Summer Series: Aroa Biosurgery Ltd (ASX: ARX)

Bryce Leske: [00:00:57] Welcome to the Equity Mates Summer Series of 2020, brought to you by superhero offering five dollar brokerage and zero dollar brokerage on ETFs in Australia over the next 12 episodes, we're going to be diving into some of Australia's largest and most well known companies as selected by the Equity Mates community will be unpacking the company, its industry outlook and key financials. And in some instances, we'll also be taking the tough questions straight to the CEO to do this. As always, I am joined by my equity buddy Ren. How's it going, Ren? [00:01:28][31.3]

Alec Renehan\: [00:01:28] I'm very good looking forward to discussing this stock. [00:01:31][3.1]

Bryce Leske: [00:01:32] Yeah, this is a very interesting one. Not within our circle of competence. Well, personally, personally, not for me. But this is what I love about the Equity Mates summer series, is that we get exposed to a bunch of new companies that perhaps we've never heard of or thought about looking into. And it's a great opportunity for us to put our research skills to the test and unpack some companies that are a bit left of field. Yeah, a big thank you to Zac from the Equity Mates community, who has done a stellar job in helping with the research and analysis for this. So, Zac, shout out to you and also to all the other contributors who have helped with the summer series of twenty 20 and to the broader Equity Mates community for sticking around and listening. So how are we going to do? The episode is always company summary, industry outlook, financials, and a bit of valuation at the end. If it's profitable, so should we. Cracken. We're talking about a Aroa BioSurgery ASX ticker is ARX. [00:02:28][55.8]

Alec Renehan\: [00:02:29] Before we get into what the company does. I just want to note that this is a New Zealand company listed in Australia. And I think as Australians, we need to just take a moment and just recognize the quality of company that New Zealand is sending across the ocean or across the sea. It's another in a long line of New Zealand companies and obviously this company's new and its journey. But some of the New Zealand companies that have become market darlings, companies like A2 Milk Zero Auckland International Airport had 10 bags prior to covid good on New Zealand. They keep sending you quality companies across. Maybe we need New Zealand companies listed on the ASX. [00:03:12][42.6]

Bryce Leske: [00:03:12] ATFP Not bad. I think we need a few more though, [00:03:15][2.9]

Alec Renehan\: [00:03:16] although there are a few more. Some haven't done as well. And New Zealand you wouldn't want to have Paul. Was there a honey one? I'm sure that will make you [00:03:24][7.5]

Bryce Leske: [00:03:24] feel like there was. [00:03:25][0.5]

Alec Renehan\: [00:03:26] So yeah, a little bit of an ode to New Zealand before we think about it. Yeah, yeah, yeah. [00:03:30][4.3]

Bryce Leske: [00:03:30] I don't know. Xeros New Zealand. Yeah. Great company. [00:03:32][2.2]

Alec Renehan\: [00:03:33] That's enough of me. Fan blowing over our neighbor to the east. No w e e yes j. [00:03:41][8.0]

Bryce Leske: [00:03:41] Like here we're not doing a [00:03:42][0.8]

Alec Renehan\: [00:03:43] geography but orienteering vodcast Aurora is a rower rather. Good point. I'm going to make that mistake at least three more times said I reckon they are a biotech company. Basically what they do is I'll read you how they describe it and then I'll tell you what in my own words about that. So a rower is a soft tissue regeneration company focused on improving the right and quality of healing in complex wounds and soft tissue reconstruction. Yeah, what does that mean? [00:04:14][31.2]

Bryce Leske: [00:04:14] That means they are looking at ways in which they can use regenerative medicine and healing of patients when it's a pretty interesting company. You said you were going to explain in your own words. [00:04:29][15.1]

Alec Renehan\: [00:04:30] So have it. Yeah, yeah, yeah. So this company was founded in 2008 and what they have done is they've taken the lining of a sheep stomach and they basically place it. They they obviously don't just take it straight from the shape and put it on one board. Yes. That's what it's made from. And they place it on wounds that aren't healing or, you know, massive and will struggle to heal. And it helps your own, like, tissue regenerate around this, I guess, like gauze like film that they put on. And what happens is as your skin regenerates around this cause, I think it basically goes away and so it helps your skin regenerate. Yeah, yeah. [00:05:18][47.9]

Bryce Leske: [00:05:18] I feel like this has been that's something that has, you know, people have been trying to master for years. And I'm not sure how close it is to the perfect solution, but we've had the spray on skin. But yeah, the Australian the name escapes me. And, you know, you look at many other companies that are playing in this space and looking at innovative ways, I guess, to solve this issue of healing skin faster, using your own body to do so without having to do those massive skin grafts that traditionally were the way to do to heal skin. So, yeah, I like the space that this is in. [00:05:48][30.1]

