the company continues to bleed money.

While losses have come down, the cash burn continues to be alarming amidst shrinking (net) cash balances.

Despite the upcoming financial troubles, Optune has great growth opportunities, certainly if it can be applied to other tumors as well, making it a potential takeover candidate in my eyes.

So far, it has been a painful ride for investors in NovoCure (NVCR). Since going public in October of 2015, when shares were sold to the general public at $22 apiece, it has gone all downhill for investors who have suffered severe losses. While the company has been able to share some good news as of late including greater coverage, good research results, potential growth in Japan and continued sales growth, actual revenues are falling short to cover the bills.

While NovoCure's Optune solution looks very good and revenues are consistently growing, NovoCure will run out of money in 2017/2018 at this pace, unless revenue growth picks up dramatically. This creates tension for investors as the company is borrowing at heavy rates already, while any equity offering would be highly dilutive at these lower levels.

On the other hand, a takeout could always be among the possibilities as Optune looks promising for its current indication, while it could over time be applied to numerous other fixed tumors as well, making it potentially a very appealing takeover candidate.

Who Is NovoCure?

NovoCure has focused on the development, production and commercialization of products, which can treat solid tumors. The therapy on which these developments are based is called ¨TTFields.¨ This is a low-toxicity anti-mitotic treatment method, which uses low-intensity and intermediate frequencies to impact molecules within cancer cells, thereby disrupting cell divisions.

The TTFields offers another methodology to treat solid tumors. Until now, these tumors are normally attacked by either surgery, radiation or pharmacological therapies. The company believes that TTFields offer a valid alternative next to current treatment procedures.

Since its founding in 2000, the company has spent hundreds of millions to develop this therapy as the company went public in October of 2015. With the issuance of 7.5 million shares at $22, it reaped net proceeds of another $150 million to boost the developments of this therapy.

The first system that the company brought to the market on the back of TTFields was the Optune system, approved by the FDA in 2011 for the treatment of glioblastoma brain cancer. Optune was approved in Europe in 2014 and Japan a year later. In 2015, Optune was furthermore approved by the FDA for newly diagnosed glioblastoma brain cancer together with temozolomide.

The market for GBM is estimated at 27,500 patients being diagnosed in the US, the largest European countries and Japan. Treatment has proven to lengthen the average life of patients by a few months, boosting the 2-year survival rate to 48%, compared to 32% for the control group. While Optune was approved for GBM and newly diagnosed GBM, the company is researching the possibilities to apply the same treatment for various other fixed tumors, although most of these studies are still in Phase I/II.

Steady Growth, Heavy Cash Burn

Optune saw real momentum following additional FDA approval in November of 2015. The company received 557 prescriptions in Q4 of 2015 for 1,777 prescriptions that year. Note that there were just 605 patients in therapy at the end of 2015. The company derived product revenues of $33.1 million from Optune that year, equivalent to $55,000 for each patient at the end of the year. With the costs per month ranging from $14,000 to $20,000, and average treatments lasting roughly 9 months, it is obvious that longer treatment periods can provide a big boost to NovoCure.

Gross margins came in at 38% in 2015, for gross profits of $12.5 million. The issue is that operating expenses came in at $116.5 million, revealing that the business lost $100 million that year. Fortunately, the company ended 2015 with $270 million in net cash, sufficient to finance these losses for 2-3 years. The 85 million shares ended 2015 trading at $20 per share, valuing the company at $1.7 billion, or at $1.4 billion net of cash being held.

The issue is that despite the reported growth, NovoCure became a ¨victim¨ of the wider biotech/pharma sell-off, which rocked the markets in early 2016. Shares halved in the period of just 6 weeks. In February, shares had fallen back to just $12 per share, causing investors to lose half their money.

First quarter revenues for 2016, as reported in May of last year, revealed that revenues grew to $13.1 million with gross profits amounting to $5.1 million. Continued elevated operating expenses resulted in a $32 million operating loss as net cash balances shrank to $213 million. The number of active patients on treatment rose from 605 in Q4 of 2015 towards 797, with 755 prescriptions received during the quarter.

The second quarter results, released in August were disappointing. Prescription numbers fell to 657, as the number of active patients rose by 94 to 891, for revenues of $17.9 million. Operating losses grew further towards $37 million, as net cash balances fell to $176 million. With shares having fallen towards $8, the market value of the firm has fallen to $680 million, or $500 million net of cash.

Growing losses and sequential declines in prescription numbers were cause for concerns, as the company admitted that prescription numbers fell on the back of competitors starting trials for their candidates, reducing the patient population for NovoCure.

In early November, the third quarter results were released as prescription numbers recovered slightly to 690. At the time there were 985 patients on treatment, roughly 104 more than in Q2, generating $21.7 million in revenues. As gross margins expanded to 48% and expenses were somewhat controlled, operating losses shrank to $28 million, being an encouraging result as net cash balances fell to $140 million, with the company resorting to loans.

At the start of 2017, the company released preliminary fourth quarter results. The number of prescriptions rose to 706, as 1,091 patients were being treated, some 106 more than the end of Q3. Based on these numbers, I think that revenues might come in at around $24 million, as operating losses might shrink slightly.

The problem is that operating losses still come in at a rate of $100 million a year, while net cash balances are rapidly approaching the $100 million mark, leaving just a year to resolve the cash burn situation with no quick solution in sight.

What Now?

At $7, NovoCure is still a business valued at $600 million ex-cash, on track to generate $100 million in sales from Optune seeing large opportunities. Of the nearly 1,100 patients being treated at the moment, 835 are on treatment in the US, a market that has 12,500 diagnoses each year. As the company only has coverage for 130 million out of roughly 300 million residents, it reaches an effective market share of 15% (835 patients * 300/130/12,500).

The good news is that the developed global market has 27,500 patients, as the company is still very small in Europe and is not generating sales in Japan yet. Furthermore, the company can benefit from wider coverage. United Health announced in November that coverage would start on January 1, 2017, adding another 45 million patients being covered.

If we assume a 30% penetration rate across the globe and 67% insurance coverage ratio, the patient base could grow to 5,500 patients down the road. Based on the current revenue numbers and patient population, that suggests revenues of $500 million a year. Applying a 5 times sales multiple to this, as being normal for a medical device/pharma company, a valuation of $2.5 billion would be attainable, equivalent to $30 per share.

This back of the envelope calculation does not even assume additional upside from coverage for other treatments as these are still early in the research process, yet it assumes no further dilution as well. The latter assumption can be challenged of course given the losses at the moment. The issue is that the company is losing money and capital is required. Loans that are entered into by the company already carry a 10% coupon as issuing stock at these levels is not ideal either.

So in essence, NovoCure has a very interesting solution, but simply not the capital or ways to find capital without diluting investors a big deal, making it an interesting prey in my eyes for a larger and resourceful competitor. That being said, additional coverage decisions are very helpful as I will continue to closely watch the developments into 2017.

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.

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