Tissue Regenix — Update 21 January 2016

Tissue Regenix (TRX) is a spin-out from Leeds University, established in 2006. It develops and commercialises medical devices for the regeneration of 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 to achieve 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 including a US Wound Care subsidiary, Orthopaedic and Cardiac business divisions. Its UK office is in York, with production and laboratories in Swillington, 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.

Our DCF valuation is £346m (raised from £325m reflecting dollar appreciation) or 45.6p/share based on a WACC of 12.5%, subject to potential dilution from an estimated £15m funding required to deliver on our estimated growth trajectory. We value the wound care business at £188m, the orthopaedics division at £101m and £37m for the cardiac division, based on risk-adjusted cash flows for each division according to the stage of development; we add end-July 2015 net cash of £25m. According to our model, the current price gives a free option on Wound Care, the most attractive and most commercially advanced division. 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.

TRX reported sales of £0.3m in the six-month period ending July 2015. We expect two stocking distributor agreements for DermaPure to be signed, worth at least $0.8m over 12 months, and broader US reimbursement coverage should propel growth in FY17 and beyond. The main growth drivers for reaching our £79m FY21 group sales forecast are Wound Care (£36.2m), Orthopaedics (£35.6m) and Cardiac (£6.9m). TRX raised £19m net in January 2015, by issuing 105.3m shares, to develop and launch human tissue OrthoPure in the US and porcine OrthoPure in CE mark regions, as well as to expand the US direct sales force. We estimate year-end 2016 net cash at £18.8m, sufficient to fund TRX into early 2018. 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. While the Wound Care division is well advanced in this respect, TRX is operating in competitive markets where sustained investment in development and marketing is required to maintain the profile of the products. Commercial success in wound care is dependent on TRX continuing to extend its distribution and reimbursement channels. TRX is running a hybrid distribution strategy and might require additional funding if it appoints additional direct wound care sales reps. 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. Wound care is the most advanced of the three target areas and the subject of this report. The dCELL process creates a tissue scaffold which, once implanted, is repopulated with human cells during the healing process. The technology benefits from several features, which we believe differentiate it from existing treatment alternatives:

Having launched a human tissue-derived wound care product (DermaPure HD) in 2014, TRX is developing a versatile range of human and animal tissue-based devices in wound care, as well as sports medicine and cardiac devices, discussed in our initiation report published in October 2015.

We consider that the global wound care market offers attractive growth prospects, with 4-5% forecast sales CAGR in 2015-18. Its key drivers are an ageing population (2.5% CAGR 2015-50e of people over 60 based on WHO data), aggravating chronic diseases such as diabetes and obesity, as well as growing prevalence of surgical site infections caused by resistant bacterial strains. Overall price inflation is minimal. This masks the fact that basic products, such as gauze and bandages, experience price erosion while novel ones, such as dermal substitutes, growth factors, debridement agents, still have pricing power.

Three companies – Acelity (US), Smith & Nephew (UK) and Mölnlycke (Sweden) – control just over half the global market. Numerous small, mostly local competitors and new technology companies such as TRX represent the rest. As the amalgamation of three mid-sized companies (KCI, LifeCell and Systagenix), Acelity has been the key driver of recent industry consolidation. Over the years, the market has proved receptive to new entrants whose products offer compelling health economic benefits and improve clinical outcomes. Examples include KCI (negative pressure wound therapy), MiMedx (amnion-based skin substitutes) and Mölnlycke (silicone wound dressings).

Large wound dressing brands typically generate annual sales of up to $50m with some advanced products clocking up revenues in excess of $200m, such as Smith & Nephew’s enzymatic debridement agent, Santyl. Large suppliers often source new growth products externally through acquisitions and licensing agreements, but also work actively with product line extensions of their existing products. In view of this market structure, we believe TRX has two main strategic options longer term: either to develop into a fully-fledged wound care supplier, most likely through acquisitions, or to sell itself to a bigger competitor.

Skin wounds have a variety of causes, including thermal burns, venous stasis, ischaemia, pressure, trauma, surgery or underlying skin disorders (eg epidermolysis bullosa). While acute wounds represent the vast majority of wounds, the value of products used in each treatment used is low. Chronic wounds, such as diabetic foot ulcers, vascular ulcers and pressure ulcers, put the patient at risk of infection, amputation and possibly death and their management demands vast human and financial resources.

