Description

Description

This is an venture stage nanocap trading on the Australian Securities Exchange with limited liquidity. As such, it may be only appropriate for smaller funds and personal trading accounts.  We believe Medibio has venture capital like upside potential if the any of the company’s product offerings in the clinical, B2B, pharma and B2C markets achieves market adoption.  As the company’s two primary end markets, clinical and B2B, are very large markets, traction in either of these two verticals would justify a stock price much higher than its current price.

Company description

“It is critical to realise that we cannot succeed if we use DSM (Diagnostic and Statistical Manual of Mental Disorders (DSM) is the standard classification of mental disorders used by mental health providers in the United States) categories as the gold standard. We need a quantitative method for diagnosing depression.” (U.S. National Institute of Mental Health - 2013)

We came across this company while we were researching emerging technologies that were using autonomic nervous system biometric measurements, including measurements such as heart rate variability, to diagnose various health conditions and general wellness.  We got interested in this company because it was leveraging a proprietary algorithm developed over 15 years using an autonomic nervous system measurement called circadian heart rate variability (CHRV), a biomarker that is well accepted in the medical field.  Medibio has a digital health offering that provides a quantitative measure of depression and other mental health disorders using CHRV in a cost effective manner. They are initially targeting two primary markets, clinical and B2B, with variations of their product and seeking to address multiple mental health disorders.  In the longer term, they have the potential to enter two adjacents markets, B2C and pharma.

Investment Thesis

1. Medibio is targeting two large markets with their technology: (a) Clinical/medical diagnostics and (b) B2B corporate wellness.  By addressing two large target markets, one of which requires regulatory approval and the other does not, the company is able to hedge the regulatory risk of the clinical product with the relatively unregulated B2B product.  Additionally, the company may be able to enter two adjacent market, pharma and B2C, which is subject to less regulatory hurdles.

Clinical / medical diagnostics market

In the clinical market, the current standard of care is a clinical or expert assessment by a healthcare professional. This current standard of care, which had existed for many years, falls short in a number of ways.  The entire field of medicine is continuing to move in the direction of employing objective measurements for various clinical diagnoses.  This trend of using evidence-based medicine is accelerating with the increasing availability of cheaper and more accessible diagnostic measurement tools driven by technological advances in hardware, software and connectivity.  A number of medical associations have called for the need for an objective, quantitative, evidence-based diagnosis of depression.  Medibio’s product has the potential to meet this market demand and be the first cost-effective, objective diagnostic tool for depression in the world.

The company describes the shortfall with the current standard of care and Medibio’s solution in the following way:

Current pain points with the current mental health diagnosis:

• No objective test for mental illness.

• The standard of care is a clinical/expert opinion which has limited access and availability.

• Diagnostic agreement between clinicians can vary considerably – concordance rates near 70%.

• Current assessments are subjective which can lead to inadequate or incorrect diagnosis.

• Misdiagnosis of depression (and other mental illness) places a huge cost burden on the healthcare system and the workplace

Medibio’s clinical solution addresses these shortfalls:

• Quantitative, scalable, and non-invasive objective test.

• Diagnosis based on patient’s biometric data (circadian heart rate waveform).

• Repeatable, reliable test with classification accuracy of >80%.

• Provides objective indication of treatment efficacy along with medication compliance and adherence.

• Savings to the health system and better patient outcomes.

The clinical market for depression and other mental disorders is very large in the US.  Primary care physicians (PCP) in the US are increasingly becoming the primary psychiatric care provider with an excess of 50% of all psychiatric diagnosis. There are 21 million annual PCP visits in the US that are mental health related.  This amounts to a total addressable PCP diagnostic market in the US of $1 billion (21 million annual PCP visits @ $45).  In addition, the post-diagnosis monitoring addressable market in the US is $1.6 billion (16 million with depression in US quarterly @ $22.50).  With existing reimbursement codes that could provide reimbursement in the clinical setting, even a low single digit penetration of the US market for depression diagnosis would generate revenue in excess of $100 million annually for the company.  As SAAS company with minimal costs associated with providing the service, this product would be a very high margin business.  With FDA approval possible in 2018 and as the most cost-effective objective tool of diagnosing depression, the clinical market alone offers a very large and attractive marketplace for the company and huge upside for the stock if the company is able to capture even a low single digit share of the addressable market.

