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SNWV: MundiMed JV Should Be Positive, But Just How Much Is Unknown

10/04/2017
By Brian Marckx, CFA

OTC:SNWV

SNWV / MundiMed (Brazil) Joint-Venture

In mid-August, during SANUWAVE’s (OTC:SNWV) Q2 earnings call, management alluded to a potential agreement with a Brazilian organization that currently generates in excess of $5M in annual revenue.  Then last week SNWV announced that they formed a joint-venture with MundiMed, a Brazilian distributor of medical devices.  Per MundiMed’s website, they operate in the hospital distribution market, mainly in the countryside of the state of Sao Paulo.  MundiMed is part of GrupoMED, which is forecasted to generate almost $90M in sales in 2017.  

Key terms of the deal are as follows;

➢ MundiMed will provide SNWV with upfront cash payments and other fees (undisclosed amounts) to be paid over the next 18 months – this is while they wait for regulatory approval in Brazil.  SNWV received an initial partnership fee on 9/30/17 and will receive monthly partnership fees over the next 18 months

➢ MundiMed is responsible for the cost related to the formation, organization and start-up of the joint venture as well as for costs associated with regulatory approval

➢ Will share profits as follows; 45% to SNWV, 45% to MundiMed and 5% each to LHS Latina Health Solutions Gestão Empresarial Ltda. and Universus Global Advisors LLC, who acted as advisors in the transaction

➢ SNWV will provide devices at cost to the JV.  The JV will place the devices and generate revenue on a per-treatment basis 

SNWV noted that they evaluated several potential partners over the past 18 months and hired Universus to help with finding the right fit.  They chose MundiMed after a due diligence period which included visits from both parties to each others’ facilities.  MundiMed also spent time with SNWV in their live territories in Europe.  

Key aspects of the Brazilian health market and DFU (per our research);


• Approximately 12M Brazilians have diabetes.  Prevalence of diabetes in Brazil, at about 8% - 12% (depending on the source) of the adult population, is similar to that of the U.S. (~10%) as is the incidence of foot ulcers (~5% - 8% of diabetics in both countries get DFUs) but amputation rates are much higher. Some studies (http://bit.ly/2xXMHZx) indicate approximately ~48% of Brazilians with DFUs undergo amputation  - this compares to a rate of about 12% in U.S.  This high rate of amputations is a direct indication of ineffective primary care of DFUs

• Direct costs of amputations in Brazil are “a very heavy burden” and major amputations (i.e. those above the ankle) are “life-threatening, leading to a poorer quality of life” and “result(s) in retirement which significantly influences the indirect costs” (http://bit.ly/2xXMHZx).  An estimated 30% - 50% of patients requiring an amputation will require another amputation, which compounds the related cost burden 

• Recent growth of the middle class in Brazil has meant an increase in vices that come with wealth including higher consumption of junk food. Roughly half of Brazilians are overweight and 15% are obese – just slightly less on both measures versus the U.S. In 2010 Brazil’s Health Minister said of the growing obesity issue; “We are in a situation of red alert … We are sitting on a ticking time bomb!”

• According to researchers at Sao Paulo University, “…it is expected that the greatest social and economic impact of Type 2 diabetes in this century will be felt in the developing nations of Africa, Asia and South America, where national diabetes programmes are non-existent or ineffective and diabetic foot care remains inappropriate” (Rezende, et al.)

• Despite a burgeoning middle-class, there remains a huge division in wealth in Brazil with the southern portion, which includes large, urban centers, representing most of the wealth and the northern, rural areas, suffering with widespread poverty

o Most hospitals are located in or near urban centers, exacerbating the difficulty of access to healthcare for the poor
o Relatively wealthy population has access to private health providers, poor typically only have access to the national healthcare system which is free but congested and often understaffed and may not always provide specialized or advanced therapies 
o Approximately 75% of Brazil’s population uses the national public health care system 
o Chronic (i.e. primary) treatment of DFUs is expensive which means the poorer classes may have little access to effective options
o Highlighting these issues is the fact that maggot therapy continues to be investigated as a viable option for treating DFUs in Brazil given it’s relatively low cost (Pinheiro, et al.)

• Lack of access to healthcare and education of diabetes and its deleterious effects on overall health have been cited as significant factors related to ineffective diabetes care and high amputation rates in Brazil (Santos, et al.) 

