Value Investors Take Note: Fire Sale on this Heart Failure Asset

With a capital raise recently out of the way and a pivotal trial enrolling towards a regulatory filing in the U.S., Sunshine Heart’s (SSH) $60M market capitalization drastically discounts the long-term potential of the company’s experimental heart assist device. The C-Pulse Heart Assist System is an implantable device being developed for the treatment of moderate to severe heart failure (Class III and ambulatory Class IV patients), an immense market currently dominated by two left ventricular assist device (LVAD) developers, Thoratec (THOR) and Heartware (HTWR), which carry $1.9B and $1.6B market caps respectively. But two facets to the C-Pulse System may make it an even more compelling asset — for investors and strategic acquirers — than existing products: the C-Pulse System remains outside of a patients blood stream, and the product may address an even larger market than Thoratec and Heartware have been able to penetrate.

A feasibility trial evidenced that the C-Pulse System was safe and efficacious in a small, proof-of-concept patient population, and the company just began enrollment in two larger studies: a 388-patient study in the U.S. to support an FDA filing, and a 50-patient post-marketing study in the EU to support the device’s commercial use. But because of the protracted timeline until Sunshine Heart nears domestic commercialization of the C-Pulse System — the pivotal U.S. trial won’t wrap up for a few years — investors have vacated this name in search of more exciting trades. It’s these opportunities that we look for as long-term entrance points, and supposing that SSH follows a similar trajectory as HTWR and THOR, investors with cash to sock away now may be buying into a potential “multi-bagger” equity.

Sunshine Heart’s news flow hasn’t dried up entirely, despite the market’s perception, as efficacy and safety data from the ongoing open-label European study should drive interest as announced, and EU sales materialize incrementally. We find SSH’s current $5.45 share price an attractive entrance point, particularly give its 52-week range of $2.50-$17.25. The company fortified its balance sheet twice in the last year — raising $14M just a month ago — and with two-years plus in funding to get to mileposts, it makes sense to take a closer look at Sunshine Heart.

Sunshine develops a disruptive and differentiated approach to the implantable treatment of  heart failure. Heart failure is a condition that develops as the heart muscle weakens and works harder to keep blood flowing through the body. Symptoms include shortness of breath, general fatigue, difficulty exercising, and swelling of the legs, and as heart strength declines, stiffens, and enlarges over time, pumping blood needed for the body to function properly becomes more and more difficult. It’s a relatively common and growing condition, with about 5.7M patients in the U.S. The New York Heart Association (NYHA) breaks down the classification of heart failure progression into four stages:

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Early-stage treatments include drug therapies to improve symptoms (vasodilators, anticoagulants, etc.) as well as the remedy of the underlying causes of heart failure (coronary heart disease, high blood pressure, diabetes, etc.). But as the disease progresses and symptoms worsen, medicines no longer suffice, and patients may ultimately require a mechanical heart pump (ventricular assist device, or VAD) or heart transplant as a last resort.

This is where Sunshine has differentiated the C-Pulse system. Approved LVADs like Thoratec’s HeartMate II and Heartware’s ventricular assist devices require small pumps within the blood stream, creating the risk of infection and the need for anti-clotting agents. The C-Pulse consists of an inflatable cuff placed outside the patient’s flow of blood. The cuff utilizes balloon counter-pulsation applied in an extra-aortic approach to assist the left ventricle in pumping blood through the body, reducing the workload on the patient’s weakened heart. A percutaneous interface lead exits the abdomen to an external driver device contained in a carrying bag. During inflation of the cuff, blood flow is increased to the coronary arteries, providing additional oxygen to the failing heart. During deflation, the workload or pumping required by the left heart is reduced. The balloon inflation and deflation is synchronized to the patient’s ECG (electrocardiogram). (This video on Sunshine’s website offers a great visualization of the technology.) Keeping the VAD from coming into contact with blood eliminates the need for blood thinners, reduces risk of infection, and ultimately, may reduce the risk of stroke. Furthermore, during the feasibility study, surgeons were able to implant the C-Pulse through a mini-thoracotomy (small incision between the patient’s ribs and sternum) rather than a full sternotomy. The less-invasive procedural requirements of the C-Pulse are conducive to shorter hospital stays, recovery times, and subsequently, lower expenses and burden on the healthcare system.

Sunshine Heart released the results of an initial feasibility study (NCT00815880) of the C-Pulse system in late-2011, with a 12-month follow-up in 2012. The data demonstrate that, on average, the C-Pulse system actually reduced patients’ NYHA heart-disease classifications by over 1 class, and demonstrated a mean improvement in a six-minute walk test of over 50 meters. To be clear, the NYHA reduction means that patients who improved by over 1.5 classifications may have advanced from “unable to carry out any physical activity” to a “slight limitation of physical activity;” a big deal for patients who are unable to move around the house comfortably. Understandably then, patients reported a mean improvement in Quality of Life (QOL) of three times that required to be considered “meaningful” by trial measurements (SSH’s patient testimonials are quite compelling).

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Furthermore, the device, thus far, has been safe and well tolerated.

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Based on the results of the feasibility trial, the FDA concluded that Sunshine Heart met agency requirements in order to move forward with an Investigational Device Exemption, and Sunshine Heart has since begun enrolling patients in the 388-patient COUNTER HF trial (NCT01740596) with the intention of filing for FDA approval following completion. And here’s why SSH’s trading activity has slowed so drastically in the last six months — the trial won’t have top-line data until 2016 (enrollment completed by YE2015), which means C-Pulse isn’t likely to be on the market in the U.S. before 2017. The COUNTER HF trial will randomize patients 1:1 to either C-Pulse or a control arm with optimal medical therapy. Primary outcome measures are efficacy (“by measuring freedom from worsening heart failure resulting in hospitalization, LVAD implantation, cardiac transplantation or death as compared to OMT”) and safety.

