Spinoff situation: Harvard Apparatus Regenerative Tech

HART is a development-stage company that has successfully grown replacement tracheas (airways) out of a patient’s own stem cells.  These replacement tracheas are then transplanted back into the patient’s body.  This is a huge improvement over the traditional method of transplanting a donor trachea, which requires the patient to be on expensive immune-suppressing drugs that shorten their lifespan and have other complications.

HART has a market cap of $38M ($4.77/share).  At the time of the spinoff, the company had $15M in cash and had spent around $16.5M developing its technologies so far ($31.5M in total).  Given the risks in developing this technology, I believe that this spinoff may be undervalued.

The technology

I am not a doctor or a medical researcher.  Please take what I say with a grain of salt.  Here’s my dumbed-down explanation of the technology:

Stem cells are undifferentiated cells that can divide into more stem cells or into a specific type of cell in the body.  The treatment involves taking a few stem cells from the patient’s bone marrow and growing them into a human trachea in a “bioreactor”.  There are many challenges.  One of the problems is that there are various tissues in a human trachea.  All of the living parts of a trachea will require a network of blood vessels to provide nutrients and to remove wastes.  I see the process as beginning outside of the body (in a bioreactor) and being finished inside the patient’s body.  The necessary blood vessels don’t form until after the replacement trachea is inside the patient’s body.  However, scientists still do not understand everything that is going on.

One of the challenges is in providing a scaffold for the cells.  The trachea is composed of cartilage and living cells.  Cartilage is structural tissue in your body that isn’t as hard as bone but is harder than flesh.  Originally, doctors used a donor trachea and got rid of all of the living cells until the cartilage remained.  The newer generation of the technology uses a synthetic trachea.  There are some advantages to a synthetic trachea.  Firstly, it doesn’t require an organ donor.  Secondly, the trachea can be manufactured to have the right characteristics for the patient.  The synthetic scaffold is made out of plastic (polyethylene terephthalate, which is sometimes used to make plastic bottles).  Thirdly, the economics of a synthetic scaffold are better as it doesn’t have the restrictions of organ donation.

Problems with the technology

An article published in the Lancet* stated:

By 12 months after transplantation, a progressive cicatricial stenosis had developed in the native trachea close to the tissue-engineered trachea anastomosis, which needed repeated endoluminal stenting.

(*The article may have a slight bias because the researchers have a vested interest in seeing their research succeed and in getting more grant money for future research.  To me, the article seems mostly balanced and honest.)

A “cicatricial stenosis” is the narrowing of a duct or tube caused by the formation of scar tissue (link).  Scar tissue built up around the area where the patient’s original trachea met the replacement section (anastomosis).  Presumably, the scar tissue made the trachea narrower and would ultimately cause problems.  An edoluminal stent (a stent inside the body) was used to keep the trachea open.  While everything was great in the first several months after the original operation, the patient had to return repeatedly for treatment for problems related to the scar tissue.  In the long run, this could create problems in research as the problems with scarring only appear after several months and start to get a little worse.  While I don’t understand the clinical trial process well, it could mean that clinical trials will take a long time as regulatory bodies will want long-term information on the treatment’s safety.

This treatment still has challenges ahead of it before it can be commercialized.  A commentary on the very first ‘neo-trachea’ states:

In 2008, Macchiarini’s team announced that they had successfully grown a neo-trachea from a decellularised human trachea.[…] We were reminded of the pioneering clinical implantation of a partial neo-bladder in the 1990s,[…] and the sobering reality that an exciting first clinical experience can be separated by decades from even potential clinical implementation. In The Lancet, Alessandro Gonfiotti and coworkers report 5-year follow-up of the tracheal implantation,[…] and do not shy away from the harsh realities of a field that begs for even broad clinical implementation while researchers are still learning how to harness our understanding of the biology. Whole organ tissue engineering is akin to converting a Ford into a Ferrari while driving at top speed. The approach is elegant but fraught with challenges and opportunities for improvement; few medical advances have needed a complete biological understanding before implementation.

