Description

In March 2021 I wrote up Pavmed (PAVM) at $4 per share, and 6 months later I recommended to exit the position after the shares reached $9, as I believed expectations were becoming too high and execution risk was significant. I was right (that happens sometimes) and PAVM ended up going below $1, and is now trading around $2.30. I believe now is a good time to look into the space again, though through a different (yet related) company – Lucid Diagnostics (LUCD).

For those who remember, PAVM was in the process of monetizing its lead asset, Lucid, which it did in October 14^th, 2022 through an IPO of LUCD at $14/share. PAVM still owns ~70% of LUCD.

You can definitely call this a busted IPO with the shares trading down from $14 all the way to ~$1.70 and are now at $3.39.

Company

LUCD owns the right to an esophageal cancer portfolio (EsoGuard / EsoCheck / EsoCure), which has already been launched (excluding EsoCure) and is now scaling rapidly.

Esophageal Cancer (EAC)

The prevelace of EAC has increased significantly over the past few decades. A diagnosis is a death sentence with more than an 80% mortality rate 5 years post diagnosis.

The progression of EAC is fairly straightforward and perdictable. It starts with GERD (Reflux) where stomach fluid gets into the lower esophagus, which is slowly transformed into its precancer state, and if no intervention is performed the area then becomes cancerous.

Guidelines suggested that high-risk population should undergo screening every 3-5 years. This population is vast and includes every person with chronic heartburn (GERD) and three additional risk factors from this list:

·         - Age over 50

·         - Male gender

·         - White race

·         - Obesity

·         - Smoker

·         - Family history

Total high-risk population according to these guidelines is 13M men in the US alone. However, guidelines have changed very recently – more on this below.

The traditional way to get screened is with an upper endoscopy. The process is similar to a colonoscopy in which you need to come with an additional person (due to sedation) and both of you would need to take the day off. Currently less than 7% of this high-risk population undergo screening. This compares to over 60% of high-risk colon cancer screening using colonoscopy.

The Solution: EsoCheck / EsoGuard

EsoCheck is a cool device the size of a pill which the patient swallows. Then as the capsule reaches the stomach the practitioner inflates the capsule which then collects cells from the relevant area. Then the practitioner deflates the capsule and retrieves the cells (there is a very narrow tube connected to the capsule which is kept outside of the patient’s mouth). This entire procedure takes less than 5 minutes and can be performed by a nurse in an office setting. After watching this 6-minute video you can probably perform the test yourselves:

https://www.youtube.com/watch?v=PKwLwiZfln0

Once the cells are retrieved, they are sent to a lab authorized to do the EsoGuard lab test which identifies pre-cancerous or cancerous cells. The test is very accurate with over 90% sensitivity and specificity at detecting esophageal precancer and cancer.

If the test returns positive, the patient will need to undergo an upper endoscopy to check how far along the disease progressed and to perform ablation to treat the area.

The company is also working on an additional device (EsoCure) which will perform ablation. They are also working on improving EsoGuard to differentiate between cancer and pre-cancer. I’ll ignore both of these advances for now as the story works very well without them.

The EsoGuard / EsoCheck combination is available and priced by CMS at $1,938 per test.

Go-to-market Strategy

The company is utilizing 3 channels to launch the product:

1)      The first is the GI channel where GIs (Gastro-Enterology physicians) are trained to perform the test and receive EsoCheck tests inventory. The reason I think this is less interesting is that a lot of patients are treated by their PCP and also, I’m not sure that GIs are financially incentivized to perform EsoCheck rather than an upper endoscopy.

2)      What I believe to be the most relevant is the PCP channel as PCPs (Primary Care Physicians) manage most GERD patients. Here, LUCD’s sales reps need to contact PCPs and educate them on the test and on the option to refer high-risk patients to a Lucid Test Center (more on these centers below).

3)      Direct to consumer channel – where patients will watch tv / billboard ads and will contact a call center where they’ll have the opportunity to speak to a physician through Telehealth. The physician will be able to refer them to a Lucid Test Center.

