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Cytori: A Low Risk Stem Cell Play

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The biotech company has had successful clinical trials yet is unloved by the market. Here's why investors should start a position now.

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Typically, early-stage biotech companies are considered to have a binary outcome. If successful with the first product that enters clinical trials the company moves on to raise more money through stock sales, enter a partnership with a large pharmaceutical company, or sell the company. In each case, investors do well. However, if the first product fails in its clinical trial, there is a good chance the company will run out of money and fail. Hence, it's binary -- all or nothing.

Stem cell therapies have been garnering significant attention as the field of regenerative medicine starts to evolve. As one would expect, there are a number of start-up biotech companies in the field. Examples are Aastrom Biosciences (ASTM) and Stemcells, Inc. (STEM). There are others, but they all harvest stem cells in some manner, expand these cell populations outside of the body, manipulate them to perform a certain therapeutic function, and pray that they can get through the required clinical trials and FDA approval process before they run out of money. That is the definition of binary biotech.

One stem cell start-up may not fit the usual binary description. This company is Cytori Therapeutics (CYTX). Cytori's approach is to use the stem cells that exist in fat tissue known as adipose tissue. Adipose tissue is connective tissue consisting mainly of fat cells, specialized to synthesize and contain large globules of fat within a network of fibers. In other words, your beer belly.

Whenever I think about the human body and diseases, I go back to the reality that we all have the same caveman genes. Our common 487th great, great grandfather as a teenager beat off a saber-tooth tiger at his cave entrance, but took a nasty flesh wound. If it hadn't healed, we wouldn't be here. What healed it? The answer is stem cells. To be more precise, adult stem cells.

There are two major types of stem cells, embryonic and adult. The role of embryonic stem cells is obvious and critical. We all started out as an egg impregnated by a sperm. This cell then divided until it was time to differentiate into organs, arms, or legs. How this happens is just amazing, but it happens. Once the embryonic stem cells are done creating babies, their role is over. Mammals don't regenerate organs, limbs, or whatever.

The role of adult stem cells is also critical, but less obvious. There are two common sources of adult stem cells:

1. Bone marrow, which contains stem cells that grow new blood cells and immune system cells, and stem cells that can form bone, cartilage, and other tissues

2. Adipose tissue, which contains stem cells that can form bone, cartilage, heart, and other tissues, and adolescent cells( something between a stem cell and a fully mature cell) that can support the healing process.

One critical component of wound healing is the building of new blood vessels to supply blood to the healing wound. Tissue that lacks sufficient blood and therefore doesn't get enough oxygen is called ischemic. Ischemic diseases/conditions include heart attacks, congestive heart failure, and strokes. There are more, many more.

Did that light bulb above your head just light up? Could stem cells in my beer belly possibly save my life down the road? Could my adipose stem cells be harvested, concentrated, and used to treat me, if one of these deadly ischemic conditions developed? Congratulations, you just conceived Cytori's business plan on your own!

Cytori has developed a medical device system called Celution. Its next generation Celution will be manufactured by the Japanese instrument company Olympus, well-known and highly respected for the quality of its products. Celution takes adipose tissue, obtained through a simple liposuction procedure, treats the adipose tissue with enzymes and other reagents to free up the ADRCs from the fat matrix, and then centrifuges the remaining cells to concentrate the ADRCs. The entire process takes about one to two hours depending on the amount of fat and happily avoids any controversy attending embryonic stem cells.

The first ischemic application that Cytori targeted was breast reconstruction after lumpectomy surgery for breast cancer. Fat transplants have been tried in the past, but typically a big enough transplant to restore the natural shape of the breast would fail over time because the transplanted fat would not receive enough blood flow to stabilize as natural tissue and it would be absorbed away over time.

Cytori's concept was to concentrate adipose-derived stem and regenerative cells (ADRCs) and inject the concentrated ADRCs along with the fat tissue hopefully generating enough new blood vessels to stabilize the fat tissue. A clinical trial in Europe called RESTORE 2 was started and enrollment was completed in November 2009. Patients were followed and evaluated for one year. Results from the 32 patients who had reached the six-month follow-up at the time of analysis were presented at the San Antonio Breast Cancer Symposium in December 2009. Final data will be available later this year. Indications from the preliminary results look very favorable.

