Jason Napodano, CFA
Initiating Coverage of InVivo Therapeutics
We are initiating coverage of InVivo Therapeutics (NVIV) with an Outperform rating and $4.50 price target. We are excited about the opportunity that InVivo presents to investors. There are currently no significant treatment options for patients with SCI. Although many companies are currently working on pharmaceutical treatment options, we like InVivo’s approach with their biopolymer scaffold device (BSD) for several reasons:
- BSD will be regulated as a medical device. Management filed the Investigational Device Exemption (IDE) to the U.S. FDA in July 2011. The proposed indication is to protect and support spinal tissue and prevent secondary injury, including inflammation and glial scarring, following traumatic spinal cord injury. We think this initial, simpler approach to treating SCI provides investors with a quicker and lower risk path to market than the traditional pharmaceutical or biologic pathway.
- Strong scientific rationale. InVivo’s technology for the BSD was born out of the labs of Robert S. Langer, ScD, Professor at Massachusetts Institute of Technology and Joseph P. Vacanti, MD, affiliated with Massachusetts General Hospital. Dr. Langer has written over 1,100 articles, holds approximately 760 issued and pending patents worldwide that have been licensed or sublicensed to over 220 pharmaceutical, chemical, biotechnology and medical device companies. InVivo’s CEO, Frank Reynolds, having suffered a paralyzing injury to his spine in December 1992, has spent years gaining subject matter expertise on the spine and spinal cord.
- Intellectual property protection is strong. Ultimately, we believe combination therapy will become the standard of care for SCI. InVivo’s owns the patent rights to use of all biopolymer scaffolding products which serve as an extracellular matrix for cell therapy, or in in combination with pharmaceutical products or biologic growth factors. These patents also protect the use of time-release drugs, design and manufacture of materials for use in SCI that mimics the natural cellular architecture of the inner grey and outer white matter of the spinal cord. We believe this creates significant barriers to entry for competitors and provides for meaningful licensing and partnering opportunities in the future for InVivo.
- Animal data has been very encouraging. Although we have only seen data in African Green monkey’s, we note the physiological anatomy and neurophysiology characteristics between how the spinal cord works and functions these primates and humans is nearly identical. African Green Monkeys are an acceptable regulatory indicator of potential hazards and research supports translation to humans, Nature Medicine, Vol-13,No.5:561-566, May 2007. The genomic similarity to humans is over 98%.
…A Simple Concept…
InVivo is taking a different approach to SCI, focusing on protection of the spinal cord and prevention of secondary injury rather than regeneration. As discussed above, it is often this secondary immune response and inflammation that does the majority of the tissue damage sustained following an acute injury. The company’s technology focuses on minimizing tissue damage sustained following acute injury and promoting neural plasticity of the spared healthy tissue, which may result in full or partial functional recovery. In fact, management believes that if as little as 10% of the healthy tissue can be spared, local reorganization can occur that adds meaningfully to functional recovery.
We think this is a model that lends itself well to clinical trials. As noted above, regulation as a Class 3 medical device should allow management to move quickly through clinical development. The IDE was filed in July 2011, with human subject trials planned for later in the year. We estimate that 10 patients will be enrolled in the pilot trial at sites in Boston and Washington, D.C. under Principal Investigators Eric Woodard, M.D., InVivo’s Chief Medical Officer and Chief of Neurosurgery at New England Baptist Hospital, and Jonathan Slotkin, M.D., neurosurgeon at Washington Brain & Spine Institute. Patients will subsequently be transferred to a rehabilitation center and will be followed for one year. The trial will evaluate safety data as the primary endpoint. Motor and sensory recovery, as determined by the American Spinal Injury Association (ASIA) Impairment Score, will also be assessed as secondary endpoints.
The next step following this small pilot study remains to be seen. We see two potential next steps following completion of the IDE study:
1. Traditionally, the next step following the IDE is to conduct a larger Pre-Market Approval (PMA) study in approximately 30-40 patients with SCI. Assuming successfully completion of the PMA program, InVivo should be able to file for approval in the U.S. through the 510(k) pathway.
2. With “Homerun” like data from the IDE study, meaning moving patients off a ventilator or taking a complete tetraplegic and returning bowel function or more, InVivo may be able to file for approval in a narrow patient population. An option is to seek approval under the FDA’s Humanitarian Device Exemption (HDE) protocol. HDE is similar in both form and content to a Pre-Market Approval (PMA) application, but is exempt from the effectiveness requirements of a PMA. An HDE application is not required to contain the results of scientifically valid clinical investigations demonstrating that the device is effective for its intended purpose. The application, however, must contain sufficient information for FDA to determine that the device does not pose an unreasonable or significant risk of illness or injury, and that the probable benefit to health outweighs the risk of injury or illness from its use. The HDE pathway may allow approval for InVivo’s BSD in an acute population or in complete tetraplegics.
