Last updated: 04:59 / Friday, 18 December 2020
Column by Quim Abril

Portfolio Manager Diary: How Do We Contrast the Information Obtained when We Analyze a Company?

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At the beginning of last September, I met by video conference with the Grifols (GRF) Investor Relations Team. We talked about accelerating immunoglobulin sales in developed markets such as the US, Canada, and some European countries. GRF produces and sells immunoglobulins for intravenous and subcutaneous administration, and they are used in part to treat diseases of patients with Primary Immunodeficiency (PIDD).

During the last week of September, I conversed with an American hedge fund manager, as we are both research contributors to Seeking Alpha (SA). In that conversation, the manager recommended Koru Medical Systems (KRMD), highly penalized by the market, but the underlying business was excellent. KRMD is an American manufacturer of low-price subcutaneous infusion devices for delivering immunoglobulin therapies in chronic diseases such as primary immunodeficiencies (PIDD), chronic inflammatory demyelinating polyneuropathy (CIDP), and others.

PIDD is a diverse group of genetic disorders caused when some immune system components (especially cells and proteins) do not work correctly.

Does it sound familiar? I repeat, patients with PIDD

Thanks to the investment in GRF and the good prospects for the immunoglobulin business, I decided to do more research on KRMD.

Its business model is very attractive due to its high recurring income component, a consequence of the fact that on many occasions, a patient with PIDD must treat for all life. Also, the maintenance and the purchase of accessories generate recurring income and high switch costs, a consequence of the fact that a machine can often only use spare parts of the same brand.

So what are the main drivers of future growth?

1. Diagnose more PIDD and SID patients

PIDD (primary immunodeficiencies) is a group of more than 400 rare genetic diseases that cause a malfunction of the immune system. These diseases affect one in every 2,000 people, 60% of cases diagnosed during childhood, and up to 10% detected at birth in countries with the corresponding screening program. According to different academic studies, globally, there are 650,000 people diagnosed and 6M who have not yet been.

Most of the people diagnosed with PIDD are in the US, specifically 500,000 of whom 130,000 receive some immunoglobulin (Ig) therapy. Of these 130,000, 35,000 are receiving subcutaneous Immunoglobulin (SCIg); therefore, there is the possibility of converting 95,000 patients from intravenous (IVIg) to subcutaneous (SCIg). PIDD therapies represent an annual recurring income per patient of $ 750, according to data from Koru Medical.

Sometimes due to external factors (those that are not caused by genetics), people develop what is known as secondary immunodeficiency (SID). As a result, patients can undergo repeated rounds of antibiotics and hospitalization for treatment. SIDs are much more common than primary (genetic) immunodeficiencies.

Chronic inflammatory demyelinating polyneuropathy (CIDP) is a rare neurological disorder that causes inflammation of the body's nerves. Although your immune system generally keeps you healthy by fighting germs, your immune system does not recognize parts of your nerves and attacks them. Over time, this can cause gradual weakness, numbness, and loss of feeling in the arms and legs. If left untreated, CIDP can cause permanent nerve damage. CIDP therapies represent an annual recurring income per patient of $ 1,500, according to data from Koru Medical.

2. Increased adoption of subcutaneous therapies

Many reasons explain the preference for subcutaneous vs. intravenous, both by patients and doctors. Some of them are: 1) It can be self-administered at home without the help of a nurse, 2) fewer side effects in a patient with low blood pressure, 3) flexibility in scheduling injections, 4) gradual adsorption of the Immunoglobulin, 5) does not require premedication, 6) the patient can continue to perform their tasks while injecting and 7) higher frequency of administration (weekly) in SGIg.

Although SCIg therapy is more expensive in terms of price per gram than IVIg, some studies indicate that over a year, a patient generates an average savings of $ 10,000.

3. Medical devices and self home administration

There are three different SCIg infusion systems, mechanical, electronic, elastomeric, and push. Mechanics are the cheapest, and this is the segment where Koru Medical operates. The electronics inject a constant flow. They are programmable, but their sale price is higher, and they require batteries and some previous training from the patient. We will analyze in more detail the mechanical pumps and a semi-electronic one.

3.1) FREEDOM60 from Koru Medical Systems: Completely portable syringe infusion system, without the need for electricity or batteries and operates at a constant and safe pressure. The FREEDOM60 pump could use for almost any subcutaneous or intravenous administration in a standard 60 ml syringe.

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3.2) Crono S-PID 50 from IntraPump: The newest, high volume ambulatory infusion pump for subcutaneous drug therapies always with a prescription. It combines high technology with an innovative design. It's small and light, accurate, and has the flexibility to change flow rates during an infusion with ease, making it ideal for home therapy. Its use with 50 ml dedicated syringe. There is also a Crono Super PID pump designed for pediatrics with reliable 10, 20, and 100ml syringes.

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3.3) EMED Technologies SCIg60 Self-Powered Pump: Utilizes a reusable constant pressure mechanical pump monitored by the VersaRate flow controller. This disposable device allows the physician and patient to adjust the inflow flow better. Today, this device is still pending clearance from the FDA.

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In mid-November, and after speaking with the company's management, it was clear that Koru Medical was present in a business with excellent growth potential and located in the right segment (subcutaneous immunoglobulins). However, I still had three questions to answer:

A. Was there a margin of safety?

B. What is the best medical device for administering SCIg?

C. Is the business model scalable outside the US?

To answer the first and most straightforward of the three questions, we must make a rough assessment of the business. We know that Koru Medical's strategic plan is to reach $ 50M in sales by 2022, a gross margin of 70%, and organic and annual sales growth of + 20%. We propose the fundamental valuation based on two methods, and for simplicity, we do not include the clinical trials and international segments (Less than 20% of total sales).

