Wednesday, November 13, 2019

IBI Research On Avalon: Fortressing Capital Structure And Strengthening Fundamentals

Summary
The drug pricing and the China Trade War concerns devastated the share price of most bioscience stocks. And, the aforesaid industry headwinds did not spare Avalon.
Due to a bearish bioscience market, Avalon's market valuation is now retraced significantly below its true worth.
Notwithstanding, there are powerful fundamental developments that substantially increased the intrinsic value of Avalon.
The next-generation CAR-T (AVA-001) is launched into the clinic. The Dragon CAR-T (AVA-101) is poised to reach patients in months while other franchises are developing at a rapid pace.
The capital structure is now strengthened as Avalon repurchased all outstanding warrants.
Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do. - Warren Buffett
Concerns relating to the China Trade War and drug pricing control have clobbered most bioscience stocks in recent months. For a significantly volatile sector, such news is like gasoline to fuel a raging wildfire. In the aftermath, the share price of a stellar CAR-T innovator dubbed Avalon GloboCare (AVCO) receded into the deep South.
Facing this calamity, it can be easy for you to dispose of your stocks to cease that sickening feeling in your stomach associated with a stock decline. Be that as it may, you must focus on the big investing picture. Time after time, there will be war scare and dark clouds to paint the investing sky with a gloomy view. Nevertheless, the market has always risen to a higher level. Amid this difficulty, I strongly believe that there is an excellent opportunity to build shares in Avalon. In this research, I'll feature a fundamental update on Avalon and provide my expectation for this spectacular growth equity.
Figure 1: Avalon chart (Source: StockCharts)

About The Company

As usual, I'll feature a brief corporate overview for new investors. If you are familiar with the firm, I suggest that you skip to the subsequent section. Headquartered in Freehold New Jersey, Avalon is engaged in the development and commercialization of disruptive medicines and diagnostics to serve the strong unmet needs in cancer and various diseases. Using a trident-like approach of Poseidon, Avalon captures opportunities in three lucrative niches. They include exosomes diagnostics, regenerative medicine, and cellular immunotherapy (i.e. CAR-T).
For the diagnostic portfolio, Avalon harnesses the power of "exosomal biomarkers" to launch an avalanche against oral cancer, nonalcoholic steatohepatitis ("NASH"), leukemia, colorectal cancer, and macular degeneration. In general, biomarker diagnostic is an evolving field. And yet, the application of exosomal biomarkers is ingenious because it can promptly pinpoint a diagnosis to provide physicians an edge against dreaded diseases. When it comes to the fight for life, I believe that accuracy, precision, and timeliness are of paramount importance. As shown below, there are several potential blockbusters such as AVA-101, -201, and -203.
Figure 2: Diagnostic and therapeutic pipeline (Source: Avalon)

Robust Infrastructure For Expansion

Notably, having a robust pipeline is meaningless unless the company has the proper infrastructure for rapid expansion. Innovating a strong pipeline without adequate infrastructure is like raising a large army without a supporting base. On this front, Avalon is doing a phenomenal job in constructing the proper foundation. I noted in the prior research,
To transform stellar science into medicines, Avalon built two world-class facilities: Avactis Biosciences and Genexosome Technologies. Back in July 2019, Avalon inked a colossal partnership with GE Healthcare to expedite research and development. The GE collaboration is proof in the pudding of its pipeline quality. Moreover, it signifies the company's capability to form meaningful partnerships. That aside, Avalon is working with other esteemed partners, including Weill Cornell Medicine, Beijing Lu Daopei, and Nanjing BenQ hospitals. With powerful ties, Avalon spans its reach from North America to China. Ultimately, this will enable the company to fully unlock the value of its medicines and diagnostics.
Figure 3: Avalon subsidiary (Source: Avalon)

