Reflections from a veteran investor
This a really more a reply to a remark that David Chang made, alleging that investors that went into the stock years ago, simply were way too early (Olympus thread)
I think differently, since I believe that the stock is severely undervalued at present and a lot of the reasons why this is the case are pretty much home-made. There are a lot of prior events and facts about Cytori that apparently are not known generally in the US- for good and bad reasons.
The early days.
What one should realize for instance there has been a past before the Cytori stem cell days: a MacroPore past, which from a stock perspective only took place in Germany, where it was listed after the IPO in October 2000.
I took for instance a larger position in the company in early 2004 at prices which were even substantially lower than the present ones. The deciding fundamental factors at the time were:
1. realized sales of about 10 Mio in H2 of 2003 with 70% margins.
2. pick up of a nice bunch of cash of 15 Mio or so from the sale of SurgiWrap
3. forecast of 18 Mio for revenue in 2004 with further growth likely in future years and break-even for 2004 a distinct possibility.
4. added bonus for the then “interesting looking” stem cell development
The early investors were counting on the implants business- nothing to do with stem cells. What actually happened is known- many promises, but only non-delivery of promises due to a horrible contract with Medtronic. The time span of about 8-9 years which is normally required to develop a mature company business came to a conclusion this summer with the HydroSorb sale to Kensey Nash for 3.4 Mio.
It was somewhat macabre to read in Schedule 14A for 2004 that the compensation committee (Rickey!) awarded all employees the same (full company) bonus for that disaster year in order to keep up moral. Of course there was no interest in the moral of the shareholder.
Talking about shareholders- in those disaster days, Calhoun, Cox and Rickey had awarded each other 200k, 135k & 50k annually in options, which was at the time, each year approx. 2,5-3% of outstanding float and of course, all at low prices because of non-performance.
Normally these options would be rendered worthless, because of bankruptcy of MacroPore. The in 2002 acquired company StemSource and Marc Hedrick have blown “new life” in the future value of these options, which in my mind are worth a gigantic fortune.
No surprise therefore that Calhoun & Cox were selling some shares occasionally in case the bottom of their wallets was visible- they have “earned” plenty of them in the past.
Concluding remarks on the “pre-Cytori” days option policy- this was changed for management in 2004 from intergalactic- to more worldly and acceptable proportions. The Board however collected for another 3 years, up to 2007, cyberspace option rewards for meeting 4-5x a year. Again hardly any incentive for those guys to buy on the market now like has been demanded by other users in this board- they got plenty for free.
As an add-on, a real “veteran-investor”, that is a guy that bought 750 shares at an over 18$ price at the IPO and who is still holding those shares today, mailed me an IPO summary powerpoint . Looking it the projected profits 2001-2004 compared to the actual achievements in the following years, I am not surprised that Marshall Cox dumped all the 2 Mio shares of his VC organization (Saratoga Boys Club) and part of his own, within 6 months after the IPO. This person who was also employed as a full time “Board director” (have never come across any situation like that) and gave Calhoun “valuable” advice over 7 years, including 3 major strategic directions over the course of only 2 years, thank god retired in April this year. Part of the advice surely was to reduce risk- Calhoun took good note of that and reduced his ownership as co-founder of the company also from 731k (post-IPO still 5%) to 120K at present or 0,5%. No further comment appears required.
No surprise therefore that I had only a token number of MacroPore shares left in my portfolio going into 2005. That changed later on though.
Why this should be a 15-20$ stock right now
Just one single event brought me and several of my fellow international investors back or new into the stock. That event was the summer 2005 pick up of 1,1 mio shares by Olympus at 10$ although the share price was 3$ at the time and stayed on the same level for a long time thereafter.
I never assumed Olympus was a charitable foundation, so the incredible premium must have had solid value reasons- certainly after doing due diligence for almost a year and closing the hardware deal a couple of months later.
