Adherium — Update 20 April 2016

Adherium is a digital health company developing technologies that address suboptimal medication use and remote patient management in chronic diseases. Clinical evidence shows that its Smartinhaler platform substantially increases adherence and reduce exacerbations in adults and children with asthma. Adherium aims to sell its devices to international pharmaceutical and medical technology companies, which provide them to patients via their own distribution networks. Adherium and AstraZeneca (AZN) entered a 10-year commercial product development and supply agreement in July 2015. The initial Product Supply Schedule under the agreement covers Adherium’s Turbu+ (SmartTurbo) devices tailored to AZN’s turbuhaler dry powder inhaler sold with its Symbicort and Pulmicort drugs outside the US. AZN is expected to begin expanding the commercial rollout of the Turbu+ programme in selected countries in H1 of CY16. Adherium listed on the ASX in August 2015, raising A$35m at A$0.50/share, including a US$3m investment by AZN. Prior to listing it acquired 100% of Adherium (NZ) Limited, which was founded in 2001 by Adherium CEO Garth Sutherland.

We value Adherium at A$188m based on a risk-adjusted DCF model, which includes our forecast costs and revenue streams from sales of devices and data management services. We assume that by 2020 clip-on Smartinhaler devices will be used by 30% of Symbicort patients in the US (risked to 90%) Europe and Japan, and that by 2021 the technology will be embedded in AZN’s drug delivery inhalers, lifting uptake to 100% of Symbicort patients by 2023 (risked to 75%). We also forecast that by 2021 hospitals, managed care, etc will supply the Smartinhaler platform to 230,000 asthma patients (1% of all patients) in the US and 115,000 patients in ex US markets to improve patient outcomes. Our valuation is equal to A$1.31 per share (undiluted) and A$1.26 per share after diluting for the 7.0m options on issue (exercise price 8-67c).

In FY15 the company sold 34,000 devices for use in clinical trials at an average of A$85 per device, generating sales of A$2.9m at a gross profit margin of 53% and a net loss of A$1.3m. In the nine months to December 2015 it sold 48,000 devices at an average of A$33 each. The average price was much lower than in FY15 because 52% of devices sold so far in FY16 were low-cost, reminder-only devices without data connectivity (not expected to be a significant product line in future periods), as well commencing commercial supply at volume-based pricing. Net loss in the period was A$3.8m on total sales of A$1.6m. Adherium had A$30.8m cash at 31 December 2015. In the IPO prospectus, Adherium projects operating funds usage of A$29.7m over the 2 year period to late 2017 in an intensive growth and investment program. We forecast Adherium profitability in FY19.

Adherium’s business is subject to the usual risks associated with any emerging technology: slower than expected commercialisation timelines, lower rates of adoption, technology leap-frogging, patent litigation, and regulatory and commercial risks. While the company is at an early stage of commercialisation, its clinical trials business has a track record of revenue growth and positive gross profit margins. There is little detail available regarding AZN’s plans for the rollout of the SmartTurbo devices for use with its Turbuhaler inhaler. The price that Adherium will receive for sales to AZN is unknown and there is no track record of patient uptake rates, so we rely on our own assumptions for these key factors. The Product Supply Schedule under the agreement with AZN does not yet include a Smartinhaler device suitable for the US market, although our analysis shows that AZN has a strong financial incentive to expand the programme to the US market.

Adherium develops, manufactures and supplies digital health technologies that address suboptimal medicine use in chronic disease. The company's first product range is its Smartinhaler platform that clips on to a wide range of prescription inhalers used in the treatment of respiratory diseases such as asthma and COPD. Smartinhaler devices record inhaler use and provide audio and visual reminders if the patient has missed a dose of the prescribed drug. The date and time of inhaler use is transmitted to a mobile device or computer network in the patient’s home where the patient can view it in an app, and onto Adherium cloud-based servers where it can be accessed by the patient’s physician or medical provider via a proprietary web portal (Exhibit 1), for the first time giving physicians accurate information about patients’ inhaler usage patterns.

Asthma and COPD represent enormous target markets dominated by inhaled therapies. Market research group Datamonitor estimated that in 2015 in the US, Japan and five major EU markets asthma and COPD drug sales totalled US$14.5bn and US$8.4bn respectively. The US Centers for Disease Control estimate there are 25.5m asthmatics and 6.8m people with COPD in the US.

