Looking back, my 2014 investment thesis on Alliqua (ALQA) was fairly accurate. The company, with the backing of strategic partner Celgene (CELG), entered into the fastest growing space of advanced wound care. During this time, Alliqua launched Biovance, a wound covering derivate of human amniotic membrane, built a sales force of 25 full time reps and raised over $30M to fund expansion efforts. Yet, the stock is down nearly 40%. I have taken this opportunity to add to my position and lower my average cost as the business continues being developed behind the scenes. Last year, I thought Alliqua was a good investment at $9/share. At a current price in the mid $5/share, Alliqua is a bargain.
Alliqua’s Developments Still in Early Innings
For fiscal year 2014, CEO Dave Johnson expects total revenues in the range of $4.7 – $5 million, representing year over year growth of approximately 170%. This number may sound colossal, but the company essentially started with zero revenues and contributions from proprietary products (ie. Biovance) accounted for less than one third of total sales. For fiscal year 2015, revenues are projected to be over $20M due to acquisition of Celleration, discussed more below. This guidance will prove to be conservative as the 2015 figure excludes any potential benefit from the Q-Code approval as well as contributions from any future acquisitions.
Implications of Q-Code Approval Gone Unnoticed
Alliqua was assigned Q-Code reimbursement in early November 2014, opening the company to the second half of the wound care market. Approximately 50% of the market is open to wound care specialists treating patients in an institutional setting (“in hospital”). Q-Code is not needed to market a product here, which is what Alliqua was initially focusing on with Biovance.
The other half of the business is in outpatient market, including Medicare clinics and physician offices. Attaining Q-Code reimbursement opens up Biovance to this second half of the market. The next step for Alliqua will be to pursue coverage from payers in Medicare Administrative Contractors (MACs). There are 8 MACs in total, and management expects it will take approximately 2 years to receive full coverage from all MACs.
Using MiMedx Trajectory for MAC Adoption
MiMedx (MDXG) top line growth (below) indicates the acceptance of placenta based wound care products becoming the norm for advanced wound treatments. It took MiMedx approximately 18 months to have full nationwide MAC coverage from the time the company received Q-Code approval for EpiFix Allograft back in January 2013. This should give investors an idea of how long Alliqua will require to get all 8 MACs on board and the potential revenue surge as a result.
By the end of the first full year of Q-Code approval (2013), MiMedx had seen sales more than double. During this time, the company had received reimbursement from 6/8 MACs. Revenues nearly doubled again in 2014 as MiMedx had gotten coverage from all 8 MACs by midyear. With a full year of complete MAC coverage, MiMedx is expecting to see 50% top line growth.
MACs have opened up their formularies to MiMedx’s placenta based products, which are substantially similar to Alliqua’s Biovance. As a result, this will make it easier for new products to penetrate the same market. Expect the company to start receiving approvals towards the backend of 2015, which should, theoretically, lead to a similar trajectory to MiMedx.
Alliqua to Leverage Fragmented Space for M&A Growth
Currently the wound care landscape is fragmented as seven companies represent 50% of market share and hundreds of smaller companies represent the other 50%. Alliqua will focus on consolidating the divided 50% of the market by utilizing available capital to build the company’s portfolio of products.
Many of these smaller potential targets don’t have the capital and/or distribution channels to scale at critical mass, and therefore, would be interested in joining forces with Alliqua, a company with access to public capital and growing infrastructure avenues. Rolling up the divided wound care segment will prove to be a viable strategy for Alliqua as the combination of organic growth supplemented by acquisition-driven growth will create shareholder value.
Celleration Acquisition: The Perfect Marriage
Alliqua announced its first major acquisition of 2015 with the purchase of Celleration, a medical device company focused on ultrasound healing technology to treat wounds. Celleration’s MIST Therapy uses low frequency ultrasound waves to stimulate cells below the wound bed, promoting the healing process. This newest addition complements Alliqua’s current product portfolio as MIST Therapy is used to prepare the wound bed before applying a skin graft such as Biovance. Additional synergies of this deal include:
1. Nearly Doubling Sales Force
Celleration employees 43 individuals, 19 of whom are sales representatives. Alliqua will add these reps to their current 25 member team, nearly doubling the combined entities footprint. As a result, cross selling synergies will be formed from adding the distribution channels of the newly purchased company. Alliqua will be selling their existing products to Celleration’s channels and vice versa.