So, what is a Lucid Test Center – it’s a small office with a nurse who performs the test and a medical assistant to answer calls and schedule tests.

A single nurse could perform 20 tests per day, generating $40K in daily revenues, or more than $10M per year. According to the company, the annual cost of a nurse practitioner, a medical assistant, and an office lease would stand at ~$180K. Breakeven for a new center is at 1.7 tests per week. The model makes sense.

In the third quarter of 2021 the company launched a pilot program in Phoenix where it established its first testing center. The pilot has since advanced into regional program covering 7 metro areas in western states. Several months ago, the company launched the second stage of the Lucid Test Center program whereby the company plans to launch in 9 additional states by the end of 2022.

As part of the pilot in Phoenix, the company launched a direct-to-consumer advertising on a limited pilot basis at the beginning of 2022 and by now should have sufficient data to assess the efficacy of different DTC avenues.

What Went Wrong?

The company IPO’d at a 500M market cap in an IPO that was destined to fail – it was done right at the end of the last IPO window (October 14^th, 2021), and I suspect it was undersubscribed given that PAVM actually participated in the IPO and increased its stake in LUCD. All of these suggest quite a bad technical setup, and indeed in the first day of trading the stock went down 20% followed by another negative 25% in the second day of trading. The stock never recovered, and when the company released actual numbers in November the shares started their decline to under $2 eventually (from the IPO price of $14). Macro trend for biotech companies certainly didn’t help.

The following table shows the tests performed and the revenues generated:

It’s relevant to note that the Q3 test numbers were flat over the previous quarter at only 203 tests (equal to potential quarterly revenues of $0.4M and actual reported revenues of 0.2M) – difficult to support a 500M valuation with no growth from quite a low starting point.

Why Now?

Quite a lot has transpired since the LUCD IPO, while the stock is still cheap. Following is a list of the recent developments that make me feel good about the timing here:

·         The two GI guidelines are now recommending EsoGuard:

o   On April 4^th the company announced that the American College of Gastroenterology (ACG) clinical guideline supports esophageal precancer screening with EsoGuard on samples collected with EsoCheck. This was the first update to the ACG guidelines since 2016. The guidelines repeated the recommendation for precancer screening but for the first time included a swallowable capsule device as an alternative to endoscopy. The guidelines mention EsoCheck and EsoGuard by name, as well as EsophaCap which is an inferior device for the same purpose (which is also owned by LUCD).

o   On August 4^th the company announced that the American Gastroenterological Association (AGA) has adopted recommendations that mirror the ones from the ACG. This is the first update to the AGA guidelines since 2011. The clinical practice update also significantly expands the target population for esophageal precancer screening, including for EsoGuard and EsoCheck, by recommending, for the first time, screening in at-risk patients without symptoms of reflux. The AGA does so by adding a history of chronic gastroesophageal disease (“GERD,” commonly known as chronic heartburn) as merely an additional, seventh, risk factor to the six risk factors for BE and EAC that have traditionally identified at-risk symptomatic patients recommended for screening. As a result, chronic symptomatic GERD is no longer a mandatory prerequisite and asymptomatic patients with three other risk factors are now considered appropriate for screening.  

·         On May 9^th the company announced its first commercial payer agreement that provides in-network access and payment for its EsoGuard DNA test to over 8 million covered lives.

·         On August 2^nd the company announced more in-network coverage for millions more of covered lives.

·         Previously the company contracted with a third-party laboratory to process the tests and file for reimbursement. This meant that LUCD invoiced the lab at 0.2M per quarter based on historical testing volume and reimbursement (which obviously doesn’t have much history). Recently, the company performed a business combination to acquire the lab such that these operations would be under complete LUCD control. This also result in revenues being based on actual reimbursement payments (the first should be in the soon to be reported Q2).

·         The company announced a few days ago that it has launched phase 2 of the test centers where it opened centers in California, Texas, Florida and Ohio. This stage focuses on higher-value target locations, as well as locations where sales reps already have traction with local PCPs and GIs, suggesting testing ramp could happen more rapidly.