• According to industry research firm, Mordor Intelligence, lack of proper reimbursement policies is one of the major challenges faced by the wound care management device market in Brazil

Regulatory

MundiMed is responsible for obtaining regulatory/marketing approval for dermaPACE in Brazil and will hire outside consultants to aid in the process.  That process first includes a technical evaluation by Brazil’s National Institute of Metrology, Standardization and Industrial Quality (INMETRO) – which is required for electro-medical devices and which we expect to be fairly straightforward (although will take time to complete).  Then an application will be filed with National Health Surveillance Agency (ANVISA) – analogous to the FDA in Brazil.  Management noted that they can use existing clinical data (such as the primary/pivotal and supplementary U.S. RCT data) to support the application and that no additional clinical studies will need to be performed.  SNWV expects the entire process (which is already underway) to take between 9 and 12 months to complete and believe that they will be able to launch dermaPACE in Brazil before the end of 2018.  

While we do believe the chances of eventually obtaining regulatory clearance in Brazil are favorable, it is less clear how attainable management’s timelines are for doing so.  According to the Emergo Group, which specializes in navigating regulatory processes throughout the world (and which claims to have registered hundreds of devices in Brazil), INMETRO testing/evaluation can be expected to take 5 to 6 months (following conclusion of any required testing by the sponsor) and ANVISA approval can be expected to take 1 to 3 months for Class II devices and anywhere from 8 to 15 months or even as long as 4 years for Class III devices.  

To state the obvious though, Emergo’s estimates are not specific to dermaPACE, or DFU-related therapies or even necessarily only to electrical medical devices (they also work with diagnostic companies) – and, as such, their estimates and SNWV’s actual experience could differ.  But we think it helps provide some context.    

Similar to FDA, ANVISA categorizes medical devices based on their risk profile (Class I – lowest risk, Class IV – highest risk).  Based on feedback from SNWV’s/MundiMed’s regulatory consultants, the expectation is that dermaPACE will be classified as a Class II device – assuming that will be the case, then management’s 9 to 12 month estimate is highly consistent with Emergo’s general guidance.  If, however, it is considered a Class III device, it could be substantially longer until approval.  

Management’s Financial Guidance

SNWV will receive periodic payments during the first 18 months.  These, along with device sales, we think will run through revenue in the income statement.  The bulk of expected income from the JV will be related to per-treatment revenue – which should be captured as proportional equity interest in the JV.  

Based on forecasted revenue and expenses over the next ten years, management believes this JV will return net income, discounted back to the present, of $25M or more (i.e. SNWV’s portion of this JV is worth at least $25M on a NPV basis).  While management did not disclose specifics surrounding all of their calculations, they did provide some data points and noted that the forecast and assumptions driving the model included input from MundiMed, who presumably has more insight into Brazil’s chronic wound segment and the country’s healthcare system.

In terms of the target markets, the JV will focus on both DFU and VLU – which combined we estimate at approximately 2.0M – 2.5M people and roughly evenly split between the two indications.  While the U.S. clinical studies included only DFU, VLU’s are similar in many respects including their chronic and advanced nature and difficulty in treating.  

Management’s $25M NPV is based on the assumption that they capture approximately 5% of the target markets within the first five years following launch in Brazil.  This includes approximately 1% penetration in year 1.  While reimbursement is currently only in the form of a tracking code, the expectation is that a dedicated code (specifically for dermaPACE), supported by pharmacoeconomic studies (demonstrating the health and economic/financial benefits of covering dermaPACE procedures) is attainable within the first 6 – 12 months following launch (in the private health care segment, possibly longer in the public sector).            

Per-treatment revenue should provide significantly wider margins as compared to the (traditional) device-sales revenue model.  Operating expenses also may be lower than they might under a device-sales model given that it may afford a less significant sales/marketing budget.  

Our Comments: We view this deal as an almost certain positive for SNWV, particularly given that it appears there is no upfront risk – financially or opportunistically, to the company.  At the least, upfront payments from MundiMed should provide some meaningful (although potentially not overly significant) operating capital.  Beyond that, it is a much larger ‘unknown’ as to how much, if at all, this JV will contribute to SNWV.  We are not modeling anything anywhere close to a $25M NPV at this point.

Based on our own research, we think the Brazilian market might be more attractive than most based on several factors including the combination of what appears to be an ineffective public healthcare system (of which ~80% of the population relies upon) and a disregard for addressing diabetes which has created an environment that will be forced to make substantive changes.  In addition, the very high DFU-related amputation rates and related costs as well as growing middle-class wealth, which is predicted to result in higher rates of diabetes, will all likely compound the problem.  The public health system in Brazil, like many national health care systems throughout the world (including those in highly developed areas such as the U.K.), consider cost as a major determinant in available treatment options.  dermaPACE almost certainly offers a lower-cost option as compared to other advanced wound therapies such as skin substitutes and VAC – which are also more invasive.  The lack of available and cost-effective advanced wound options has also likely contributed to the high amputation rates – amputations are also relatively costly, particularly because they often require longer hospital stays as compared to primary-healed wounds.   

