2023-04-04 08:47:51 ET
Summary
- Harrow Health began commercial operations in 2014 with no products or customers, and today is the largest U.S. ophthalmic focused pharmacy.
- Harrow entered an opaque market filled with middle men and dissatisfied ophthalmologists. Harrow understands their customers, solves their pain points, and has earned their trust. This is a deep moat.
- Growth so far has been robust, to say the least, with revenue up 10x in the past 7 years, from ~$10M to ~$90M. $1B revenue in 2026 is plausible.
- Harrow's new drug, IHEEZO, was recently awarded an FDA J-Code. IHEEZO is the only ocular anesthetic with this designation, conveying massive advantages. IHEEZO may generate $1B revenue all by itself.
- As good as IHEEZO is likely to be, the thesis does not depend on it. Harrow's other operations and equity ownership are likely to drive FCF above $5/share, perhaps as soon as 2025.
Harrow Health ( HROW ) was born when its entrepreneurial CEO, Mark Baum, spoke with doctors in the eye care market, found their pain points - they were not happy! - and set out to solve them. Ophthalmologists had a lot to complain about, feeling poorly served by the existing group of producers, distributors, pharmacy benefit managers, insurers, wholesalers, and pharmacy retailers. In short, a confusing and inefficient network of middle men feeding on an opaque system. Harrow was built in response to this, by listening to customers, as an efficient, transparent, and vertically integrated company with production, distribution, and marketing all under one roof. They are obsessively focused on understanding their customers' needs, and this is a core competence of the company. Customers love them as a result, and their legacy compounding business, ImprimisRx, has grown rapidly in its little niche to become the largest ophthalmic compounding pharmacy in the US in only 9 years. I first wrote about HROW last year, so check that out if you want to.
HROW's best of breed distribution and deep customer relationships have created a powerful opportunity for the company to add branded pharmaceutical products [BPPs] into their repertoire. HROW's move into BPPs makes obvious strategic sense, as they can acquire drugs which they have a high degree of confidence their customers actually want, and then efficiently deliver those drugs to an existing customer base that has come to trust them. Unloved or orphan drugs that are too small for the pharma giants to care about fall directly into the sweet spot for HROW, and in my view the company is perfectly positioned to exploit a once in a generation opportunity.
The expansion into BPPs is about to pay off in a big way, as their first major acquisition, IHEEZO, may have $500M or more annual revenue potential, and their second, a suite of drugs they've designated the Fab 5 , is expected to approach $200M. Notably, these acquisitions were accomplished with minimal share dilution. More acquisitions are likely on the way, as the company has recently developed a relationship with global giant Oaktree to facilitate these.
HROW is a growth company
Harrow began commercial operations in 2014 with no products and no customers, and today is the largest ophthalmic compounding pharmacy business in the U.S., a testament to both the vision and tenacity of its CEO. Here is revenue since 2015, all numbers are in . 2023 revenue is the midpoint of guidance.
Year | 2015 | 2016 | 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 |
Revenue | 9.7 | 19.9 | 26.8 | 41.4 | 51.2 | 48.9 | 72.5 | 88.6 | 140 |
Note that the only year revenue didn't ramp way up was 2020, the result of the pandemic.
IHEEZO
HROW bought IHEEZO in 2021 for peanuts from Sintetica, which was looking for a US distribution partner and retains a 5% royalty. IHEEZO is a surface ocular anesthetic that allows for pain free cataract surgery without resorting to opioids, and has patent protection through 2037. Zero patients in the clinical trial required opioid rescue, and reducing opioid dependency is a major focus in medicine today.
The addressable market for IHEEZO is huge. CEO Baum addressed this - at the time, pre-FDA approval, IHEEZO was called AMP-100 - on the February 24, 2022 Aegis call :
Without question AMP-100 is a huge opportunity for us. When you talk about 12.5 million annual procedures in a market that we have a strong foothold in... even 4.5 million cataract surgeries... we make drug currently for about one out of every 5, so a 20% market share within that cataract surgery market... and you take that unit opportunity and you multiply by... $600 dollar a unit range... you can come up with a multi billion dollar annual revenue opportunity for just AMP-100... that would not be possible... were it not for the core ImprimisRx business, because those customers that order from us month in and month out, those are the customers that we're going to bring AMP-100 to...
The economics here are staggering. We now know that IHEEZO will be priced at $544 per procedure. After paying the wholesalers, rebating to hospitals and physicians, and paying Sintetica's royalty, this works out to about $400 per procedure to HROW. And there are 12.5M procedures in the US. A 20% share would result in $1B of annual revenue to HROW, which one can compare to their 2022 revenue of just under $90M.