As of the company’s May 14th 1Q results, the company had activated the first two sites in the COUNTER HF trial, received reimbursement approval from the Centers for Medicare and Medicaid (CMS) for one site, and had activated the first site in a European multi-center post-market trial called OPTIONS HF. The trial is a 50-patient, 24- month multi-center study to support C-Pulse’s use in Europe; the C-Pulse system already received the CE Mark, allowing for sale in countries that accept the designation, but the ongoing trial acts as a post-marketing study to support clinical use and reimbursement. What’s crucial to understand about the European study is that the trial is open-label, meaning that Sunshine Heart will report new data every chance it gets – the news flow should be value creating for shareholders.

Sunshine hopes to target a yet untapped population in heart failure. In addition to a differentiated technology, Sunshine Heart hopes to address a larger market than the leading approved LVADs. Currently, LVADs are used and approved almost exclusively in end-stage heart failure patients (Class IV) due to the risk of adverse events that accompany the implanted devices: stroke, infection, and bleeding. Physicians debate whether the benefits of current LVAD technology outweigh the risks in patients who have not yet progressed to Class IV, and a trial sponsored by the National Heart, Lung and Blood Institute (NHLBI) of the National Institutes of Health and Thoratec are beginning the REVIVE-IT study to evaluate the HeartMate II in Class III patients. But this ongoing debate is centered on adverse events that the C-Pulse System isn’t likely to incur due to its extra-aortic qualities; it’s the blood contact, experts believe, that raises the incidence of these risks.

With that in mind, we believe that C-Pulse has a high chance of success and approval in Class III and ambulatory Class IV heart failure (essentially the healthier of the sickest patients, life expectancy of more than 1 year). Sunshine Heart estimates the number of eligible patients at 1.5 million in the U.S., with another 3.7 million in Europe. Note that Heartware estimates approximately 7 million Class III/IV patients worldwide, and that approximately 20% of these patients could benefit from a circulatory assist device. The CDC pegs the number heart failure patients domestically at 5.7M, and extrapolating from a study of the association between NYHA class and outcomes in heart failure patients, which indicated that Class I, II, III and IV represented 19.9%, 58.0%, 20.9% and 1.2% of the total heart failure population respectively, Sunshine Heart’s estimates seem reasonable.

For a simple valuation comparison, Thoratec carries a $2B market capitalization and expects revenues of $490-510M in fiscal 2013. Heartware did $49M in revenue in the first quarter (its VAD was approved in November of 2012) and has a market capitalization of $1.6B. The market clearly values these device growth stories at a premium, and if Sunshine captures a fraction of its anticipated addressable population, even a $600M valuation implies upside of 10x from current levels. It doesn’t take much for SSH to turn-out an impressive ROI.

Phase III data, Sunshine’s most critical inflection point, is a ways out, but the incremental news flow continues. Again, we believe that investors have taken leave of SSH in the last few months as initial enthusiasm for the stock, which moved to the NASDAQ early last year, has slowed in recognition of the company’s development timeline. But it’s this lull in combination with the company’s recent financing that we believe make SSH’s current trading range an optimal entrance point. Sunshine netted $14M in a public offering that closed on April 16 (the company sold 2.875M shares at $5.25), and with the release of its first quarter results, the company revealed $25M in cash on the balance sheet including the offering. This runway should last another six quarters at an average burn of $4M quarterly, backed up by a common stock purchase agreement with Aspire Capital for an additional $24M, extending that ramp materially if the company exercises opportunistically.

So as Sunshine Heart begins enrollment in a U.S. trial that won’t be complete for three years, what does the news flow from here look like? First, it’s important to note that the European post-marketing trial is open-label, and the company has indicated that after the first month of patient data is in, it will be presenting updated results whenever and whereever it can, namely, medical meetings and investor presentations. These updates have clear read-throughs for the U.S. trial — positive clinical results in Europe are indicative of the same from the American pivotal trial. Second, Sunshine Heart plans to publish the full data set from the C-Pulse feasibility study in a medical journal; “Ambulatory Extra-Aortic Counterpulsation in Patients with Moderate to Advanced Chronic Heart Failure” will contain the finer details on C-Pulse’s proof-of-concept study. Third, Sunshine Heart will have results from the first animal study of its fully implantable C-Pulse system by the end of the year. While a long ways from the clinic, this experimental system represents the next generation of Sunshine’s technology and a major step up on existing products due to a transcutaneous power source. Finally, Sunshine Heart has indicated that it is discussing with providers the possibility of two more existing patients being weaned from C-Pulse entirely; essentially these patients’ heart function has improved sufficiently to warrant going off-device, a major vote of confidence in C-Pulse’s ability to improve heart function. Of course, Sunshine will also be updating investors on enrollment progress in COUNTER HF alongside earnings announcements, but we don’t expect these to be particularly value-driving.

The bottom line? Sunshine Heart, at a $52M valuation, is trading at a fraction of its long-term potential, and is particularly cheap next to its closest comparators and competitors Thoratec and Heartware. We believe that stepping in now, with two financing arrangements out of the way in the last five months, in expectation of building a long-term position makes sense. SSH below $6.00 remains a fire-sale price as the company progresses steadily towards a substantial market opportunity.

In connection with SSH, PropThink has taken a long position.