On Wednesday shortly after the lunch hour, the FDA posted publicly a letter dated August 28 that was sent to MiMedx Group (MDXG), a developer of regenerative biomaterials and allografts processed from human amniotic membranes. Essentially, the FDA alleges that MiMedx is marketing some of these amniotic products – specifically AmnioFix Injectable, AccelShield Injectable, and EpiFixInjectable – without proper FDA approval. MDXG tumbled more than 40% before rebounding to close the day down 37%, at $3.85. On Thursday morning, the stock is up 17% in pre-market trading.
MiMedx currently sells its allografts and injectable amnion products under the FDA’s definition of human cells, tissues, and cellular and tissue-based products (HCT/Ps), often called the “361” rule. MiMedx accepts donated placentas from birthing centers, harvests amniotic tissue from the samples, and modifies them through their proprietary “Purion” process. These modified tissues make up the company’s skin allografts and injectable products. So long as the tissue is “minimally manipulated”, the FDA doesn’t require a biologics licensing application – cord blood, sperm donation, and skin grafts harvested from cadavers all fall into this category. In other words, HCT/Ps bypass the formal regulatory approval process because they’re minimally modified and either not dependent on the metabolic activity of living cells for their primary function, or do, but are used autologously, in a blood relative, or for reproductive purposes.
At least they’re not supposed to. Apparently, the FDA is taking issue with MiMedx’s aforementioned products and, following an evaluation of MiMedx’s “micronization process,” has suggested that these tissues are more than “minimally manipulated.” Here are the juicy tidbits from the letter:
Injectable amniotic/chorionic-based products are human cells, tissues, and cellular and tissue-based products (HCT/Ps) as defined in 21 CFR 1271.3(d). However, [the products listed above] are HCT/Ps that do not meet all of the criteria in 21 CFR 1271.10(a) and therefore are not regulated solely under section 361 of the Public Health Service Act (PHS Act) and the regulations in 21 CFR Part 1271. Specifically, the products do not meet the minimal manipulation criterion set forth in 21 CFR 1271.3(f)(1) due to the micronization process which alters the original relevant characteristics of the structural tissue, relating to the tissue’s utility for reconstruction, repair or replacement. As a result, your HCT/Ps are drugs as defined under section 201(g) of the Federal Food, Drug, and Cosmetic Act (the Act) [21 U.S.C. 321(g)] and biological products as defined in section 351(i) of the PHS Act [42 U.S.C. 262(i)].
Please be advised that in order to lawfully market a drug that is also a biological product, a valid biologics license must be in effect [42 U.S.C. 262(a)]. Such licenses are issued only after a showing of safety and efficacy for the product’s intended use. While in the development stage, such products may be distributed for clinical use in humans only if the sponsor has an investigational new drug (IND) application in effect as specified by FDA regulations [21 U.S.C. 355(i); 42 U.S.C. 262(a)(3); 21 CFR Part 312]. None of the amniotic/chorionic-based products described in this letter are the subject of an approved biologics license application (BLA), nor are there INDs in effect for any of these products. Based on this information, we have determined that your actions have violated the Act and the PHS Act.
If a person or firm violates the Federal Food, Drug and Cosmetic Act, the FDA generally grants the firm an opportunity to correct the violation before initiating enforcement action. In these situations, FDA will issue either a Warning Letter or an Untitled Letter. The FDA issues Warning Letters for violations that may lead to enforcement action if they are not promptly and adequately corrected; the FDA issues Untitled Letters for violations that are not as significant as those that trigger warning letters. An Untitled Letter does not include a statement warning that failure to comply may result in an enforcement action.
The notification sent to MiMedx is an Untitled Letter, a step down in severity from a Warning Letter. The FDA stated that during a Current Good Tissue Practice (CGTP) inspection of MiMedx’s manufacturing facilities from July 30, 2012 to August 1, 2012, the FDA collected information on the manufacture of amniotic/chorionic-based products. A year later, the Center for Biologics Evaluation and Research (CBER) has issued an Untitled Letter. Interestingly, MiMedx notes in Wednesday’s press release that following the same inspection, an FDA employee “advised [MiMedx] that CBER had completed its review and had no findings or further questions.” Clearly that wasn’t the entire story, but the fact that CBER is issuing an Untitled Letter instead of a Warning Letter suggests the violation won’t be immediately followed by enforcement. As noted above, wound-care products listed as HTC/Ps operate in a somewhat gray area of regulation. We’ve spoken with a number of consumer advocacy groups who agree that regulation of these products should and may tighten up with increasing pressure on regulators to take action. We suspect that the FDA is beginning to feel out tighter regulation of the HCT/P wound-care segment, and this is the first foray.