LUCD vs PAVM

PAVM has quite a few potential products beyond the LUCD related ones. But to be honest, the crown jewel here is LUCD. These additional products are startups in nature and will burn cash for the foreseeable future. Further, PAVM recently entered into a quite dilutive financing agreement which I did not like. Finally, comparing market caps, PAVM has a ~$200M market cap while LUCD’s is ~$130M – this is even though PAVM only owns ~70% of LUCD. So PAVM share of LUCD is worth $91M while the rest of the company is valued at ~$109M. I’m just not sure the other products are worth 109M on an absolute term, and on a relative term to think the other assets are more valuable than LUCD doesn’t make sense to me.         

Valuation

My assumptions for valuation are the following:

·         13M patient population – this is conservative as it is actually based on male only population whereas the guidelines are now also recommending including women in the high-risk group. The company is now suggesting the population is now double. Further, if the guidelines are adopted such that GERD is only a risk factor and not a prerequisite – this will increase the population even further (so far just one of the two guidelines support this).

·         $1,938 reimbursement.

·         Test frequency being once every 5 years – guidelines suggest 3 to 5 years.

·         20% penetration – this is conservative as the screening rate for colon cancer is ~70% where most of this is done through invasive colonoscopy. Further only single digit % are currently being screened using upper endoscopy.

·         3x peak sales multiple – rule of thumb.

All of these bring us to a total valuation of ~$3B. I’m quite confident this will happen eventually (probably within 5 to 7 years), but the big question is how much dilution shareholders will endure until that point. I think assuming 3x shares from today is a conservative assumption (which would mean the company raises $260M at today’s valuation and probably more as the share prices increases) which would mean the company should be worth ~$1B vs a current market cap of $130M. Upside is significant at more than 7x which is a 31% IRR over 7 years. I want to stress this is hardly the bullish case.

Risks

Cash –

I expect the cash balance as of 6/30 to be ~$34M as the balance for Q1 was $48M and I reduced it for ops burn (8M), lab acquisition (4M) and EsophaCap acquisition (2M). This leaves the company with about one year of runway so a raise is potentially imminent and could be a good entry point once that happens.

The thing is that the company is performing the tests but not yet getting full reimbursement. Medicare is probably 50% of the target population and the company is in process of an LCA – this process will probably take 12 months more or so to conclude. The other 50% is from private payers which currently reimburse as out-of-network at a rate of $1000 to $1300 per test which means that until establishing reimbursement, testing is a bit of a cost center (not really but not as profitable as it should be). In this context it’s worth quoting the CEO from the recent earnings call:

“But we're trying to take a middle ground here. We want to obviously grow testing volume, to generate data for clinical utility, to support reimbursement, and to generally prove that the model works. But we are also cognizant of the fact that right now we don't have predictable reimbursement, we are starting to bring some of that in, but we're not at the stage where a large proportion of these cases are getting full reimbursements.

With an eye towards being protective of our cash and our capital, we're trying to take a middle of the road approach with regard to the throttle, to use a metaphor, but once we have more predictable reimbursement and we start getting more of these private payer agreements under our belt, then we have the ability to dial these up and to increase the cadence and so forth. But our plan really for the rest of this year is to stick with our targets with regard to the expansion of our sales force and the expansion of the test centers, to give us time to start getting more predictable reimbursement.”

Earnings release tomorrow –

The timing of this writeup is interesting with LUCD releasing earnings tomorrow on August 15^th. I would expect some interesting news to come out during the call and definitely look forward to getting test numbers for the quarter. The stock has run a little with anticipation of earnings so a bad print would send the stock down (which could be another interesting entry point).

Catalysts

·         Reimbursement decisions

·         Utility trial results

·         Tests ramping

·         Revenue ramping

Catalyst

Reimbursement decisions

·         Utility trial results

·         Tests ramping

·         Revenue ramping