T2 Biosystems (NASDAQ:TTOO) T2 Magnetic Resonance ("MR") technology, powered through their T2Dx Instrument, is a diagnostic system that can do a variety of blood tests from inserted panels. They just had a big launch in mid-2018 for the T2Bacteria which got FDA approved in May 2018 that was supposed to be a "game changer". But it is becoming a commercial flop like other bacteremia (bacteria in the blood) testing diagnostic systems before it. You can see that TTOO still has very meager sales and huge losses every quarter.
We have nothing against progress and early-stage companies attempting to develop breakthrough medical technologies. However, when such a company is not the first mover in its market, they better have a superior product. Unfortunately, for TTOO, it appears that this is not the case. We believe our research shows that TTOO has no real competitive advantage in a crowded space with significant established players. In its 2014 10-K, TTOO listed five competitors and in its 2018 10-K, it listed eight (Becton, Dickinson and Co. (BDX), bioMerieux (OTCPK:BMXXY), Bruker (BRKR), Accelerate Diagnostics (AXDX), Luminex (LMNX), GenMark (GNMK), Cepheid, and Beckman Coulter). There are some big players in this list.
We, at White Diamond Research, are continuing our rampage of exposing mediocre medtech device companies. In the past 8 months, we have exposed the mediocre medical devices of Viveve Medical (VIVE), TransEnterix (TRXC), Helius Medical (HSDT), and Apyx Medical (APYX). All four of those companies have stock prices that are considerably lower today than when we first published our reports on them.
We interviewed a couple of physicians who are experts in the field of sepsis testing. From the information we collected from them, we realized that TTOO's T2Dx is also a mediocre medical device. We learned why the company is having a hard time selling it to hospitals.
A major fundamental problem with the T2Dx is it doesn't matter whether the result is positive or negative in detecting bacteremia, the clinical procedure remains the same. The patient still needs to be treated with a broad spectrum of anti-biotics until more testing is done. Therefore, the T2MR test has little practical value and isn't worth the high cost of the device for the vast majority of hospitals. We provide evidence in this report.
T2 Biosystems was a creation and start-up of Prof. Robert Langer and his coworkers at MIT. Langer is an insider in the top political and business circles and is envied by his peers for his larger-than-life academic achievements.
Yet, Langer has a bad reputation on Wall Street for his failed startups that went public. This article, for example, states:
However, that big dollar figure is based on each company's value at IPO, and four of those five Langer-founded companies have lost a lot of that value since going public.
The article refers to the failed Bind Therapeutics and cautioning investors on the fresh IPO of Selecta Biosciences (SELB), which went public in 2016, right after the article was published. How has Selecta performed since this article's warning? Patient death and pericardial effusion in its Phase I trial, the resignation of its CMO and stock dilution resulted in a precipitous drop of stock price from $14 at its IPO to $2 today. TTOO has gone on a similar downward trajectory, from $11 in its IPO in 2014, to $22 later that year, to as high as $9 in 2018, to around $4 today.
Right after the market closed on February 27, TTOO announced that the FDA has granted "Breakthrough Device" designation for its T2Resistance panel. In response, the stock went up 30%+ in the after-hours, increasing TTOO's market cap by about $50M. This is after the stock had suffered a 5% loss on the day. There's no justification for this kind of rally from this designation. We believe that, at best, the stock should've risen 3% on the news. The designation doesn't increase the value or perceived value of the device that would increase future sales, which is what really matters. The only positive from it is the T2Resistance panel might now get approved a little bit quicker.
As explained in this article from MedCity News:
The Breakthrough Device designation was instituted in 2016 and is meant for products that are meant to address or diagnose life-threatening or irreversibly debilitating conditions. Since the program has been introduced, 110 devices have received the designation and eight products have received approval through the regulatory pathway.
As stated above, a whopping 110 devices have received this designation since it was instituted in 2016. That implies that the designation is given liberally and isn't much of an accomplishment. The article further states:
Benefits from the Breakthrough Device designation include early and more frequent contact with the FDA in an effort to collaborate and streamline development and regulatory approval.