Alec Renehan\: [00:05:48] Yeah. And you know, the other reason why I like it. Twenty two million sheep were killed in twenty nineteen and many of us. It went to waste. So not only is this a good biotech play, it's a good recycling place because it's a fair call. But I mean, in all seriousness, they have found a use for a product that was not really being used or was only being used in really low value ways. And so for a company that wants to keep their costs low, this is a pretty innovative way to come up with a medical innovation that uses something that is cheap and was previously not being really used. [00:06:23][34.5]

Bryce Leske: [00:06:24] Yeah. So where would they be using this sort of product, I guess. And so just to reaffirm safe, I've got it right. What the product is, is they provide some sort of a patch or a placement over the wound that encourages the body itself to regenerate and grow over that. [00:06:39][15.8]

Alec Renehan\: [00:06:40] Yeah, yeah. It acts as like a scaffold, I guess. And then your body grows new tissue over that. And yeah. You know, like it helps reestablish blood supply and all of that stuff. Now, obviously, the science scientific side of it is outside of my circle of competence. Think of it like, you know, gauze or a patch. Yeah. [00:06:59][19.7]

Bryce Leske: [00:07:00] This is probably going to be a silly question, but is this available over the counter? I don't think so. Yeah, you'd have to go into hospital to get this. [00:07:07][6.7]

Alec Renehan\: [00:07:07] Sorry, hospital may be a misnomer. I think it can be prescribed by any health professional. So it would have to be a health professional that gives it to you. But I don't think it has to be a hospital. Yeah, right. [00:07:18][10.7]

Bryce Leske: [00:07:18] Okay. Where do we want to go from here? [00:07:20][1.3]

Alec Renehan\: [00:07:20] Just to put some, I guess, practical use cases on the table. And this is from the company. They talk about some of the ways that their product has been used for breast reconstruction, soft tissue repair, acute wounds, chronic wounds. Tell me the difference between acute and chronic wound. No there is no hernia repair, pressure ulcers, venous ulcers, diabetic ulcers, surgical wounds, traumatic wounds, partial and full thickness wounds. [00:07:49][28.3]

Bryce Leske: [00:07:49] So that covers everything [00:07:50][1.1]

Alec Renehan\: [00:07:51] really where the skin has been broken or disrupted and it needs to repair and it's unlikely to repair on its own or it's going to be slow to repair on its own. This can accelerate that process. [00:08:02][11.2]

Bryce Leske: [00:08:03] And so is the idea that this eventually dissolves and is that how this works? It encourages the growth and as the skin and cells itself grow, it disappears? [00:08:12][8.9]

Alec Renehan\: [00:08:14] Well, I don't think it disappears, but it's not like it's taken off at any point. Yeah, yeah. So I guess in that sense it does disappear. I imagine your skin just grows over it and then it gets, I guess, absorbed into the body. This isn't just something that is an idea. They did a study and in that study, 89 percent of wound's closed at the 12 week mark and 100 percent of the wounds closed over six months. So I'm not sure what the normal timeline was and how that compared, but it obviously does do what it's meant to do, which is support tissue regeneration and skin growth. [00:08:46][32.8]

Bryce Leske: [00:08:47] So just looking at it, when they have over four million, well, it has been used on over four million patients whilst they're based in New Zealand. Their major market is in the US. They've been there since 2010 in the market for wounds and hernia. It seems like their strategy has never really been to build out a sales infrastructure, but rather partner with large global companies who will take the sales and marketing responsibility on themselves. So I guess that's one way they've kept themselves reasonably lean. I think they only have 30 employees. [00:09:20][32.7]

Alec Renehan\: [00:09:21] They were partnered with a North American biotech company that was doing their sales and marketing Hollister Biotech. But they have brought that back and now they want to do it in-house. [00:09:30][9.5]

Bryce Leske: [00:09:31] So when they IPO here in Australia in 2020, they listed on the ASX on the 24th of July, they raised 45 million dollars. And a lot of that is going into their commercial expansion. Now, we talk a lot about R&D for a company like this. You would imagine that they have a pretty strong commitment to to research and development. And they say that they've got a deep pipeline of products on the way. I think it took five years of product development before they were even able to launch their original product. But I think given the success that it's having, it seems like that R&D is certainly worth it. It is approved in 37 countries around the world and more importantly, has FDA approval, 600 hospitals currently use it and strong distribution. [00:10:18][47.3]

