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Whalebone Advisory provides investor relations and strategic advisory services to publicy-traded, pre-IPO, and development stage healthcare companies.
September 22, 2017

Graham-Cassidy Repeal Effort To Be Voted On Next Week;
Plus: PFE/JNJ Suit, Robotic Surgery Update, MDXG Vs. Shorts

Senate Majority Leader Mitch McConnell announced this week that he will bring the GOP’s latest Affordable Care Act (ACA) repeal/replace effort, the Graham-Cassidy bill, to the floor for a vote next week. The main feature of the proposed bill is to take back funding from those states that chose to expand their Medicaid programs under the ACA (as well as to eliminate cost-sharing subsidies for the exchanges) and distribute those dollars as block grants to states that did not expand. In 2020, those block grants will convert to per capita caps (here is a primer on the differences). The bill also repeals the medical device tax and individual and employer mandates, although it retains the Health Insurance Tax.
As was the case with the Senate’s previous repeal/replace effort over the summer, 50 “yes” votes are needed for passage, meaning that no more than two GOP senators can vote “no.” Given the tight timeframe for passing this bill (the deadline for doing so via budget reconciliation is September 30), it is unclear whether the CBO will have a chance to score it in time for a vote. Without a comprehensive score (which would likely show meaningful deficit savings but similar increases in the number of uninsured as previous proposals), the odds of passage are slim.
For example, Rand Paul (KY) is already on record as saying he will vote against, while several others – including John McCain (AZ), Susan Collins (ME), Lisa Murkowski (AK), Rob Portman (OH), and Shelley Moore Capito (WV) – are officially leaning “no” or are on the fence pending more information about the bill’s impact on their states. In total, 20 GOP Senators come from states that expanded Medicaid, with eight up for re-election next year. To combat this, the Graham-Cassidy bill proposes to exempt several sparsely-populated states (potentially Alaska, Montana, North and South Dakota, and Wyoming) from losing Medicaid funding, which could put Murkowski back in the “yes” column.
With all of the uncertainty about the impact on states and CBO score, the Street thinks passage is unlikely. And if it does pass, there are questions about whether it could pass the House, which remains severely divided. We therefore expect Congress to return to the ongoing bipartisan repair process to move back to the front burner after next week.

PFE's JNJ Lawsuit Becomes Centerstage For Drug Pricing Debate

Pfizer (PFE) this week filed suit against Johnson & Johnson (JNJ), alleging that JNJ’s contracts with insurers over Remicade are anti-competitive and creating an impediment for sales of PFE’s biosimilar Inflectra. Despite pricing Inflectra at a roughly 15% discount to Remicade, PFE claims that JNJ’s deals with insurers and providers prevent them from offering generic or biosimilar versions, and therefore Inflectra sales have performed far below initial expectations. Those who do offer alternatives would not qualify for any rebates or discounts, a practice that PFE argues is anti-competitive. JNJ responded by saying it does not believe the suit has any merit and that it is operating within its rights to be price competitive in a market with an increasing number of options available to patients and providers.
It is obviously unclear at this stage how this case might go and how long it will be until a verdict or settlement is reached. But the broader implications are clearer, particularly in light of the ongoing debate over how to address the enormously complex issue of drug pricing. While high list prices for blockbuster drugs have been squarely in the crosshairs of legislators and regulators, more recent chatter has centered on both the role of middlemen (PBMs and distributors) and the various rebates and discounts available to customers.
Pricing for generic drugs (i.e., virtually exact copies of branded drugs) has declined steadily in recent years as providers have sought to rein in costs, but there has been less activity with respect to biosimilars. Because biosimilars are, by definition, not exact copies of branded drugs (since they derive from living cells), insurers and providers can claim that they are not necessarily perfect substitutes and therefore do not have to offer them as alternatives to the branded drug. This point would seem to harm PFE’s argument, but it is still very early, and we will continue to monitor this case.

