Allium Medical Solutions — Continuing to execute on an ambitious plan

Allium Medical Solutions is a medical technology company that develops, manufactures and markets minimally invasive products grouped under four medical fields: urology, obesity/diabetes, cardiovascular and urogynecology. Allium has products in different stages, from in-house development to products marketed through its group of companies. In particular, the company offers fully covered urology and biliary stents in different countries, through Allium Stents. Allium provides soft tissue fixation devices sold through IBI and embolic protection devices through its subsidiary, Gardia Medical. Additionally, the company is developing a gastroduodenal sleeve to treat obesity and Type 2 diabetes through Allevetix in a clinical study. Lastly, TruLeaf is a transcatheter mitral valve replacement (TMVR) device in preclinical development. The company is listed on the Tel Aviv Stock Exchange (TASE) and is headquartered in Caesarea, Israel.

We now value Allium at NIS117m, or NIS1.91/share (vs NIS1.64) on an undiluted basis using a DCF approach based on a 12.5% discount rate (10% for terminal value), explicit free cash flow forecast for Allium Stents, IBI and Gardia to 2026 and a 2% terminal growth rate. The upgrade is due to Allevetix, which we now value based on the last funding round (NIS30m for Allium’s 85% stake). Overall, our valuation of Allium is driven by the anticipated increase in stents, EndoFast and Gardia sales, which should mainly come from the distribution deals in emerging markets (China, Mexico and Russia) as well as established markets. Our base case forecasts are unchanged and imply overall revenue CAGR of 20% for 2018-26e. Delays or difficulties in executing on this ambitious growth strategy could represent significant downside risk to our valuation and vice versa.

In FY17, sales were up 5% to NIS7.7m vs NIS7.35m in FY16. We expect sales to continue to increase as the distribution agreements in China, Russia and Mexico start generating revenues. We therefore continue to forecast sales growing at a CAGR of 57% in 2017-20e, from NIS7.7m to NIS30m. We estimate operating expenses associated with these agreements to be small as distributors normally support regulatory and marketing activities in their local markets, while committing to purchasing a minimum amount of products over a certain period of time. We continue to forecast EBITDA break-even in 2020. The company raised c NIS19m net in two equity raises during 2017, which we expect to provide runway into mid-2019.

We base our forecasts and valuation on the company’s ability to execute on its ambitious growth strategy, with revenues expanding at a double-digit rate as it continues to gain share in established and new markets. Allium has signed distribution agreements worth c NIS192m, with the bulk concentrated in three emerging countries: China, Mexico and Russia. Commercial, political or economic stability may have an impact on these deals. Regulatory uncertainty and reimbursement are equally important in obtaining the maximum value from these deals. Relying on the private sector may provide a base level of revenues, but we think reimbursement is critical to increase sales. The company's distributors are actively promoting reimbursement codes for each of Allium's products. IBI’s EndoFast products may face challenges as a result of the safety issues seen in the products of other competitors. Gardia Medical has had limited revenue expansion so far and depends on either finding a strategic partner or outlining a more ambitious commercialisation strategy. Allevetix and TruLeaf’s challenges are related to achieving successful manufacturing and clinical results, and obtaining approval from regulatory authorities.

The main revenue generators for the company are Allium Stents and IBI Medical’s EndoFast products, which generate the bulk of sales (92% in 2017). Allium markets these products through distribution agreements with regional players. In Allium’s model, the partner initially sells to private centres and markets to public centres once reimbursement has been achieved. Allium sells its products to distributors at an agreed transfer price, eg an average of NIS2,330 per stent in 2017. A distributor generates around a 50% margin on the final selling price; distributors are subject to penalties in the case of breaching agreement terms (eg being unable to sell pre-agreed volumes). Allium has the right to terminate the agreement, terminate exclusivity or raise prices.

Over the past three years, Allium has signed distribution agreements with a purchase commitment of at least c NIS192m in total over approximately five years per contract, as shown in Exhibit 1.

