Tony Featherstone Columnist

Tony is a former managing editor of BRW, Shares, Personal Investor, Asset and CFO magazines. He writes a weekly column for BRW and The Australian Financial Review, specialising in small listed companies,IPOs, entrepreneurship and innovation.

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More than a slim chance

Published 01 March 2012 05:09, Updated 01 March 2012 05:16

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Investors may be forgiven for overlooking the float market. Most offers have been for speculative micro-cap explorers and seven in 10 floats ended 2011 below their issue price. But often the best opportunities emerge when people stop looking at markets.

GI Dynamics is one of them. The US medical device company raised $80.3 million and listed on Australian Securities Exchange in September 2011. Its $1.10 shares slumped to 75¢ within weeks of listing and roared back towards their issue price in February after company presentations and bullish sharebroker research.

I wrote about GI Dynamics in October when was it 95¢. Its lead product, EndoBarrier, is a thin plastic sleeve that lines the first 60 centimetres of the small intestine. Blocking off this section of the intestine causes patients to eat less, lose weight and treats diabetes and obesity. The device is implanted through the mouth in a short procedure.

EndoBarrier is targeting obese patients with type 2 diabetes, a global market it estimates at 63 million people. Some life sciences companies promote huge markets for their product and seduce novice investors.

More important is the science, commercialisation strategy, practitioner acceptance, intellectual property position, management, and valuation. Understanding the company’s milestones, news flow and market dynamics is important for short-term investors.

Bell Potter’s 12-month share price target for GI Dynamics is $2. Its base case and optimistic scenarios value GI Dynamics at $1.83 and $3 a share respectively and it expects the company to break even in 2014.

Bell likes GI Dynamics’ research results, which show EndoBarrier works better than comparable therapies such as bariatric surgery to reduce stomach size. Bell Potter was lead manager on the GI Dynamics initial public offering.

Analysis by US corporate adviser Lazard Capital Markets is insightful. It is unusual for a US broking firm to research a small-cap ASX-listed company. Apparently a Lazard analyst has followed GI Dynamics from its early days of raising venture capital. Lazard has a price target of $US2.15 for GI Dynamics and describes it as its top small-cap medical technology pick.

Lazard’s consultant said EndoBarrier may appeal to markets beyond diabetics. Patients too obese for surgery could use it to kick-start weight loss; others could use it to lose weight for cosmetic reasons. Lazard was buoyed by its consultant’s opinion that EndoBarrier was safe for use in cosmetic surgeries. GI Dynamics has expanded its market to include diabetic patients who are overweight yet not obese – a potential market in Asia. Lazard estimates EndoBarrier’s market is worth $US200 billion. The US and Germany are the prime targets because of their high prevalence of obesity.

Earlier studies showed patients who used EndoBarrier lost 20 per cent of their body weight. New data shows EndoBarrier affects certain hormones that affect glucose control and the feeling of fullness. I doubt investors understand the significance of EndoBarrier’s affect on some hormones. It may explain why patients maintained, on average, 75 per cent of their weight loss after EndoBarrier’s removal.

The device was previously thought to treat diabetes and obesity only by reducing calorie intake. EndoBarrier’s hormonal effects may attract interest from drug companies that target similar hormones to treat diabetes or obesity.

The other attraction is economics. Medical centres pay $US4000 ($3737) for EndoBarrier and are expected to charge about $US8000 for the procedure. That is a decent margin even after use of a surgical room and other costs. Doctors who are experienced with EndoBarrier insert it in 10 to 15 minutes. Some did as many as 10 procedures a day in trials. The procedure is non-invasive and done under controlled sedation rather than anaesthesia. This suggests EndoBarrier is an interesting commercial opportunity for diabetes centres and cosmetic surgeries.

These favourable economics should speed up the adoption of EndoBarrier in medical centres, help the commercialisation strategy and see GI Dynamics break even in 2014 or beyond.

That is the potential. The reality is EndoBarrier was launched in Europe only last year and approved for sale in Chile a year earlier. Only 13 diabetes centres worldwide use EndoBarrier and GI Dynamics stills needs to secure medical reimbursement for the product across countries.

The Therapeutic Goods Administration approved EndoBarrier for sale in Australia in 2011; a product launch is expected mid-year. Selling EndoBarrier locally is an important milestone even though Australia is a small market.

GI Dynamics is a long way from selling its product in the US. It is in discussions with the US Food and Drug Administration and expects to start US clinical trials later this year. These are costly and time consuming and GI Dynamics might need two clinical trials to understand how EndoBarrier treats type 2 diabetes and obesity separately. This would take a big chunk of the GI Dynamics’ $US66 million in cash. There are concerns about its US patent position, with key patents expiring between 2023 and 2030. There is also litigation risk: GI Dynamics has had to defend claims by a key supplier, WL Gore & Associates, which believes it is the joint owner of all the patents and protections. GI Dynamics expects the case to be heard this year. Analysts do not seem worried by this risk.

A frustration is the speed of GI Dynamics’ commercialisation strategy and the uptake of EndoBarrier. Faster sales growth might not emerge until 2014 and beyond. GI Dynamics should have good news flow this year: the launch of EndoBarrier in Australia, the results of three research studies, the start of US clinical trials, the expected conclusion of litigation and regulatory approval in other countries.

Investors need patience. GI Dynamic management is building the foundations for a much larger company with sustainable long-term growth. As a small-cap company yet to make profit, GI Dynamics suits speculators. It is among the more interesting medical device makers to emerge on ASX in recent years.

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