MiMedx wasted little time on Wednesday in publishing a press release contesting the allegations and reiterating the company’s 2013 and 2014 guidance. Frankly, reiterating guidance should be the last of the company’s priorities following allegations of illegally selling biological products. But talking up revenue projections has been a repeat strategy at MiMedx when there’s a hint of volatility in the stock. Back in July, a bearish article posted to Seeking Alpha caused a sharp intra-day drop in MDXG; the company responded quickly with a press release stating that revenue would “slightly exceed” the high end of its previously communicated sales expectations for the second quarter – this just five days after the company announced its 2Q earnings release and two weeks ahead of the official release.
In May, we sent a note to PropThink Premium subscribers suggesting that the stock was highly overvalued and that we were dubious of the business in general, noting a number of red flags and risks at MiMedx that investors have overlooked amidst a highly promotional barrage of news and guidance. When Wednesday’s FDA letter was published, we were, in fact, in the middle of drafting a full research report outlining our bearish outlook. Here are our concerns in a nutshell:
MiMedx traded at just $1.05 at the end of April 2012 but touched an all-time high of $7.73 on June 25, a 700% increase that makes the biotech sectors’ lauded gains appear paltry by comparison. The stock’s climb has, of course, coincided with an expansion of MiMedx’s valuation, and MDXG now carries a fully diluted market capitalization — which includes the effects of additional outstanding warrants and options — of over $750M. Based on a comparison to peers in its industry, there’s reason to believe that the market has gotten well ahead of itself in valuing a company that only recently moved into meaningful commercialization. We find a number of qualities disconcerting about MDXG at these levels — $6.60 per share and a fully diluted market cap of ~$750M: 1) Its valuation compared to peers in regenerative medicine and the broader medical device space; 2) A confluence of risks to the business and shareholders; and 3) The company’s worryingly low cash position at the end of the quarter and a questionable ability to raise capital if necessary.
While we believe that MiMedx operates a potentially compelling business, the hype around this name has pushed MDXG outside of a reasonable valuation, and MDXG is arguably one of the most expensive healthcare equities on the market. We also note a number of risks to the business that the market seems to have overlooked, which may present severe hurdles to expansion in the future, as well as to existing shareholders. Namely, the company’s lead products are marketed under a somewhat gray area of regulation – in our view, MDXG is taking advantage of a loophole in the regulatory system. Furthermore, the company has historically funded itself in large-part through the exercise of warrants and options and has paid for acquired assets through the issuance of common stock, not cash outlay. MiMedx’s cash balance is worryingly low, and if the company turns to the markets as a source of much-needed capital, institutional investors won’t be willing to play at current prices. That means MiMedx will be forced to either offer large investors excessive warrant coverage to sweeten the deal, as it has done in the past, or will need to price a potential deal far below market, sending the stock tumbling.
MiMedx shareholders should be aware that they own a premium-priced equity whose share price fails to accurately portray the risks that this young business still faces. And, investors considering a position in MDXG would do well to weigh the risk/reward of buying this comparatively expensive regenerative medicine business now. MDXG already bakes in all but the most picture perfect of near-term outcomes, and a whiff of things awry could send the stock spiraling.
As we suggested, just a whiff of trouble sent the stock spiraling. The wound-care space is rife with claims supported by teetering efficacy data and poor comparator arms in small clinical trials; MiMedx’s rich valuation and bold efficacy claims based on small trials are what originally drew us to the story earlier in 2013. In addition, we noted a precarious balance sheet ($3M in cash on a $700M valuation), a repeated focus on EBITDA, not earnings, in company press releases, a track record of stock-based compensation, and a history of financing the company through the exercise of convertibles. Basically, our hypothesis is that a few entrepreneurs noticed a healthcare segment with limited regulation, extremely high margins, a low barrier to entry, and highly concentrated customer base – the U.S Veteran’s Administration made up 64% of MiMedx’s sales in the first half of 2013.
It’s worth noting that despite the FDA sending this letter on August 28 by Express mail, MiMedx had yet to file this material information or alert investors in any form – we assume that the company had the Untitled Letter in hand late last week, which should cause some consternation among investors.
MiMedx will host a conference call on Thursday at 11:00 AM EDT to discuss the receipt of the Untitled Letter and for “the reiteration of revenue guidance for 2013 and 2014.”