M&A News: CTLT Acquires Cook Pharmica; WBA/RAD Closes

In M&A news this week, Catalent (CTLT) announced the acquisition of privately-held Cook Pharmica, an integrated provider of drug substance and drug product manufacturing for biologics, for $950 million, or 5x revenue and ~17x EBITDA (on a trailing twelve-month basis as of June 30). The deal is expected to close by the end of the year and to be accretive to CTLT’s adjusted net income per share during the first fiscal year following completion. The key to this deal for CTLT is the opportunity to expand its exposure to biologics, particularly to the faster-growing drug substance market. Cook is also operating at only 40% capacity, which should enable CTLT to materially boost productivity and operating margins at Cook’s facility. Management estimates that it can double Cook’s revenue through capacity optimization. As a result, the Street is generally very positive on this acquisition for CTLT, which has been identified as a possible takeout target itself in light of the recent Thermo Fisher/Patheon deal.
Walgreens Boots Alliance (WBA) announced this week that the FTC has granted clearance for its amended agreement to purchase 1,932 stores, three distribution centers, and inventory from Rite Aid (RAD). The previous arrangement was for WBA to buy 2,186 stores, so this reduced asset purchase alters the company’s expected synergy target from $400 million in four years to $300 million. The Street still views the deal positively, although several analysts were modestly negative on the lower synergy expectations. In addition, the stock came under increased pressure following news that Amazon (AMZN) is in negotiations with PBMs to possibly start a mail-order pharmacy targeting the uninsured and those with high-deductible insurance plans. There are still many hurdles for AMZN to clear before becoming a significant player in the pharmacy business, but the Street is hesitant to doubt AMZN in any retail-facing endeavor it chooses to pursue.

Robotic Surgery Developments: MZOR Secures CE Mark; 
TRXC Files Response to FDA; Titan Installs First SPORT

We have discussed emerging technologies in robotic surgery in the past. For more than 15 years, this has been a market entirely dominated by Intuitive Surgical (ISRG), which is on track to exceed $3 billion in revenue and more than 850,000 procedures performed this year. Several large players are working on products to compete with ISRG’s da Vinci, including Verb Surgical (a joint venture between JNJ and Google) and Medtronic (MDT). In addition, other players have pursued robotic solutions for orthopedic and spine applications, most notably Stryker (SYK) with Mako system for joint reconstruction and Globus (GMED) for spine surgery.
This week saw positive developments for other smaller players. Mazor Robotics (MZOR) this week announced that it has secured a CE Mark for its Mazor X Surgical Assistance Platform. The Mazor X is the company’s next-generation platform for robotic spine surgery, and this regulatory approval will enable MZOR to begin selling the system in Europe (and any other markets that honor the CE Mark) with MDT, its commercial partner. MZOR had recently entered the next phase of its partnership with MDT as the latter made an additional $40 million equity investment and will purchase specified quantities of Mazor X systems and disposable kits. This approval, which was widely expected, will help the sales ramp commence in the very near term.
TransEnterix (TRXC) this week filed its official response to the FDA’s request for additional information related to TRXC’s 510(k) regulatory submission for its Senhance Surgical Robotic System. The initial expectation was for the company to file a response by October, so TRXC is slightly ahead of schedule and could be in position to secure an approval before year end. TRXC recently entered into a new $50 million at-the-market equity offering and continues to ramp up its U.S. sales and marketing team in anticipation of approval. Senhance is a multi-port robotic surgery platform that helps general and gynecological surgeons with features such as haptic feedback and eye-sensing camera control. Senhance would be the second robotic surgery platform (for non-orthopedic or spine applications) to be approved in the U.S., so the Street is anxious to see how the market develops for this da Vinci alternative.
Finally, Titan Medical (TITXF) announced that it has installed its first SPORT Surgical System at Florida Hospital Nicholson Center in Celebration, FL for pre-clinical feasibility and validation studies. Titan plans to install two more systems in the U.S. and Europe before the end of the year, and the feasibility and validation studies are expected to commence in the coming weeks in several different surgical disciplines. It has been a long and arduous journey for Titan, which has had to push out its milestone timeline multiple times in recent years. However, it appears that the company is finally on track with the latest timeline for its single-port robotic surgery platform, which is intended for general abdominal, gynecologic, and urologic procedures. Titan is aiming for commercial release in the U.S. and Europe by the end of 2019.