Rapid Pipeline Advancement

Founded in 2016, Avalon is progressing rapidly in just a few years. Regarding the CAR-T franchise, AVA-001 is already available in the clinic for relapsed/refractory B-cell acute lymphoblastic leukemia and non-Hodgkin lymphoma back in July 2019. Pertaining to my most favorite molecule, i.e. the Dragon CAR-T dubbed AVA-101, it recently entered into process development and validation phase. By 1Q2020, the Dragon CAR-T is ready to roar over the landscape of devastating cancer.
Out of countless CAR-Ts that studied, I vote my highest confidence in Avalon's molecule because it uses the most advanced technology known to men. By employing a transposon instead of a viral vector, AVA-101 can shuttle adequate genes for two cancer targets (i.e. CD19 and CD22). I strongly believe that hitting two CAR-T targets at once is the best way to decimate cancers. This fits within the cornerstone of cancer management using combination therapy. Better yet, Avalon captured lightning in a bottle by incorporating the combination aspect into one molecule! Additionally, there is a "kill switch" to shut down the CAR-T, in case that the dreaded cytokine release syndrome occurs. 
Of the diagnostic franchise, Avalon will commence the human study of AVA-201 in 4Q2019. A regulatory filing is expected to occur in 4Q2020. I like Avalon's exosomal diagnostic because it leverages precision medicine which enhances efficacy and safety. Interestingly, AVA-201 is a novel miR-185 enriched exosome that delivers both diagnostic and therapeutic value against oral cancer.
If you're like me, I initially overlooked the regenerative medicine molecules. On deeper inspection, I know that Avalon has invaluable hidden assets. Specifically, the company is leveraging Dr. Jin's years of experience in exosome-based regenerative medicine to deliver a solution for many indications. They include hair restoration, skincare, anti-scar, anti-wrinkle, diabetic foot ulcer, wound care, anti-fibrosis, etc. 
The fact that these exosomes are derived from stem cells gives them the uncanny capability to grow and repair the defective cells. That being said, Avalon intends to launch AVA-202 into a clinical trial by 4Q2019 for diabetic-foot ulcer and vascular disease. For an in-depth discussion of all franchise's development, you should refer to my previous work.

Strengthening Capital Structure

Shifting gears, let's assess the other fundamental development. As follows, Avalon recently executed a corporate move that I strongly believe strengthened its capital structure and thereby unlocks the stock's value over time. You might not think much about improving the capital structure yet this is crucial for a young life science innovator. In strengthening its capital base, a biotech can have the springboard to raise cash for its pipeline innovation. Without adequate cash, there is no gunpowder for ongoing battles against deadly diseases.
That being said, Avalon announced on October 21 that the company plans to repurchase all of the 1.7M outstanding warrants for approximately $1.4M. Of note, the warrants were issued to institutional investors in a direct offering back on April 25 this year. Looking ahead, the warrant repurchase will be completed by November 8. At that time, all of the outstanding warrants will be canceled.
Of note, the repurchase of the warrant doesn't mean much to the market because investors are more familiar with stocks buyback. Consequently, the warrant repurchased confused the market and thereby caused the shares to tumble. In my view, the market action is mostly dictated by emotion rather than intelligence. Instead of rewarding Avalon, the market punished the stock with significant share price depreciation. Adding further injury to the insult, the China Trade War and drug pricing concerns aren't helping.
Notwithstanding, I believe that the warrant repurchase truly enhanced the true worth (i.e. intrinsic value) of Avalon. In other words, the warrant repurchase is essentially a "leveraged" stock buyback. In repurchasing either the shares or warrants, the management is working for your best interest to ensure that your shares are worth more. That is to say, Avalon should be worth at least $1.4M higher than what it was before the warrant repurchase. Regardless of the short-term market sentiment, the long-term fundamentals are stronger than ever.
Now it can be difficult for you to appreciate the fundamentals amid a stock decline. Be that as it may, Warren Buffet's teacher (i.e. Phillip Fisher) stated that a stock's market valuation will eventually move up to match its true worth over 91% of the time. While you might not appreciate Fisher's wisdom, when Buffett's teacher speaks I listen. As such, I believe that this warrant repurchase added intrinsic value to Avalon. And, it'll manifest as a share price appreciation.
Based on my analysis, I'm confident the shares will rally robustly when the market sentiment shifts in favor of Avalon. It might take a while but the dark clouds always evaporate when the sun shines. Elucidated key developments in the most poignant terms, the President and CEO (David Jin, M.D., Ph.D.) enthused,
We believe the repurchase of these warrants, combined with the recently announced $20M non-convertible line of credit from our Chairman, provides a platform for significant growth with less potential dilution. This repurchase enhances our capital structure and demonstrates the confidence that we have in the future of the Company. We are advancing towards the next phase of growth as an active clinical-stage company. We have a strong pipeline of cellular immunotherapy candidates and we look forward to continuing to advance our clinical studies using our cellular therapeutic platforms in CAR-T and stem cell derived exosomes. We believe that our strong balance sheet leaves us well-positioned to take advantage of future opportunities to create value for our shareholders.