Adherium’s current portfolio of Smartinhaler devices clip on to the inhaler, with different devices tailored for each pharma company’s proprietary dry powder or pressurised metered dose inhaler. This allows pharma companies to supply devices to patients and be confident that they can only be used with that company’s product. Adherium is developing a miniaturised device that can be integrated within the inhaler during the manufacturing process. We expect embedded devices to be a key part of the longer-term growth of the company and assume a market launch in 2020.

Inhaled corticosteroids (ICS), either as a single agent or in combination with long-acting beta agonist reliever medication (ICS/LABA), are the mainstay for long-term control of asthma. These “preventer” or maintenance medications reduce airway inflammation and prevent asthma symptoms, and minimise flare-ups or exacerbations. However adherence to these medications is often poor, with low adherence associated with excessive health care costs and an increased risk of emergency room visits and mortality (Howard et al 2014). For example, a study of children with asthma by Lasmar et al (2009) reported adherence rates of 84-90% in children whose asthma was well controlled and adherence rates of 34-48% in patients with poorly controlled asthma.

To our knowledge Adherium’s Smartinhaler platform is the only technology for which independent clinical studies published in scientific journals demonstrate that the feedback and reminders from the device lead to improved adherence to maintenance asthma medications. Two completed randomised controlled trials by Chan et al and Foster et al found that patients receiving reminders and feedback showed significantly better adherence to ICS than controls, with increases of between 59% and 180% (Exhibits 2 and 3). In addition, an interim analysis of an ongoing trial in children in Sheffield, England by Morton et al reported that adherence was 144% higher in the intervention group, although no statistical testing has been done at this stage (Exhibit 3).

Importantly, the improved adherence is long lasting. For example, at the end of the six-month study described by Foster et al the adherence of patients receiving inhaler reminders and feedback was double that in the control groups (~60% vs ~30%, Exhibit 2).

The trials in Exhibit 3 provide statistical proof that Smartinhaler reminders and feedback improve medication adherence, while the evidence that this improved adherence leads to better clinical outcomes is still building. The trials summarised in Exhibit 3 paint a consistent picture of fewer asthma exacerbations in patients receiving reminders, including a 61% reduction of severe exacerbation reported by Foster et al. Reducing exacerbations is an important clinical benefit, and it was somewhat surprising to see significant improvements in these relatively small trials. However, we note that neither the trial of Foster nor Chan showed significant effects on the primary endpoints of asthma control scores or days off school, respectively, possibly due to relatively small trial sizes.

A separate trial by Pilcher et al showed that SmartTurbo devices attached to Symbicort turbuhaler dry powder inhalers were 99.9% accurate in recording inhaler actuations over a three-month period.

The Smartinhaler platform for the first time gives physicians accurate information on the inhaler usage patterns of patients who are prescribed ICS medications. This is a big improvement on the current situation where physicians have to interpret patient feedback such as “yes, I take the medication most of the time”.

We believe that physicians who are given access to accurate information about medication usage patterns will feel that they are better able to manage their patients’ health. This would be particularly relevant for patients whose asthma is poorly controlled. We expect this sense of empowerment to build strong brand loyalty among prescribing physicians.

Eight of the 10 highest-selling respiratory drugs in the US are inhaled medications, and four are ICS drugs, where we expect improved adherence to bring the greatest healthcare benefits. The ICS drugs include the top seller, GSK’s Advair (2015 global sales of US$5.6bn), and the third-highest seller, AZN’s Symbicort (2015 global sales US$3.4bn). Exhibit 4 shows the top ICS drugs in the US market. AZN’s second biggest respiratory drug, Pulmicort, had global sales of US$1,014m in 2015.

The two top-selling ICS drugs Advair and Symbicort are already facing generic competition in some markets in Europe, and both are expected to face generic competition in the US and Japan by 2019 (Exhibit 5). The generic competition is likely to be in the form of branded generics that cannot be directly substituted when the original brand is prescribed. Teva’s DuoResp Spiromax, which is an analogue of Symbicort that is sold in selected countries in Europe, fits into this category.