The sharp rise in diabetes and obesity, plus an ageing population, mean that chronic wounds should become a growing health and cost of care problem and thus a priority for medical advances: in the US eight million individuals (1% of the adult population and 3.6% of the over-65s) are estimated to suffer from chronic wounds.1 Diabetic foot ulcers (DFU) and venous leg ulcers (VLU) are particularly difficult and expensive to heal. Pressure ulcers are also prevalent, developing in 8-15% of all hospital patients, and cause a fourfold increase in mortality.2

The cost of chronic wound care in the US is estimated at $25-50bn annually, mainly consisting of nursing time and hospital admittance costs. In Europe, wound care costs represent as much as 3-4% of healthcare budgets. The direct cost of materials such as dressings is estimated to be 15-20% of total care costs, according to Smith & Nephew. The cost of treatment per patient varies enormously depending on ulcer duration and severity, but figures range from $10,500 to $33,900 for VLU treatment and from $1,890 to $27,700 per DFU episode.3 4

We envision a sharper focus on health economics to drive demand for products with demonstrable clinical benefits. In this spirit, the US Affordable Care Act incentivises care givers to achieve better care at lower overall cost for any given treatment episode.

Wound care is not the focus of any single physician speciality, but is handled by a range of medical professionals such as vascular surgeons, gynecologists and dermatologists. Consequently, finding consensus about treatment protocols is challenging, which is exacerbated by great variations in reimbursements and budgets of treating facilities. Moreover, patient populations are affected by a high degree of co-morbidities and adverse socioeconomic factors, which often undermines compliance with prescribed treatments. In clinical trial settings, these challenging preconditions are compounded by patients showing much improved results compared to real life, thanks to the controlled conditions, which distorts the outcomes, not least in the control arm. Indeed, several novel treatments have shown good results in Phase II only to fail in Phase III. Recent examples including aclerastide for DFU (Derma Sciences) and HP802-247 for VLU (Smith & Nephew). Accordingly, even well-designed randomised controlled trials with standardised outcome measures struggle to produce approvable regulated wound products.

Typical wound healing protocols include risk factor modification, offloading, debridement and a protective dressing. Risk factor modification includes elimination or minimisation of causes for wounds, such as ischaemia. The US Wound Healing Society has issued treatment guidelines (see Exhibit 6) using debridement (removal of necrotic tissue), antibiotic treatment, moist dressings, complete pressure off-loading (DFU) and compression bandages (VLU) as first-line treatment. Second-line treatments include hyperbaric oxygen (HBOT) and negative pressure therapy (NPWT), widely used in the US but less so in Europe. Dermal substitutes, so-called Cellular and Tissue products (CTP), are widely adopted in the US with the aim of improving healing rates and reducing secondary complications, such as infections and amputations. According to US Wound Registry analysis (2005-10), 51% of wounds healed with standard care, while hard-to-heal chronic wounds required advanced therapies such as HBOT, NPWT or dermal substitutes.

Wound care procedures are by and large performed in an outpatient setting in Europe with a well-developed system of specialised wound nurses, not least in the UK. In the US, the lion’s share of procedures are performed in wound care centres – the commercial operators Healogics and Restorix are the two biggest – but surgery centres and physician offices also perform a large number of procedures.

CTPs are either biomaterial (synthetic) or cellular matrices (minimally or extensively manipulated human or animal tissue). When applied to a wound they act like an autologous skin graft and provide the functions of normal skin. The field is crowded, with more than 70 products available, the most important of which are illustrated in Exhibit 8. While Medicare covers most products, private health insurance providers like UnitedHealth and Aetna currently regard only a handful as “medically necessary” for the treatment of VLU and DFU. However, TRX expects a growing adoption of DermaPure as a result of Medicare coding, coverage and utilisation. Private health insurers also administer Medicare managed plans that typically follow the reimbursement rules stipulated by Medicare.

The use of biologics in wound care outside the US is limited, due to constrained healthcare budgets, a more conservative use of tissue-derived products and greater hurdles in the production of processed human tissue. Competition over tissue processed by tissue banks is tight, particularly in orthopaedic applications, as is the regulation of trade of human tissue in Europe. Moreover, religious and other sociological considerations have an impact on the use of porcine devices, which are an order of magnitude cheaper to manufacture than human tissue-based products. However, xenografts are rarely used in dermal applications, as they are seen as less efficacious.