Olympus´ due diligence inspired me to do my own and I spent at least 5-6 man months in the past 2 years looking at stem cell science in general, IP issues, everything available on the web on ADSC´s and evaluating the business models of Cytori and all known present and future competitors. The result of that due diligence is simply, that in my mind there is no other business model in the stem cell sector and all other biologics spaces known to me, which is as compellingly simple, efficient and cost effective and at the same time addressing major markets for unmet needs with a strong (but not perfect) IP- portfolio. One cannot at the present time estimate its true value in 10 years time, other than saying, it could be gigantic, if the company is managed in the proper fashion. One can only applaud the thinking and execution of the employees at Cytori so far of the Celution based model using fresh autologous cells, whose plasticity and potency, based on the evidence available to me, are beyond any doubt.
Coming back to Olympus ; even if they didn’t exercise their option to buy more shares after the first round, which need if you like was negated by picking up 2 Mio shares from the summer 2006 share issue, the prices paid were still at a high premium over market, but at the same time more in line with sector development. If you take a look at the sector, STEM, ASTM, GERN, OSIR etc you will notice that the "hype and hope" valuation of 2 years ago, at the time of the Olympus equity deal, was roughly 200% higher for all players compared to the present one, is gone and has turned into "prove it to me" wait and see approach by the market, despite encouraging clinical progress by all sector participants.
Now on top of that premium paid by Olympus for equity, one has heard thru-out the years that Olympus is spending 7-10 Mio a year on salaries of their employees in developing the technology and is probably laying out somewhere between 30 and 50 Mio for construction of a building or building-extension in Nagano, together with putting together a assembly line, moulds for parts etc. All value created, that at a minimum benefits CYTX for 50%.
Again, Olympus is not a charitable foundation and looks to optimise value for stakeholders (whether Cytori pursues that goal is very questionable when reading their mission & values) and cannot achieve a meaningful contribution for its stakeholders by spending much money (read above) and only producing hardware i.e. Celution for Cytori, which is meant to be the razor in the razor-razorblade concept for marketing of the therapies. Meaning the return thereof will be minimal if any.
What is obviously much, much more important is the complementary synergy of stem cell technology to the business of Olympus itself. Next to the camera business, the endoscope business is the biggest revenue driver at Olympus (70% world market share) and obviously the fit is right there to deliver Celution cells with Olympus engineered delivery systems into the intestinal tract of patients to sites of injury or disease.
This is going to be huge, no doubt about it. On top of the “undisclosed” application (fistula), which should have been tested in the clinic by now, other (much smaller) companies like Cellerix in Spain have already proven the efficacy of treatment of fistula problems with and without Crohns disease with cultured ADSC´s through the IND pathway (>70% healing rate compared to 20% with standard of care), which also applies to the therapies of French Celogos with myoblasts for urinary incontinence. These tiny outfits obviously have a head start, but the favourable regulatory pathway (certainly in Europe) together with the Olympus delivery competence and marketing clout will certainly make them irrelevant.
This brings me to the next vastly underrated key aspect of the Cytori technology. That ADSC´s work extremely well for reperfusion of ischemic tissue, as pre-clinical results on large animals have delivered compelling evidence, which were much better than competing marrow sourced cells have ever delivered in similar settings. This is known and hard fact for heart, legs and neo-vascularisation of fat issue, basically useful in all parts of the body.
But the versatility is a lot more widespread in respect of wound healing (intestinal, body surface and infections of the mouth or lungs), orthopaedic applications for bone-and disk regeneration, immune system disorders (of which there are about 60) and organ regeneration, kidney, liver and yes even endocrine therapies look feasible, probably on a more attractive timeline compared to (partial) resolving of neurological disorders.
Basically an immensely broad platform technology is visible for the investors that want to see it. Several of those opportunities have apparently been tackled, but are kept “undisclosed” and basically are “waiting” for development with partners. We have been told that a few potential partners already have been turned down by Cytori for lack of “total” commitment for the technology. That certainly did not please anybody, but apparently we got the Green Hospital banking deal instead to keep the stakeholders happy.