We expect patients to be slow to switch to generics due to hesitation to switch to new inhalation devices and concerns over the dose and efficacy equivalence between the branded and generic products. AZN commented in its FY15 results presentation that it is maintaining over 90% share of prescriptions in the markets in Europe where it is facing competition from generic analogues.

In this environment manufacturers are searching for ways to differentiate their branded drugs from generic analogues and build brand loyalty among prescribers and patients. Electronic monitoring devices (EMD) such as the Smartinhaler platform seem an ideal way to achieve these goals.

Embedding the Smartinhaler technology into the drug delivery device would take this strategy to the next level, and would offer a potential way to extent market exclusivity. In this regard we note with interest that Adherium is undertaking a number of projects driven by AZN, including preparations for major clinical studies in international markets. We suspect that this could refer to a study of a drug delivery device that contains embedded Smartinhaler technology. We await further details of the proposed clinical trials to see whether our interpretation is correct.

Adherium’s main path to market is selling the Smartinhaler platform to pharma and medical device companies, which provide the device and app to patients via their own distribution channels. Adherium has already entered a non-exclusive commercial supply agreement with AZN, which markets the third biggest-selling respiratory drug, Symbicort (2015 global sales US$3.4bn), a combination maintenance and reliever medication (ICS/LABA) and the ICS drug Pulmicort.

Supplying Smartinhalers to asthma and COPD patients should allow hospitals, managed care organisations and other healthcare systems to reduce overall healthcare costs and at the same time improve health outcomes.

The Smartinhaler platform can collect accurate data about inhaler use in clinical trials. Adherium is providing Smartinhaler devices, software and data management to 31 clinical projects and programmes around the world, which will eventually involve more than 89,000 devices. The trials are an important way of building relationships with pharma customers and are an important step towards gaining additional commercial supply contracts with pharma and med-tech companies.

In July 2015 Adherium entered a 10-year global Master Supply and Development agreement with AZN, including an associated Quality Assurance Agreement. The initial Product Supply Schedule covers the SmartTurbo device for use with AZN’s turbuhaler dry powder inhaler. The turbuhaler device is not approved in the US where Symbicort is sold in a pressurised metered dose inhaler (pMDI). We expect AZN-driven development projects that are currently underway to lead to a Smartinhaler suitable for AZN products in the US market being added to the supply schedule.

Exhibits 6 and 7 illustrate the potential near-term return on investment (ROI) that could flow to AZN from providing Smartinhalers to Symbicort patients in the US, from either improved adherence or increased market share. In this illustration we assume that each device costs AZN US$25, in line with our base-case valuation assumptions, and that AZN pays a further US$10 for distribution and setup assistance (“onboarding”). We assume medication adherence of 40% in estimating Symbicort patient numbers, based on the average 37% adherence in the control arms of the Smartinhaler studies in Exhibit 3 and the range of 20-73% reported in a systematic review1 of asthma studies.

The ROI for AZN would be positive even for the smallest 5% relative improvement in adherence and after allowing US$10 per device for onboarding costs. This provides a strong incentive for AZN to extend its agreement with Adherium to include devices appropriate for the US market. It also provides a strong incentive for other pharma companies to adopt the Smartinhaler platform.

Adherium has indicated that it expects to sign two new commercial agreements over the next 18 months, which could potentially be with any of pharma, med-tech or managed care organisations. While we believe that this objective is achievable, at this stage we do not include additional pharma or med-tech agreements in our forecasts.

Adherium is engaged in active AZN-driven projects spanning product development, supply chain management, regulatory and quality requirements, clinical operations and product internationalisation. We would expect this to include Smartinhaler devices tailored to AZN inhalers sold in the US market, which we risk-adjust to 90% in our forecasts.

We expect Adherium to succeed in developing miniaturised smart inhaler technology that can be embedded into the drug delivery inhaler (“Smartinhaler inside”). We assume that these new drug delivery devices will require some clinical trials before they receive regulatory approval. The trials could be as simple as demonstrating that drug delivery is equivalent to existing devices, or alternatively could be designed to demonstrate efficacy in disease control. We conservatively assume the latter and allow for a commercial launch in 2020 (we risk-adjust embedded inhaler revenues to 75% in our forecasts). We would expect Adherium to supply the miniaturised Smartinhaler integrated circuit chip to AZN for use in the manufacture of the inhalation device.