At the time of purchase, IHEEZO was not yet FDA approved, and still somewhat speculative. But since then absolutely everything has gone right, starting with early FDA approval in September 2022. Early approval was a great sign that regulators were positively disposed to the drug, but even so, the market was positively surprised when IHEEZO received a J-Code on Feb 2 2023. The stock was up more than 15% on the news, but this is a gross underreaction, as I will explain below. Further good news came when IHEEZO received transitional pass through status from Medicare & Medicaid.
The company has been ramping SG&A way up to prepare for IHEEZO's launch in 1H 2023. As a result, expenses have been elevated for more than a year against no associated revenue. And with SG&A already ramped up, any revenue from IHEEZO in the future will be netted against little to no incremental SG&A from here. Gross profits of perhaps $400 per procedure will almost entirely drop into pre-tax FCF.
IHEEZO will only begin ramping in the second half of 2023, and will not be a big part of 2023 results in my view. However, revenue will grow dramatically each year from there, to perhaps $1B in 5 years, and continue through patent expiration in 2037.
Pass through and J-code
Much of US healthcare is reimbursed according to a capitated model, in which healthcare providers are compensated on a formula based on expected costs. This encourages providers to reduce their own expenses for a given procedure as much as possible, given that any "extra" expense literally comes out of their own pockets. However, the US Congress has carved out some exceptions to the capitated model, including the J-code use in office settings and Medicare/Medicaid pass-through in surgery centers. In the case of IHEEZO, the former applies to roughly 8M annual intravitreal injections in the US, while the latter applies to roughly 4.5M cataract surgeries.
These exemptions exist in order to encourage medical innovation and to achieve policy goals. In the case of IHEEZO, the policy goal is to reduce opioid use, and IHEEZO has received a permanent J-Code and a 3-year pass-through exemption, as regulators believe IHEEZO may help reduce opioid use.
These allow for separate reimbursement of a given drug that regulators are attempting to support. This means a drug's maker can charge a relatively high price - $544 per treatment in the case of IHEEZO - but none of this is out of pocket to providers or patients.
This is obviously a huge economic incentive. HROW can charge a high price for IHEEZO, and then market it as not only a better choice for patients, but also free to patients and providers. Pass through is actually even more impactful than the J-code, since Medicare actually pays the provider to use it ! It's not a huge amount - about $30 in the case of IHEEZO - but still, if providers have to choose between a competing drug that they have to pay for, and a new, better drug that pays them? I'll let you decide for yourself if that will motivate them or not.
Note that competitors who lack a J-code or pass through will be at a competitive disadvantage compared to those that do. And, importantly, IHEEZO is the only ocular anesthetic with either.
Here's what CEO Baum had to say on the Q4 2022 earnings call on this topic:
In February, we received a permanent J-Code for IHEEZO, and just weeks ago, we received temporary pass-through reimbursement status, making IHEEZO the only topical ocular anesthetic in the U.S. eligible for reimbursement.
And then on J-codes and pass-through more generally:
a policy that Congress put into place that really facilitates innovation... in a capitated fee environment, there are not the incentives to pharmaceutical companies or for pharmaceutical companies to innovate... the policy really allows for innovators who come up with a novel product like IHEEZO... to receive payment outside of the capitated fee, outside of the bundled payment... IHEEZO... can be billed outside of the bundled fee beginning on April 1st. We are really excited about that...
we make drug at Harrow for about one out of every five cataract surgeries and so when you think about what that means in terms of numbers, there's 5 million or so cataract surgeries, it's about 1 million procedures a year. And so we are of the belief that our customers, many of them will be excited to try an FDA approved product... they will also be excited about the opportunity to... have reimbursement for the topical anesthetic, as opposed to having to pay for it out of their capitated fee...
Baum goes on to note that the J-code, which addresses a TAM of about 8M annual procedures, is permanent, at least through patent expiration in 2037:
in the office environment, the J-Code itself is permanent and what that allows is for physicians to use the product in that environment and to use the J-Code for payment and there is no limitation in terms of the number of years, unlike that of the ASC environment.
IHEEZO has so far received 3 year transitional pass-through on the Ambulatory Surgical Center [ASC] market, of about 4.5-5.0M annual procedures. However, Baum points out that in 3 years the company will be eligible to apply for permanent pass through status:
with respect to the temporary nature of the pass-through code, to be clear. We do intend to demonstrate that we may be able to extend that pass-through payment period as some other products in that environment have been extended, such as, OMIDRIA and DEXTENZA, but we will have to see how that goes...