It seems to me that the treatment is still having problems with the area where the replacement trachea attaches to the patient’s existing airway.  The form 10 filing talks about 2 Russian patients who had operations in 2012:

Both patients developed granulation tissue at the anastomoses (i.e., at the joins between the natural trachea and the scaffold) which was treated with mitomycin therapy. At approximately four months post-surgery both patients developed critical scaffold malformations which were treated using stents. The authors concluded that “The first transplantation of nanocomposite tracheao-laryngeal complex covered with patient own stem cells (a 6-month follow-up period) demonstrated reliable immediate results, but the technology of the nanocomposite scaffold needs to be improved.” The scaffolds used in these two patients were not made by us but were made by a third party. We developed our own scaffold technology in part in order to improve the quality of the scaffolds. We believe that the scaffolds that we made that were used in the first U.S. surgery in April 2013 and other 2013 surgeries were a significant improvement over the prior generation of scaffolds.

I honestly don’t fully understand the statement above.  The abstract for a medical article on the follow-up results of these patients is a little clearer:

In terms from 6 to 8 weeks patients developed scaffold deformities and excessive growth of granulation tissue along the anastomotic line.

Firstly, there are problems with the older scaffold technology.  The abstract states that “the technology of nanocomposite scaffold needs to be improved”.  It is possible that using a donor trachea for the scaffold is a better approach (???).  Secondly, there is an issue with granulation tissue around the anastomotic line (where the replacement trachea connects).  Granulation tissue is “new connective tissue and tiny blood vessels that form on the surfaces of a wound during the healing process” (Wikipedia). This problem seems similar to the original problems with the natural scaffold (???).

It seems that the treatment still has problems that have not been overcome.  I am definitely not a medical researcher and I do not understand the technology or science very well.  The company does not seem that forthcoming in informing investors about problems and challenges with the treatment.  For example, the form 10 filing does not contain the words “stenosis” or “scar”.  It does not describe the problems with the longest-surviving patient (from the 2008 surgery).  This is disappointing.

Other side effects?

We won’t know if there are other side effects (and how frequent they are) until somebody performs a wider trial on more patients.  We will also need time to see if later problems develop.

Christopher Lyles

Lyles received treatment in 2012.  He died 2 months after getting his synthetic trachea.  His family did not disclose the cause of his death according to this NY Times article.  This is very curious to say the least.  (To be fair, patients’ family have a right to privacy.  There may be a cause of death that they do not wish to reveal.)


It seems that this technology has promise.  It would be a huge breakthrough if the doctors can figure out how to solve the problems with (1) scarring that leads to stenosis/narrowing of the airway and (2) synthetic scaffolds.  We will see if the latest generation of synthetic scaffolds (manufactured by HART) in 2013 surgeries hold up.  Even without these breakthroughs, the treatment may compare favorably to chemotherapy for patients with (later-stage) cancer in their trachea.  While management often compares HART’s treatment to a conventional trachea transplant with immune suppressing drugs, I believe the most common treatment for (later-stage) tracheal cancer is some form of chemotherapy.  Early-stage cancer can be treated with surgery if the tumour is detected early enough.

Note that HART is involved in developing the equipment (the bioreactor) necessary for the treatment.  Their patents relate to the bioreactor technology.  Other companies may develop alternative treatments that do not infringe on HART’s patents or require a bioreactor.

HART will apply for orphan status for its treatment, which will give it a 7 year exclusivity period in the US and 10 in the EU (among other benefits).  The CEO has stated in an interview that the worldwide market for the treatment is around 6,000 patients (the form 10 filing states around 6,500 patients/year).  This will likely qualify the treatment for orphan drug status in the US (the threshold for the US is fewer than 200,000 people in the US).  If the treatment is ultimately approved, HART will price its treatment at $100,000 and expects the market to be around $300M.  I don’t understand the treatment options very well but it is possible that the market size may be overstated.

To reach commercialization:

  1. The treatment has to pass clinical trials.  This is not a sure thing.
  2. The company will need more cash.  The burn rate is around $7-8M/year.  The company has around $15M in cash.  The company will see small amounts of revenue from selling its bioreactor to stem cell researchers.  The CEO has stated that the company will likely need to raise additional capital.

In the future, HART is looking at developing the technology for more complex organs.  The esophagus is the next most likely organ that may turn into a real treatment.


From Wikipedia:

Harvard Apparatus was founded in 1901 by William T. Porter, a physiologist at Harvard Medical School. Frustrated by the lack of high quality and cost-effective equipment then available, Porter began manufacturing physiology teaching equipment in a machine shop that he created on the medical school campus. This shop supplied equipment to Harvard Medical School and provided surplus equipment to other schools. Charles W. Eliot, the president of Harvard University, although supportive of Porter’s work and mission, was concerned that Porter’s enterprise would be viewed as a commercial venture operating on nontaxed property. So, in 1901 Eliot secured capital for Porter to found the Harvard Apparatus Company, which was moved off the Harvard campus to a converted barn in Dover, Massachusetts.

