Tissue Regenix — Update 15 September 2016

Tissue Regenix (TRX) is a spin-out from Leeds University, established in 2006. It develops and commercialises medical devices for regenerating human tissues and organs based on a patented decellularisation technology known as dCELL. The business model is based on commercialising dCELL through partners, initially in the human tissue market and subsequently, following regulatory clearance, with animal tissue implants, allowing greater commercial scale. The dCELL process removes cells and DNA from human and animal tissue for transplantation and repair, minimising the risk of rejection and infection and overcoming the limitations of standard treatments. TRX is developing dCELL-based products for a range of applications and indications across three divisions, comprising a US wound care subsidiary, orthopaedic and cardiac business divisions. Its UK office, production facility and laboratories are in Leeds, UK. The US wound care subsidiary is based in San Antonio, Texas. The company employs 60 staff and has raised c £50m since flotation on AIM in 2010, via its reverse takeover of Oxeco.

We recently revisited a number of our key valuation assumptions to reflect the clarity on launch timeframes, associated costs and updated revenue guidance. We maintain our DCF valuation at £338m or 44.4p per share, subject to potential dilution from an estimated £15m funding requirement in 2018 to deliver on our forecast growth trajectory, via a hybrid distribution strategy and including development of OrthoPure XT and XM in the US. This dilution would be reduced, or not required, if the US approval were to be undertaken alongside a partner. We value the wound care business at £251m, the orthopaedics division at £77m and the cardiac division at £39m, based on risk-adjusted cash flows for each division depending on each stage of development; we add reported FY16 net cash of £19.9m. According to our model, the current price gives a free option on wound care, the most commercially advanced division. There are a number of near-term catalysts ahead, including the potential CE mark grant and launch of OrthoPure XT, which would lead us to increase the probability of success for these products.

We forecast £40.7m in net sales by 2019e, which should take TRX to profitability. We expect a key driver of this to be from the wound care division as detailed in our January note on the wound care division. We estimate that group revenue will increase from £2.4m in 2016e (new financial year end) to £40.7m in 2019e. The main growth drivers for reaching our £40.7m 2019 group sales forecast are wound care (£27.4m), orthopaedics (£9.6m) and cardiac (£3.6m). Based on end-January 2016 net cash of £19.9m, TRX has a cash runway for the immediate pipeline (OrthoPure, SurgiPure and dCELL valves). Our forecasts indicate that TRX would require an additional £15m funding to cover FDA studies for OrthoPure porcine products.

All three divisions depend on the availability of reimbursement for the products, with the wound care division being the most advanced. TRX operates in competitive markets where sustained investment in development and marketing is required to maintain the profile of the products. Commercial success in the cardiac division depends on the success of the regulatory process, reimbursement and surgeon uptake. Human tissue products are dependent on the availability of donated tissue and on forming new collaborations with human tissue banks. Porcine products offer significant potential in terms of ease of supply and lower-cost processing, although there is a limited amount of data published by TRX to demonstrate how well its products perform in humans.

TRX develops and commercialises medical devices for the regeneration of human tissues and organs based on a patented decellularisation technology, dCELL. This process removes cells and DNA from human and animal tissue for transplantation and repair, minimising the risk of rejection and infection. The company’s business model is based on commercialising dCELL through partners, initially in the human tissue market and subsequently to achieve regulatory clearance, with animal tissue implants allowing greater commercial scale.

TRX’s investment story is built on the versatility of its patented dCELL technology, used to develop regenerative medical devices across three areas with high growth potential: wound care, sports medicine and cardiac applications; the cardiac division is the subject of this report. The dCELL process creates a tissue scaffold that, once implanted, is repopulated with human cells during the healing process. The technology benefits from several features, which the company indicates differentiate it from existing treatment alternatives:

Having launched a human tissue-derived wound care product (DermaPure) in 2014 (£0.8m net revenue to date), TRX is developing a versatile range of human and animal tissue-based devices in wound care, as well as sports medicine and cardiac devices. These are discussed in our initiation report of October 2015, our January 2016 report, which focused on the wound care division and our July 2016 report, focused on the orthopaedic division.