Medibio’s clinical product has the potential to be the world’s first FDA approved diagnostic test for mental illness for depression. Medibio is working with Johns Hopkins University School of Medicine to conduct a validation trial to differentiate between depressed and non-depressed individuals. The trial will provide provide initial clinical data to prepare for the confirmatory trial needed for FDA submission.  The initial trial is fairly inexpensive (approx $500k), quick (completion anticipated 4Q16) and powered to only need about 60 patients (30 subjects with MDD and 30 control). This initial trial will be followed by a confirmatory trial in 1H17. Further down the line after this trial, Medibio plans to extend the CHRV technology to other mental health disorders: general anxiety disorder, mixed depression/anxiety, panic disorder and psychosis.  The studies will look at heart rate variations during transitions across awake/sleep states and compare patients with anxiety, depression, bipolar and psychotic disorders and evaluate the associations between heart rate variations, age, psychiatric symptoms severity, and any relevant medication.

B2B / Commercial Market

There are 54 million employees in the US, 90% of corporations have an existing wellness program, and annual wellness spend is $100-$500 per employee in 70% of companies with 200+ employees.  The revenue potential in the corporate wellness market is in excess of $4 billion.

Stress is estimated to cost US employees $300 billion annually as a result of accidents, absenteeism, employee turnover (30% of staff turnover is stress related), diminished productivity, direct medical, legal, and insurance costs, and workers’ compensation awards as well as tort and FELA judgments.

Using stress specific algorithms Medibio’s technology provides objective indications of the stress, which can plug into a wellness partner that can provide interventions based on the diagnoses. Based on an extensive number of indicators and measures from CHRV, individuals are classified into one of six distinct categories ranging from normal to very severe, each of which indicates different levels of action that may warrant intervention or therapy.  By allowing employees to check their stress levels and providing an early warnings system for people at risk, Medibio’s technology is intended to reduce healthcare costs, reduce absenteeism and increase productivity to the employer.

For its sales strategy, Medibio is using channel partners to penetrate this market rather than hiring its own sales & marketing staff.  This strategy reduces the overall revenue potential, it also reduces the financial risk by lowering marketing and sales costs while allowing Medibio to focus on its core competency, which is data analytics and reporting.

B2C / Consumer Market

There are currently a myriad of consumer digital health and wellness offerings for the iOS and Android mobile platforms.  These wellness apps are largely geared towards managing stress and tension via breathing, yoga, and relaxing sounds.  The mental health apps are generally based on digitization of the DSM.  Medibio could potentially offer the first consumer mental health and stress assessment and management app based on an objective, quantitative standard, supported by extensive research.  The company has done some prelimary validation with popular wearable devices such as Fitbit so determine compatibility and possibility of integration with these wearable devices as part of the commercial launch strategy.  The basic business model in the consumer space would be a mobile app that would be based on a subscription model that includes objective diagnosis and stress management intervention tools.  An example of the potential of the app is the popular competing app called “Stress Doctor,” which has generated over 60 million iOS downloads.  The subscription price for the app is still being evaluated by the company.  While this market has potential, the market potential for the company is still speculative so we put this market potential in the way-out-of-the-money call option bucket.

Pharmaceutical Market

The antidepressant pharmaceutical market to treat depression and other mental disorders is valued at over $12 Billion. Given the high-cost of these drugs, payers are increasingly demanding demonstration of effectiveness through objective means. Medibio can provide objective screening to ensure patients are properly diagnosed.  The objective screening of various mental disorders can serve to generate revenue opportunities for adjunct therapies or to funnel patients to the proper therapies. While this market has potential, the company has not shown a lot of progress in this area yet. We put this market potential in the way-out-of-the-money call option bucket.