1) Company guidance

Growth of 15% for 2020, 20% for 2021 and 25% for 2022, less than company guidance. In the gross margin, we started from 68% in 2020 to 70% in 2022. We think the company will reduce its salary cost to 40% of total revenue, which implies an Ebit margin of 23% in 2022. To estimate the target value, we applied 5x sales or 25x profits to reach a theoretical value of 6.35 dollars. At the current trading price (3.90 dollars on November 11), we obtained an upside potential of over 60% for estimates below the company's target.

2) Total addressable market (TAM) in the US

FREEDOM60 use in 35,000 subcutaneous patients, but there are 130,000 intravenous patients. Therefore, Koru Medical has the opportunity to convert an additional 95,000 patients. If we perform the same calculation for CIDP, we see the possibility of converting 4,750 patients. If we estimate that Koru Medical will capture 30% of the market opportunity in PIDD and 15% in CIDP, we achieved target sales of 51.3 million dollars, a figure very much in line with the company's strategic plan. Applying the valuation multiples above, we obtained a target price of 7.65 dollars or a potential upside of 96%.

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Because of the assessment achieved, there is no doubt that we obtained a sufficient margin of safety, but we still had to answer two more questions. Most fundamental analyzes end at this point or much earlier. Even at DRACO GLOBAL, we go one step further, and we need to contrast the information we have obtained from the company, analysts, or colleagues.

Information Contrast

At DRACO GLOBAL, we do not make an act of faith. We believe what the company, a report, or an analyst tells us; Instead, we contrast the information with those who best know your product or service (Clients, suppliers, distributors, etc.). On this occasion, we got in touch with BarcelonaPID Foundation and we talk to your president and pediatric immunologist, Pere Soler Palacín.

The PID Foundation is a non-profit organization founded in 2014 as the initiative of a group of professionals dedicated to pediatric patients with Primary Immunodeficiencies (PID) and their families. Its objective is to promote the knowledge, study, research, and dissemination of PIDs and the complications derived from these diseases.

As president of the foundation and with more than 25 years of experience in IDPs, Dr. Soler extended information to our study with the following words:

• There is a wide variety of PID diseases, and some are more or less common and more or less serious.

• More typical in children, but it can also occur in adults.

• Treatment for PIDs can reduce the number and severity of conditions and help children and adults lead as everyday lives as possible.

• Immunoglobulin treatment is the essential treatment for many of these PIDD, helping protect against a wide range of infections and reduce autoimmune symptoms.

• Dr. Soler confirms that they mostly use the subcutaneous route due to: less need for injections, self-administration at home with prior instruction to the patient, faster administration, fewer side effects, and lower QoL.

• Artificial plasma could be a very long-term option, but today it is not possible in any case.

• SIDs (secondary) is also an exciting opportunity, although there is still a lot of work.

While talking to Dr. Soler, I convinced that I had found a great investment idea, but when I asked him about existing medical devices, his answer left me blank.

• From 2006 to 2009, they used the typical low-cost mechanical pump called the Infusa T1 from Physan. In his experience, the infusion pump did not generate a constant flow. It was easily clogged and made it difficult to administer medication. In 2009, they chose to change their supplier to InterPump, the company that owns the Crono S-PID 50 device. This device significantly reduced the problems related to tube occlusion and drug inlet fluidity. Its size is smaller, and its design is lighter, making it ideal for home therapy and providing complete freedom for the patient to administer medications at any time of the day without interrupting daily life or leisure activities.

After this revelation, I went to the InterPump website and began to read testimonial comments that had used both devices and just confirmed everything that Dr. Soler told me.

Finally, I asked Dr. Soler if there was any explanation why FREEDOM60 used more than Crono S-PID 50 in the US, and according to his opinion:

• The fact that healthcare is private and expensive encourages you to buy low-cost devices like FREEDOM60. On the other hand, healthcare subsidies in Europe and Spain and the cost is not the main problem.

Finally, I understood that the investment thesis could be valid in the US as long as the current health system continues but not in Europe. A part of Koru Medical's future growth is international expansion, Europe included. Still, after Dr. Soler's revelation, my opinion changed radically to the point that I am rethinking my investment in Koru Medical Systems.

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There is always the possibility that Koru Medical will consolidate the market and buy another company, and why not one of its best competitors. InterPump (Crono) is a small Italian company and does not trade on the stock exchange. You never know if the owner would be willing to sell it. In the release of the 3Q20 results, the CEO of Koru Medical spoke that they are always attentive to the M&A possibilities offered by the market and that after the June capital increase, they could use the $ 32M they have in the box.

In this article, I wanted to show how we analyze and contrast the DRACO GLOBAL information before investing, especially in small companies. Unfortunately, it is not a common practice in the sector, but in DRACO GLOBAL we try to do it.

PS: I want to publicly thank Dr. Soler for his time, his kindness and encourage people to read this article and go to the PID Foundation website.

Column by Quim Abril, President and Portfolio Manager of Draco Global Sicav at Gesiuris AM.

For your information...

Disclaimer: As of the date of publication of this report, DRACO GLOBAL, SICAV, SA (“DRACO GLOBAL”), has a long position in Repro Med Systems, Inc. (“KRMD”). DRACO GLOBAL may profit from the increase in the KRMD share price. After the publication of this report, DRACO GLOBAL may carry out purchase/sale operations of shares in KRMD. All opinions expressed here are subject to change without notice, and DRACO GLOBAL does not commit to update this report or any information contained therein.

About Quim Abril

Quim Abril is President and Portfolio Manager of Draco Global Sicav at Gesiuris AM.

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