If you’ve been following the medical device (and/or pharmaceutical) space for a while, you know that congestive heart failure is one of the nastiest, hardest to treat, chronic conditions out there. There’s really no way to reverse the disease short of a heart transplant, and the drugs and device therapies available sort themselves out between "largely ineffective" and "effective, but with serious issues".
That’s terrible news for those patients who have congestive heart failure, but it leaves a tremendous opportunity for Sunshine Heart (NSDQ:SSH). This small-cap med-tech from Minnesota appears to have an ingenious solution to the problem, one that is based around well-understood principles and relatively simple technology. Although it will be at least four to five years before commercialization in the U.S., and that’s only if the pivotal study shows adequate efficacy and an acceptable risk/benefit profile, this is definitely a name to watch in the med-tech space as the company looks to bring a new option to the table for seriously ill CHF patients.
Simple, but ingenious
Sunshine Heart’s C-Pulse system is ingenious and relatively simple. Basically a redesigned balloon pump device, the C-Pulse cuff (an inflatable balloon) is wrapped around the ascending aorta and uses counterpulsation in sync with the heart’s natural rhythm to help the heart pump blood through the circulatory system. The basic technology used here has been used in intra-aortic balloon pumps for decades, and it achieves the desirable outcome of improved blood flow for the patient with a reduced workload to the diseased and damaged heart.
At no point does the C-Pulse device actually contact the blood stream, so there is no need for blood-thinning agents to avoid clots. It is a powered mechanical device – there is a pacing wire that attaches to the heart to maintain rhythm, and the device has to be externally powered through a power pack and controller outside the body connected to the device by a percutaneous driveline.
There are a few potential problems with this approach. First, that external power/control source requires that lead/line into the body, and that’s a gateway for infections – and there have been several cases of infections in the studies done to date. Although a fully implantable device should be possible down the line, the risk of infection (and the plans for preventing/controlling them) is a clear safety concern.
It’s also possible that the nature of the device itself could be problematic for some patients. Those CHF patients who have aortic stenosis, aortic atherosclerosis or calcifications, atrial fibrillation, and/or any sort of aortic valve issues (regurgitation, etc.) may be contraindicated for this device. Likewise, nobody knows the long-term ramifications of manipulating the ascending aorta in this fashion, though I would argue those ramifications are very unlikely to be worse than the underlying disease.
Studies underway, but real sales are a long way off
Sunshine Heart has a CE Mark (European approval) for the device, but that’s honestly not worth all that much today. Sunshine does not have the resources right now to build out a full commercialization effort, and given the novelty of the device, it’s going to take quite a bit more clinical data before physician interest in Europe takes off. To that end, though, the company has started the Options HF European post-marketing study, and 2 sites had been activated as of early August 2013.
Far more important to the company’s future is the Counter HF study – the U.S. pivotal trial. This study looks to enroll 388 patients in a randomized study where half will get the C-Pulse and the other half will get "optimal medical therapy," which can include LVADs. The primary endpoint for the study will be a reduction in events leading to hospitalization – 50% of Class III patients typically require rehospitalization within 6 months, and this study is powered to show a 30% reduction at 12 months.
There will likely be some challenges for the company with this study. Site enrollment appears to be going a little slowly, which is pretty common for smaller med-tech companies. On the other hand, management had initially guided for an enrollment process of 2½ years, so I do believe some conservatism was built into the plans. It’s also important to note that patients can disconnect the device if they choose (say, to shower), and the device must be on 80% or more of the time for a patient to be in compliance with the study – if patients feel better and disconnect more often, that could interfere with the final data.
The C-Pulse has been designated a CMS category B3 device and management expects around 70% of implants to be covered by Medicare or insurance, meaning that the company can generate some much-needed revenue and cash flow during the study.
The first implant in the Counter HF study was made Sept. 12, and given the time needed for enrollment, follow-up, filing, FDA review, and so on, I would not expect approval until 2018 (though I suppose 2017 approval is not impossible).
Considering the possibilities
I certainly believe there is a real market opportunity out there for the C-Pulse. There are at least an estimated 1.1 million patients in the U.S. who have Class III/IVa heart failure – the key target market for the C-Pulse. The company’s own estimate is 1.5 million, with another 3.7 million in Europe.
The LVAD devices developed and sold by HeartWare International (NSDQ:HTWR) and Thoratec (NSDQ:THOR) are best suited for the Class IV market (very seriously ill patients) and the expense, complexity, and risks of the devices make it less likely that they will crowd into the Class III market. Thoratec has approval for the Class IIIB market, but reimbursement has proven quite challenging. Given the cost of the device, the risk of clotting, the need for surgeon training and so on, I think it will be hard for these devices to really compete in Class III if the C-Pulse proves effective and adequately safe.