We include these deals in our revenue forecast, with a particular focus on Mexico, China and Russia, which represent the majority of the revenues from these distribution agreements (NIS132m). In May 2018, the company announced that all stent products had been approved for marketing by the China Food and Drug Administration (CFDA) and in June 2018 the first order of NIS200k from its distributor was placed. The prostatic stents and EndoFast have been approved in Russia and the company expects approval of the rest of stents and first orders in Russia this year. We also expect approvals of the rest of the stents and EndoFast in Mexico this year. We show the detail of these contracts in Allium’s key growth markets and our 2018 forecast in Exhibit 2.

Additionally, we include revenues in the company’s established markets, mainly the EU5, South Africa, Australia and Israel.

Ureteral stents are used in pathologies such as kidney stones, urinary incontinence and kidney transplant, to prevent or treat obstruction of the urine flow from the kidney to the bladder. Traditional ureteral stents are 24-30cm long and are called JJ stents or double J stents due to the curl at both ends. Allium’s stents are self-expandable, metal stents made of nitinol (nickel titanium), fully covered with a biomaterial that prevents encrustation, tissue ingrowth, stone formation and calcification. Allium’s stents are intended to address stenosis in the urethra, ureters, prostate and biliary duct.

Allium Stents products are intended to treat lower urinary tract symptoms (LUTS), which are voiding and storage disturbances that affect the lower urinary tract. LUTS may be caused by a number of conditions such as bladder cancer, nocturnal polyuria prostatitis and, in a significant number of cases, by benign prostatic hyperplasia (BPH). BPH happens when the prostate enlarges and is associated with age. It is estimated that about 40-50% of men between the ages of 51 and 60 and 80-90% of men older than 70 have it. Each year around 150,000 men in the US have transurethral resection of the prostate (TURP), the most common surgery for BPH. However, it is associated with up to 20% morbidity, and risks such as bleeding. Therefore, for patients unfit for TURP or other modalities, minimally invasive solutions such as stenting are needed.

IBI (Israel Biomedical Innovations) develops and markets soft tissue fixation products. These products are based on the EndoFast fastening technology, which consists of a device that attaches to soft tissue (ligament, muscle and fascia) and deploys a pull-out force. It is composed of a surgical mesh placed with the Spider Fastener fixation device in the desired anatomic location. Meshes can be retrieved and repositioned, without causing pain or tissue damage.

EndoFast products are trocarless (ie do not use a sharp-pointed instrument to puncture), as opposed to most soft tissue fixation products used nowadays, which have trocars that may cause irritation and damage to internal organs as they pass blindly through the pelvis walls.

According to Allium, market research by Millennium Research Group and other sources, the global market is around $1.2bn, with $460m in the US, $345m in Europe and $345 in the rest of the world. This represents about 1m procedures worldwide. The same sources state that the market grew at a 9.5% CAGR from 2008 to 2013.

In March 2018 Gardia Medical’s Wirion system received FDA approval for leg artery catheterisation. Wirion is an embolic protection device (EPD), which has the competitive advantage of allowing doctors to use any guidewire of their choice and locate the filter anywhere along the guidewire during the procedure. It is approved with all FDA atherectomy devices, as opposed to SpiderFX, which is limited to use with a specific atherectomy device.

After this FDA approval, Wirion has become the only protection system cleared with all atherectomy devices in the US. It is approved in Australia and New Zealand for embolic protection during carotid artery catheterisation procedures. It is also approved in Israel and Europe for use in all interventional vascular procedures including carotid, coronary, renal and lower extremities.

The FDA approval is based on data from the WISE-LE study. In this trial, an independent Clinical Events Committee (CEC) assessed the primary endpoint of freedom from major adverse events (MAEs) 30 days after procedure in patients undergoing LE atherectomy for the treatment of peripheral arterial disease (PAD). The WISE study compared the safety and performance of Wirion to a performance goal based on data from previous studies of SpiderFX, which was the only FDA-approved EPD for the lower extremities. The study met the primary endpoint with a rate of only 1.9% MAEs, vs 12% MAEs in the historical control group.

