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Diagnostics and Stem Cells Power Productive Portfolios: Kevin DeGeeter

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Kevin DeGeeter New medical tests can be moneymakers for small- and mid-cap companies: They save insurers the pain of paying more to treat maladies and save patients from unnecessary treatments. In this interview with The Life Sciences Report, Senior Biotechnology Analyst and Director Kevin DeGeeter of Ladenburg, Thalmann & Co. makes his case for diagnostics companies with compelling ideas in the realms of cancer, cardiovascular and surgical testing. He also has one interesting stem cell idea to share.

The Life Sciences Report: Kevin, you follow several diagnostics companies. Would you like to comment on the case heard at the U.S. Supreme Court on April 15, the Association for Molecular Pathology v. Myriad Genetics, Inc.? The justices honestly sounded like they were reluctant to stifle innovation, but they were clearly conflicted on that principle versus the prohibition on patenting laws and products of nature. The case surrounds Myriad Genetics Inc.'s (MYGN:NASDAQ) patents on BRCA1 and BRCA2 genes. I am interested in whether this could have a sweeping effect on biotech research. Do you have a take on this?

Kevin DeGeeter: It's very topical, and I do follow Myriad. We will have to wait for the actual ruling, which is expected in June, but a number of interesting arguments came through. The Supreme Court justices are trying to sort out how to craft language that differentiates the simple processes of isolating DNA from the process of analyzing what's known as cDNA (complementary DNA, created from a messenger RNA [mRNA] molecule), which is generated in the lab. Myriad argues that this is a distinct technical achievement that can be patented. It is not just isolated DNA.

I think most investors listened to the justices' questions and came to the view that we are likely to see a decision based on the specific issues of the Myriad patents, which will be pretty narrow in scope whichever way the decision falls. I think it is quite likely to fall on the side of allowing adequate intellectual property (IP) protection. The U.S. Department of Justice argued that the central items of cDNA analysis and process should be patentable, and thus those patents should be able to withstand scrutiny. As for the justices' questions, the concerns they raised in oral arguments may not necessarily foretell where the court comes out in its ruling.

TLSR: On April 17, you and I both attended the RegenMed Investor Day conference in New York City, which was sponsored by the Alliance for Regenerative Medicine (ARM) and co-hosted by several investment banks. I'd like to hear why you might think pharma hasn't jumped into stem cells and regenerative medicine with full force and commitment.

KD: There are multiple answers to that, and they tie in to different questions for different cell therapy products. It's not a homogenous group by any means. There is a great deal of variety within the cell therapy space, and the different approaches come with unique questions from the big pharma perspective. The overriding issues for big pharmas have tended to fall into three major catagories.

First, can you scale up production to serve large markets in a cost-effective way? For some of the early cell therapy products, that has been a real issue. For some of the autologous (derived from and readministered to the same patient) cell therapy products, it's still very much an open question as to how big pharma sees production and financial metrics. Getting to scale is a central issue.

Second, the regulatory hurdles have been an unknown. It's really only in the last two to three years that we've seen the first therapeutic cell therapy products navigate the regulatory framework in the U.S. Our precise understanding of the mechanism of action in cell therapies often is not as clearly delineated as in traditional small molecules, and even in biologics such as monoclonal antibody products. From the pharma perspective, there is also the question of how regulators will weigh the risk/benefit issue of a cell therapy in the case of an adverse event. Since the mechanism of action may not be as clear as with a traditional drug, articulating to a regulator why he or she should or shouldn't be concerned about an adverse event could be more complicated.

The last category, from the pharma perspective, is essentially a question of inertia. Only in the last five to seven years have some of the big pharmas made substantial commitments to biologics, in the form of recombinant projects and, more specifically, monoclonal antibodies and related mechanisms. The point is, I think it's just a matter of time. The midsize biotech may be more fertile ground than big pharma, and it will be interesting to see which will ultimately be first to leap into the realm of cell therapy. If we see specific products with strong commercial profiles begin to reach late-stage development, we may see much stronger interest in partnering from large biotech, in fact, before large pharma.