In Other News: MDXG Responds to Allegations of Fraud;
Hurricanes Cause CSII to Lower Revenue Guidance

MiMedx Group (MDXG) hosted a call with analysts and investors on Thursday to discuss a wide range of issues hanging over the company and the stock. The most notable story this week was the publication of two reports from outfits called Aurelius Value and Viceroy Research. These reports both allege channel stuffing and kickbacks to doctors, allegations that MDXG management strenuously denies. MDXG has been subject to similar allegations in the past, as well as to multiple lawsuits from former employees, and the company also received a subpoena from the SEC related to channel-stuffing allegations by former employees (although there is no SEC investigation ongoing at present).
While these allegations may amount to nothing, these reports (albeit by outfits known for publishing negative and inflammatory work) create a cloud that the company will have a hard time overcoming. Management’s call with the Street also focused on the numerous market opportunities in front of MDXG and on the investments the company is making in its R&D pipeline, but investors may have a hard time looking past these salacious stories. The Street appears torn on what to do from here, with bulls using the stock’s weakness opportunistically and bears shying away from what may be further negative headlines. Ultimately, the company will have to execute successfully to put these allegations (assuming they are false) in the rear-view mirror.
Cardiovascular Systems (CSII) on Monday announced that Hurricanes Harvey and Irma have had enough of an impact on procedure volumes in the Houston area and throughout Florida to cause management to reduce fiscal 1Q18 revenue guidance. These markets make up an estimated 15% of CSII’s revenue, and September is typically a high-revenue month as a rebound from the seasonally slow summer months. Management did not specify a revenue target for the September quarter but did indicate that it expects the number to come in below the previous guidance range of $52.6-$53.6 million.
For the most part, analysts believe that CSII will be able to recover the lost procedures in time. Much will depend on how quickly hospitals are back up to regular capacity, and it may take another quarter to return to normal volumes. As a result, delayed procedures will be rescheduled, and the company will likely be able to make up for the delays by the end of fiscal 2018 (June 30, 2018). The more interesting implication will be the extent to which other companies will pre-announce misses as a result of hurricane-related disruptions. With the quarter ending next week, we expect any pre-announcements to begin coming either at next week’s conferences or in the early part of October prior to earnings season.

The Week Ahead: Obama to Speak at Cantor Conference;
ASTRO Kicks Off Sunday; RGEN/VAR Investor Days

The healthcare calendar heats up again next week with several, trade shows, investor conferences, and analyst days. The Clinical Robotic Surgery Association (CRSA) Worldwide Congress takes place today and tomorrow in Chicago. And the American Society for Therapeutic Radiology and Oncology (ASTRO) holds its annual meeting in San Diego from Sunday through Wednesday. As it does every year, Varian Medical Systems (VAR) will host an Investor Meeting at ASTRO on Tuesday at which management will update the Street on its product portfolio and operating strategy. The company will also likely introduce financial guidance for fiscal year 2018, which begins October 1.
Cantor Fitzgerald is holding its Global Healthcare Conference in New York on Monday through Wednesday, and former President Barack Obama is scheduled to deliver the keynote address on Monday. In addition, Ladenburg Thalmann hosts its 3rd Annual Healthcare Conference in New York on Wednesday.
Finally, Repligen (RGEN) hosts an Investor Day in New York on Friday morning. In addition to presentations from key members of the executive leadership team, there will also be panel discussions on bioproduction industry trends. Topics will include flexible manufacturing of biologics, global bioproduction capacity, advances in both technology and the types of biologics developed, and how RGEN fits into this market.
Please see the calendar below for a comprehensive look at key events in healthcare through the end of October, including an updated look at the September quarter earnings season that is increasingly taking shape. As always, we welcome all feedback, and we wish a sweet and happy New Year for those celebrating Rosh Hashannah!


Jeremy Feffer
Managing Member
Whalebone Advisory, LLC
T: 646.580.5583 | M: 917.749.1494
Copyright © 2017 Whalebone Advisory LLC, All rights reserved.

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