Obviously in view of the preceding comments on platform technology, this appears to make sense to start building up the infrastructure for banking now. To do so without explaining why appears a totally different story.
Nonetheless, with the fact that CYTX will be the first stem cell player that will make good revenue from their technology already next year (I expect 30-50 Mio from breast and banking and 10 Mio development revenues) and has an incredibly broad pipeline on products, this stock under “present normal” conditions already should have a $15-20 price ticket right now (multiple of 7-8 for next year).
“Present normal” circumstances would entail several factors that are not there and which I anticipated to be there for which reason this stock is still creeping around at the 5-6$ level. Absolutely appalling if you ask me and I will give my views on the “reasons why” in the next posting-
Reasons why the stock is at 5-6 and not 20 $.
There are many reasons in my mind; however which all centre on two things, communication to the street and management attitudes and capabilities. I will split my subjective key reasons up in those two major areas:
Content of communication:
1. The main drawback for management of course is, having to do a balancing act between the interests of the publicity shy Japanese, confidentiality agreements with this partner and SEC reporting responsibilities. My legal friends tell me that the disclosures of the JV deal and following first right of negotiation deal in February 2006 of an undisclosed indication are waterproof. Common sense tells me that the communication to stakeholders other than insiders, as to the real INTENT, ECONOMICS AND PURPOSE of those two deals are closely interconnected and intertwined and therefore could be severely misleading to the general public. Future transactions and events will provide us with the answer to that question and will govern upcoming actions.
2. The company is extremely un-precise and vague about its regulatory success in Europe. In February Cytori announced going to market early with its breast application and was planning to perform a “post-market” pivotal trial in 2007. This announcement was accompanied by the following statement : “This accelerated product launch is primarily the result of Cytori's receipt of a favorable regulatory notice regarding the Celution™ System by the Competent Authority, a European medical device governing body”. What the added claims for Celution really represented has never been conveyed, despite several requests for explanation. It could very well be that the notice also covers a range of other applications, like GI, PAD etc which would upgrade the value of the technology tremendously. Than again it doesn’t have to be- remains a mystery, which is never good.
3. This of course also ties into the virtual omittance of data and information on pre-clinical progress in developing the PLATFORM technology, which in my mind is critical in order to assess the technology value of the company. A visitor to the Companies website would find absolutely nothing on this theme. Information wise this page is in general in extremely poor condition, one gets the impression the web developer has been paid by the number of words. Examples of how to do it properly, can be found at the Aastrom- or even the CellCyte website- the last company having a present market cap of >350 Mio without having any substance at all- but the marketing is good, which I would like to see at Cytori also.
4. In my opinion the recent announcement of the Green Hospital deal was timed very poorly and looked like emergency news to coincide with the release of the Q2 financials. The lack of common knowledge of the potential applications for the future plus the lack of a financial short term plan (2008/2009) of installations from both partners gave this show more the impression of wishful thinking instead of a solid business opportunity, which it most likely is. The adverse market reaction was therefore really not a big surprise.
Addressees of communication
Cytori tends to issue announcements, which are difficult to understand by the Street- the “phase” 510k US approvals are perfect examples of that or the above referenced February news of the early breast application launch in Europe, however I think that is the lesser problem- the main communication is done in the quarterly conference calls, however this reaches only the hard-core Cytx-investors who hardly need convincing. Max 100 people?
On top of that management has been pounding the pavements of national- and international streets on its way to hundreds of investment conferences. Apparently without any visible result, which to me is largely due to the issues in the communicated content listed above, which are misguiding the value of the Olympus partnership, regulatory success and platform technology.