Financial Assessment

Just as you would get an annual physical for your well-being, it's important to check on the financial health of your stock. For instance, your health is affected by "blood flow" as your stock's viability is dependent on the "cash flow." With that in mind, I'll analyze the 2Q2019 earnings report for the period that concluded on June 30. When Avalon reports its 3Q2019 earnings, I'll keep you updated.
Accordingly, it's remarkable that Avalon procured $399.7K in revenues this quarter, even as a young company. I'm impressed because a young biotech isn't expected to garner any revenues for many years. That aside, let's look at other meaningful metrics. Notably, the research and development (R&D) registered at $949.7K compared to $263K for last year.
The multiple folds ramp up in R&D signifies that Avalon is hitting an inflection point in its Trifecta development. As such, the R&D correspondingly increased to reflect more R&D efforts. Going forward, I expect R&D investment to ramp up due to various clinical development.
In terms of bottom-line earnings, Avalon logged in $4.4M ($0.06 per share) net loss compared to $1.4M ($0.02 per share) decline for the same comparison. I'm not deterred by the widened net loss. Like other young/aggressive growers, Avalon made the prudent decision to commit its resources for infrastructure expansion. When the company is more matured, I'd expect the bottom-line to improve. At the point, I believe that Avalon's shares will never look back.
Of the balance sheet, Avalon had $3.4M in cash versus $2.2M for last quarter. Since the Chairman (Daniel Lu) recently provided $20M in the credit facility, Avalon's cash position is boosted to roughly $23.4M. Against the $4.4M quarterly operating expense (OpEx) rate, there should be adequate capital to fund operations into 1Q2021 before the need for an offering.
If you look at $23.4M, you might not think of it as much. Nevertheless, the fact that the firm is backed by an extremely wealthy/successful Chairman Lu, is a testament to its financial strength. In my view, Chairman Lu won't let his company run into any cash flow constraints. Chairman Lu is young and has many decades of fire in him to navigate this ship to the Promised Land of mega-profits for shareholders while delivering hopes to countless patients worldwide. That's an intangible edge (i.e. moat) that Avalon has over other competitors. In combination with Dr. Jin's taking helm of the ship, it's spaghetti to sauce that Avalon will grow into a giant of the future.
Though financially strong, I believe that Avalon might conduct a public offering in the future. This is not a bad thing as many of you might believe. In my market observation, a stock usually tumbles on news of a public offering. For me, I rather have the company raises capital this way than to incur substantial bank debts. Short-term bank debt is a bad way of raising money because the bank can recall their money at the first sign of trouble. If the company cannot pony up the money, you're looking at a Chapter 11 filing. But the key to conducting a public offering is to execute it when the shares are trading high.
Though I don't mind a strategic offering, I usually run through the balance sheet to see if the company is a "serial diluter." After all, a firm that employs dilution as a "cash cow" will render your investment essentially worthless. As the shares outstanding increased from 71.9M to 75.1M for Avalon, my calculation yields the 4.4% annual dilution. At this rate, Avalon easily cleared my 30% dilution cutoff for a profitable investment. Viewing this financial metric, it's obvious that Avalon is working in your best interests.