Alec Renehan\: [00:10:19] Yeah, yeah. I just went down a bit of a rabbit hole of flicking through one of their investor presentations. If you want to say some pretty gross photos of healing, we'll include them in the show. No, no. When you look at the wounds and the way that they heal in these photos, it's pretty incredible what they're able to do. There's some pretty bad wounds in these photos. So it's cool that these guys have found a new and innovative way to help patients that are suffering these wounds and these issues. But anyway, enough about that. Let's talk about the industry, because I guess these guys. Would be doing incredible things, but if their competitors are doing more, then they might be a great company, but not a great investment. So I think when we start talking about the industry and the competitors, if we define the industry to begin with, I think we're really talking about soft tissue reconstruction, healing of these acute and complex wounds. And there's really three types of technologies that are out there. This is one of their investor presentations. So there's permanent synthetics, absorbable synthetics and then biologics. This technology fits in the biologics. And I guess the spray on skin you were talking about earlier sits in one of the synthetic categories. There are a number of competitors looking at this issue and coming up with different ways to do it. Two of the big ones listed are Vater ABH and Poly Novopay. And they they are both synthetics. Aroa is able to achieve a cost advantage over both of them and has better margins, 74 over 75 percent gross margins. But there are a number of others. So I guess I'll list some and forgive me with this pronunciation. Biotech companies have interesting names allowed a Applegarth said Aram Dermagraft Epistle A-Z, Integra laser skin. That's that's an easy name. Oasis or cell trans site. And they all use different technologies. So, you know, some of them use patients, skin cells themselves, some of them use cow, some of them use sort of like synthetic materials, some of them use skin substitutes. There's one that uses pigs. So Arawa uses shape, but it feels like there's a number of different ways to skin the cat. Pardon the pun the analogy there, but there's a lot of companies that are finding different alternatives to attack this problem. And when we're analyzing this company, I guess the two questions are, one, how do we determine what's best and what will be adopted? And then two, even if it's the best, if it's incredibly more expensive, hospitals probably aren't going to buy it. So, like, what's the best for doctors and for patients is probably question one. And then question two is where do they sit on the cost scale? The first question is difficult for us to answer. There's a lot of reasons to suggest that this is a really good one. It's noninvasive, doesn't require skin grafts. Clinical trials have performed well. It heals really quickly. It's shown a really positive lack of relapses occurring. So there's a number of reasons to think that it's the best part. I would probably say that actually analyzing all these different treatments for soft tissue regeneration is probably outside of our circle of competence. The second question is a lot easier to answer the financial question. And this is where a rower has a bit of a moat, I guess, or a bit of a competitive advantage over some of its competitors. [00:13:56][217.3]

Bryce Leske: [00:13:57] That's right. And they have a price moat, twenty to sixty percent cheaper than competing biological products in their area. So, I mean, that's a pretty significant margin to fight against your competitors when going out and selling your product. [00:14:12][14.1]

Alec Renehan\: [00:14:12] Yeah, the important distinction here is that over competing biological products. So that's the, you know, the cow or the pig and stuff like that. It is a little bit more expensive than some of the synthetic products. [00:14:25][12.9]

Bryce Leske: [00:14:26] Yeah. To your point, the intersection of quality versus price would come into play for people who are buying it, I would imagine. [00:14:33][7.6]

Alec Renehan\: [00:14:34] Are you saying biologics are better quality than synthetics? [00:14:37][2.3]

Bryce Leske: [00:14:37] I'm not suggesting that. All I'm saying is that people have to think about it. [00:14:41][3.0]

Alec Renehan\: [00:14:41] It's probably right. You would probably think so. But I have no way of confirming that. [00:14:46][4.6]

Bryce Leske: [00:14:46] No. If we continue to talk about Moat's when they do hold ten patents, and that's pretty important, you know, they obviously have discovered some pretty important things and hold the patents for those. So it becomes very, very, very difficult for competitors to come in and essentially rip off what they're doing. And they do have 25 pending patents as well. So I'm imagining that is all stemming from the research and development section of their business. And when you're looking at investing in these sorts of businesses, that is certainly something to consider the number of patents that they hold and how long they hold them for. Because, you know you know, you look at pharmaceutical companies and it's the periods in which they hold the patents that they generally generate a lot of their profits, because as soon as those patents relapse, or I guess I'm no longer protecting themselves, competitors can come in and really keep the pressure on the price at which you can sell by essentially copying your product. [00:15:40][54.1]

Alec Renehan\: [00:15:40] Well, yeah. Yeah, I think really the summary of the industry context and its competitors is it's a big market. The global wound care market globally is estimated to be about nineteen dollars billion dollars. The traditional way that these serious. Complex wounds were dealt with with skin grafts is being disrupted and people are finding better ways to do it. The caveat being there's a number of companies working on this, all with slightly different solutions on how it can be disrupted and what the best way forward is. So you've got a big industry that's undergoing disruption, but a number of disruptors all competing for market share in that industry and really two key buckets of disruptors, those creating synthetic products and those creating biological products. One other note that I found quite interesting is apparently there's a strong feeling in the vegan and animal rights community around these biological products. And obviously, because, you know, animals have to be killed to create them. They're against using animals to create products and in favor of the synthetic ones. That that's just a note that I read that I thought was quite interesting. [00:16:50][69.9]

