GlassesOff: Asymmetric Upside Opportunity Presented From Systematic De-Risking

April 11, 2014 • Analysis • Tags: ,

Biotech and pharmaceutical investors, or arbitrary venture capitalists as I term them, are exposed to risks that are inherently exclusive to the sector. Dissimilar to other industries, biotech and pharmaceutical share prices are provoked by binary events that can transform a company’s valuation overnight creating immense volatility. These binary events include but are not limited to:

Regulatory/Clinical Trial Risk – The inability for a company’s product or drug candidate to satisfy regulations and requirements set forth by the FDA; includes meeting efficacy and safety endpoints.

Financing Risk- Prevalent amongst a majority of small-cap biotech’s and pharmaceuticals. Financing risk occurs when additional financing cannot be secured, or a round is completed at a price unfavorable to shareholders; the predecessor of dilution.

Reimbursement Risk -Even with an FDA approved marketable product, demand is largely contingent on the reimbursement policy set forth by regulatory government bodies. Practitioners will often forgo prescribing or recommending expensive treatments that run the risk of not being reimbursed by insurance coverage.

Marketing/Manufacturing Risk -Even with regulatory approval, a company’s product can fail due to inadequate production facility infrastructure and/or in combination with ineffective sales strategies; includes the potential inability to secure favorable agreements with marketing and manufacturing partners.

Understanding the Risks: The Dendreon Example

Dendreon (DNDN) is a biotechnology company that has established itself as one of the pioneers of the modern-day technology shift ongoing in oncology. Immunotherapy is a treatment that optimizes the immune system, provoking it into attacking the tumor cells by using cancer antigens as the targets. Dendreon’s lead product, Provenge (Sipuleucel-T), targets metastatic prostate cancer by extracting the patient’s own blood cells and infusing them with their proprietary PAP-GM-CSF protein at their plant off-site. Though the company was successful bringing the therapy to market, Dendreon has fallen victim to the inherent risks in healthcare in the past, and still has many to overcome in the future.

Regulatory/Clinical Trial Risk -Does not currently exist for Dendreon. The company’s sole and lead product Provenge received FDA approval in 2010 in the U.S with European approval succeeding that in the latter part of 2013. However, Dendreon’s stock experienced immense volatility as a result of these phase trials. In March of 2007, the FDA voted 17-0 that Provenge was reasonably safe and 13-4 that the phase III trial data showed substantial evidence for its efficacy. This sent the stock from the low $4’s to $20 in a matter of days. However, in May of the same year, the company received a letter from the FDA requesting more results and information before approval. Subsequently, the stock returned to the mid-6’s in just under a month and continued to downtrend until results came back positive in the end of 2009, shooting the stock to $50/share. While regulatory/clinical trial risk poses no threat today, it is important to understand how impactful they can be to the share price of a company’s stock.

Financing Risk -Upon scratching the surface of the balance sheet, you’ll notice some very troublesome figures:

Dendreon Balance Sheet

 

As of December 31, 2013 the company’s working capital stands just shy of $200 million. Since 2009, it has been reduced from $606 million representing a 67% decrease over 4 years. This can be attributed to continual annual losses resulting from Provenge which was $89 million in Q4 of 2013 alone. The most worrisome figure however are the long-term liabilities standing at $578 million. Of the $578 million, $28 million is due within the next 3 months with the full amount due in 2016. Historically, Dendreon has diluted shares increasing the share count from 98 million in 2009 to 157 million by the end of 2013. This raises the question of when the company will execute their next public offering, and at what discount.

Reimbursement Risk -With Provenge therapy costing roughly $100,000, the company quickly found out that physicians’ weren’t willing to put their neck on the line to cover the unusual “cost-density” associated with the therapy. As with many cancer drugs, once a doctor prescribes Provenge, he or she has to buy it, typically using their own private practice account. Since Dendreon’s drug is given through three infusions in one month, doctors have to shell out for a full $93,000 bill for giving one month of infusions to one patient. Though Provenge is comparably priced to other expensive cancer treatments, its treatment period is 30 days compared others than can span over the course of several months, even years.

With the approval of Provenge in Europe, Dendreon is now faced with the challenge of getting nation-by-nation approval for reimbursement. Almost all therapy payments are from government health programs that watch costs far more carefully than private insurers, or even Medicare, do in the U.S. Dendreon will need to be far more cost efficient in Europe than they have been in the U.S., as the allowed price of Provenge therapy may be reduced to about $80,000 per patient.

Marketing/Manufacturing Risk -First, as a cancer vaccine, Provenge is tailored to each individual patient, which heightens the cost of manufacturing and deteriorates margins. This of course weighed in on the company’s decision to either outsource manufacturing or build the infrastructure to produce it themselves. Dendreon stuck with the latter, and built three plants where they infused Provenge. Due to their inability to control costs, they subsequently sold their largest 173,100 square-foot plant to Novartis in the end of 2012. Through a tough lesson learned, Dendreon has decided to partner with PharmaCell who will be the primary contract manufacturer of Provenge in Europe, while maintaining their two plants in the U.S. This shift in strategy is a testament to the complications that arise when initially deciding to manufacture or outsource, though the results of the latter are yet to be witnessed.

Marketing risk is also prevalent as competitors fight for market share of cancer patients. Dendreon responded with a series of direct-to-consumer (DTC) ads that launched in the beginning of March 2013. The ads have been aired over 500 times spanning across national television and radio broadcasts. Though the cost and effectiveness of the campaign is unknown, Google searches for Provenge have spiked significantly hinting towards a marginal benefit. Marketing will be integral to the success of Provenge in Europe as the prostate cancer patient pool is significantly larger, spanning across a considerably larger geographic area. Alongside increased competition, the capital expenditure required to capture market share in Europe may be more than Dendreon can afford.