TRX is providing access to decellularised human pulmonary or aortic donor heart valves, CardioPure HV, which were developed by Pontificia Universidade Catolica do Parana (PUCPR) Brazil and spearheaded by Professor Francisco da Costa, using dCELL technology. The first patient was implanted with a human pulmonary valve c 10 years ago. To date, more than 1,500 patients in total have been implanted with dCELL heart valves – 1,400 human pulmonary valves and approximately 100 with human aortic valves – resulting in a significant body of clinical evidence.

The rationale for dCELL heart valve implants (CardioPure HV) is the high efficacy rate and ability to overcome many of the major shortcomings of standard heart valve replacements. Currently, available heart valve replacements are either mechanical, made from synthetic material or made from animal or human tissue. The major downside for mechanical valves is the need for life-long anti-coagulation medicines. For patients under 60 who undergo valve replacement surgery, it is likely that they will outlive their valve, and the potentially superior longevity prospects of a dCELL valve could be an attractive selling point. Tissue valves tend to need replacing every 10-15 years due to calcification mainly caused by immunogenic reaction, eg 52% of infants need to be reoperated on within five years (see article by Nelson et al, 2014). In addition, in younger patients, body growth might require a larger valve to be inserted. Other essential characteristics of an ideal heart valve replacement therapy include sufficient structural durability, absence of thrombogenicity, resistance to infections, lack of antigenicity, ‘off the shelf availability’, excellent haemodynamics, an intrinsic regenerative capacity and potential to grow with the patient. CardioPure HV potentially offers:

TRX is in a position to launch its human dCELL heart valves commercially now that it has built up clinical evidence, has the funding and established the route to market (JV). It plans to do this in 2017 via its recently established joint venture (GBM-V) and aims to subsequently develop and launch a xenogenic version of the graft under the CE mark process. In future, we expect TRX to develop a xenogenic dCELL valve for the US, although we wait confirmation of the details of this strategy.

In January 2016 Tissue TRX entered into a joint venture agreement with a German tissue donation organisation (GTM-V), based in Rostock, Germany, to form the first German, multi-tissue bank, GBM-V. TRX has granted a non-exclusive licence to the JV for human dCELL heart valves (first licence to be granted) and DermaPure. The joint venture will prepare the regulatory submission to the German authorities, with the first products planned to be launched in 2017, depending on regulatory approval. The partnership brings together the ability to procure donor tissue (a key limiting factor, as discussed below) and experience in managing the German regulatory approvals (GTM-V) and access to the patented dCELL process for heart valves and DermaPure. Tissue Regenix intends to replicate this business model in other jurisdictions in the future.

Initially, TRX will launch into a select group of European and RoW geographies.

Heart valve replacement is indicated for patients with valvular heart disease, an important clinical problem worldwide. For an overview of the heart and valves please see here. The global market for heart valve replacement procedures is 225,000 a year according to TRX. The prevalence of heart valve disease is increasing in the Western world due to growing ageing populations and the consequent increase in degenerative valve disease, and in the developing world due to the inadequate treatment of rheumatic heart disease and increasing access to healthcare. As a result, the number of heart valve interventions is expected to increase to over 800,000 annual procedures worldwide by 2050.2 The most prevalent valvular heart disease is aortic stenosis (AS).3 This forms around 75% of all heart valve replacements (the remainder is comprised of mitral and pulmonary valve replacements). The prevalence of aortic valve disease increases with age, ranging from 2% of people over the age of 65, through to 4% percent over 85. Congenital aortic valve disease occurs in 0.3% of births.

The current options available for heart valve replacements include:

The majority of heart valve replacements are achieved with open heart surgery. However, a growing alternative for patients unable to undergo surgery is a Transcatheter aortic-valve replacement (TAVR). TAVR is a technique where the new valve is delivered through a catheter and positioned in place without removing the old, damaged valve. The market leader, Edwards LifeSciences has indicated that the potential TAVR market size is over $5bn and that it expects to expand its patient base to intermediate and lower risk patients.

