HRTX - Cleaning The House May Not Solve Heron Therapeutics' Problems

2023-04-21 15:11:46 ET

Summary

• Shares of Heron surged this month as CEO Quart was replaced by Craig Collard.
• The company also made commercial leadership changes and all of this was driven by the recent cooperation agreement with Rubric Capital and Velan Capital.
• However, leadership is not Heron's only problem and many of the problems are product-specific.
• Zynrelef is unlikely to be a major growth driver anytime soon, and Heron is likely to shift most of its focus in the near term to the launch of Aponvie.
• Heron can still deliver shareholder value, but it faces a tough road ahead.

Shares of Heron Therapeutics (HRTX) surged this month as CEO Barry Quart was replaced by Craig Collard and Adam Morgan was named Chairman of the Board. Both roles were previously held by Quart. And the company continues to clean the house - Chief Commercial Officer John Poyhonen and Senior Vice President Commercial, Acute Care, will leave the company at the end of April. Jason Grillot will take the role of Vice President, Sales and Marketing, Acute Care, and CEO Collard will oversee the commercial organization.

These changes were the result of the recent cooperation agreement with major shareholders Rubric Capital Management and Velan Capital Investment Management. Collard and Morgan were added to the board at the time, and so was Broadfin Capital's Kevin Kotler, and the new board wasted no time and made the above-mentioned changes.

And while I welcome the changes at the top and consider them as really the right move considering many disappointments over the past few years and failures to execute, I am not so sure leadership changes alone will be sufficient to get Heron in a much better place as many of the issues are product-related.

Specifically, the very slow and disappointing launch of Zynrelef was met with new excuses by the management team each time.

First, they said their market research shows a narrow label will not be a problem, and that turned out to be incorrect.

Then, they said growth will accelerate as the label is expanded, but that did not happen either and there was plenty of time since the label was expanded a year ago.

And most recently, now-former CEO Quart admitted that even the broadest label the company anticipated getting later this year may be insufficient to get Zynrelef sales to levels that would create significant shareholder value. The problem now is how the product is used in the operating room and that they will need a different product presentation - specifically a prefilled syringe that will not be ready for (probably) several years. This is what Quart said on the Q4 2022 earnings call :

Because ZYNRELEF is viscous, it can still take several minutes to withdraw all the product, and even if the - if the nurse doesn't follow instructions, it can take even longer. This can be annoying and diminished use of the product. With the broader label expected later this year, we want to make sure the product is as easy to use as possible. Optimization will be in two steps. Step one is to complete the development and gain approval of a greatly improved custom device designed to speed the withdrawal of the product with step two being the continued development of a prefilled syringe.

The current expectation is that the custom device can become available by mid-2024 and it will probably take two years or longer to get the prefilled syringe to market.

So, significant growth acceleration for Zynrelef seems highly unlikely in the next few quarters, and possibly through at least mid-2024.

And ex-U.S. markets should be written off too as Heron is unable to find partners, and even if it did, I would not expect the product to sell any better than it is selling in the United States. It is actually more likely to do worse outside the United States.

And looking beyond Zynrelef, the oncology franchise is definitely not a high-growth business for Heron. Revenues grew 17% in 2022 to $97.5 million and the company's guidance for 2023 is $99 million to $103 million. The oncology franchise has also been a big disappointment. Prior to the launches of Sustol and Cinvanti, their combined peak sales potential (including my own estimates) was $300 million to $400 million, or even more. For example, a Reuters article from 2016 says the analyst consensus for Sustol for 2021 was $306 million. Sustol generated $10 million in net sales in 2022.

The prolonged arbitrage periods of key competing products that have gone generic right around the time Sustol and Cinvanti were launched were initially blamed for the poor performance of Sustol and the growth of Cinvanti taking a hit and then plateauing, but both products remain largely stuck around the $100 million run rate and I would not expect the situation to improve materially going forward.

The development of HTX-034, the longer-acting version of Zynrelef, was stopped and that was probably the right decision because there is no reason to develop a longer-acting version of a drug that is failing in the market.

This leaves Aponvie as the only viable growth product for Heron in the next 12 months, and possibly longer if the company is unable to revive Zynrelef even with an improved product presentation and a prefilled syringe.

Aponvie has the same active ingredient as Cinvanti, but it is indicated for the prevention of postoperative nausea and vomiting as opposed to chemotherapy-induced nausea and vomiting for Cinvanti. However, as the situation stands today, I have no reason to be bullish about Aponvie any more than I am on Cinvanti and I will be skeptical of Aponvie's growth prospects until I see the product getting traction.

And before I move to the potential positives, Heron's cash position is not that great at the moment. The company ended 2022 with $85 million in cash and equivalents and it burned $27.5 million in the fourth quarter (this number excludes a $10 million milestone payment in the fourth quarter). It will more than likely need to raise cash in the following months.

Not everything is terrible

And while nearly everything I wrote until now sounds very negative, there are reasons to be bullish on Heron going forward.

The first reason is the above-mentioned changes at the top. A refreshed management team could inspire positive changes and improve the sales trajectories of all products in the following quarters.

The new CEO presented at the Needham Healthcare Conference this week and he was surprisingly honest about how bad the situation is and that there is a lot of work to be done to turn the ship around. Among other things, he said there will be changes around the sales processes, and the structure of the teams, and there will be some cost-cutting as well. And it also appears his current thinking is to focus more on the launch of Aponvie in the near term as it is a much easier sales process than Zynrelef and wait for the expanded label for Zynrelef to put the focus back on it and longer-term, wait for the completion of development of the prefilled syringe.

The second reason is that Heron has a stable and growing revenue base. Granted, the growth rates are not exceptional, but the launch of Aponvie and the incremental gains of Zynrelef, Cinvanti, and Sustol should reduce the cash burn going forward.

Gross margin should improve considerably in the following quarters as well due to the implementation of large-scale manufacturing and this should result in more than $25 million higher annualized profits in the following quarters (unless Quart overpromised on this as well). This too should significantly contribute to reduced cash burn in the following quarters.

The third and final reason is Heron's valuation. It is trading at a very low enterprise value to revenue multiple (around 3.5) and it could end up being acquired by a company that has higher scale and that can be profitable with a $150 million to $200 million revenue base. Such a company would likely be able to extract $40-50 million in annual cash flow from a $150 million revenue base.

Based on the management changes and the combination of improved gross margins, some revenue growth, and a very low valuation, I believe the company can deliver shareholder value from current levels, although I say this with reduced conviction now that it is more or less clear that Zynrelef is unlikely to be a considerable competitor to Pacira BioSciences' (PCRX) Exparel anytime soon.

Conclusion

There is not much to like about Heron at the moment, but the potential for value creation from current levels is still there. The company is likely to continue to grow revenues, gross margins will likely improve, and the combination of the two along with some additional cost-cutting will likely contribute to a much lower cash burn and push the company closer to cash flow breakeven.

The wild card in the following quarters is the launch of Aponvie. If it grows much better than my very modest expectations, it could completely revive the company even if Zynrelef's growth rates do not improve after it secures an expanded label later this year and after the product presentation is potentially improved by mid-2024.

The most important issue to solve in the near term is the low cash balance and if this is done right, it could put a floor under the stock and fuel a real turnaround in the following quarters and years.

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