On the other hand, Medtronic (NYSE:MDT), Boston Scientific (NYSE:BSX), and St. Jude Medical (NYSE:STJ) have worked hard to carve out the Class III market for themselves with their cardiac resynchronization therapies (pacemakers or pacemaker-defibrillator combination devices that shock the heart into better performance). While Medtronic et al have prodigious marketing capabilities, only about 20%-30% of the Class III patient pool are good candidates for CRT therapy, and even then about ⅓ of patients fail to respond to the approach.
In Sunshine’s feasibility study for the C-Pulse (a small 20-patient study), 60% of the study participants were classified as responders. There was an average improvement in heart failure classification from 3.1 to 2.2 at 6 months, with further improvements at 12 months. The left ventricular ejection fraction improved from 28 to 31, and there was a 24-meter improvement in the 6-minute walk test at 6 months and 47 meters at 12 months. Two of the patients responded so well (became Class I) that they were disconnected from the device, though 1 later died from a heart attack. On that basis, I do believe that C-Pulse therapy can capture a meaningful share in the Class III (and maybe some Class IV) heart failure market.
These results are not entirely a slam-dunk. Almost ½ of the patients (9 of 20) had a major infection, and 8 of those were related to the lead exit site. In addition, 1 patient died from an aortic disruption tied to a surgical procedure to treat a sternal infection. It doesn’t appear that the device weakened or remodeled the aorta, but I believe the FDA will be keenly focused on any signs of "aortic consequences" from the device.
Adding it up
With a potential device ASP of $59,000, it doesn’t take much work to generate large numbers for Sunshine’s revenue potential, and both sell-side analysts and retail/freelance financial writers have started getting excited about this name. I certainly share some of that enthusiasm, though I’m seeing a lot of familiar mistakes in the coverage of Sunshine Heart – namely, overestimating the extent to which this device will "sell itself," overestimating the pace of market penetration, and underestimating the challenges of marketing and competing in the real-world market of physicians, reimbursement, and competing approaches.
All of that said, 10% penetration of just the American Class III/IVa market points to nearly $6 billion in revenue, and just 1% penetration ($600 million) would make Sunshine Heart a rousing success by the standards of most small-cap med-techs. With that, I do believe these shares are undervalued.
If Sunshine can muster $255 million in revenue in 2022 (roughly 4,325 devices or 0.4% penetration of U.S. Class III patients 4 years after launch) and garner an 8x multiple, you’re talking about a discounted value of about $12 per share today on the assumption of 33% odds of success or $18 with a 50% success probability. That assumes a fully-diluted share count of 19 million shares, and that could be a little too low as the company will all but certainly need additional rounds of equity fundraising before reaching cash flow break-even (small cap med-techs always burn through more funds than investors and analysts expect them to while launching a product).
On a discounted cash flow basis, I currently calculate a fair value of about $14.50, but I believe I’m using conservative assumptions. I’m looking for $50 million in 2018 revenue, $254 million in 2022 revenue, and $740 million in 2027 revenue, with negative free cash flow in 2018, a 17.5% free cash flow margin in 2022, and a 25% margin in 2027. SSH shares were trading at $10.75 apiece as of this writing.
The bottom line
A lot of those writing about Sunshine Heart believe that it’s a "when, not if" question of the company being acquired. Having heard the same thing about HeartWare and Thoratec for years, I’m skeptical, although I freely admit it’s an elegant device that, if proven effective, would fit in almost any cardiology business (including Medtronic, Boston Scientific, St. Jude, Abbott (NYSE:ABT), or Johnson & Johnson (NYSE:JNJ), just to name a few). Likewise, too many companies have shown great feasibility/pilot study results only to flame out in pivotal studies, so I wouldn’t assume approval is in the bag, nor would I assume that the infection issue is unimportant.
All of that said, no exciting small-cap opportunity comes risk-free, and I think Sunshine is an exciting opportunity. This is not a "widows and orphans" stock by any means, but I’m legitimately excited by what looks like a real step forward in helping patients with congestive heart failure live much longer, better lives.
Stephen Simpson CFA is a former sell-side and buy-side analyst who focuses most of his professional attention on financial and investment writing. In addition to a decade of work as an analyst, Mr. Simpson has worked as a wet-bench biomedical researcher and a consultant in the med-tech industry, as well as writing on a freelance basis for over 10 years. He can be reached via email at tuonela.fool@gmail.com.