Potential Risks

Since investment research is an imperfect science, there are always risks associated with your stock regardless of its fundamental strength. At this point in its growth cycle, the main concern is if Avalon can deliver positive clinical data for its Trifecta businesses. I believe that the Dragon CAR-T (AVA-101) is the most valuable asset. As such, if AVA-101 doesn't generate good results, it's quite likely that Avalon will tumble over 60% and vice versa. Because I believe it'll garner excellent results, I ascribed a corresponding 30% chance of clinical failure for AVA-101.
The other potential concern is that a young company like Avalon can grow too aggressively and thereby runs into a cash flow problem. Be that as it may, I believe that Chairman Lu will do whatever it takes to ensure adequate funding. The other risk, which is transient, is that the financial market tends to lose interest in a young bioscience stock. Furthermore, the market concerns about Trade War and drug pricing might keep the shares at a depressed level longer than usual. However, I believe that Avalon will rebound when powerful fundamental developments induce a market sentimental shift.

Conclusion

In all, I maintain my strong buy recommendation on Avalon Globocare with the five out of five stars rating. On the two to three years horizon, I expect the $12.5 price target to be reached. If you're interested in how I got that valuation, you can refer to my initial article. I also ascribed the 70% "investment profitability score" on this stock. Moreover, I graded the stock with the medium investment risk score. In a nutshell, you have a strongly favorable chance of making money on Avalon, provided that you hold your shares for the long haul.
Powered by stellar science and top-notch management, Avalon is aggressively advancing its broad pipeline that captures three lucrative niches: CAR-T, precision medicine powered diagnostics, and regenerative medicines. Since AVA-001 is launched into the clinic back in July 2019, I anticipate good clinical outcomes within the next two years. I believe that there is a 70% chance of clinical success for AVA-001. It's a no-brainer that this CAR-T alone is worth at least several hundred million dollars in future revenues.
Now with the Dragon CAR-T (AVA-101) is reaching the clinic several months from now, all hell breaks loose. I believe that patients will enjoy a CAR-T that is more powerful than any first-generation drugs or other new CAR-Ts in the market. Regarding the medical diagnostic and regenerative medicine, developments are precisely on target. Specifically, AVA-201 will go in a clinical trial by year-end. Furthermore, exosome-powered regenerative medicine (AVA-202) will be available to patients within a similar time frame.
As usual, I'd like to remind investors that the choice to buy, sell, or hold is ultimately yours to make. In my view, selling out during a market decline is an emotional rather than a logical decision. If you're holding Avalon's shares, I'd keep them "as is." If you don't have a position, I'd start to accumulate shares in a "stepwise" fashion to enjoy a lower average cost. When Avalon churns out more results in the future, I highly doubt that the stock will remain at this depressed level. Stay tuned to IBI for this evolving saga.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. Business relationship disclosure: Due to my medical and market expertise, companies and third parties like GuidePoint Advisors hired me as a paid consultant. As such, my views may not be completely objective. On October 4th, 2019, I established a paid consulting relationship with Avalon. However, I'm neither paid for nor required by the company to publish this research.
Additional disclosure: As a medical doctor/market expert, I’m not a registered investment advisor. Despite that I strive to provide the most accurate information, I neither guarantee the accuracy nor timeliness. Past performance does NOT guarantee future results. I reserve the right to make any investment decision for myself and my affiliates on any security without notification except where it is required by law. I am also NOT responsible for the actions of my affiliates. The thesis that I presented may change anytime due to the changing nature of the information itself. Investment in stocks and options can result in a loss of capital. The information presented should NOT be construed as a recommendation to buy or sell any form of security. My articles are best utilized as educational and informational materials to assist investors in your own due diligence process. That said, you are expected to perform your due diligence and take responsibility for your actions. You should also consult with your financial advisor for specific guidance, as financial circumstances are individualized.