Longer-term, upside to the story comes from gaining approval for the injectable Hydrogel formulation, which can be used with pharmaceutical products like methylprednisolone sodium succinate (MPSS). This will then be followed by applications for use of BSD in-combination with stem cells. We think this has the potential to turn BSD into a potential blockbuster for the treatment of SCI because it opens up the opportunity to heal chronic SCI in the 250,000 to 300,000 patients in the U.S. currently living with SCI. If we look outside the U.S., and include Canada and Western Europe, the number grows to 400,000 chronic SCI patients in these markets. Including Asia, Australia, and Latin America, the number of chronic SCI patients is around 2.0 million worldwide.
…Large Market Opportunity…
In the U.S., we estimate that 50% of SCI patients would benefit from a new treatment paradigm.
We think the initial focus will be on the acute market, with greater penetration coming as InVivo demonstrates utility with combination therapy, the Hydrogel, or with stem cells (hNSC). Given the significant unmet medical need and the lack of existing treatment options, we envision a price almost similar to an Orphan Drug. We think that $60,000 per implant is reasonable for the BSD alone, with InVivo maintaining the ability to raise the price to $75,000 and $100,000 as the Hydrogel and BSD + cells comes to market. Under this scenario, with just 10% market penetration, InVivo’s device could have billion-dollar potential. We think once the next-generation products are approved, market penetration can soar to 20%, meaning peak sales for the BSD + cell is in the area of $2.5 billion.
We believe all this can be accomplished with little overhead as well. We estimate that there are only 75 Level-1 trauma centers in major cities around the U.S. with qualified neurosurgeons and the necessary equipment to perform spinal surgery. A sales force of 20 to 25 representatives can effectively target 90% of the market.
InVivo’s goal is to take BSD to the market alone in an effort to build the most shareholder value possible. Ultimately, we believe this is a device that will end up in the hands of a major medical device company like Johnson & Johnson, Medtronic, Stryker, or Abbott Labs. The economics to InVivo will be higher if BSD is approved, and next-generation products like the Hydrogel and BSD + cells have advanced into registration studies.
Valuation
…On DCF…
We have performed a discounted cash flow (DCF) analysis on our sales assumptions outlined above. We assume that InVivo looks to launch BSD in 2014 at a price of $60,000. We assume 90% gross margin, a sales force of 25 full-time representatives, and ongoing R&D funding the registration programs for Hydrogel and BSD + cells. We model approval of the Hydrogel in 2015 and the combination therapy in 2016. We think management can slowly raise the price towards $100,000, and capture 10% of the 100,000 to 150,000 chronic and acute SCI patients in the U.S. We have used an extremely aggressive discount rate of 50% to account for the early-stage nature of the product. We arrive at a market value of approximately $360 million, or $4.41 per share based on roughly 65 million shares currently outstanding, 6.4 million unregistered shares, and a future dilution of 10 million shares to fund operations in 2012 (adjusted fully diluted share count of 81.6 million). Our DCF model can be found in our full report on the Zacks-SCR website.
We see investment in InVivo Therapeutics as an investment in the growth of the entire SCI market. As noted above, the company’s technology can be used in concert with anti-inflammatory drugs, growth factors, and stem cells. The device is designed to protect what little healthy tissue may remain in the cord, promote neuroplasticity and reorganization, and provide the extracellular matrix to hold the cells or pharmaceutical product in place. Advancing time-released technology and the liquid injection (Hydrogel) provides meaningful opportunity for partnerships and collaborations in the near future.
…On A Takeout…
As noted above, our DCF model assumes InVivo bring BSD to the market alone. However, if BSD is a success, a larger partner will surely come along and make shareholders and offer. Accordingly, we can adjust our valuation to see, “What it could be worth” to a potential larger company on a takeover. We do this so that investors can get a true sense of fair market value for the stock.
Starting with our DCF model, we’ve increased sales by 20% to account for “overwhelming” promotion of a massive sales force like J&J (JNJ) or Medtronic (MDT). We’ve also removed future dilution and lowered the discount rate to account for a much lower cost of capital. Finally, we’ve reduce the S&GA expense figuring that a larger company will use representatives already in the field promoting products for spinal surgery, biomaterials, tissue engineering, or neurology. We arrive at a “take-out” value of $525 million, or $7.25 per share. We believe this is a price that a company like J&J or Medtronic could easily pay and still see accretion.
We can also look at previous deals between larger pharmaceutical or medical device companies and see – on average – what multiple of revenue seems fair to pay. We have looked at several previous deals:
By 2015, we expect InVivo’s BSD and next-generation products roughly $200 million in sales. If we apply our average P/S multiple of 6.1x, we arrive at a take-out price of $1.2 billion. Based on our fully diluted share count, we arrive at a fair price of $14.75 in 2015. Discounting that back to present day at 20%, we $7.10 per share.
…Upside To Our Target…
We are initiating coverage an establishing a near-term target of $4.50 per share based on DCF (rounding up slightly from the DCF). However, with the financing risk out of the way, perhaps later this year, and clear momentum on the clinical front, we think InVivo can trade as high as $7 per share on speculation of a take-out.
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