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Cellular Dynamics’ Swing for the Fences: A New Stem Cell IPO?

July 8, 2013
Update #1 (7/10/2013, 12:00 PM ET): CDI announced the launch of its IPO today, offering 4.4 million shares for a target price of $12-$14. If buyers embrace the offer the company's resulting fully diluted market value, on the order of $212 million, would make CDI the second- or third-highest market cap company in the SCSI index, ahead of every SCSI component with a therapeutic development program except Osiris Therapeutics ($346 million market cap).
Update #2 (7/12/2013, 9:00 AM ET): CDI's second amendment to its S-1 reports "For the quarter ended June 30, 2013, we anticipate that revenue will be between $2.7 million and $2.8 million." This would constitute the second consecutive quarter of essentially flat revenue growth above Q4 2012's record revenues (see chart).
Update #3 (7/25/2013, 7:45 AM ET): CDI's announcement of the pricing of its IPO (at $12, the bottom of its hoped-for range, grossing the company $46 million) and the SEC's notice of effectiveness mark the company's successful execution of its IPO. It is expected to begin trading today on the NASDAQ (ticker: ICEL), making the company the 15th and newest component of the SCSI Stem Cell Stock Index.
Update #4 (7/26/2013, 9:25 AM ET): In its NASDAQ debut, CDI shares slumped 21% yesterday. Commenting to the Milwaukee Journal Sentinel, Busa Consulting noted "They've identified a good opportunity. And like any young company, they will face incredible challenges delivering on that opportunity. Few biotech tools companies are able to pull off an initial public offering, so the fact that CDI was able to is a testament."

Should its plans come to fruition, Madison WI based Cellular Dynamics International, Inc. (CDI) may soon become the 15th and newest component of our Stem Cell Stock Index. On July 1st it filed an amended S-1 form with the U.S. Securities and Exchange Commission signaling its continuing intention to pursue an imminent IPO worth up to $57 million.

IPOs are exciting for reasons beyond the most obvious one -- the opportunity for insiders to cash in on years of risk and hard work. From our perspective here at SCSI as analysts of the U.S. stem cell industry, a good deal of the excitement derives from the opportunity, afforded by the SEC’s rather strict disclosure requirements for S-1s, for the first time to really look closely behind the hype that is the stock in trade of a privately held company, and dig into the real numbers. As but one example of the difference between PR fantasy and S-1 reality: a 2011 MIT Technology Review article quoted Cellular Dynamics’ CEO claiming "CDI gets ‘multimillions’ in revenues from selling its heart cells," while the company’s S-1 now documents that its total product revenues for 2011 (including products other than cardiomyocytes) totaled just $1.5 million.

The Promise: Bottomless Barrels of Powerful Cells to Transform the Pharmaceutical Industry

Founded by stem cell pioneer Jamie Thomson, Cellular Dynamics since 2007 has been in the business of commercializing induced pluripotent stem cells (iPSCs), and cells derived from iPSCs, for research (particularly as tools for pharmaceutical drug discovery). The company is not alone in this market. In its own words (from its amended S-1): "Some other companies have either announced an interest in or begun to market products based on pluripotent stem cell technology. These companies include Axiogenesis AG, Cellectis, General Electric Co., Life Technologies Corporation, Lonza Group Ltd. and Sigma-Aldrich." SCSI component companies also playing in this same space (but not mentioned in the S-1) include:

Busa Consulting’s proprietary database, tracking over 170 stem cell-focused companies worldwide, includes an additional 22 companies also selling various flavors of stem cells and/or stem cell-derived cells.

In this relatively crowded field, Cellular Dynamics’ particular value proposition hinges on its exclusive focus on iPSCs -- an artificial stem cell engineered by genetically re-programming common cells, such as skin or blood cells, to adopt the properties of stem cells. Because the starting cells from which iPSCs are engineered are easily acquired via simple procedures such as blood draws or skin biopsies, it is practical to develop iPSC cell lines from hundreds or even thousands of individuals with different genetic backgrounds -- such as from individuals harboring genetic predispositions to various diseases such as cancers, diabetes, Alzheimer’s and cardiovascular disease, among many others. This approach holds out the promise of offering pharmaceutical companies cells that amount to a ‘disease in a dish,’ which could fundamentally transform the way new pharmaceutical drugs are discovered and tested in future (or so the thinking goes).

And while the disease-in-a-dish paradigm for drug discovery still remains something of a distant goal, already the availability of limitless quantities of stem cell-derived cardiomyocytes (heart muscle cells) and hepatocytes (liver cells) offers the more immediate prospect of testing drug candidates earlier in their preclinical development for potential cardiotoxicity and hepatotoxicity -- two of the leading causes for the failure of new drugs during or after clinical trials in humans. This prospect alone has already drawn strong competitors like GE Healthcare and Sigma Aldrich into Cellular Dynamics’ space.