TLSR: Kevin, can we talk about some of the companies that you're recommending currently for investors?

KD: Just to round out the topic of cell therapy, we recently picked up coverage of Mesoblast Ltd. (MSB:ASE; MBLTY:OTCPK), which is Australia-based but also has large operations in New York. It's a mesenchymal cell company.

"Midsize biotech may be more fertile ground than big pharma. It will be interesting to see which will ultimately be first to leap into the realm of cell therapy."

For the Mesoblast story, we focus on the overall stem cell platform and company's planned phase 3 program for heart failure patients. In phase 2 studies of heart failure patients, the company's mesenchymal precursor cell (MPC) therapy was shown to dramatically reduce rehospitalization rates. That bodes well for phase 3 development, which will be conducted in conjunction with partner Teva Pharmaceutical Industries Ltd. (TEVA:NASDAQ). In addition, we've been very impressed with the company's continued work on proof-of-concept studies in multiple large end-market indications. The company has two ongoing studies in rheumatoid arthritis (RA) and a number of studies in progress in spinal disc repair.

The underlying mechanism of action focuses on the anti-inflammatory aspects of dosing with mesenchymal stem cells. In our mind, Mesoblast is the bellwether in the cell therapy space. This company may emerge as a multiproduct cell therapy company, and it is, perhaps, the most interesting candidate from a partnering or an acquisition standpoint.

TLSR: Mesoblast currently has about a $1.7 billion ($1.7B) market cap, and your implied 12- to 18-month target price of $52 gives it about a $3B market valuation. You have not built in a huge risk premium. Are you banking on three years of data emanating from the 1,700-patient congestive heart failure (CHF) trial that you referenced above?

KD: Not necessarily. There are a couple of items that could unlock value. Two interim analyses are scheduled for the heart failure study, and although the company will remain blinded to the specific analysis, the Data and Safety Monitoring Board (DSMB) will provide assessment as to whether to continue. Within an 18-month window, at least the first of those interim analyses is likely to play out. If the DSMB recommendation is to continue the study as designed, we think investors will and should read something into that data point.

In addition, we think the company's ongoing studies in RA could be very important for demonstrating another therapeutic use in a large-market indication. The product seems to regulate a lot of the same cytokines that are regulated by currently approved biologics—tumor necrosis factor-alpha (TNF-α) and interleukin-6 (IL-6). Other targets inhibited by biologics have shown they can be regulated by mesenchymal stem cells. We feel optimistic about how that study may read out within that 12- to 18-month timeframe.

There are two other catalysts. In the near term, potentially by this summer, we'll have a final readout on the company's phase 2 program for patients with lower back pain related to spinal disc problems. If that study is successful, that program will move into phase 3 later this year, and that could be very material.

We think there is meaningful opportunity for interesting commercial partnerships around the spinal program if it moves into phase 3 as we expect, or with one of the company's systemic delivery programs if the RA study reads out positively in phase 2.

TLSR: The company has $332 million ($332M) on its balance sheet currently, and it is already partnered with Teva for the CHF trial. Why would you think it would want to partner these other programs?

KD: At its core, this company has a very versatile platform technology. I think, ultimately, management is interested in being commercially focused in certain indications, but if you look at the number of indications that the company could move into late-stage clinical development, it becomes clear Mesoblast can't have commercial focus in each of these areas. Frankly, even most big pharmas can't be a focused commercial entity in each of those indications.

"Stem cell companies need to show data that is as good as or better than existing therapies from an efficacy standpoint."

The right road forward for some of the company's products may be in patients with earlier-stage disease, closer to front-line therapy in RA or potentially in diabetes. Those would involve extremely large clinical trial designs that even a well-capitalized company like Mesoblast would, operationally and financially, do well to partner.