2. Early evidence of market traction in the B2B market.  The B2B market has limited regulatory hurdles, and the company can get early adoption in this market while awaiting FDA approval for the clinical market, thereby hedging the FDA risk for the company.

Medibio is beginning to get traction in the B2B market through various channel partners. The company launched its corporate stress product on a limited basis and has made progress with three channel partners. With Vital Conversations (a WA based wellness partner), the company completed a 50 person pilot program and is pursuring opportunities for a potential of 5,000 Australian staff (and 200,000 staff internationally).  With Australian National Wellness Partner (a health services provider), the company is running a 100 person pilot program via an internal staff wellness program (~6,000 Australian employees). The partner’s existing corporate wellness clients exceed 500,000 Australian staff. The company is also working with WellNovation to target clients with 360,000 participants in the Middle East region including state owned enterprises and the military.

3. Competitive advantage / IP / company algorithm underpinned by years of research

Description of CHRV technology

There are numerous approaches to diagnose mental health disorders, but Medibio’s approach has advantages over current and other emerging diagnostic methods: it’s an objective quantitative measurement, much less expensive, non-invasive, and has comparable to better accuracy than other methods. Studies using this techonology have demonstrated classification accuracy in the range of 78%-98% while diagnostic accuracy in the primary care setting is in the range of 33%-50%.

The following is a chart from the company laying out the competitive landscape:

The company has a suite of patents surrounding the method for diagnosing psychiatric disorders, the method for monitoring stress conditions using CHRV for stress assessment, and the method for using CHRV to diagnose psychiatric disorders.  The existing patents in the US and Canada are expiring in 4 years but the company filed two new provisional patents in 2015 seeking to extend protection for another 20 years. One is entitled “Method and System for assessing Mental State” was filed with the USPTO for the use of CHRV technology in the diagnosis of mental health disorders including depression. The other is entitled “Method and System for Monitoring Stress Conditions,” which is for measuring stress levels and determining the impact of stress on health and wellbeing.

In addition to the patent protection, we believe the proprietary algorithm owned by the company that was developed over 15 years and is based the collection and analysis of a dataset containing 12+ hours of ECG data from over 10,000 patients with corresponding psychiatric diagnosis will not be easy to replicate.  The company estimates that it would take 5 years and $30mil of research to replicate it, assuming a competitor would even want to undertake that task rather than just acquiring the company.  In the B2B and B2C space, a multi-year head start in technology is often an insurmountable competitive advantage since even if competitors decide to try to enter the market, by the time competitors copies the current technology, Medibio will have improved its product offering in those intervening years so that the competitor’s product will be at a competitive disadvantage and/or obsolete.  It will be difficult for competitors to catch up to Medibio as long as it continues to improve and develop its product offering.

4. Large insider ownership, approximately 43% of the shares outstanding, aligns management and insider with investors.

Here is the market capitalization table:

Ordinary Fully Paid Shares 105Mil

Options exercisable at $0.10 expiring 1 April 2018 15Mil

Options exercisable at $0.30 expiring 1 April 2017 6.7Mil

Options - exercise price $0.40, expire 3 years – 28 August 2016 – 3Mil

Options - exercise price $0.60, expire 3 years – 28 February 2017 – 1.5Mil

Options - exercise price $0.80, expire 3 years – 28 August 2017 – 1.5Mil

Last trading price: A$ 0.31

Valuation: A$24.1

Additional Milestone* Shares: 20Mil

Convertible Debenture 2020 @$0.31 AUD 2.5Mil

Valuation (Fully Diluted)  A$33.6Mil

Milestone 1* 6,666,667 Independent Validation

Milestone 2* 6,666,667 Commercial Algorithm Development

Milestone 3* 6,666,667 FDA/CE Mark

Available Cash – $1Mil (plus ~ $3M from R&D Rebate in Sept 2016)

Insider ownership: Board & Management 38,671,470 shares, which is 43%

5. Stock is mispriced -- reasons for mispricing.

• The company is completely off the radar screen. It’s a nanocap with limited liquidity trading on the Australian exchange.  Early stage tech and digital health companies in Silicon Valley (with even less traction than Medibio) are being assigned pre-money valuations of $10-$15 million (and post money valuations of $15-$20 million) after graduating from any number of well-known incubators after showing some early traction.  It may well be that these private market valuations will turn out to be unjustified, but it goes to highlight the valuation discrepancy between Medibio’s current public market valuation versus the prevailing private market valuations in the US.