While devices that receive the breakthrough designation will still need to meet the high premarket approval standard of safety and effectiveness, the FDA said it is willing to "accept a greater extent of uncertainty of the benefit-risk profile for these devices" dependent on the post market controls and the need for patients to have earlier access to the device.
What the above shows is the designation will allow TTOO to get more attention from the FDA regarding the device, in order to get it approved more efficiently and earlier. But the designation doesn't say anything about its safety and effectiveness. This certainly doesn't mean that TTOO can expect to sell more of these devices due to this designation once it gets approved.
This is also confirmed in TTOO's own PR. It states:
The Breakthrough Designation allows T2 Biosystems to work closely with the FDA during the premarket review phase to ensure patients can have access to the benefits of this innovation as soon as possible.
Furthermore, TTOO management already expected it to get approved soon. This Breakthrough Designation news would be even more insignificant if it was already expected. In the Q318 earnings call, the company's CEO John McDonough stated regarding the T2Resistance Panel (referred to as the T2 CARBA resistance plus panel in the call):
We met the Allergan milestone ahead of schedule and now plan to make it available to research customers in the first half of 2019.
This panel has already been discussed by management and is expected by shareholders to be available in 1H19. It's only expected to be available for research use only ("RUO") in the US and receive CE Mark for commercial availability in Europe later this year. This won't allow TTOO to sell this panel commercially in the United States, and it can only be used for research studies.
The following are TTOO's select financials over the past three years:
Source: TTOO SEC Filings
For the past three years, TTOO's sales numbers have been dreadful, and quarterly losses have been very high. And, the company's device sales numbers are even worse than they seem on the surface. TTOO's research revenue was much higher than its product revenue in 2018. In fact, TTOO doesn't separate the two in its interactive data financial filings anymore. Note that in the long form 10-Qs and 10-Ks, the different types of revenues are always separated between product and research revenues. However, starting in Q218, in the short form Interactive Data 10-Qs, the company stopped separating the two types of revenues and started bundling them together.
This is illustrated in the screenshots below:
Source: SEC filings
Source: SEC filings
One might wonder why management suddenly decided to combine the two types of revenues into "total revenue" in Q218 in the interactive data SEC filing, when they've never done it before. We aren't going to speculate on management's intentions. That's for the reader to form their own opinion. But we will note that, in Q218, research revenue was more than double product revenue, as shown in the financial data above.
Even though research revenue was more than double product revenue in Q218, in the Q218 earnings call, the CEO barely discusses the research revenue at all and where those funds go. He just discusses the much more important product revenue. Research revenue isn't sustainable. It's generally for temporary research projects, and once those projects are finished, the research revenue stops. It's also not revenue that the company keeps. It goes straight to R&D. For example, TTOO received a one-time, $1.3M milestone payment from its partnership with Canon in Q218.
On top of the miniscule sales numbers, TTOO has $44M in debt and pays a usurious, "venture capital" rate of 12.5%, which will perpetually add to the company's considerable cash burn. The stinging interest expense is shown in the financial table above.
TTOO filed a $100M mixed securities shelf on 10/15/18. We believe the company will run out of cash soon, likely in the next 2-3 quarters, so we expect the company will opportunistically access this shelf. We believe it would be a good time to do a secondary now on this rally.
Upon speaking with physicians, we have found the reasons why hospitals aren't buying the T2Dx Instrument on a widespread basis.
TTOO brags on its website about much faster identification time for bacteria in blood in comparison with Standard of Care - Blood Cell Culture ("BC"). Investors may think, therefore, that this rapid, yet expensive test will eventually replace old, slow, ineffective BC. This is not true, however. In practice, once a patient is suspected of sepsis, the patient is immediately administered a bundle of broad-spectrum antibiotics. Once the causative pathogen has been identified, typically through BC analysis, the antibiotic regimen is peeled back so only the required therapies continue to be administered.