Four companies control nearly three-quarters of the $865m5 US biological wound care market, comprised of dermal substitutes, topical delivery/drugs and collagen/active dressings. The European market is valued at $25m and the market in the rest of the world a mere $7m.

The biggest category is dermal substitutes (2014: $526m), in which amnion-based EpiFix (MiMedx) has overtaken the manipulated skin grafts Dermagraft and Apligraf (Organogenesis) as the leading product following changes to Medicare reimbursement rates in 2014. Of the 6.5m chronic wounds there were 665,800 applications of CTPs in 2013, accounting for 222,000 wounds, assuming three applications per wound. The vast majority were used in the treatment of DFU and VLU.

In October 2014, the Centers for Medicare & Medicaid Services (CMS) introduced a new reimbursement system for wound care in the outpatient setting with the purpose of reducing wastage and cost. Previously, facilities would claim two separate payments through the Outpatient Prospective Payment System (OPPS) for the cost of a wound care procedure (eg debridement) and the cost of the skin substitute product, based on their historic average sales price (ASP) plus 6%. Under the new system, skin substitutes are reimbursed at a fixed price for the entire procedure by bundling the product payment with the procedure payment and adjusted for wage index. Products are assigned to high/low-cost groups (Exhibit 11) as a function of the size of the graft.

We expect the availability of smaller sizes of skin substitutes to be critical under the new system. According to MiMedx, the median size of ulcers is 1.35 cm2 for DFU and 2.32 cm2 for VLU, with 67% of DFU and 77% of VLU being under 5cm2, prompting TRX and others to manufacture increasingly smaller patches (Exhibit 8). Pricing details for many products are sketchy, but range from $126/unit for Oasis, a xenograft in the low-cost group, to a starting point of $595 for DermaPure and more than $1,000/unit for Apligraf/Dermagraft and in the high-cost group. Even compared to the relatively inexpensive EpiFix (starting from $320 per patch), DermaPure HD comes out more favourably in terms of cost per wound closure. Based on an average price point of $1,400, we estimate treatment costs using DermaPure at $1,540 based on 1.1 applications, compared to an average treatment cost using market-leading EpiFix at $2,4406 owing to multiple applications.

Moreover, unless Medicare beneficiaries have taken out secondary insurance coverage they are liable for a 20% co-payment, making patients sensitive to the number of treatment episodes before the wound heals. This pitches patients against physicians, who have historically benefited from products requiring multiple procedures. However, the new bundled reimbursement incentivises physicians to minimise overall treatment cost, which we expect to be supportive for the use of DermaPure HD, intended for single application.

The use of tissue for human use is subject to regulations depending on its source: xenograft (animal derived tissue, eg porcine, bovine, ovine), human allograft (cadaver or live donor) or cell-based bioengineered tissue, illustrated in Exhibit 12. Acellular dermal matrices from human tissue, such as DermaPure HD, are regarded as minimally processed and classified by the FDA as donated human tissue. It can therefore be commercialised pending clearance of the participating tissue bank with no regulatory burden directly on the manufacturer, unlike many of its competitors.

Historically, regulatory oversight for many tissue-based products has been relatively relaxed. However, in late October 2015 the FDA issued draft guidance on homologous use of human cells, tissues, and cellular and tissue-based products, particularly relating to the fast-growing use of amniotic tissue-based products. We expect the intensified regulatory scrutiny to prompt major players to invest more in controlled trials to support efficacy claims for their products and convince healthcare insurers to cover their use. Based on the FDA’s proposed changes, we do not expect any impact on DermaPure. Conversely, usage may slow some amnion-based products in the event that 510k clearance becomes mandatory for their use. Earlier in 2015, the FDA also issued a draft on what tissue is considered minimally manipulated. DermaPure is considered minimally manipulated and approved as a homologous use product (dermis for dermis replacement) and should remain unaffected.

In Europe, TRX is reviewing its distribution options and may look to establish agreements with local tissue banks, from which it may secure a licence fee. The use of medical products originating from an EU tissue bank (unless minimally manipulated like DermaPure) is governed by the Advanced Therapy Medicinal Products regulation. Unlike products under the Medical Device Directive, such as xenografts, this regulatory pathway necessitates clinical trials. Once approval is granted, it covers the entire European Union. Human tissue derived products fall under a variety of national legislation. For example, in Germany human tissue-derived products like DermaPure are regulated by the federal institute for vaccines and biomedicines, the Paul-Ehrlich Institute, and in the UK by the Human Tissue Authority.