TLSR: Will the RA trials be in combination with anti-TNF-α products that you alluded to, such as adalimumab (AbbVie Inc./ Abbott Laboratories' (ABT:NYSE) Humira), etanercept (Amgen Inc. (AMGN:NASDAQ)/ Pfizer Inc.'s (PFE:NYSE) Enbrel) or infliximab (Janssen Biotech Inc./ Johnson & Johnson's (JNJ:NYSE)Remicade), or will the pivotal trials be head-to-head against those?

KD: That's the proverbial $64,000 question. I think the phase 2 work currently ongoing will inform the right road forward. Given that a lot of the cell therapy products have demonstrated a clean safety profile so far, there is an argument that the right time to dose patients would be prior to putting them on already-approved biologics, such as the various TNF-α inhibitors.

The alternative view is that it is often easier to get regulatory buy-in for treating the sickest patients first, and then trying to move into treating earlier-stage disease. It gets down to what the data look like in Mesoblast's exploratory phase 2 studies. If we see a strong suggestion of clinical activity or efficacy in patients who are more refractory, which is what most of the early studies are looking at, there's an argument for moving forward. These are open questions for prospective pharma partners and investors.

TLSR: If I'm an RA patient, and knowing what I know, I would certainly prefer an infusion of stem cells twice a year versus a monoclonal antibody or a fusion protein once a month.

KD: Stem cell companies need to show data that is at least as good as or, frankly, better than existing therapies from an efficacy standpoint. Some of the existing biologics have very well characterized safety issues. In fact, that's the point—they are well characterized, and both clinicians and patients have a lot of experience with how to manage those side effects. We'd do well to remember that a new product that is just as good as a current product often isn't good enough to change practice patterns.

TLSR: Kevin, these are blockbuster indications—CHF, RA, degenerative disc disease, not to mention macular degeneration. How much could Mesoblast be worth as an acquisition?

KD: If you run through biotechs from a mergers-and-acquisitions perspective, look at the companies that have been bought in the $3.5–5B range, and then look at where the Mesoblast pipeline has the potential to be, say in two years, the profiles square up pretty nicely. In our view, there's a lot of room to the upside on this one.

TLSR: Another company?

KD: I want to talk about a basket of three diagnostics companies, which is an area where I focus. These companies are pushing toward commercial launches on new tests for prostate cancer, which is arguably one of the most active areas for new diagnostic products, at least for large-market indications.

"A new product that is just as good as a current product often isn't good enough to change practice patterns."

Genomic Health Inc.(GHDX:NASDAQ) launched its Oncotype DX prostate cancer test on May 8 at the American Urological Association (AUA) meeting. Myriad Genetics, the subject of the Supreme Court case, is going to have some very interesting data on its Prolaris test. Both of those tests are used to help stage men already diagnosed with prostate cancer to determine how aggressive the cancer is and whether the patients need more intensive follow-up or would be candidates for what's generally known as watchful waiting. The third test is OPKO Health Inc.'s (OPK:NYSE) 4Kscore, which is already approved in Europe and should be approved in the U.S. sometime in 2013. The 4Kscore is used to help reduce the number of patients sent in for a prostate biopsy due to a false positive associated with prostate-specific antigen (PSA) testing.

TLSR: The 4Kscore is used when you do get a positive PSA, as a secondary test to affirm or disprove the routine PSA test. Is that right?

KD: Yes. From a pharmaco-economic standpoint, there's a pretty dramatic economic and clinical incentive to reduce the number of men who are going in for biopsies. We know that a great majority of prostate biopsies are negative despite the positive PSA results.

TLSR: I'm thinking about the 50- or 55-year-old urologist who is going to wonder if the 4Kscore can really be trusted. All these years he's been thinking biopsy after a positive PSA. Do you think this is going to be a difficult uptake for the 4Kscore?