Indeed, as stated in this peer-reviewed clinical publication from March, 2018, co-funded and reviewed by TTOO, among four limitations of the study, two relate to technology fundamental weaknesses: inability to detect all bacteria types and inability to provide antimicrobial susceptibility - both require the BC test.
From the publication:
Second, as the pathogen coverage by the T2Bacteria Panel is restricted to only six bacteria, this assay is not intended to replace culture methods.
Third, T2Bacteria cannot provide antimicrobial susceptibility information, thereby making it necessary that it is integrated into a diagnostic algorithm that includes susceptibility or resistance should patients continue to deteriorate in the presence of targeted therapy based on T2Bacteria's results….
This explains the lack of commercial interest in T2MR tests. Running this expensive test does not change the clinical practice, which requires running a BC test. Few hospitals see value in the T2Dx instrument, given its expense, complexity and additional resource wasting on the false-positives of this test.
A physician with a background in sepsis and bacteremia, who we interviewed, confirmed the above. He said running tests like the T2MR technology doesn't change the clinical practice of putting patients on a broad spectrum of antibiotics. He said:
Whether the patient has bacteremia (bacteria in the blood) or not, doesn't change clinical practice. When a patient has symptoms of sepsis, they are put on a broad spectrum of antibiotics. Even if the patient comes back as positive to having bacteremia, the doctors aren't going to change the dosing because if they get it wrong, then the hospital will get in trouble.
If there's no bacteremia, that doesn't rule out the presence of non-bloodstream infections. So patients are still put on the same broad spectrum of antibiotics.
The physician also mentioned the importance of identifying bacteria susceptibility information. This is a measurement of how sensitive a bacteria is to specific antibiotics. For example, a specific bacteria from the patient's blood may be 10 times more sensitive to Antibiotic 1 than Antibiotic 2, meaning that a 10 times smaller concentration of Antibiotic 1 is enough to inhibit (kill) bacteria growth. The physician, therefore, will prescribe Antibiotic 1 to treat the patient, not Antibiotic 2.
The physician confirmed this when he told us:
In a hospital setting, you think this patient has a bacterial infection, so you are going to do a blood cell culture ("BC") test to figure out what the bug is and what antibiotics it is susceptible to. Once the choice is made to admit patients into the hospital, they are all coming on some kind of broad-spectrum antibiotic coverage based on the symptoms they have. Almost never when you discover bacteremia does it turn out that you aren't covering (with antibiotic) the bug that's already there. The question almost always is "Can I narrow my antibiotic coverage based on this test (BC test)", or very rare, I would estimate 5% of the time, you find out for sure that the broad-spectrum antibiotic isn't appropriate and we should broaden antibiotic coverage. If the bacteremia test is negative, it doesn't tell you that patient is safe not to treat. It just says there's no bloodstream infection but that doesn't rule out the presence of non-bloodstream infections.
Not unless you are doing antimicrobial susceptibility testing (BC test), does it change the antibiotics use. The technologies that win won't be those that identify bugs quickly. Those that identify anti-microbial susceptibility quickly will be winners. T2 test says here's the bug but not what it's susceptible to.
On February 13, 2019, Diagnosticsworldnews.com published an article interviewing Inflammatix CEO, Tim Sweeney. The first sentence of the article says:
Diagnostics for acute infections and sepsis typically focus on "finding the bug," but most patients with infections do not have pathogens in their bloodstream.
Note that the above quote is a statement of fact from Diagnostics World, a division of Cambridge Healthtech Institute.
A physician we interviewed told us:
Most patients with bacterial infections don't have bloodstream infections. In an emergency department population that is judged to have bacterial infections, only about 10-20% have blood stream infections. For the rest, the infection is walled off by the immune system from the rest of the body.
This is a problem with the T2MR technology. It only tests the blood. Even if the test comes out negative for bacteremia, the patient could still have a bacterial infection in another part of their body. The T2 test usually doesn't get the whole picture of a patient's infection.
