AxoGen Still In The Doghouse, But The Opportunity Is Compelling

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About: AxoGen, Inc. (AXGN), Includes: BAX, IART, SYK
by: Stephen Simpson, CFA
Summary

In addition to a second-quarter disappointment, concerns have started to grow regarding potentially competitive new products from established nerve repair players.

AxoGen's core product still appears to offer superior performance, and usage in its established base is growing at a strong pace.

AxoGen looks undervalued below $40 even as larger competitors seem to be getting more active in nerve repair.

The going hasn’t gotten any easier for AxoGen (AXGN). This up-and-coming med-tech company specializing in nerve repair has spooked growth investors with regard to its revenue growth rate and investors have also grown more concerned over the possibility of more intense competition from companies like Integra (IART) and Baxter (BAX) in the nerve repair market. While all that’s been going on, there seems to have been a general shift away from higher-growth (and higher-risk) stories in the med-tech space.

I’m still bullish on AxoGen, as I believe it addresses a large and under-served market with better products, but sentiment won’t turn around overnight. The 30%-plus long-term revenue growth I expect from AxoGen is hardly conservative, but I do believe these shares can outperform as surgeons become more familiar and comfortable with the procedure/products and increase their orders in the coming years.

Competition Was Always Going To Be A Factor

AxoGen has always had to contend with competition, and future competition was always a part of my underlying modeling assumptions. Integra, Stryker (SYK), and Baxter have been in the market for some time with various conduit and wrap products, and those are the products that most surgeons know best. While AxoGen’s RANGER study continues to support the thesis that Avance allograft offers meaningfully better results, surgeons are generally a cautious bunch and it’s going to take more time for them to shift their procedures toward Avance.

More recently, investors have been factoring in the risk of newer products from Integra and Baxter. The mid-September meeting of the American Society for Surgery for the Hand (or ASSH) saw Integra talking up its NeuraGen 3D collagen-filled conduit. Not only is this product likely to target markets that aren’t core to AxoGen (gaps of less than 5mm), the product has been FDA-cleared for years now and the company has yet to launch. Integra’s historical strength in nerve repair shouldn’t be ignored, but I don’t think this product is likely to represent a significant threat to AxoGen. I’d also note that a poster presentation from Rbia comparing AxoGen’s Avance to Integra’s older NeuraGen product showed better sensory recovery in Avance patients despite a trial design skew that I’d argue should have favored NeuraGen.

Baxter, though, could be a more meaningful threat in the coming years. The company announced a licensing agreement with Japan’s Toyobo to market Nerbridge – a collagen-filled synthetic conduit. Baxter will initially be focusing on conduit lengths up to 25mm, but has the option to go up to 55mm, which would certainly be more competitive with Avance. There’s very little available data on the product, but what early-stage data I’ve been able to find suggested superior outcomes to traditional conduits in sub-10mm gaps, but more or less equivalent outcomes at 30mm. From the comments made by Baxter, it sounds like the company intends to be relatively aggressive on pricing, with a likely list price of around $2,000 versus $1,500 for traditional conduits and $3,900 for Avance.

While price competition from Baxter’s Nerbridge cannot be dismissed (particularly as a better conduit will be a promising option for surgeons who are very comfortable with the conduit approach), AxoGen isn’t helpless here. The company gave an update on its RANGER study at the ASSH meeting, with 87% of all patients showing meaningful sensory recovery and 70% showing exceptional recovery. While the recovery rate does fall with the length of the gap, the 82% recovery rate in gaps of 30mm-70mm is still excellent compared to other options on the market.

Sticking To The Plan

Between third-quarter earnings in late October and the mid-November Investor Day, I haven’t heard anything from AxoGen management that suggests a meaningful shift in the company’s commercialization strategy. Management remains focused on building out its sales force and driving greater utilization in its existing base, while also using training and clinical trials to expand/develop the company’s market potential in pain (particularly ortho and trauma).

Revenue growth returned to a 40%+ clip in the third quarter (up 41%), and I suppose some investors could grouse that the company should have delivered a beat-and-raise to make up for the disappointment in the second quarter. Direct sales were up 50% in the quarter, and not only did the active account base grow 21%, the revenue per account grew 17% as surgeons move beyond their own trialing process and begin using the grafts more in their own practices.

I found AxoGen’s mid-November Investor Day to be more or less a reiteration of what was already known and/or widely-assumed. Management increased its addressable market estimate by $500 million (to $2.7 billion), outlined a plan for three new clinical trials in 2019, and a larger plan to start addressing the large potential market in post-surgical/post-trauma pain (including the launch of Nerve Cap). As a reminder, a significant number of patients (around 10%) undergoing major joint replacement experience long-term pain due to nerve damage that AxoGen’s products can address. AxoGen also continues to support its growth potential in breast reconstruction by expanding its training programs for the ReSensation technique.

I will note that AxoGen set out an initial growth target of 35% or more for 2019 with third quarter earnings (and reiterated that at the Investor Day). That was a modest negative revision relative to where the sell-side was before (the sell-side had been at around 40%), but I don’t believe it fundamentally alters the long-term thesis. Still, the models for early-stage high-growth stories are very sensitive to even minor changes, and med-tech growth investors are seldom patient with even modest disappointments or revisions.

The Opportunity

Although I do think AxoGen will still grow to about $1 billion in revenue over the next 10 years, recent guidance suggests a possibly slower early-stage ramp (if you can really call 35% growth “slow”). I have decided to pull my 2019 revenue estimate down by about 3% and my 2020 estimate by about 7%, but my 2027 estimate doesn’t change (a 0.2% revision). Those changes do lead to lower near-term fair value estimates – from a range of $41-to-$43 to $37.50-to-$41, but I still see significant long-term potential as AxoGen’s sales force matures and as surgeons become more familiar and comfortable with the outcomes that AxoGen’s products can produce.

The Bottom Line

Given that AxoGen is trying to drive a shift in how surgeons operate, I still see above-average risk even though the product/procedure outcomes look compelling. By the same token, I believe investors will be well-compensated for that risk, and I won’t be surprised if a company like Stryker or Baxter buys them out. It’s tough to recommend a higher-risk story in a market that seems to be souring on risk, but this is one of my favorite med-tech names today and one that I still think is undervalued.

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.