KD: I do think that will be an issue for some urologists, and that is where practice guidelines are going to become central. There has been a lot of open debate within the medical community about the number of biopsies done by urologists, and the perception by some that there is an overutilization of biopsy, which can be economically attractive for the urologist to perform. It's a bread-and-butter test for them.

But our take is that the 4Kscore is the right test at the right time because biopsy overutilization is already a hot-button issue between payers and the urology community. The 4Kscore falls in a very healthy spot, allowing urologists to have a stronger justification for choosing to biopsy without being second-guessed. From the payer perspective, it's not just the frequency of biopsy but also that a lot of biopsy patients have morbidities or complications, including infection. From a system standpoint, I can envision payers being interested in understanding the pharmaco-economic model in light of the total cost of biopsy and potential costly complications, not simply the cost of paying urologists for the procedures.

TLSR: Do you want to do Genomic Health or Myriad next?

KD: They're really a pairing, but let's do Genomic Health because it just launched its Oncotype DX prostate cancer assay at the AUA meeting. The test is used in men who are already diagnosed with prostate cancer to assess whether they should be candidates for watchful waiting or more aggressive treatment following prostatectomy.

Genomic Health has had great success with its Oncotype DX breast cancer assay in a treatment paradigm that begs the same clinical question. In the case of breast cancer, it was about which women should not receive chemotherapy following diagnosis of invasive breast cancer. Initially, it was very controversial to deny women chemotherapy. Genomic Health has a lot of experience from a commercial perspective on how to generate data that allows clinicians to feel comfortable changing their clinical practices, as well as dealing with the question of getting reasonable reimbursement from payers as well.

TLSR: Go ahead with Myriad.

KD: Myriad's Prolaris prognostic test for prostate cancer has been on the market for about a year and a half. It addresses the question of how aggressive a tumor is, and can be applied either before or after surgery.

"When payers will pay for a test, utilization goes up and revenue goes up. It's that simple."

The next metric for Myriad is whether or not it can win Medicare coverage for Prolaris. That's been a high priority of management for the last 6–12 months. Each dataset the company generates and presents in a scientific forum pushes it closer to arriving at the milestone of achieving that coverage goal. From a commercial standpoint and an investor standpoint, that's when product stories really begin to work. When payers will pay for it, utilization goes up and revenue goes up. It's that simple.

TLSR: It's helpful to hear these three stories juxtaposed. Are you recommending that investors own all three of these companies?

KD: I have Buy ratings on both Genomic Health and OPKO. I currently have a Neutral rating on Myriad, and that's tied to a lack of visibility, to some extent, on the Supreme Court case. Long term, it's been a story we have liked for many years. In the near term, it is difficult for us to get our minds around how to handicap the reimbursement and the Supreme Court risk.

TLSR: Your next idea?

KD: Another company that we like, which recently had its first diagnostic product approved by the FDA, is Navidea Biopharmaceuticals Inc. (NAVB:NYSE). Its product, a radiopharmaceutical called Lymphoseek (technetium Tc 99m tilmanocept), is now approved for use in lymphatic mapping during surgery associated with breast cancer and melanoma.

We continue to think there's opportunity for Navidea to expand the market into areas where the older lymphatic mapping products are not appropriate due to slow diffusion time. Specifically, we think there's an opportunity to expand into head-and-neck cancer, where the company has some interesting data from an interim analysis, and into colorectal, prostate and certain other areas that are potentially large markets.

The company has a couple of other radiopharmaceuticals in phase 3 development, including one to detect beta-amyloid plaques in the brain, which are markers for risk of Alzheimer's disease. It may have the best signal to noise ratio in the beta-amyloid testing area.

TLSR: Lymphoseek was approved back in mid-March, and it is not really a black box, like the 4Kscore. The surgical oncologist can get a reading during the surgical procedure with a gamma detector. It seems like it shouldn't be such a hard uptake for the clinician, yet this stock is down 26% in the last seven weeks. Can you comment?