Reading the Tea Leaves: Cellular Dynamics’ Track Record

Nothing in the company’s S-1 filing suggests that it harbors any reasonable expectation at this time of becoming a stem cell therapeutics company. So think of CDI not as a gold prospector searching for one (statistically unlikely) multi-billion dollar strike, but rather as the unsung shopkeeper selling lots of picks and shovels, at little risk, to all those risk-taking prospectors. Despite its relative lack of sex appeal, this can be a compelling business model: just consider today’s leading biotechnology shopkeeper, Life Technologies Corp., with its $3.8 billion in 2012 sales. But one has to sell a whole lot of picks and shovels to strike it rich, so the question of Cellular Dynamics’ future sales growth potential becomes paramount

Nowadays, fundamentally new biotechnologies always face quite lengthy sales cycles in their early days, in part as a consequence of the go-go Nineties biotech bubble, during which early-adopting customers were burned too many times by too many promises of ‘game-changing’ technologies that simply failed to live up to their hype. As a consequence of this very long sales cycle -- during which potential early adopters may spend years carefully evaluating the technology without jumping in feet first -- prospective investors considering a new public offering have very limited historic sales data on which to base their decisions to invest in very young companies such as Cellular Dynamics.

The company’s S-1 filing offers some limited hard numbers: product sales revenues grew from $1.5 million in 2011 to $5.2 million in 2012, and seem on pace to hit $7-$10 million this year. Total revenues (including grants and contracts) similarly grew from $2.6 million in 2011 to $6.6 million in 2012. These are encouraging, though hardly eye-popping, numbers. The company’s S-1 states that "in 2012 we sold our products to 18 of the top 20 biopharmaceutical companies," but of course what really counts is the number of those who are or soon will be high-volume customers, and here it is simply too early to expect the company to chalk up any really impressive numbers.

Here’s what we do know. The company’s first important validation studies with a potential whale of a customer began in 2008, when the pharmaceutical and biotech giant, Roche, signed on to a fairly typical evaluation project with Cellular Dynamics, in which Roche would provide the company with 50 well-characterized drug candidates for CDI to evaluate for cardiotoxicity using its iPSC-derived cardiomyocytes. That initial study seems to have gone reasonably well, judging by Roche’s decision sixteen months later to extend its agreement with CDI for another two years, and to tack onto it an all-important two-year supply contract. CDI recognized $338,000 in 2011 revenues from this collaboration with Roche, which also resulted in a reasonably encouraging 2011 technical publication by Roche scientists concluding that the system they developed to employ CDI’s cells for cardiotoxicity screening "provides a means to understand a drug’s potential to induce arrhythmia."

While the Roche collaboration was an encouraging start, it unfortunately was not without some mixed signals. Most notable among these is the conclusion we must draw from information presented in the company’s S-1 filing that Roche did not elect to renew its supply contract with CDI when it expired in 2012. The company’s S-1 does state that Roche has nonetheless "continued to purchase our products," but the absence of a renewed supply contract suggests that Roche has not judged Cellular Dynamics’ cells to be obviously mission-critical to its long-term efforts.

CDI has two newer collaboration and supply agreements with major pharmaceutical companies still underway, one with Eli Lilly and Company (with a 1.5 year term expiring December 2014, and worth up to $5 million including milestones) and another with AstraZeneca (1 year term expiring December 2013, with a $1.3 million potential). The proposed timing of CDI’s IPO is thus somewhat unfortunate in that it leaves us with only the Roche collaboration’s mixed signals with which to judge the company’s long-term value as witnessed by repeat business and long-term customer commitments.

The Evolving Competitive Landscape

One possible explanation for Roche’s failure to renew its supply agreement might be that Cellular Dynamics is no longer the only game in town with respect to stem cell-derived cardiomyocytes. Emboldened, no doubt, by CDI’s trailblazing efforts, a handful of major biotechnology tools vendors with very deep pockets have recently entered this space -- most notably GE Healthcare with its own cardiomyocyte offering.

One inevitable result has been downward pressure on prices due to competition. In 2011 CDI’s CEO, Robert Palay, was quoted as saying that the company’s cells "cost about $1,500 for a standard vial of 1.5 million cells." Today, competitor GE’s stem cell-derived cardiomyocytes list for just $391 for 1 million cells. Obviously, it can be tough on a small young company when a giant like GE decides to compete with it on price. Pharmaceutical companies are extremely sensitive to the price-per-test for the assays they use in their drug development programs, since they can run millions of such tests per year. And judging from the data cited above, the stem cell-derived cardiomyocyte market has already seen its price-per-test plummet by 60% in just two short years...and probably even further, if one or more competitors are willing to give volume buyers deep discounts (which is common in the biotech tools industry).

