Cogstate
Q1 20201
By Manuel Maurício
October 29, 2020
Earlier this week, Cogstate announced its first quarter results. The results were OK, but what REALLY made me smile was as a new licensing deal with the pharma and biotech company Eisai AND a joint statement by Eisai and JD Health announcing the launch of a new online platform with a special focus on dementia.
The revenue coming from the Clinical Trials segment was hindered by the social distancing that complicated things for in-person clinical trials, but Brad, the CEO, is confident that they’ll be picking up in the future…
… mostly because of the already contracted backlog that is at all time highs.
EISAI LICENSING DEAL
But the big news was the licensing deal with Eisai. As mentioned in previous write-ups, Eisai is Biogen’s partner in the leading Alzheimer’s disease treatment called Aducanumab, that is currently looking for FDA approval. Let me remind you that Eisai owns 7% of Cogstate and both companies already had a licensing deal for the Healthcare segment in the Japanese market. The Healthcare segment is the one related to the diagnosis and direct-to-consumer testing. It doesn’t include clinical trials.
The Japanese deal with Eisai is a 50/50 partnership where both companies will share the costs and split the profits. This new deal is much better. You see, Eisai is spending millions of dollars rolling out this technology. If the deal were to be similar to the Japanese deal, it would take a long time before Cogstate would see any profit.
Now, the fact that this contract is a pure royalty contract makes it so that Cogstate makes money right from the start.
Add to this the fact that Eisai will bear all the costs related to marketing, distribution AND software development. Could this be any better? In fact, it gets better.
On top of this all, there are minimum royalty payments that HAVE to be made to Cogstate, no matter what. The way the deal was structured is that there is an upfront fee of $15 Million US dollars to be paid in the next 45 days and then a minimum of $10 Million US dollars for the first 5 years and another $20 Million dollars for the subsequent 5 years. Eisai can back out of the deal after the first 5 years.
CHINA PARTNERSHIP
As if this wasn’t enough, Eisai has also announced a partnership with JD Health in China. For those of you who don’t know, JD is one of the largest e-commerce players in China.
China is a particularly interesting market because since November 2019 there is an approved treatment for Alzheimer’s disease there. It was developed by a pharmaceutical company called Green Valley and it obviously means that there is a huge market in China since everyone applying for the medicine must be tested.
To those subscribers who are shareholders of Cogstate, I strongly encourage you to read the announcement. Here are some bits that I found very interesting:
“The two companies will first build a platform with a special feature for dementia, and in the future plan to expand the platform to a wide range of diseases which frequently found in the elderly.“
“For the purpose of dementia awareness and early detection, in addition to information regarding disease awareness of dementia from Eisai, tools will be provided via an internet platform for self-assessments of cognitive function, implementation and habitualization of dementia preventive action.”
“Through this service, pharmaceuticals, healthcare products, and lifestyle support devices targeted for those living with dementia will be sold online based on potential consumer needs as obtained by analyzing big data on elderly consumers.”~
VALUATION
I bought Cogstate for the Portfolio because of its potential. With both of these announcements, the downside is getting more limited and the upside even higher.
If the company is able to grow the Clinical Trials revenue at 10% per year for the next 5 years, in 2025 it will be making $44 Million in revenue and $31 Million in profit, from that segment alone.
Add to that the minimum royalty revenue of $2 Million coming from Eisai, which at a 90% margin, will generate $1,8 Million in profit.
Let’s say that the Research and Admin costs are $16 Million. The company would be generating $17 Million in Free Cash Flow. At a 20x Multiple, the Market Cap would be $475 Million Australian dollars (assuming a conversion of 1.4x).
Add to that the cash that the company will generate until then which should be around $98 Million Australian dollars and we get to a 2025 MarketCap of $574 Million Australian dollar, or $3.38 per share. That’s a 23% annual rate of return.
Can the company grow the Clinical Trial segment at more than 10%? I believe it can do MUCH better than that, especially if Aducanumab gets FDA clearance.
Can the company get more than the minimum $10 Million of royalties for the next 5 years? I believe it can make MUCH more than that.
Remember that Cogstate still has other irons in the fire. Cogstate has been training the guys from ERT and 75% of all drugs approved in the USA in 2019 came from studies that were supported by ERT. ERT provides Cogstate with line of sight to hundreds of studies outside of the central nervous system diseases, which is the only market that was being “worked” before.
RISKS
Back in 2018/19, the company saw 2 big clinical trials related to the Alzheimer’s Disease get cancelled which led to a major decrease in revenue. Can that happen again? It can happen, but after that debacle, the management understood that it needed to diversify away from the Alzheimer’s Disease trials. The ERT partnership is proof of that.
The slide shown below is from 2019, but illustrates this diversification.
I am still to find the current backlog composition. A fellow investor told me that the Alzheimer’s Disease clinical trials account for less than 40% whereas in 2018 it was higher than 60%. I have found no evidence of that, but the company do states that in 2020, 36% of its Revenue was from Alzheimer’s Disease Clinical Trials.
He also told me that no contract is larger than 4% of the total revenue. I’m also having difficulties finding this piece of information. All that I was able to gather is that the pharmaceutical company Eli Lilly accounts for 10% of the total revenue, but it’s surely conducting several different trials.
CONCLUSION
I believe we’re standing in front of a major opportunity here. Cogstate is becoming THE method for measuring cognition around the globe. As you know, I prefer to stay cautious with my assumptions; I have not included the possibility for the approval of Aducanumab in my assumptions, but if it were to be approved by the FDA (it’s a long shot), virtually everyone above 65 years old could be considered part of the targeted market because everyone applying for the drug would have to be screened. We would be talking about huge numbers here.
Having said all of this, I am increasing my stake in Cogstate with an additional €5.000. Since the company is traded on the Australian Stock Exchange, it trades during the night (in Europe). I’ll be buying it on the coming session stated that I can get it at around $1.2 per share. If it ever comes down below $1, I will be buying another €5000.
If there are subscribers following me on this one, do me a favor. Don’t bid for more than $1.2 per share. The stock is tightly held, highly illiquid and it can shoot through the roof in no time.
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