We are modeling much lower penetration and reimbursement rates, however, as compared to what management indicated that they believe is attainable in the first five years.  We also model only the DFU, and not the VLU market, given dermaPACE clinical data mostly relates to the former.  We also note that much of the diabetic population resides outside of the major cities and instead lives in much more rural areas which have less access to major hospitals and clinics.  These rural populations also account for a higher proportion of related amputation rates.  Evidence has also indicated that while the lack of advanced wound care options is problematic in Brazil, factors such as lackadaisical efforts towards implementation of effective diabetes programs and lack of access to healthcare may be even more problematic (i.e. amputation rates may not necessarily be improved with a better, cheaper wound-care solution).  And while MundiMed’s distribution reach, particularly given their association with GrupoMed, may extend far beyond Sao Paulo and other large urban areas in Brazil, we think initial adoption is most likely to be largely concentrated within the most-accessible (i.e. urban) areas.  And finally, the reimbursement picture is cloudy and given that coverage is often the most important gatekeeper to utilization, until there is more definitive insight into the likelihood of ‘sufficient’ reimbursement, we think this also warrants a more conservative forecast to uptake, adoption and reimbursement rates. 

This is not to suggest that 5% penetration within the first five years is necessarily an aggressive forecast, but with no history of anywhere near that level of utilization to-date, we are taking what we think is a pragmatic approach to modeling this JV.  We also believe the implied very low level of operating costs that are factored into the $25M NPV are aggressive.  Our model is subject to updating, however, particularly if more relevant information becomes available.  Contribution from the JV has now been factored into our model (see Valuation section of our updated report). 

Q2 Results, Operational Update: Disappointing Revenue, But Still Guiding for a Big Pick-Up in 2H….


In mid-August SANUWAVE reported Q2 financial results and provided a business update.  Relative to the financials, revenue was disappointing, falling significantly on both a yoy and qoq basis and coming in at less than one-half of our estimate.  In fact, this was the second consecutive quarter in which revenue was pretty much a dud.  For additional context of just how bad recent sales have been, revenue in the first half of 2017 represents the worst showing of any consecutive six-month period since Q1/Q2 2010.  

Nonetheless, based in part on what they indicated was a significant steepening of orders post-Q2, management was still shooting for revenue to set a new record for the full year-2017.  Optimistic, particularly given that 2H sales will need to be more than 4x that generated in 1H?  Perhaps, yet comments on the call including the indicated jump in order flow in July, anticipated revenue from the recent onboarding of additional distributors and countries, and what may be a resurgence in activity from the ever-important territory of S. Korea should provide at least some hope that it is a possibility.  And with the MundiMed JV now consummated, it is also possible there could some related revenue from that channel – potentially in the form of initial device sales (for training purposes) as well as from the upfront (and subsequent) payment.     

Relative to the operational update - while the De Novo application and what FDA's response will ultimately be remain the most significant topics, there have been recent international-operations related activities (in addition to the MundiMed JV) that have also been of interest - most of which surround expansion of the geographic footprint.  We talk about the U.S. and OUS strategies and operational updates in more detail below.  

Financials
Q2 revenue was$111k, representing a yoy and sequential decline of 45% and 26%, respectively, and 55% below our  $244k estimate.  Revenue in 1H 2017 was just $261k, down 45% from the same period in 2016 and 71% from 2H 2016 (i.e. sequentially).  While it is not completely clear why revenue seems to have fallen off of a cliff, management's comments on recent conference calls indicate that the recent softness may be related more to timing than fundamental weakness in demand.  

However, there do seem to be some tangible issues that have been a headwind to growth.  This includes relatively modest contribution from S. Korea - which had been a strong contributor in 2016 (particularly in Q4), but which appears to have been a disappointment during the current year.  Management has pointed to political turmoil in that country (related to the recent arrest of their President) as having an adverse impact on sales of their products.  SNWV, per comments on the Q1 call, had expected revenue from that country to pick back up, however, with the anticipation that reimbursement would come online and help stoke demand. But, clearly we saw to little-to-no improvement in the Q2 results.  We think that there are reasons to be optimistic that S. Korea can again be an important territory for SNWV including the recent issuance of a temporary reimbursement tracking code (with the possibility that a permanent code is assigned in the future) as well as initiation of dermaPACE clinical studies in that country in an effort to further validate utility and effectiveness of the device.   