The global EPD market is around $0.5bn at present depending on the source. It was estimated at $200m in 2009, according to Startup Magazine. A Market Wired report pointed to $500m in 2015. In addition to carotid and coronary indications, the large underserved market of PAD could represent a significant opportunity. Med Device Online estimates that there are around 10 million people in the US with PAD, although only 2.5 million are currently diagnosed, leading to 600,000 interventions including stenting, balloon angioplasty, plaque removal and even amputations. Finally, we note that there is strong interest in the market for atherectomy procedures, as demonstrated by the acquisition of the Spectranetics Corporation by Philips in August 2017 for a total enterprise value of €1.9bn. Spectranetics is a medical devices company focused on cardiac devices and PAD. At the time of the acquisition, Spectranetics expected to record revenues of $300m in FY17.

We model Wirion as part of Allium’s overall business and valuation, and project revenue of NIS2.4m after launch in 2018, rising to NIS8.6m in 2020. We believe that full FDA approval makes Wirion an attractive product for partnering and there is potential for the company to enter into a strategic transaction for this product as it intends to.

According to Allium, Allevetix recently raised NIS3.2m from Allium’s management, the company’s German distributor and additional undisclosed investors. The private placement values the company at NIS35m and leaves Allium owning 85% of Allevetix, vs 100% previously. Allium may consider an IPO for the Allevetix business in the future. Interestingly, one of the clauses for future investment rounds includes a 25% discount in case the valuation is less than NIS72m post-money, giving a hint of the valuation the company may potentially be seeking for the next fund-raise.

The company is developing an indwelling gastroduodenal sleeve as a minimally invasive alternative to gastric bypass surgery for obese Type 2 diabetic patients. The sleeve acts as a barrier to prevent caloric intake in the intestine. Currently it is undergoing a first-in-man clinical trial in 10 patients with obesity and diabetes; Allium expects to complete the study by the end of 2018 and to start a pivotal trial in 2019.

Nearly 13% of the world’s adults are obese (body mass index, BMI ≥30) and 39% are overweight (BMI ≥25), according to World Health Organization data from 2014. Furthermore, over 85% of people with Type 2 diabetes are overweight/obese (American Diabetes Association, ADA). The ADA now recommends weight reduction (bariatric) surgery for diabetics with a BMI >35, if glycaemic control by medication/diet is poor (2016 ADA guidelines).

According to Research and Markets, the market for bariatric surgery devices was $2bn in 2017 and is expected to reach $3.2bn in 2026. Bariatric surgery procedures are effective, but require general anaesthesia, have morbidity rates of 3-20% and are irreversible (apart from banding). Although diabetes resolves in a significant amount of cases (completely in 77% of patients), only 1% of the 18 million eligible US adults undergo bariatric surgery, as a result of perceived invasiveness, high morbidity, cost and restricted insurance coverage. Therefore, given these factors, there is room for minimally invasive therapies to expand patient uptake beyond the current 228,000 procedures in the US.

Allium’s TruLeaf device is currently undergoing preclinical trials in large animals. Once preclinical studies are completed, the company will need to run clinical trials in humans for registration in Europe and the US. TruLeaf is a transcatheter mitral valve replacement (TMVR), for the treatment of mitral valve regurgitation. Regurgitation in the heart happens when blood flows backwards and the body does not get the necessary amount of blood. In mitral regurgitation, there is leakage of blood backward through the mitral valve each time the left ventricle contracts. As a result, the heart changes to adapt to pumping more blood, and these changes may lead to heart failure in the long run.

Approximately four million people in the US have significant mitral regurgitation, with an annual incidence of 250,000 newly diagnosed patients. In the EU approximately 20,000 mitral valve repair procedures are performed annually. As no TMVR devices are currently commercialised, the most similar benchmark is Abbott’s MitraClip for MV repair, which sells for $30,000. The procedure is not fully reimbursed under Medicare, where the payment is based on a standard, fast coronary angioplasty. MitraClip is limited to patients who are too ill for open-heart surgery. A 2014 report states that 10,000 procedures had used the device and that implantation now takes about 100 minutes.