The preliminary results of this trial appeared as a cover story in Wired Magazine last November.

The next step for Cytori was to start trials in ischemic indications with larger markets than breast reconstruction. There is nothing bigger than cardiac applications. Ischemic heart problems can be classified simply. Either your heart muscle suddenly doesn't get enough oxygen (acute, a heart attack) or your heart slowly loses its ability to get enough oxygen (chronic, called congestive heart failure (CHF)). The money spent on treating heart problems is enormous.

In 2007 and 2008, Cytoria started two trials to address both types of ischemic heart conditions. The trial addressing myocardial infarctions (heart attacks) was called the Apollo trial.

Apollo was a safety and feasibility study in Europe to evaluate the use of ADRCs as a treatment in heart attack patients. Within 36 hours of experiencing heart attack symptoms, a patient's own ADRCs are extracted and injected into their coronary artery. The harvesting technique was similar to the RESTORE trial, but the concentrated ADRC cells were not mixed with any additional fat tissue. The size of the trial was very small but the results were quite good.

The chart below shows the reduction in infarct size (infarcted tissue is the dead or damaged heart muscle caused by the reduced blood flow from the blockage).

Cytori Apollo Trial

Cytori used these results to design a new major clinical trial called Advance. It will use ADRCs to treat acute heart attacks. The trial will be conducted in Europe.

The trial addressing CHF was called the Precise trial. Precise was more complicated than Apollo. After a heart attack, there is strong signaling by the damaged tissue that it needs help. The addition of ADRCs to the coronary artery in the Apollo trial augmented the natural response and helped to return damaged, but not dead, heart muscle to normal function.

In CHF, heart muscle function and activity are gradually but materially degraded. Generally, there is a central area of dead heart muscle surrounded by weakened heart muscle that doesn't get enough oxygen to return to normal beating heart muscle. Alive, but not beating heart muscle is pretty much useless. In this case, the ideal solution is to deliver ADRCs to the weakened tissue in hope that the ADRCs could help restore normal blood flow and start the weakened muscle beating again. To accomplish this, a highly sophisticated catheter manufactured by a division of Johnson & Johnson (JNJ) was used. This catheter was threaded down the coronary artery to the area of weakened heart muscle. An extremely small needle is inserted through the artery into the weakened tissue and a dose of ADRCs are delivered. Typically, this is repeated 10 to 15 times in different areas.

The Precise study produced the following results in the chart below. MVO2 is a measurement of how much oxygen the heart is consuming, which is directly related to how well it is beating and how much blood is being pumped.

Cytori Precise Trial
Change in MVO2: Baseline to 18 months

CHF normally results in a slow, steady decline in heart function over time. The Precise results demonstrated a statistically significant difference from the patients that did not receive ADRCs. This is no magic rebuilding of heart muscle from scratch, just a logical "healing" approach to restore available weakened heart muscle back to functional use. It looks like it works.

You have to admit that these results look intriguing, but if ADRCs were designed to heal wounds before bandages and antibiotics, why didn't they heal heart attacks on their own? Perhaps the answer is that ADRCs evolved for skin and muscle wounds and these cells had to be close at hand and ready to act in a timely fashion. Damaged heart tissue was internal and remote to these cells, plus you have the cavemen gene exclusion principle. If cavemen didn't get heart attacks until after their kids reached adulthood, there was no natural selection opportunity to eliminate adult onset diseases. Heart attacks, diabetes, or Alzheimer's didn't matter if you already passed your bad genes on to your kids. Our 487th great, great grandfather was lucky if he got to be that old.

The other alternative to this theory is why didn't wound-healing stem cells evolve to circulate with the blood system? That's a good question, but it may simply be that the volume of additional cells required to be pumped by the heart all the time was not worth the biological effort. Plus, if the wound resulted in severely damaged blood vessels, circulating ADRCs might not be able to get to the wound at all. Either way, like all politics, ADRCs are local.