KD: The debate for investors is how big the market is. I think there was an assessment by investors that there was a high probability this product would be approved. We didn't see a big movement to the upside following FDA approval because the product was largely derisked already.

TLSR: In other words, the good news was baked in before the approval.

KD: Yes. Then the questions become, how does the initial product move along, and how big will the market be ultimately? This gets down to the central debate of whether this product will compete for market share with existing products or will allow Navidea to grow the overall market into areas where the older products aren't generally used. The older products require multiple hours—two to three in some cases—to diffuse following injection. Lymphoseek diffuses and can give a clinician a readout on the lymphatics within 15 minutes of injection.

TLSR: Surgeons are interested in speed. They have patients lined up from 7 a.m. until whatever time in the afternoon, and they want those patients fed from the holding area into surgery one after the other, without delay. It seems Lymphoseek would fit into that kind of scheduling much better than vital blue dye—and surgeons would have the comfort of knowing they have a better tool for detection of cancerous lymph nodes. If I were a surgical oncologist, that would convince me.

KD: I think you hit on a great point, and an important point, especially in the early adoption of Lymphoseek. From a surgeon's standpoint, this makes his or her life easier, which is a key hallmark for any product. It makes life easier in terms of staging and getting patients in and out of the surgical suite. A surgeon's actual experience in surgery is going to be very similar to current practice, but there are very strong financial and surgical convenience angles to Lymphoseek.

Navidea does have a very strong partner in Cardinal Health Inc. (CAH:NYSE), which has the largest sales force in radiopharmaceuticals. From our perspective, I think there's an opportunity for the launch to really surprise some people to the upside.

TLSR: Since it's the largest seller of radioisotopes, is Cardinal Health incentivized in any way to sell this product?

KD: The answer is yes, and the incentive is twofold. Cardinal sells many radiopharmaceutical products into larger hospitals and medical centers, but historically very few new products have been brought to market in the radiopharmaceutical area. There aren't a lot of companies committed to developing them. Aside from Cardinal Health, the other large player is Mallinckrodt (a unit of Covidien Ltd. [COV:NYSE)], but neither company is a developer. They are distribution companies.

Being able to provide a better product to its hospital customers and further the dialogue about the other products that Cardinal sells to a specific hospital is a pretty compelling reason for a Cardinal rep to go out and sell Lymphoseek aggressively, from my perspective. It's a new product, and a product that's good for the hospital. It is good for Cardinal's overall portfolio.

The second piece, which is also important, is that, even allowing for the revenue split with Navidea, which is roughly 50/50 based on our analysis, Cardinal makes more money versus older products and, thus, is in a position to incentivize its reps to promote Lymphoseek more aggressively. The company makes more money because the preparation process for the radioisotope is much easier than for the older sulfur colloid imaging product. Cardinal's overall cost and labor components go down with the newer product, leaving it a lot more margin to work with.

TLSR: Cardinal Health as a middleman, or wholesale distributor, operates largely on single-digit gross margins in most of its product lines. That's its business model as a wholesaler. It needs higher-margin items, doesn’t it?

KD: Radiopharmaceuticals are one of the more profitable businesses, from a margin perspective, within Cardinal. The overall organization is committed to putting resources into growing the radiopharmaceutical business when possible.

TLSR: I know you follow another diagnostics company, NeoGenomics Laboratories (NEO:NASDAQ). Could you comment?

KD: It's a good name. We continue to look at the business and note the company is operating very strongly. The stock has had a tremendous run, from the $1.50 range around this time last year up as high as $4. It has pulled back a little now, below $4. From an operating metrics standpoint, the company continues to take costs out of the business and lower its cost of goods per test. Its target for this year is a 20% reduction in cost of goods per test, and it has made a lot of headway in Q1/13.

NeoGenomics is dealing with some reimbursement pressure, like a lot of other diagnostic companies, but it has been able to continue to grow the topline nicely and maintain margins of more than 45%, despite the reimbursement headwinds. The key has been laboratory efficiencies.