Adherium receives significant quantities of data daily from Smartinhaler devices that are in use, and it is establishing a dedicated data team to mine and extract value from data. Existing commercial agreements allow the company to earn additional revenue through value-added reporting. At this stage the revenue opportunity from data analysis is difficult to quantify, so we have not included it in our revenue forecasts or valuation model.

Adherium has the benefit of 14 years of experience in developing and trialling Smartinhaler devices. A number of competitors have entered the field more recently and we briefly describe the four main competitors below. None of the competitors can match the independent clinical trials showing the efficacy of the Adherium device in improving adherence.

Three of the four competitors have developed EMDs that can clip onto several different brands of inhalers. In contrast, Adherium’s devices are tailored to a specific drug delivery device. This gives Adherium an advantage in dealing with pharma companies, which know that the Adherium device can only be used with that company’s drug. Exhibit 8 briefly describes the four main competitors.

At the time of its acquisition by Teva, Gecko was marketing the CareTRx cap which attaches to the top of pMDI inhalers and monitors inhaler use. The CareTRx cap is not suited for use with for dry powder inhaler devices such as the Symbicort turbuhaler, which is marketed outside the US.

Adherium has regulatory approvals in place in the US, EU, China, Australia and New Zealand for the devices that are appropriate for those markets. It has only sought approvals in the jurisdictions that are relevant for each device, as some pharma companies sell their drugs in different delivery devices in different markets. We note that Adherium has US FDA 510(k) approval for a SmartTouch device that is compatible with the metered dose inhaler used with AZN’s Symbicort in the US, but we assume that a modified device is being developed for that market.

Adherium has strong in-house capability at its ISO 13485-certified facility in Auckland for the development and prototyping of new devices and small batch manufacturing. The company engages an ISO 13485-certified third-party contract manufacturer in Asia for volume production of its products. Based on current manufacturing lines the contract manufacturer can produce 8,000 devices per week, which will be sufficient to meet demand into FY18 based on our forecasts. The contract manufacturing in place is scalable beyond these forecasts.

Adherium has lodged patent applications relating to various components of its Smartinhaler technology platform, most of which have not been granted and are in the process of examination by the relevant patent offices. Several of the patents have already been granted in New Zealand and one in the US, indicating that the inventions claimed by Adherium meet the tests for patentable subject matter and have good prospects of proceeding to grant in other jurisdictions if the scope of the claims is appropriately modified to account for the prior art.

We value Adherium at A$188m based on a discounted cash flow model, which includes our estimates of the future costs and revenue streams from sales of Smartinhaler devices and data management services to AZN; to hospitals/managed care, etc, to improve outcomes for asthma patients; and for use in clinical trials. Exhibit 10 shows our forecast assumptions for the three revenue streams and the sum-of-the-parts NPV. Our valuation is equal to A$1.31 per share (undiluted) and A$1.26 per share after diluting for the 7.0m options on issue (exercise price 8-67c).

The Product Supply Schedule under the Master Supply and Development Agreement with AZN does not yet include a Smartinhaler device suitable for the US market, but we assume a 90% likelihood that AZN will purchase Smartinhalers for use in the US market in due course..

We assume uptake of the clip-on Smartinhaler device reaches 30% of Symbicort users in Europe, Japan and the US by 2020. We further assume a 75% likelihood that in 2020 AZN will launch a version of Symbicort with Adherium’s Smartinhaler technology embedded into the drug delivery device, lifting uptake to 100% of Symbicort users by 2023 and displacing clip-on sales to AZN. Exhibit 10 includes forecast revenues in FY20 and FY23, the years when we forecast peak penetration of clip-on and embedded devices, respectively, to be reached.

We assume that at volume production (eg 1.2m devices in 2020) fully-featured, connected devices sell at US$25 per device, in line with the average price so far in FY16, and earn a 50% GP margin.