The worldwide tissue heart valve market is dominated by Edwards Lifesciences. It holds a c 48% share in the US and 54% in Europe with its bioprosthetic Perimount bovine tissue valve. The remainder of the US market is dominated by Medtronic (26%), St Jude Medical (17%) and Sorin (now LivaNova) (5%). The newer generation of implantable ‘tissue engineered’ grafts accounts for c 4% of the US heart valve market. CryoLife is a leader in human tissue valves (35k sold since launch in 2008). Exhibits 4 and 5 outline xenograft and homograft/allograft competitors (not mechanical valves).

CardioPure HV has been implanted in over 1,500 patients to date, with 10 years of follow-up data recently presented. Exhibit 6 outlines key studies.

The number of human tissue valves is independent of growth in the overall human valve market, and depends solely on the number of available donors. The supply of human donor pulmonary and aortic valves is limited to only 3,700 pa in the US, or around 7% of RoW total heart valve replacement procedures.5

The processing of donor tissue is controlled by licensed tissue banks. Currently, most human heart valves are processed using cryopreservation technique (stored frozen at -135°C after processing the donated tissue), although data have been presented that demonstrate a better outcome with dCELL (see above). The collection, paperwork, processing and preparation of human tissue are performed by tissue banks. The tissue banks are non-profit organisations with a code of ethics.

To penetrate the market, TRX needs to demonstrate that the dCELL process will be an improvement on the current technique and that by using the donated tissue, it will be able to further optimise the use of donated tissue to benefit more people who require transplants. Hence the importance of the study outlined above.

Clearly, the availability of human donor hearts poses a problem so if the dCELL process can improve on the properties of porcine tissue valves, it could revolutionise the treatment of patients with heart valve defects. Valves that induce no immunogenic reaction and are less prone to degeneration promote repopulation by the body’s own cells and thereby regenerate with the patient’s body and eliminate the need for recurring surgeries. Moreover, if the low levels of calcification and low immune system activation levels observed in human dCELL valves extend to dCELL-treated xenogenic valves, then these could eventually become the treatment of choice.

TRX has not yet confirmed its US cardiac strategy, although the most likely option in our view is an approach with the porcine version subject to completing the longer development process via an investigational device exemption (IDE), as there would be limited commercial potential with a human tissue valve. Potential would depend on uptake in CE mark regions. The ASP in the US is likely to be at least 30% higher than in CE mark regions in line with peer group pricing. We include the $20m cost of obtaining the IDE in our forecasts.

For the group as a whole, key sensitivities include execution of the wound care commercial strategy and the rate of clinical progress in wound care and orthopaedics. Commercialisation of wound care products is dependent on raising the visibility of DermaPure among key opinion leaders (KOLs), which are typically conservative in adopting new technologies. While existing study data demonstrate excellent results, larger studies could be needed to differentiate the products from the range of skin substitutes available. The orthopaedics division is at an earlier stage of development and although its products potentially meet a significant innovation gap, there are limited published clinical data to substantiate them. US development of porcine orthopaedic products would require additional, potentially dilutive, funding. The cardiac division has a proven technology with the broadest clinical experience, although the process of market access and commercialisation is costly compared to the market size for human heart valves. Each division is subject to additional funding to support ongoing studies and/or to grow sales forces that could prove dilutive to current shareholders.

The company has announced that it will alter its reporting year end from January 2017 to December 2016; the years quoted refer to the new year-end reporting periods. We recently revisited a number of our key valuation assumptions to reflect the clarity on launch timeframes, associated costs and updated revenue guidance. We maintain our DCF valuation at £338m or 44.4p per share using a WACC of 12.5%, subject to potential dilution from an estimated £15m funding requirement (2018) needed to deliver on our estimated growth trajectory, via a hybrid distribution strategy and including development of OrthoPure XT and XM. This would be reduced or not required if the US approval is undertaken alongside a partner, or if OrthoPure XM goes down the 510k route instead of an IDE/PMA route. We recently increased the sales mix costs in both the wound care division (35%, from 30%) and orthopaedic division (45%, from 30%), altered the launch date for OrthoPure XM in the EU to 2018 (2017) and for OrthoPure HM and HT in the US to 2018 (2017). We also rolled the model forward to Q116e (please note the change in year end, so first forecast year is 2016e), updated the $:£ exchange rate ($1.44 to $1.3), adjusted the probability of an IDE in the US to 30% (from 35%) and use reported cash of £19.9m at end FY16 (vs £25m at 31 July 2015). We also split out central costs as the company has started to break figures into respective divisions.