TRX’s commercial strategy focuses on building a portfolio of dermal substitutes (xenografts and allografts) addressing a range of indications and price points, while extending its commercial reach by adopting a hybrid strategy of sales reps and independent distributors.

DermaPure HD was launched in the US and Europe in June 2014. In the first phase, TRX addressed inpatient settings, representing 20% of wounds, such as acute care hospitals and Veterans Affairs (VA) hospitals. Reflecting the need to educate new users in the early phase, TRX generated a mere £0.1m in DermaPure HD revenues in 2014.

The second phase of the DermaPure launch is now underway, targeting outpatient facilities that deal with about 80% of chronic wounds and where Medicare is the main payer. Having been awarded the requisite Q code in late 2014, eight out of 11 Medicare reimbursement agencies have now approved the reimbursement of DermaPure, making it accessible to two-thirds of Medicare beneficiaries (1.5 million addressable patients). By targeting the outstanding north-eastern, Georgia and the Michigan/Illinois Medicare agents, TRX is aiming to secure full coverage in the future.

TRX adopts a hybrid strategy of employed sales reps (15) and independent distributors, allowing it to build channels in 1,000+ outpatient centres across the 30 states where it currently enjoys Medicare coverage. It has also deployed sales resources in non-Medicare covered states targeting physicians in the hospital setting. TRX’s reps primarily target larger hospital institutions, groups of hospitals (GPOs/integrated networks) and wound care chains.

We consider DermaPure HD to be well positioned by virtue of the indications of good efficacy in hard-to-heal chronic wounds and the fact that it is economic to store and use. For example, Dermagraft must be stored at -75°C ± 10°C, while DermaPure is stored and transported at room temperature. The absence of immunogenic substances such as silicon and glycosaminoglycan in the dCELL extraction process makes DermaPure a ‘cleaner’ alternative to many other skin substitutes. As the product launch is still at an early stage, we forecast <1% market share in the US in FY21 with $6m in sales. To contextualise our $31m peak sales estimate for Derma Pure in more than 10 years’ time, we note that MiMedx reached over $100m in sales with its amnion-based product only a few years after launch.

As discussed in our initiation report, there is a growing body of peer-reviewed clinical evidence for DermaPure HD, illustrating the efficacy of the allograft in both chronic and acute wound care settings. A UK study of DermaPure HD in 20 DFU/VLU patients demonstrated that DermaPure met the primary outcome measure despite the treatment-resistant nature of the wounds.

Furthermore, DermaPure HD has been shown to enhance angiogenesis vs controls in a 50-patient study in acute wounds. Angiogenesis, or new capillary formation, is crucial to prompt wound healing and scar prevention. The study compared wound healing with DermaPure to healing with collagen-GAG scaffold (Integra Matrix Wound Dressing), autograft and no intervention, with the main observations summarised in Exhibit 16.

A US multi-centre clinical validation case series of hard-to-heal chronic wounds was initiated in August 2014 to support the company’s marketing and reimbursement strategy and to provide data for line extensions. The primary outcome measure of the study is incidence of wound healing. Secondary measurements include the quality and rate of wound healing. Interim results from the 10-patient study presented at the Symposium on Advanced Wound Care (SAWC), Arizona in May 2015 represented a significant step towards raising the profile of DermaPure HD among key opinion leaders. Because of rigorous inclusion/exclusion criteria, enrolment has been slower than expected such that results, previously expected in Q415, are likely to become available in H116.

TRX is also promoting the application of DermaPure HD in acute wound care management, initially targeting lower extremity amputations, surgical wounds and burns. These are considered complex wounds treated in the acute setting. The commercial potential for dermal substitutes in burns alone (10 million cases per year globally) should be at least as significant as chronic wounds (35 million cases per year globally) because the average number of grafts used per patient would be higher. A minimum of two applications is needed to cover larger wound surface areas and we estimate the average graft cost per procedure at c $4,000. The use of skin autografts is the gold standard for the restoration of epidermal function of the skin in burn patients. The limitations of autografts include risk of additional scarring and inadequate available skin. TRX initially intends to target treatment of severe burns and abrasions, a population of around one million patients pa in the US, expanding into other indications such as trauma wounds, subject to clinical data.

Having started with human tissue implants, TRX is developing porcine tissue implants, which could pave the way for greater commercial scale, easier sourcing and lower-cost processing.