The Sun Will Come Out Tomorrow (?)

Fortunately for Cellular Dynamics, cardiomyocytes and hepatocytes for toxicology testing are only the first step along its potential growth path. As discussed above, the ultimate value proposition for iPSC-derived stem cells is to provide ‘disease-in-a-dish’ assays to transform pharmaceutical drug discovery. If the concept lives up to its promise, this could skyrocket far beyond the opportunity presented by mere toxicology assays today.

But that’s a big ‘if,’ and thus presents prospective investors and customers alike with the single most important unknown they face in evaluating Cellular Dynamics’ proposed offering. Conceptually, there’s a lot to like about the disease-in-a-dish concept. But seasoned biotechnologists know that Biology is a fickle master and, in the immortal words of Gilda Radner’s Roseanne Roseannadanna, "There’s always something--if it ain't one thing, it's another." In other words, a lot can go wrong in reducing the promise of disease-in-a-dish to practice. So far we know that iPSCs can indeed be differentiated in vitro into many different kinds of cells largely resembling cell types that are useful in drug discovery. But we also know, from a growing body of scientific evidence, that in many (most?) cases these cells are not perfect replicas of the corresponding adult body (somatic) cells -- often their gene expression patterns more closely resemble the corresponding embryonic (as opposed to adult) cells. And in some cases they can even display certain characteristics that resemble no natural cell known to man (recall that iPSCs are engineered cells, and -- like it or not -- cellular engineering remains an imperfectly mastered black art, not a science).

Will today’s differences between iPSC-derived cells and the diseased somatic cells they seek to duplicate present roadblocks to their wide adoption in drug discovery? And if they do, will work-arounds be found to make iPSC-derived cells more closely resemble natural cells? For Cellular Dynamics this is the $57 million question, and no one can answer it with assurance today. All that we can say with confidence is that the company will continue to face long sales cycles as prospective customers seek answers on a case-by-case disease at a time. If past experience in the stem cell industry is any guide, that, in turn, will almost certainly require the company to issue one dilutive share offering after another, carving deeply into early investors’ stakes. Given the scale of its ambitions, combined with the fact that competitors are already breathing down its neck, CDI looks certain to continue to generate red ink for some years to come. The company currently posts $22 million net losses annually, mostly attributable to its necessarily steep R&D expenditures.

Tall Fences Make Good Investments

To the extent that CDI can raise barriers to the entry of competitors into its field, it might buy itself the time it needs to crack the long sales cycle problem. But here too, prospective investors face more questions than answers. The company’s claimed portfolio of over 700 patents, patent applications, and licenses is certainly numerically impressive, though hardly an impenetrable fortress -- as witnessed by the competitors already ramming at its gates. The IP landscape for iPSCs is a notorious mine field, and most knowledgeable observers would probably agree that it will be years before we really understand who owns what, which patent applications will issue, which patents are really commercially important, which aren’t, who will end up suing whom, and who will ultimately prevail in those suits. As CDI itself correctly states in its S-1, "The patent positions of companies in the life sciences industry can be highly uncertain and involve complex legal and factual questions for which important legal principles remain unresolved."

Then too, there’s more than one way to skin a stem cell. This is an extremely active field of academic and industrial research, with new and improved means of generating iPSCs from somatic cells, plus new and improved means of differentiating them into useful somatic cells, appearing regularly in the scientific literature. Additionally there are alternatives to iPSCs, such as embryonic stem cells (ESCs, such as those used by GE Healthcare) and even possible new paths to the same goal that don’t involve stem cells at all, such as ‘trans-differentiation,’ the latest buzzword in the field.

Without diving into the weeds of the stem cell intellectual property landscape, it seems safe to say at this point that no one, including Cellular Dynamics, has anything like an unassailable IP position. If true, that implies that competition can be expected to continue to pour into this arena, and that this competition will end up being based on pricing, product performance, strategic partnering, and the numbers of feet on the street (i.e., sales reps) each such competitor can muster.

The Take-Home

Biotech IPOs are traditionally complete crap-shoots for prospective investors. The risks are always high because science, by its very nature, is risky business. Ideally though, the potential rewards are equally high. Tools companies like Cellular Dynamics are always a more awkward fit into this risk/reward calculation than are therapeutics companies (such as the majority of the current components of our SCSI index), if only because, realistically speaking, they don’t have billion-dollar opportunities ahead of them, but nevertheless still tend to present very substantial risks. This is especially true for such an early-stage tools company as CDI, with little in the way of a track record and even less in the barriers to entry department.

What is all but certain is that the company’s founders and earliest investors will profit from a successful IPO. What is highly uncertain is everything else. Whether the company’s risk/reward ratio remains attractive anyway is a question investors may soon be voting on with their dollars.