The "Fab 5" acquisition
On December 14 2022 HROW announced a transformative acquisition , in which they would acquire 5 new drugs for as much as $185M. There is a roadshow slide deck you can check out, if you want to. HROW paid $140M up front, with a $45M milestone payment to be paid later if certain conditions are met. Funding included cash on hand, a $25M share issuance, and $100M of new 2027 debt at just over 11% interest.
The market's response to this announcement was quite positive, driving the stock price to a new all time high. But not anywhere near as positive as it should have been. It's easy to see why the market is confused, because the full power of the deal is understated in filings so far. Here's how HROW described the impact of the acquisition in the press release
Assuming this transaction closes during the first quarter of 2023, Harrow expects 2023 net revenues to be between $135 million and $143 million and adjusted EBITDA to be between $44 million and $50 million, with both net revenues and adjusted EBITDA ramping up during 2024 and beyond
and from the prospectus :
Management estimates that during the twelve months ended September 30, 2022, the Products acquired in the Acquisition with near immediate commercial availability (Ilevro, Nevanac, Vigamox and Maxidex) would have generated Adjusted EBITDA of $33.3 million...
A first impression might lead one to think that HROW is spending $185M to buy $33.3M of EBITDA, and perhaps $50M or revenue. That is not quite right.
There's a lot to unpack here, and I doubt the market understands most of it. First, just a technical point. They acquired 5 products, but only 4 of them have any TTM EBITDA. The fifth, Triesence, was not available during the past 12 months, and produced no EBITDA. The $45M milestone payment is for Treisence, once it's back in production and available. Adjusting for this, HROW is actually paying $140M for $33.3M of TTM EBITDA, and then another $45M for Triesence at some point in the future.
Actual EBITDA likely will be much higher than this once the company is able to support the growth. From the roadshow investor presentation:
within the past 5 years, aggregate gross sales of the Fab 5 products exceeded $200M per year... There is ongoing strong clinical need for the Fab 5 products, with demographic changes expected to further increase target patient populations... As a result of several factors, including the abandonment of marketing and sales detailing, sales of the Fab 5 products have declined...
HROW's thesis is that these drugs have tremendous potential, and that HROW will realize this. The company didn't overpay even if the drugs never turn around. But any progress from the current ~$50M level of sales - any at all -toward the historical $200M peak would be a huge win. Remember, HROW in 2022 had sales of ~$90M. The Fab 5 could easily be a lot bigger than the legacy company.
Here's what CEO Baum had to say on the Q4 2022 earnings call on the potential for the Fab 5:
This January, we completed our Fab Five transaction and we are currently working to transfer all the new drug applications connected to those products as quickly as possible, which will allow Harrow to begin the process of reviving marketing and sales detailing for ILEVRO, NEVANAC, VIGAMOX, MAXIDEX and TRIESENCE, products which in the aggregate in recent years provided north of $200 million in revenue for their former owner...
We believe that the market need for these products is largely the same today as it was back then when these products were doing $200 plus million in revenue and we are very excited to release our commercial organization in this effort.
More accretive M&A is probable
The company established an initial funding relationship with international giant Oaktree , replacing B Riley as the primary lender on $100M of funding. A virtually unlimited level of capital is now available to them in the future for any acquisitions that make financial sense.
Here's what CEO Baum had to say on the Q4 2022 earnings call about the potential additional highly accretive M&A:
I want to add that we are not stopping our momentum. In fact, we are currently working on several M&A transactions that are in various phases of closure, including some which are at an advanced stage.
We believe closing any one of these deals could add rocket fuel, if you will, to our growth trajectory for this year and for many years to come. And while I can't guarantee that any of these transactions will be consummated, I think our recent record for executing complementary M&A transactions speaks for itself.
New product launches: Fortisite and Atropine
The company called out two other major developments last year, Fortisite and Atropine .