• The target addressable market is the primarily the US, but the business is based in Australia and the security trades in Australia.

• It’s an early stage company with venture capital level of risk.

• Mr. Market has difficulty properly assigning value to companies that exhibit high growth in outer years.

• There’s been limited investor outreach and limited research coverage. The company hasn’t reached out much to institutional investors in the US and elsewhere.  We’ve suggested that they make the rounds around the US to the big healthcare conferences such as the JP Morgan, Morgan Stanley conferences, etc.  They are continuing their investor outreach, so it’s just matter of time before the investment community in the US and other developed markets gets better acquainted with the company.  Better research coverage may come once they hire a large bank to raise additional capital to fund growth.

Valuation

• As a rapidly growing business with high margin, recurring SAAS revenues addressing multiple large target markets, we believe the company would trade on a multiple of future revenues.  We are using a rough estimate of $80-100 million in revenues 5-7 years from today and assuming a revenue multiple of 5x-10x for this type of high margin, high growth company. That would equate to a potential future valuation of $400 mil to $700 mil in 5-7 years. This revenue projection is based on the company achieving about a low single digit market penetration of the clinical depression market just in the US and a low single digit market penetration of the B2B market.

The company provides a long term financial projection as shown below.

Obviously, the projections are subject to high degree of uncertainty, but nonethelss they are instructive in how the company is thinking about topline and bottom line growth.   It’s our view that the an investment in the company today will be end up being a binary bet: either the company achieves strong revenue growth and our investment is a home run, or it muddlles along with limited revenue traction and the stock languishes with multiple bouts of dilution along the way. The other two target markets, the B2C and phama markets, provide additional upside if the company is able to gain traction in those markets.  We realize this exercise is imprecise and may seem woefully speculative to the value investing crowd, but that’s just the nature of this type of early stage investment.  Reasonable people may differ about the potential outcome of this type of investment, but we feel that at these prices, this stock is an attractive call option with huge upside.  Definitely not for widows and orphans, but there may be a place for this type of security in some people's portfolio.

Risks

• clinical trials results are not compelling

• FDA may not grant approval for the clinical product

• Reimbursement for the clinical product may be delayed or not obtainable

• The existing patents expire in 4 years. The company has filed 2 new provisional patents to extend the life of the patent portfolio. The new patents may never be granted or granted only in part.  However, the key barrier to entry and competitive advantage Medibio is the company’s algorithm developed over 15 years, which would take 5 years and $30mil to replicate.  

• Market adoption may never materialize.  However, the company is hedging its bets by targeting multiple large markets.  Market adoption in any one of these target markets would be a home run for the company.

• Financing risk

Near Term Catalysts

• Completion of John Hopkins University initial validation study on depression 4Q16

• Completion of Independent calidation study for the corporate stress product 4Q16

• Confirmatory study to support 510k submission commences (Johns Hopkins and commercial CRO’s) 1Q17

• Submission of FDA de novo application (Depression Diagnostic) 2H17

• FDA approval potentially in 2018

• Traction in the B2B market.

• Potential for listing in the US / expanding US presence / relocation of headquarters to the US.

• Additional investor outreach by the company

Catalyst

• Completion of John Hopkins University initial validation study on depression 4Q16

• Completion of Independent calidation study for the corporate stress product 4Q16

• Confirmatory study to support 510k submission commences (Johns Hopkins and commercial CRO’s) 1Q17

• Submission of FDA de novo application (Depression Diagnostic) 2H17

• FDA approval potentially in 2018

• Traction in the B2B market.

• Potential for listing in the US / expanding US presence / relocation of headquarters to the US.

• Additional investor outreach by the company