Bryce Leske: [00:16:51] Yeah, I mean, it makes sense. Yeah. All right. So should we move on to a little bit about future plans and then touch on the financials? [00:16:58][7.0]

Alec Renehan\: [00:16:58] Yeah, but before we do, let's just take a quick breath and hear word from our sponsors. [00:17:02][3.7]

Bryce Leske: [00:17:04] So we've had a look at company summary, as well as a little bit about what's going on in the industry. Let's have a look at some of the future plans. Obviously, the big thing for them is to continue the adoption of their product portfolio within existing accounts. So focusing on marketing and expansion, they've got their R&D pipeline and they want to move into surgical repairs, which is going to offer some expansion opportunities and then also move beyond USA into to Canada, Europe and then some selected Asian countries where there's a big focus on a new addressable market. So a lot of opportunity for them there. [00:17:39][35.7]

Alec Renehan\: [00:17:40] Yeah, yeah. In theory, what this company will try and do is open up more markets. The USA is the biggest market now, but if they can open up more markets, then they can manufacture at a greater scale that hopefully will lead to cost efficiencies in their manufacturing, which will allow them to offer this cheaper, which will extend their cost advantage over some of their competitors and hopefully improve their already strong margins or the already strong gross margins. They're not actually profitable at the moment. So in theory, that's what the company is going to try and do, commercialize their existing products more through new markets, get a better cost advantage that way, while at the same time investing in research and development. [00:18:17][36.9]

Bryce Leske: [00:18:17] And what do they think that is going to lead to? Well, if we move on to some financials, Ren Tribecca expects that Arawa is going to have annual growth rates of at least 50 percent over the next three years. So nothing to shy away from potential revenue of New Zealand. One hundred and fifty million by 2025. So this is a reasonably I guess they're not generating huge sums of money at the moment. [00:18:40][22.7]

Alec Renehan\: [00:18:40] No, I mean, the company only worth three hundred and eighty million dollars. Yeah, a [00:18:44][3.5]

Bryce Leske: [00:18:44] bit of a specky. [00:18:44][0.3]

Alec Renehan\: [00:18:45] Yeah. [00:18:45][0.0]

Bryce Leske: [00:18:47] You did mention their gross margins are in healthy gross margins of 66 percent. That is slightly down on last year, I guess due to covid. But that is not translating into a bottom line profit at the end of the day. And 20 revenue was 22 million gross profit of 18, however, hasn't really translated at the end of the day into into profit profitable numbers. But they have said that they're looking to be profitable over the next three years. [00:19:12][24.6]

Alec Renehan\: [00:19:12] Yeah. So with this company not making a profit and being so early in its journey, it's difficult to do a valuation. As with most specs, if you're doing the analysis, you're really asking, is this company's product better than its competitors? Does it have the potential for that unbelievable growth that you really want to see in a specky? Like does it have five by 10 big potential? So I'm pretty intrigued by this company. I've got to say I'd never heard of it before. We looked at it for the summer series. The only thing that gives me pause is the number of competitors in its space. But it's cool. I mean, you look at the investor presentation and you say what it actually does on a practical level, like it's clearly a useful product. And it would be cool to say if it's a good company. [00:19:54][41.5]

Bryce Leske: [00:19:54] Yeah, useful product, but also one that is, I guess, on the edge of leading the innovation in this space backed by a number of patents as well, and a focus on R&D. [00:20:04][9.2]

Alec Renehan\: [00:20:04] So, yeah, the thing is, like, they have 10 patents. That's great. But I'm sure the company that's making a similar thing out of like bovine material, like out of cows also has a number of patents around their method of manufacture. I'm sure the company that's doing it out of pigs has a number of patents around their method of manufacture. It doesn't stop the competition. [00:20:22][18.4]

Bryce Leske: [00:20:23] No, no. [00:20:23][0.4]

Alec Renehan\: [00:20:24] It just stops the competition doing the same thing that they're doing. [00:20:27][3.0]

Bryce Leske: [00:20:27] Yeah, well, that brings us to the end of the deep dove into a row, a massive shout out, as I said at the start, to Zach from the Equity Mates community, who has helped us with the research and analysis of this company. Great job. You've intrigued Ren, which is something that is not easy to do. As always, a massive thank you to the sponsors of the Equity Mates summer series of 2020 superhero. They're offering five dollar brokerage flat fee and also zero dollar brokerage on all of your ETFs here in Australia. So if you want to build that core portfolio or if you want to take a bit of a satellite approach and add a roll to your portfolio, it can all be done through superhero at incredibly low cost. So go to superhero dotcom that are you to check them out for more information. But again, as always, it's been fun chatting stocks, loving, doing the summer series and chat next week. Sounds good. [00:20:27][0.0]

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