This probably wont change until the therapeutic partner deal is closed and Olympus will have picked up their last portion of cheap Cytx shares at 5-7$ or something. But I really do expect for them to finally step up after these events have occurred and the confidentiality chains are removed, to take up a leadership role in the stem cell industry by being the voice and frontrunner in the media to influence public opinion. I hope they have the capabilities to step up to the plate to carry out this responsible task, since you cannot leave this to the Okarma´s and West´s of this world, who will be playing around with their rat models for the foreseeable future.
Next to communication, management attitudes and capabilities have played a major role in keeping this stock down- the points below are just a short list thereof:
1. Credibility and reliability- you should not ask a German former MacroPore shareholder to rate the credibility virtues of management. He/she would tell you there are none in view of broken promises of the past. Hopes were high that such would improve due to new “blood” in management and the name change to Cytori i.e. stem cell business. Hopes were shattered again when one listens to a public statement in the fall of 2006 announcing 20 to 30 Mio $ from the sale of none-core business soon. Part of that business fetched less than 3,5 Mio much later and for the other one (SurgiWrap) a Phase IV clinical trial has been started in March in LA with completion target February 2009. Don’t count on cash before 2010 please. The estimating of start dates of key clinical trials have not been better- APOLLO was due to start either late Q4 06 or early Q1 2007, we are still waiting.
2. Unnecessary dilution- obviously the cash inflow of the sale of non-core business was planned and did not occur so was substituted by the second placement of shares in February. The first one in 2006 was fine- the shares went virtually all to Olympus and other friendly addresses. The second one was pretty lousy with a half warrant attached. If one than later hears that partner deals with a few potential partners have been abandoned due to lack of “total commitment”, one wonders in who´s interest such decisions are made- it certainly cannot be the shareholder. Losing 25% of all future profits surely has been more painful than having to alleviate the hurt of partners being slow in adapting the technology.
3. “Bad luck picking” and past history- financial management selected Piper Jaffray to lead the placing of the (first and) second share placement. “They were worth every penny they earned” was the message shortly after the issue. In hindsight it is easy to criticise of course, but noticing sell-out of “known pipers” like Sandell and RG Capital within 4 months after placement, speaks a totally different language, with surely more selling to report in the third quarter. Both buy- and sell side Jaffray are for the birds. Its that simple. Together with the inheritance of MacroPore days of Medtronic as an investor, who´s shares most likely will have been sold on the market by now- 1 Mio - and the cashing of dismissed former employees of options from the “golden” options days, a total of over 3 Mio shares must have hit the market in the last 6 months. A big number with the present turnover.
4. Egocentric attitudes of top management- insider sales of stock are always a drain on the stock price, but especially with development outfits with low volumes on the market. The insider sales of Cox and Calhoun of over 200k end 2005, early 2006 did its thing to drive the stock down with average daily volumes under 15k. The 50k stock sale of Calhoun in August is relatively fresh on our minds. Horrible timing with logical consequences for prices. Since one can reasonably assume, that the sale has no fundamental reasons or expectations of lower prices in the future, it can only be for private cash needs. If somebody is not in control of his finances with a CEO salary, one wonders if he should oversee the same of an emerging company. Anyway, do expect a repeat performance next year same time, since 53k options with a strike price of 15 cents will expire 01/01/09. Deserved compensation for major personal financial sacrifices from the founding days, as Cytori would qualify this.
The above I consider the major reasons why Cytori is not the 15-20$ stock that it should be. Those reasons have nothing to do with technology or development issues- simple management communication and workings incl. neglect in my subjective opinion. Of course there are other issues, like uncommitted board, a buy-side analyst from Piper Jaffray (Ted Tenthoff, who has 1 Mio $ revenue for 2008 in his analysis even after the company has announced an early therapy launch and closed a banking deal, talk about disconnect) and a few other things that however are not under direct control of management.
Conclusion- great technology, huge potential and most likely a great future, but with a leadership that puts up smoke screens, which investors should try to see through, but is the reason why we are where we are. Probably also to provide strategic investors (Olympus and others) more cheap entry points. Nevertheless highly recommended to stick with and try to visualize those objects that fly below the radar screens.
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