2. Added Reimbursement Expertise to Assist with MAC Coverage
Celleration’s MIST Therapy has been cleared by the FDA with indications to promote wound healing and is currently reimbursed by the Centers for Medicare and Medicaid Services (CMS). With 5 out of 8 MACs covering reimbursement, MIST covers 87% of potential patient population. Celleration’s expertise with reimbursement coverage will be utilized by Alliqua in the company’s own process to gain coverage for Biovance (as discussed above).
3. Benefits to Top & Bottom Line
Celleration generated fiscal 2014 sales of $8.7M, down 8% from 2013. This decrease was due to the company cutting sales force in favor of securing reimbursement and generating clinical data around pipeline products. This was a classic example of “short term pain for long term gain”, as Alliqua CEO Dave Johnson put it. For 2015, Celleration should add $10M to Alliqua’s top line.
The newly acquired company follows a razor & razor blade model in which the majority of revenues are generated from the high margined disposables, indicating recurring revenues. Celleration’s disposables generate 80% of revenue at a gross margin of ~80%. This will prove to be beneficial to Alliqua’s revenue mix as it will cause overall margins to increase. Alliqua expects the Celleration acquisition to be accretive to the consolidated financials due to the overhead cost savings.
The above revenue mix assumes the impact from Q-Code approval adds an additional 30% (or $4M) to the original 2015 guidance of $13M. Biovance margin is assumed to be 75%, as per management’s projections. With proprietary offerings becoming a larger segment of generated revenues, expect Alliqua margins to near mid-70% range in the long term. For 2015, the above projections yield 63% due to addition of Celleration and greater mix of proprietary offerings.
Acquisition Funded by Large Healthcare Hedge Fund
The initial purchase price of the Celleration acquisition was $30.4M, which is comprised of cash and stock. Perceptive Advisers, one of the most renowned healthcare hedge funds, loaned the $15.5M upfront cash Alliqua needed. Joseph Edelman’s fund, which already owns approximately 6% of Alliqua’s shares outstanding, provided further financial validation. The remainder of the acquisition was paid in the form of 3.2M shares, bringing the total shares outstanding to approximately 19.3 M.
Alliqua’s Acquisition Strategy an Arbitrage Opportunity for Shareholders
CEO David Johnson has gone on record saying that a focus for 2015 will be to add to Alliqua’s product portfolio through M&A deals. Looking at Johnson’s history, growth through acquisition was how he and his current Alliqua team (whom he brought on from ConvaTec) built Bristol-Myers Squibb’s ConvaTec wound care business into over billion dollar sales before being acquired for $4.1B. Johnson is mirroring his ConvaTec strategy at Alliqua.
Adding companies with operations, sales and cash flows will allow Alliqua to build aggregate cash flows that may be used to service additional debt. As a result, shareholders will see little dilution. Even the dilution that does happen will be at a much slower pace than the growth of the company. Take Celleration acquisition, for example. By taking on debt, Alliqua equity was diluted by ~20%, but top line is expected to increase by at least 50%.
If we were to look at Alliqua’s latest acquisitions, there is a discrepancy between the sales multiple that Alliqua pays and what public companies in the advanced wound care space are being given. Alliqua paid 2.2X and 3.5X sales for Choice and Celleration acquisitions, but receives a market premium of over 7X sales, in line with peers. Therefore, this can be seen as an arbitrage opportunity for Alliqua investors who essentially see accretion of $2M in market cap for every million added to top line.
Public multiples are higher than private ones due to the transparency and liquidity factors. Anyone can analyze the publicly regulated filings corporations that trade on stock markets report and investors are able to move in and out of the asset at their own discretion. These options are not available with private companies, thus leading to lower multiples.
Deals Will Continue to be in the Mix for 2015
As explained above, Alliqua will continue to implement the M&A strategy that management has set out. The synergies from potential deals go beyond just financials and the discounted premium Alliqua pays will prove to be accretive for shareholders in the long run. Celleration was the start Alliqua was looking for in 2015, but the company is not done yet.