Another apparent issue, which SNWV alluded to on the Q2 call, has been that while some distributors may have expertise in wound care or orthopedics, that relying on them so detail to both markets may not always work.  Management mentioned that they were in-process of re-evaluating certain of their distributor relationships in Europe to better address these distinct call points.  

Q2 OpEx was $1.4M, which was significantly higher than our ~$800k estimate as well as the $950k quarterly average in 2016.  Much of the difference, however, relates to ~$500k in non-cash stock compensation.  

Cash used in operating activities was $458k and $573k ($850k and $1.60M, ex-changes in working capital) in the three and six months ending June 30, 2017.  Cash balance was $62k at Q2 quarter-end.  SNWV continues to expect monthly cash burn to average $125k - $225k through the remainder of 2017.  While the upfront and subsequent (over the first 18 months) fee payments from MundiMed should provide incremental capital, it will not be enough to fully fund operations.  SNWV indicated that they have been evaluating similar agreements with potential partners in India, China and the Middle East which, if closed, could also possibly bring in additional funds to the company.  Burt, we continue to expect the company to look to raise additional cash via the sale of equity or debt or potentially through one or more partnering arrangements. 

International Strategy…
As a reminder, earlier this year management outlined several goals that they expected to accomplish by year-end including the onboarding of an additional 7 - 10 new distributors/territories.  Including the MundiMed JV, they are now at number six and based on comments on the Q2 call, management is confident that they will further expand their international footprint by the end of 2017.  While many of the recent additions are in the orthopedics space, MundiMed adds a high-potential wound care channel and other DFU opportunities could follow - which could be facilitated if and when dermaPACE is approved in the U.S. (as OUS uptake is likely to benefit from implied validation that comes from FDA approval).  SNWV is also currently evaluating several wound care related distributors in parts of Europe.        

Recent "wins" on this front included the signing of major distributors in Taiwan and Indonesia as well as engaging an organization in Columbia to source qualified distributors in that country.  Romania is another country where they also recently added distribution.  SNWV is also active in looking to expand to other parts of Asia (including China and India) as well as to the Middle East and S. Africa – all of which represent relatively large populations and could be particularly well-suited for a MundiMed-type arrangement (i.e. JV with large, local and experienced distributor).   Management mentioned that they already have several distributor-related meetings lined up for MEDICA, held (in Germany) in mid-November – results of which we might here about on the Q3 call (typically held around the same time).     

SNWV recently updated their strategy in selecting distribution partners with additional emphasis placed on expertise in wound care versus orthopedics given the differences and difficulties in detailing to two distinct end-markets.  Management also noted that some of their distributors - notably Alat Medika (a prominent Indonesian med-tech company) - also have the capabilities to help facilitate clinical trial activities in their respective territories. 

As we have noted in the past, given the dearth of non-invasive and relatively inexpensive DFU-treatment options, we think dermaPACE has a place in chronic wound care and believe a reasonable scenario exists where SNWV can reach a point of operating profitability from OUS business alone.  Clearly, much of the ultimate success of the international strategy may rely on partnering with organizations with sufficient and appropriate expertise, contacts and channel depth (at both private and national healthcare levels) to execute their strategy.  We have yet to see much substance (in the form of revenue) from this international expansion - although given the lag between fundamental operational progress and related revenue, the next few quarters should be a much better judge in that regard.  

This international strategy involves targeting key opinion leaders to help drive adoption.  Management noted that it typically takes about 3 – 9 months after a new distributor/territory comes online to be able to assess the potential of the launch and before any significant related revenue may be generated.  As such, assuming SNWV continues to expand their distribution footprint through the remainder of the current year, much of the revenue benefit may not be realized until 2018.  Nonetheless, management noted that new distributors are required to purchase at least two systems initially ($40k - $60k revenue) which means the initial fruits of the recent geographic expansion should be apparent by 2H of this year.  

As noted, management mentioned on the Q2 call (mid-August) that they had record shipments in the month of July and that they continue to believe 2017 will be a record year in terms of revenue - assuming that turns out to be the case, that should provide at least more substantive validation of the merits of their international strategy.  It might also provide an additional glimpse of what an ex-U.S. path (in the event of an adverse FDA decision – although we do not think that will be the case) towards profitability might look like.   

See below for free access to our updated report on SNWV, which includes our financial model and updated valuation.

READ THE FULL RESEARCH REPORT HERE

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