As we do not usually include preclinical projects in our forecasts or valuation, we are not including TruLeaf until it enters clinical trials and there is more visibility on the development plans.

Our forecasts and valuation are based on Allium’s ability to execute on its business plan. To achieve our financial forecasts, which are broadly based on company’s guidance, Allium will need to demonstrate significant growth, which relies heavily on its distribution agreements with local partners. Growth of the Stents and EndoFast business depends largely on obtaining regulatory approvals within reasonable timelines, in particular in Mexico and Russia. The company has achieved a big milestone by securing approval of the stents in China and the first order from its local partner. Allium has achieved reimbursement in some countries, but in others it relies on the private sector. Furthermore, competition is high in these markets and the ability to maintain certain price levels may prove challenging in sustaining or increasing market share.

EndoFast devices are advanced soft fixation devices, which are believed to be less invasive than those of competitors, with an enhanced safety profile. However, given previous experience with the first generation of these devices and the fact that certain companies pulled their products from the market, we believe that marketing in the US and other regions may bring challenges in gaining acceptance by doctors and regulators.

With FDA approval for all atherectomy procedures, Gardia Medical’s Wirion could attract partnering interest. The company has not provided an update on its negotiations with potential partners or its commercialisation strategy after it won approval in March 2018.

Allium reported sales of NIS7.7m in FY17, with stents contributing the bulk of revenues (see Exhibit 9). Importantly, the company received its first order for the ureteral stent products in Mexico for NIS300k, paid in Q417. In May 2018, Allium obtained approval of its urological stents in China and received the first order of NIS200k from its distributor in the country. We include this order in our FY18 forecast, which stands at NIS0.82m for stents in China. Our overall sales forecast for Allium is NIS14m in FY18, which implies roughly doubling revenues against the backdrop of anticipated growth in China, Mexico and Russia. We expect further growth in FY19 with forecast revenues of NIS21m.

We expect R&D expenses to be NIS10m in FY18, lower than FY17 as the company expects to receive public grants from the Israeli government. R&D expenses in 2018 are mainly associated with the continued clinical development of Allevetix and the preclinical study with TruLeaf. From 2019 onwards we expect a decrease in R&D expenses as the company completes clinical development of Allevetix.

The EBITDA loss in FY17 was NIS20.8m. We forecast an EBITDA loss of NIS13.2m in FY18. The net loss was NIS22.7m. Our net loss forecast is NIS15.2m in FY18, mainly due to the sales increase. We expect Allium to reach EBITDA break-even in 2020.

In 2017 Allium consumed NIS18.9m in cash (cash flow from operations plus capex) and raised total net proceeds of NIS19.1m. We estimate that net cash, cash equivalents and short-term deposits at end-2017 of c NIS23m provide runway until mid-2019, when we project a cash shortfall that for illustrative purposes we cover with long-term debt of NIS20m. Cash will be spent on the first-in-man study with Allevetix’s gastroduodenal sleeve (recently started) and the ongoing animal study with TruLeaf. We keep our capex projections unchanged.

Our updated DCF valuation of Allium is NIS1.91 per share (vs NIS1.64 previously), or NIS136.2m, which includes net cash of c NIS23m at end 2017 and an updated valuation of Allevetix. The latter is the main driver of the upgrade. We now value Allevetix based on its last funding round, which resulted in an overall post-money valuation of NIS35m (Allium now owns 85%). Our previous valuation of the company (NIS11m) was based on the estimated book value.

Overall, we maintain our assumptions for revenue CAGR of 20%, margins and earnings growth in the explicit forecast period (2018-26e). We assume approval of the remaining stents and EndoFast in Mexico, as well as approval of all stents in Russia in 2018. Delays to these assumptions, as well as slower than expected execution of the agreements with distributors, would have a pronounced downside impact on the valuation.