We value the three divisions in discrete units owing to the various growth trajectories and estimated profitability. We value the wound care business at £251m, the orthopaedics division at £77m and the cardiac division at £39m, based on risk-adjusted cash flows for each division according to the stage of development (see Exhibit 8). We assume a higher success probability for human tissue due to lower regulatory risk. There are a number of near-term catalysts ahead, including the potential CE mark grant and launch of OrthoPure XM and US launch of OrthoPure HM/HT via the HCTP pathway, which would lead us to increase the probability of success for these products. According to our model, orthopaedics and cardiac alone account for the current share price, leaving wound care as an option for free. Exhibit 9 illustrates our forecast divisional and group sales and profitability 2016e to 2021e.

TRX could be an acquisition target either on a divisional basis or for its platform technology as a whole. In a takeover scenario, subject to demonstrating clinical and economic value alongside a clear sales trajectory, the valuation of the cardiac division could be between 2x and 7x sales based on the price paid by Cardinal Health for Cordis Vascular and St Jude Medical’s acquisition of Thoratec Corp in 2015 (both in the cardiovascular space, with the higher multiple relating to a technically advanced portfolio). This implies a potential valuation of between $32m and $111m for the cardiac division alone, based on the same 2x and 7x multiple of FY21e cardiac sales of $16m (or £12m), one year post estimated US launch. Equally, in a takeover scenario for the group, subject to gaining commercial traction, it could achieve 5x sales based on the price paid by Integra (wound care) in August 2015 to TEI Biosciences for its range of dermal substitutes. Again, this would imply a valuation of $615m for the group based on a 5x multiple of FY21e sales of $123m (or £94m).

The company has announced that it will alter its reporting year end from January 2017 to December 2016. As a result, our model shows a 2016 actual and the first year of forecast figures as 2016e. We forecast £40.7m in net sales by 2019, which should take TRX to profitability. We see a sequence of potential catalysts over the next couple of years that could lead to delivering the estimated commercial potential. Our revenue estimates are calculated net of a 35% distributor margin for the wound care and cardiac divisions, assuming TRX continues to operate a hybrid distribution strategy. They are calculated net of a 45% distributor margin for the orthopaedic division, assuming TRX follows a pure distributor sales model. We forecast wound care revenue of £2.4m in 2016, rising to £5.2m in 2017, driven by the commercial focus on outpatient wound care clinics and continuing expansion of distribution channels. In 2017, TRX targets launch of OrthoPure XT in CE mark regions; we estimate £1.1m of net revenue in launch year, rising to £4.1m in 2018, which includes a contribution from the launch of OrthoPure XM. We forecast orthopaedic operating expenses of £4.2m in 2016, including SG&A of £0.8m and R&D of £3.5m, reducing to £2.5m in 2017, as one of the clinical trials completes (SG&A of £1.6m and R&D £1.8m). The cardiac division is forecast to launch dCELL heart valves in 2017, with sales of £0.1m in launch year rising to £1.4m in 2018. Our estimated cardiac opex in launch year (2017) is £3m rising to £4m in 2018, due to increased R&D costs to cover the estimated cost of the IDE for porcine valves.

We estimate that group revenue will increase from £2.4m in 2016 to £40.7m in 2019, reaching profitability on a margin of 2%, when we estimate that tax would be payable on a blended basis of 15%, offsetting US corporation tax of 20% against a UK patent box R&D tax credit, trending towards 20% by 2025. Based on end-January 2016 net cash of £19.9m, TRX has a cash runway for the immediate pipeline (OrthoPure, SurgiPure and dCELL valves). We do, however, estimate a £15m funding requirement in 2018 to deliver on our estimated growth trajectory, which includes commercialising via a hybrid distribution strategy and development of OrthoPure XT and XM in the US. This amount would be reduced or not required if the US approval and launch are undertaken alongside a partner, or if OrthoPure XM goes down the 510k route instead of an IDE/PMA route.