In 2015 AZN reported Symbicort sales of US$1,076m in Europe and US$176m in Japan. The average ex-factory price for Symbicort in the five major European markets estimated by Datamonitor in a 2015 report was US$58 per inhaler. Using this price and assuming 40% average adherence we estimate that in 2015 there were 3.85 million Symbicort patients in Europe and 0.36 million in Japan. We estimated US Symbicort patient numbers from Bloomberg prescription data.

Datamonitor forecasts Symbicort volumes to decline by 4% per year in the period to 2024 due to competition from analogues (so called branded generics such as Teva’s DuoResp Spiromax). We assume that the provision of Smartinhalers to patients will slow the decline to 2% per year.

We assume that over time Adherium enters agreements with a combination of managed care/pharmacy/hospital and disease management organisations that cover the supply of inhalers to 230,000 (1%) asthma patients in the US, and 115,000 patients outside the US.

We have extended our cash-flow forecasts for 15 years (to 2031) but do not include any terminal valuation. We assume a long-term exchange rate of US$0.76/A$ and apply a 12.5% discount rate. Under our base case assumptions we forecast Adherium to become profitable in FY19 and begin paying tax at the NZ corporate tax rate of 28% in FY21.

At this stage we do not include any revenue from 1) additional device supply agreements with pharma or med-tech companies; 2) monetising insights from analysis of the data collected; or 3) technology expansion beyond respiratory disease to the management of other chronic diseases.

Adherium’s business is subject to the usual risks associated with any emerging technology: slower than expected commercialisation timelines, lower rates of adoption, technology leap-frogging, patent litigation, as well as regulatory and commercial risks. While the company is at an early stage of commercialisation, its clinical trials business has a track record of revenue growth and positive gross profit margins. Adherium currently relies on a single Asian-based contract manufacturer for volume production, which increases the risk that it may not be able to guarantee supply of devices. This risk is mitigated by active supply chain management and known alternatives.

The Product Supply Schedule under the agreement with AZN does not yet include a Smartinhaler device suitable for the US market, although our analysis shows that it has a strong incentive to do so. If AZN does not sign up for a device suitable for the US market then that would be downside risk to our valuation. SmartTurbo pricing is unknown and there is no track record of patient uptake rates, so we rely on our own assumptions for these key factors in our valuation.

Exhibit 11 shows the sensitivity of our NPV model to the price at which Adherium sells Smartinhaler devices and the gross profit margins achieved. NPV ranges from A$0.58/share at US$20 per device and a 30% gross profit margin to A$2.53/share at US$40 per device and a 60% gross profit margin.

For FY15 (the 12 months ending March 2015) device sales totalled A$2.886m for 34,000 devices, at an average of A$85 per device. Gross profit margin was 53%. Total revenue in FY15 was A$3.11m including A$203k grants income and A$21k other sales. Net profit in FY15 was a loss of A$1.3m after total operating expenses of A$4.3m. The company is transitioning from a March to a June year end, so FY16 will encompass the 15 months to June 2016. The interim financial report covered the nine months to December 2015. Net loss in the period was A$3.8m on revenue of A$1.6m from the sale of 48,000 devices. The average price of A$33 per device was substantially lower than in FY15 because i) 52% of the devices sold in the period were low-cost, reminder-only devices without data connectivity for a specific customer order (we assume these devices were supplied to AZN for market testing); and ii) the commencement of commercial supply at volume-based pricing vs higher-priced clinical supply the year before.

In the period to June 2016 the company expects AZN to begin expanding the commercial roll-out of the Turbu+ programme into selected countries. We note that this programme incorporates the fully featured (and therefore higher price) Turbu+ device with data connectivity. The transfer of volume manufacturing to an Asian-based contract manufacturer reduced manufacturing costs per device by 32% in 2015, delivering a gross profit margin of 48% despite lower device prices. Adherium had A$30.8m cash on 31 December 2015 after raising A$35m (~A$32m after costs) in an IPO in August 2015. Under the use of funds outlined in the IPO prospectus, based on a 24-month programme of intensive growth and investment, Adherium projects operating funds usage of A$29.7m over the two-year period to late 2017, representing substantial growth compared to FY15. The breakdown of the proposed use of funds is R&D (40%), manufacturing support (8%), sales, clinical operations, marketing and business development (22%) and other working capital (31%).