I think that going forward, we can expect the company to be cash-flow positive and earnings-per-share positive. Having the company reinvest that cash can be a central point for investors to consider as we think about the longer-term growth potential of the business.

TLSR: I've enjoyed this, Kevin. Thank you.

KD: I've enjoyed it as well.

Kevin DeGeeter is a director at Ladenburg Thalmann & Co. Inc. He is responsible for equity research coverage of personalized medicine and medical device companies with market capitalizations between $50M and $5B. His coverage focuses on molecular diagnostics and medical equipment used in oncology, cardiovascular disease and infectious disease, as well as related research markets. Prior to joining Ladenburg Thalmann he was an analyst at Oppenheimer & Co., with responsibility for small-cap molecular diagnostic and biotechnology stocks. He has 10 years of buyside and sellside research experience, including positions with J. P. Morgan, PaineWebber, Natexis Bleichroeder and Manning & Napier Advisors. DeGeeter received a bachelor's degree in economics from Colgate University.

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1) George S. Mack conducted this interview for The Life Sciences Report and provides services to The Life Sciences Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Life Sciences Report: NeoGenomics Laboratories, OPKO Health Inc., Johnson & Johnson. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment. Johnson & Johnson is not affiliated with Streetwise Reports.
3) Kevin DeGeeter: Ladenburg Thalmann & Co. Inc. provides research coverage on: Myriad Genetics Inc., Navidea Biopharmaceuticals Inc., OPKO Health Inc., Genomic Health Inc., NeoGenomics Laboratories and Mesoblast Ltd. With the exception of Navidea Biopharmaceuticals Inc. (NAVB) and OPKO Health Inc. (OPK), Ladenburg Thalmann & Co. Inc. makes a market in all of the stocks mentioned. Ladenburg Thalmann & Co. Inc. had an investment banking relationship with Navidea Biopharmaceuticals (NAVB), OPKO Health Inc. (OPK) and NeoGenomics Laboratories (NEO) and received compensation for investment banking services from those companies in the last 12 months. Ladenburg Thalmann & Co. Inc. acted as sole underwriter in secondary offerings for Navidea Biopharmaceuticals (NAVB), acted as placement agent in a private securities offering for OPKO Health Inc. (OPK), acted as co-manager in a securities offering for NeoGenomics (NEO) in the last 12 months. Ladenburg Thalmann & Co. Inc. expects to receive or intends to seek compensation for investment banking services during the next 3 months from the companies listed. Neither the analyst, nor members of the analyst's household, own any securities issued by any company mentioned. A member of the board of directors of Sequenom Inc. has an affiliation with members of the board of directors of companies in which the chairman of Ladenburg Thalmann Financial Services Inc, the parent company of Ladenburg Thalmann & Co. Inc., has a beneficial interest. Genomic Health Inc. (GHDX) and Teva Pharmaceuticals Industries (TEVA) have joint distribution interests. The chairman of Ladenburg Thalmann Financial Services Inc. is also chairman of Teva. The chairman of the board and controlling shareholder of Ladenburg Thalmann Financial Services Inc., the parent company of Ladenburg Thalmann & Co. Inc., is the chairman of the board, CEO and director and controlling shareholder of OPKO Health Inc. Members of the board of directors of OPK have a noninvestment banking securities-related relationship with Ladenburg Thalmann & Co. Inc. Mesoblast, Ltd. has a strategic alliance with Cephalon Inc., wholly owned by Teva Industries Ltd. The chairman of Ladenburg Thalmann Financial Services Inc., the parent company of Ladenburg Thalmann & Co. Inc., is also chairman of Teva. A member of the board of directors of Mesoblast, Ltd. is also a member of the Teva executive committee. Teva beneficially owns 1% or more of any class of common equity securities of the subject company. Ladenburg Thalmann does not cover Cardinal Health (CAH), Teva Industries (TEVA) or Covidien (COV).
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