Harvard Apparatus ultimately became Harvard Bioscience (Nasdaq: HBIO).  HBIO originally wanted to sell 17%-20% of HART in an IPO at $10-12/share (see spinoffstocks.com’s coverage).  This IPO was cancelled due to low interest.  Instead, HBIO transferred $15M to HART and spun it off to shareholders.  The current share price is around $4.77, well below the $10-12 expected in an IPO.

Insiders / spinoff dynamic

The main interest why I am interested in something outside my circle of competence is because the CEO (David Green) and CFO (Thomas McNaughton) decided to go to the smaller company.  Often, insiders will stay with the larger parent company because larger companies can support higher salaries.  The prospects for the spinoff must be really, really good if insiders are willing to take less cash.  In this case, the CEO and CFO of HART will take a lot of their pay in options.

(Chane Graziano retired from HBIO and passed the reins of the company to David Green.  Green quickly left HBIO for HART.)

Integrity of insiders

It’s not the best and it’s not the worst.

Insider compensation is on the high side.  At Harvard Bioscience, insider compensation has ranged from 1-3% of HBIO’s market cap (see Morningstar’s summary).  The board of directors at HBIO was paid $598k, which is high for a company with a roughly $150M market cap.

While the CFO was at HBIO, HBIO would add stock-based compensation to non-GAAP earnings.  In my opinion, this practice is silly and misleading.

The company does not make it easy to understand the problems and challenges with stem cell technology.

The development-stage medical industry

In general, I think that this is an area of the stock market that destroys a lot of shareholder capital.  Firstly, the economics of the industry don’t seem to be that great.  While medical research has been profitable in the past, new drugs are less profitable whenever they have to compete with ever-increasing ranks of generic drugs and generic treatments.  Secondly, the stocks are awful.  There seems to be a lot of fraud and stock promotion with development-stage pharma stocks.  When there are no consequences for committing fraud, it is likely that fraud will be extremely high.

To HART’s credit, they are not as promotional as they could be.  If some sleazy promoter were running the company, there would likely be a lot of hype over stem cells and how the company will ‘soon’ be producing equipment for the production of esophagus, lung and heart.

Bottom line

I don’t really understand this industry.  I’m sure that there are others out there who would have a huge advantage over me.  However, I am attracted to this stock because insiders (through their actions) seem to be really excited about the treatment’s prospects.

Valuing this company is difficult for me.  If the treatment does become a $300M market for HART, then HART’s market cap should be several times what it is today.  However, if the company is so valuable, then why would insiders want to IPO it at $10-12/share?  They could have simply avoided the spinoff and funded future R&D through HBIO’s cash flow.  The spinoff weakened HART’s ability to finance its R&D.  Because I don’t understand this industry particularly well, I don’t know why management chose their current path.  I will likely be cautious with this stock and will strongly consider selling it if it reaches the $10-12 IPO price range.  (I may have a cognitive bias in anchoring onto the IPO price range.)

This is not a high conviction trade for me and I do not understand the company as much as I would like to.  I may very well change my mind in the future.

*Disclosure:  Long HART.

EDIT (Dec. 31, 2013):  I sold my shares and only have 2 shares left of this.  I should probably stick to things I understand.  I also don’t like that management isn’t entirely upfront about the challenges of the treatment.  The commentary on the very first ‘neo-trachea’ also doesn’t contain any ideas about solving the scarring problem so I don’t know if the scarring problem will be a huge obstacle to commercial viability.

EDIT (March 30, 2014): Proactive Capital Group, an “investor awareness” firm, used to list HART as a client.  See this excellent article on undisclosed paid promotion.

3 thoughts on “Spinoff situation: Harvard Apparatus Regenerative Tech

  1. Have you looked into HBIO instead as an investment? With the removal of HART’s R&D, it is a very profitable company. The next Q will show this and may cause the stock to re-rate with its comps.

    • FYI I changed my mind and sold my investment. This was partly because I was running out of margin and should be making room for better ideas.

      As far as HBIO goes, I would want to go where the insiders are going. If HBIO were to make $10M/year (this might be generous), then its P/E would be roughly 15. I don’t see undervaluation there??? (Then again I haven’t read its 10-K and don’t understand it.)

  2. Pingback: Short selling update May 2014 | Glenn Chan's Random Notes on Investing

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