Making the Connection: The GlassesOff Opportunity

We understand that value today is a function of the risk return ratio, and asymmetric views of that ratio create arbitrage opportunities as investors. Understanding these risks, investors looking to profit in the industry must necessitate mitigating risks to be successful. In Dendreon’s case, risk cannot justifiably be mitigated as it is apparent in ¾ categories outlined. However, this is not the case for GlassesOff (GLSO), a company that I believe to be an anomaly within the industry. Using the same format, I will outline how GlassesOff offers a significantly de-risked profile and show why I believe there is asymmetric upside opportunity in the market exclusivity they posses.

GlassesOff is a neuroscience health-tech company, utilizing proprietary technology to develop and commercialize mobile software applications that address the condition known as Presbyopia. The company’s flagship application aims to improve near vision sharpness by improving the image processing function in the visual cortex of the brain. Human vision is limited by two main factors:

(I) The quality of an image captured by the eyes; and

(ii) The image processing capabilities of the brain as it interprets an image captured by the eyes.

At some point, natural age-related changes in reading abilities affect virtually everyone. Typically, the people attempt to improve reading abilities through the aid of reading glasses. GlassesOff technology is proven to enhance the image processing capabilities of the brain thus improving a person’s reading abilities and effectively eliminating the need for reading glasses. Presbyopia is estimated to affect 120 million Americans, with that figure reaching over a billion worldwide. As it stands, GlassesOff is the only company that has successfully created any treatment or product to eliminate the need for reading glasses. Therefore, there is an immense market opportunity that presents itself. The only question that remains is whether or not the company is subject to the same inherent risks that exist in healthcare.

Regulatory/Clinical Trial Risk – Since GlassesOff’s technology is a mobile software application, it is not subject to the same regulations as medical devices or drug therapies. However, the FDA has introduced an oversight approach for a sub-set of medical apps that will be subject to regulatory guidelines. This sub-set includes apps that:

  1. are used as an accessory to medical device already regulated by the FDA
  1. transform a mobile communications device into a regulated medical device by using attachments, sensors or other devices

As it stands, GlassesOff’s technology satisfies the regulations outlined by the FDA as it not an accessory to a regulated medical device nor does it use attachments of any sort to transform it into a medical device. This means that the company does not have to undergo the scrutiny of clinical trials and the associated volatility.

This does however raise the question of whether the technology is validated or merely anecdotal. A study was conducted at The UC Berkley School of Optometry to clarify it. Published in the respected Nature’s Scientific Reports, surveyors concluded that users who completed GlassesOff’s program witnessed a >80% improvement in visual activity, effectively reducing the biological “eye-age” by 8.6 years. All 30 presbyopes, who could not read a standard font size newspaper without reading glasses, were able to effortlessly read the newspaper with their “glasses off” by the end of study.

Financing Risk – Back in August of 2013, GlassesOff successfully raised $3.1 million dollars in a private placement at $1.25/share while simultaneously completing the merger with Ucansi, the private company who designed the technology. Recorded on the books as of December 30, 2013, the company had $1.686 million in current assets equating to a monthly burn rate of approximately $282,800. Ceteris Paribas, the company should have approximately $554,800 in current assets at the end of April 2014. Expenses related to research and development, as well as outsourcing marketing services (outlined in the 10-K) highlights the need for a capital raise in the coming months.

I believe the company will be able to raise funds at a slight discount to market. The 50 day moving average hovers at the $2.00 mark, therefore it’s reasonable to assume the company will raise funds in the $1.75 range, or a ~ 15% discount to market. The ability to raise funds could serve as a catalyst for the company as money raised will be a testimony to investors beliefs in the prospects of the company and allow for a ramped up marketing campaign.

Reimbursement Risk -GlassesOff’s product will not be prescribed by doctors, nor will it be covered by Medicare, so the company will not face any dilemmas associated to reimbursement but the cost will be coming out of the consumers’ pocket. The applications pro version is currently selling for $59.99. At first this may seem pricey for a “app” (Lumosity can run as much as $300), but comparable to the cost of reading glasses without the inconveniences.

Marketing/Manufacturing Risk -GlassesOff has successfully developed and launched their software-based application, which requires no manufacturing whatsoever. Other than maintenance costs for troubleshooting and updates, the company incurs no overhead costs relating to the production of the program. However, significant capital expenditures will be required to successfully market the product to the broad base of consumers worldwide. The company has strategically positioned themselves to meet the marketing requirements to drive sales for the app by hiring one of the biggest names in the business. M&C Saatchi, the marketer who represents brands like Coca-Cola, Twitter, Playboy, etc., was appointed by the company in early October of 2013. Marketing will be the key revenue driver, so the company is expected to use incoming funds towards a advertising campaign.

GlassesOff is currently sold on Apple’s iTunes, with the launch on Google’s Playstore platform expected in Q2. Combined, these offer global stage for sales with low barriers to entry. It would be my expectation to see a full-fledged marketing campaign after the program is launched on all platforms. Due to this, I expect the second half of 2014 to show topline traction as the app is adopted amongst a wide array of users.

Conclusion

Mitigating risk is an integral part of successful investing, especially true in the healthcare sector. As we learned from Dendreon’s case, the greater number of inherent risks that are prevalent in a company’s profile equates to increases in volatility of the stock. The upside potential of GlassesOff will be dependent on the increased consumer awareness rather than conventional risk measures shared by other healthcare companies. As financing risk is alleviated in the coming months, longer term investors will be seeing the benefits of the increased adoption generated by a marketing campaign.

 

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