SurgiPure XD, a xenograft based on the dCELL technology, is being developed initially for hernia repair with a US launch prepared for 2016, subject to FDA approval. TRX submitted a 510(k) application in Q415, making an approval in the course of 2016 possible.

Growth drivers of the surgical matrices market (US sales of $360m in Q115) include the need to cut down complications (reintervention and infection) associated with the use of currently available mesh products. The US surgical matrices market is led by Bard/Davol, LifeCell/Acelity (AlloDerm, a decellularised human tissue product) and J&J/Ethicon. A range of animal tissue surgical patches is already on the market, which paves the way for SurgiPure XD, including Strattice Tissue Matrix (KCI/Acelity) and SurgiMend (TEI Biosciences). As there are no published data on the product, we conservatively estimate that the market share of SurgiPure XD would be less than 0.5% in the initial launch years. There are c 1m hernia repairs pa and around 25% of patients suffer complications from hernia mesh. Currently, the reimbursement per procedure for surgical soft tissue patches is c $7,500.7 In future, TRX plans to target a range of new soft tissue replacement/augmentation indications for a human tissue version of SurgiPure HD, including breast reconstruction and soft tissue tendon repair, with a sales price per patch of c $2,000, well above the chronic wound care setting. However, SurgiPure HD does not currently have a reimbursement code. We await confirmation of the timelines before adding in sales estimates for SurgiPure HD.

We forecast £45m in net sales by 2020e, which should take TRX to profitability. We see a sequence of potential catalysts over the next couple of years that could lead towards delivering the estimated commercial potential. Our revenue estimates are calculated net of a 30% distributor margin for simplicity across all three divisions, assuming that TRX continues to operate a hybrid distribution strategy. We forecast wound care revenue of £0.5m in FY16, rising to £1.6m in FY17, driven by the commercial focus on outpatient wound care clinics and continuing expansion of distribution channels. We forecast wound care operating expenses of £4.9m in FY16 including SG&A of £2.8m and R&D of £2.4m, rising to £6.6m in FY17 (SG&A of £3.7m and R&D £3.3m) to cover ongoing DermaPure and SurgiPure studies and expansion of the direct sales force to enable the full roll-out to wound care clinics. Wound care operating expenses are forecast to increase to £8.6m in FY18, in line with the launch of successive products. We estimate that the subsidiary will become profitable in 2020, realising £0.8m of operating profit.

We estimate that group revenue will increase from £0.5m in FY16 to £79m in FY21, reaching profitability on a margin of 3% in 2020, when we estimate that tax would be payable on a blended basis of 15%, offsetting US corporation tax of 20% against UK patent box R&D tax credit, trending towards 20%. Based on end-July 2015 net cash of £24.9m, TRX has a cash runway for the immediate pipeline (OrthoPure, SurgiPure and dCELL valves) and to launch wound care products in the US via a hybrid strategy. Our forecasts indicate that the company has a funding requirement of £15m in 2018 to cover FDA studies of OrthoPure XT/XM.

Our DCF valuation is £346m or 45.6p per share using a WACC of 12.5%, subject to potential dilution from an estimated £15m funding requirement needed to deliver on our estimated growth trajectory via a hybrid distribution strategy. We value the wound care business at £188m, the orthopaedics division at £101m and the cardiac division at £37m, based on risk-adjusted cash flows for each division according to the stage of development; we add end-July 2015 net cash of £25m. According to our model, Orthopaedics and Cardiac alone account for the current share price, leaving Wound Care as an option for free. 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.

Exhibit 20 illustrates our forecast divisional and group sales and profitability 2016-21. We estimate that TRX will become profitable in 2020, on this basis trending towards an 18% group EBIT margin in 2021. We adjust all developing products, using standard medtech probabilities of success, as shown in Exhibit 21. We assume a higher success probability for human tissue due to lower regulatory risk.

In a takeover scenario, subject to TRX gaining commercial traction, the valuation of the company could be 5x sales based on the price paid by Integra (wound care) in August to TEI Biosciences for its range of dermal substitutes, which would imply a valuation of $565m for the group based on a multiple of FY21 sales of $113m (£79m).

There is a range of potential value drivers for TRX: in 2016, events that would lead us to increase the probability of success for the individual products include data from the ongoing chronic wound care study in H116, 510k clearance of SurgiPure XD, OrthoPure XM CE mark grant and launch/US launch of OrthoPure HM/HT. Launch of the dCELL human heart valve is planned during 2017.