Investment opportunities don't get much more obvious than this.
AVITA Medical announced Breakthrough Device designation was bestowed upon the ReCell System for its two pending indications, soft tissue repair and stable vitiligo. The highest designation in the land speeds up development for device candidates, provides smooth feedback from regulators during the submission process, and grants priority review to accelerate time to market.
Clinical development for these indications has wrapped up, but the post-development perks are meaningful.
- AVITA Medical will now have an open line of communication with FDA officials and independent experts ahead of regulatory submission, which is expected for both indications before the end of 2022. This self-imposed deadline could be pushed into early 2023.
- AVITA Medical can receive timely feedback from FDA officials during the review process, which can mitigate or eliminate delays should problems or questions arise.
- Most important, Breakthrough Device designation also grants priority review. That means the FDA will make an approval decision within six months of submission instead of the standard review period of 10 months.
If the company sticks to its previous timeline of submitting both indications before the end of 2022, then approval decisions could be announced by the end of June 2023 at the latest. That could pull revenue projections forward by more than one full quarter, which is meaningful for a $118 million business with a limited cash runway.
It's important to draw a distinction between the two indications:
- Solt DB Invest forecasts already assumed a high likelihood for accelerated review (even informally) for the soft tissue indication, which is now cemented by Breakthrough Device designation.
- Solt DB Invest maintains prior expectations for the stable vitiligo indication, which I expect to formally launch in 2024 – and be really expensive to do so. The abrupt CEO change and Breakthrough Device designation may increase the odds of bringing in a well-funded partner to de-risk commercialization. This is my preferred scenario.
AVITA Medical will announce third-quarter 2022 operating results and provide a business update on Thursday, November 10 after the market closes. It will be the first with the new CEO and set expectations for the ReCell System's expansion.
Margin of Safety & Allocation
(No change.)
AVITA Medical is considered a Growth (Quality) position. The current margin of safety range for the company is as follows:
- Current Price (market close November 3): $4.70 per share
- Likely Undervalued: <$8.47 per share
- Midpoint: $11.01 per share
- Likely Overvalued: >$13.55 per share
- Allocation Range: Up to 10%
AVITA Medical reported 25.664 million shares outstanding as of August 2, 2022. The margin of safety range above assumes 29.514 million shares outstanding, which accounts for 15% dilution.
It's tempting to think every down-on-its-luck stock is a screaming buy right now, but investors need to be careful not to anchor expectations to frothy valuations from 2021. Many well-run businesses deserved to have their valuations reset to more realistic levels. Some are merely fairly valued right now. Many won't return to 2021 valuations for years. Some will never reclaim those levels.
The problem is everyone is likely to think the down-on-their-luck stocks they own are among the lucky few that were unfairly punished. AVITA Medical makes things relatively easy.
- The business expects to deliver full-year 2022 revenue of $30 million. It's currently valued at 3.9x sales.
- The business expects to grow its core indication (thermal burns) in 2023, which is likely to be accelerated in the second half of the year with regulatory approval of a next-generation device. Expansion in Japan alone could be responsible for total revenue growth of 2% to 4% next year.
- The soft tissue repair indication should generate meaningful revenue upon approval. It already has reimbursement. It's already sitting in inventory at trauma centers using it for burns. It has a serviceable addressable market opportunity that's twice as large as burns and doesn't require years to build commercial infrastructure.
- Full-year 2023 revenue could grow 30% to 50% compared to the prior year. A successful launch and early ramp in soft tissue repair could instill more confidence in full-year 2024 revenue forecasts, which could be supported by successful execution of the outpatient treatment setting. This would result in $40 million to $45 million in full-year 2023 revenue, while driving valuation premiums higher.
- Even with a conservative valuation premium of 5x sales that doesn't look ahead to the next year (2024 in this context) or assign any value to stable vitiligo, AVITA Medical would need to be valued at $200 million. That's 70% above the closing price from November 3.
I don't find many stocks insanely attractive at the moment, even with depressed valuations relative to the liquidity bubble of 2020 and 2021. Markets and valuations still need to drift lower to account for prolonged periods of higher interest rates and force acceptance that the last 10 years or so were unusual from a historical perspective.
Despite all of that, I would say AVITA Medical has reached "Dicerna" level of obvious. It's one of the only non-Anchor stocks I would buy right now.
Further Reading
- November 2022 press release announcing Breakthrough Device designation
- FDA website explaining Breakthrough Device designation
- September 2022 company update discussing CEO change
- September 2022 article communicating why I increased my allocation in AVITA Medical
- September 2022 company update discussing positive clinical trial results in stable vitiligo
- August 2022 company update discussing positive clinical trial results in soft tissue repair