According to the physician we interviewed, the following bloodstream pathogen diagnostic devices have gone bust:
He said all of the above tests are highly accurate, yet all were commercial flops. The reason why is as stated in the previous section, knowing if a patient has bacteremia or not doesn't change clinical practice. Therefore, there isn't enough benefit for a hospital to own the device to outweigh the cost.
The physician we interviewed said that the T2Dx Instrument is "absurdly expensive" and so are the tests. Our research showed the T2Dx costs about $140K, and the cost per test for the T2Candida panel is $200 and for the T2Bacteria panel is $150. The physician said the buyer would have to be a hospital that has a big enough population of immune compromised patients, whether it's bone marrow transplant or cancer chemotherapy that justifies the price of the T2Dx.
The T2Candida tests for fungal pathogens. The physician said that about 3% of all infected patients have fungus. In a typical patient with a healthy immune system, you have close to a 0% probability of having fungus. But an immune-compromised patient has more than a 30% chance of fungus. Unless a patient is immune-compromised, you don't worry about fungal infection.
Immune-compromised patients can be from a bone marrow transplant or cancer chemotherapy. Where the drugs the patient takes weakens their immune system.
Since a fungal infection can be fatal if not identified right away, the T2Candida can be a useful test. But it's more of a niche, only useful for a specific type of patient. TTOO's T2Candida panel received FDA approval in 2014, and product revenues have remained tiny.
For readers who want a deeper scientific look, this peer-reviewed article provides a detailed analysis of the prevalence of candida infection in different populations and concludes that T2 Candida tests should be only run for selected group of patients, when Positive and Negative Predictive Values of T2Candida tests exceed a high threshold value.
Excessive Executive Compensation
Where we think TTOO does excel at is in compensating its executives and directors very handsomely. We believe the top three executives are being paid excessively for a company that has such small product revenue numbers. Below it shows the top three executive pay, including stock compensation.
Source: SEC filings
As shown above, overall stock compensation and dilutive equity raises are also high. TTOO has filed a whopping 165 Form 4s since its IPO. We looked through them, and only around 10 are non-option-related purchases. The vast majority are either option conversions to stock, or stock sales. In our opinion, TTOO is the kind of company that spins a good story on their product as they collect dollars by using company stock as an ATM machine. But the end result is investors holding the bag.
We Expect T2 Biosystems To Lower 2019 Guidance
TTOO's next earnings report is scheduled for March 7th after the market close. The following are TTOO's past and expected revenues:
Assuming the company hit its sales estimate in Q418, it's trading at a whopping Price/2018 Sales of about 19. The only justification for that high of a P/S is large growth. As shown above, sales are forecasted to double in 2019. We don't believe TTOO will be able to reach those revenue numbers, for the reasons explained in this article. Until TTOO solves the problem with its technology, product sales will not grow. The majority of 2018 revenue was non-recurring research revenues. Therefore, we expect the company to lower 2019 guidance, which could cause the stock to fall to new 52-week lows.
We came upon the $1.50 one year price target because we expect the company to underperform in 2019 and guide down earnings expectations. We believe that will put the stock in the high $2s or low $3s soon, either this quarter or next quarter. At some point, we believe the company will do an equity raise which we believe will then push the stock below $2. We foresee the story will play out similar to that of Viveve Medical of which we predicted a $0.90 price target in our June 2018 report. VIVE underperformed in Q318, which knocked down the stock from the $3+ level to the $2+ level. Then, it did an equity raise at $1.50 per share even though it had sufficient cash to last another quarter or two. That raise quickly knocked the share price from just above $2 to around $1, where it sits today. TTOO could even go below $1.50 this year, depending on their earnings performance, cash burn, how brutal their equity raise is, and how much shareholders lose hope. Of course, this is only a one-year price target. In the long run, we believe TTOO is likely a zero with their debt balance higher than the value of their product.
This article was written by
Disclosure: I am/we are short TTOO. 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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