Next, let's address competition, patents, and cash.

At the moment, there are three approaches to cardiac stem cell treatments. Cytoria has worldwide patents on a process and automated device that uses your own (autologous) ADRCs from adipose tissue and can complete the process in a couple of hours. Nobody else has anything like it. Another autologous approach is to take stem cells from your bone morrow, but the quantity of stem cells that can be obtained this way is much too small for a therapeutic effect. The cells have to be cultured and grown to a therapeutic dose, which can take three days to three weeks. You might well die waiting for a dose. Compared to Cytori's technique, this approach makes no sense. The other approach is to take someone else's (allogenic) bone marrow stem cells, culture them, freeze them, store them, and then eventually use them. The timing is quick, but the expense of culturing the cells, maintaining quality controls, and ensuring consistency between donor batches will make that process much more expensive than Cytori's.

Cytori has 30 issued patents, more than 100 pending worldwide, and last week got a "foundational" Japanese patent for the Celution system. At the end of 2010, Cytori had roughly $50 million in cash although it had about $20 million in debt at the end of the third quarter of 2010, almost all of which was owed to General Electric (GE). Cytori has a partnership with GE Healthcare to distribute Celution in certain European countries -- an intriguing partner to say the least.

Putting all this information together, Cytori looks like it has excellent potential, good patents, and enough cash to complete its clinical trials. Is there any reason that you need to start a position now? I think there might be and it has to do with the CHF data that came out of Europe. As small as the CHF trial was, it produced statistically significant improvement in overall heart function. CHF means that your heart does not get enough oxygen to beat strongly enough to get enough blood to your lungs and body; therefore your long-term prognosis is not good. The surgical options to CHF are coronary bypass surgery or a heart transplant. If you no longer qualify for either of these options, you are called a no-option CHF patient.

You really don't want to be classified as no-option, and interestingly enough, the European regulatory agencies seem to agree. Let's step back and look at what Cytori already has done in the EU. The Celution system is approved for soft tissue repair. Autologous ADRCs concentrated and reinjected in clinical trials worked on stabilizing transplanted fat tissue. A small trial using autologous ADRCs in CHF has also produced statistically significant improvement in heart function.

A few months ago, when I talked to Cytori management, they discussed a possible narrow EU approval for CHF using the existing results for compassionate use. All of a sudden, the most recent corporate presentation predicts 200,000 new patients in the EU market every year for treating no-option CHF. At $5,000 to $10,000 per patient, that is a $1 billion to $2 billion market. Trying to game regulatory approvals isn't easy, if not dangerous, but my guess is that a 2011 approval isn't crazy. Again, your cells, no toxicity, looks like it works, and you have no options. How many people would say, "Let me try it," even if there is no initial insurance reimbursement?

Despite all of the apparent successes in clinical trials, Cytori is unloved by the market. There is a large short position of 6 million shares. Excluding management and partner shares, this is about 25% of the float. Although some of these short shares may be hedged against outstanding warrants, there is still a significant downside bet against Cytori. There are a few small brokerage firms that follow Cytori, and one flat out hates the stock with a $2 target.

I have a hard time understanding this. Is it because Cytori sells a device system and sales have been slow to ramp up? That's possible, but the initial approvals have not yet included insurance reimbursement. That should start to change in Europe with the soft tissue applications. Maybe it's that biotech analysts view Cytori as a medical device company, and the medical device analysts don't understand stem cells, look at weak sales growth, and simply don't care.

Either way, Cytori doesn't look like the typical binary biotech bet. The soft tissue and skin wound-healing applications look to me like high probability winners. If the cardiac applications prove out, Cytori will be a monster winner. I'm in the "tails you break even, heads it's a home run" camp.

Of course, timing is everything. Cytori management has indicated that they will update the status of the European no-option application on the earnings conference call on March 10. Maybe that will be the catalyst to draw attention to the possibility of a major stem cell approval in 2011 that seems to be under the radar screen of Wall Street.

Dig into the information at the Cytori company website and keep it on your watch list. I think there is a lot of potential here.
Position in CYTX

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