Fortisite
Fortisite is a shelf stable fortified antibiotics solution administered as eye drops to treat eye infections. Antibiotics are prescribed for roughly 1 million eye infections each year in the US. The legacy compounds are not shelf stable, however, so doctors cannot store them at the office. Instead, the product has to be rush ordered and delivered after a day or two, delaying treatment and potentially putting the patient's sight at risk. With Fortisite, a doctor can keep some in a refrigerator at the office and treat patients immediately. Here's what Baum had to say on the Q2 2022 call :
fortified antibiotics are used all over the country to treat sight threatening conditions. And unfortunately, there is no FDA approved product... formulations are compounded at local pharmacies... There is no way for an eye care professional to actually stock the medication... when a patient presents with a sight threatening condition... eyecare professionals want to have access right then and there...
the formulation that we've been able to create... will allow an eye care professional for the first time to have in their office a medication, a fortified antibiotic product, to prescribe to these patients and make sure that at their office at the time the patient presents, they will be able to know that that medication is on the patient's eye and that they are being treated for... [a] potentially sight threatening condition... No one else has it and we're going to bring it to the market.
The market opportunity for Fortisite is over $200 million annually, with a price point over $200 per treatment, with more than 90% gross margins. While it's not clear what share HROW will earn, they have a genuinely superior product, and might therefore get some real traction. Given that HROW's revenue in 2022 is roughly $90 million, it could be a needle mover.
Atropine
The second new launch, Atropine , is a product in which HROW has no special product advantages. Atropine is used to treat myopia and presbyopia, and is expected to have a huge end market, estimated at $4.5 billion in 2028 . While HROW is able to sell Atropine today as a compounded product, the economics will most likely be captured by branded, FDA approved drugs. There is a major effort underway to develop these, and HROW is not a contender.
However, HROW is advantaged as the largest distributor in its tiny niche, and owns the Atropine.com domain name. The company believes Atropine could prove to be a needle mover, perhaps on par with Fortisite. HROW's role would be as a compelling distribution partner for those who ultimately own the patents. I do not have insight into this other than to say it's plausible, and even a tiny fraction of $4.5 billion will make a big impact on tiny HROW.
Hidden assets: Melt and surface
Harrow has made a regular habit of starting businesses opportunistically that don't necessarily fit into their core mission. Harrow deconsolidates these and arranges for outside financing and independent leadership, but retains equity ownership and royalty rights. A case can be made that these hidden assets may be worth more than Harrow's current market cap. They are:
- Surface Ophthalmics. Harrow owns 20% of the equity and retains a 4% royalty on all 3 of Surface's chronic dry eye drug candidates. There's been a very positive outcome in phase 2 trials at Surface, which has revenue potential in the hundreds of millions of dollars. While Harrow is probably not the ideal commercialization partner for these drugs, if one of Surface's drugs is approved the equity will be monetized for many tens of millions of dollars, while the royalty might be $10 million a year, with no offsetting expenses.
- Melt Pharmaceuticals. Melt recently completed a successful pivotal phase two trial, easily besting the current standard of care drugs for non-IV non-opioid sedation and analgesia. The phase 3 trial is expected to be conducted against a placebo, virtually guaranteeing success, and launch is expected in 2026 or 2027. Melt's addressable market is ~100 million annual procedures in the U.S., a $20B addressable market at the proposed $200 price point. It's easy to imagine Melt as a $1 billion drug, or more, if things go well. Harrow owns a 46% equity stake, a 5% royalty, and a $13.5 million note. It's not hard to imagine an eventual royalty stream from Melt of $1 per share or more, plus monetization of the equity and repayment of the note.
Valuation
I estimate $1B of revenue for HROW no later than 2028, and perhaps as soon as 2026. If we use even $500M of revenue for 2025, that works out to $300M of fully taxed FCF. On roughly 30M shares, that's $10 a share. Put a 15 multiple on that and we are at $150, and then add in another $20 for Melt and Surface. That's a $170 price target for 2025.
Risks to the thesis
The main risk to HROW is that both IHEEZO and the Fab 5 will, for some reason, simply not be able to ramp up anywhere close to the kind of revenue I expect them to. Either one by itself could be an absolute dud and the stock would still be far too cheap. This would also be the case if they achieve half, or even one third, of my revenue projections. But if both IHEEZO and the FAB 5 simply fail, HROW investors would have to rely on a successful outcome at Melt and Surface to achieve a good outcome. And while these, along with the legacy compounding business ImprimisRx, would probably still be worth more than the current $21 share price, it would be far from certain at that point.
Conclusion
HROW is a fast growing business with earnings potential above $10 a share as soon as 2025. The company is run by its obsessive and entrepreneurial founder, Mark Baum, who built this best of breed business from nothing to where it is today in only 9 years. Harrow possesses a deep moat in its niche ophthalmic market, because it understands its customer base and has earned their trust. For this reason the new products are likely to succeed, and if they do then the company is trading at 2x forward earnings. Harrow also possesses hidden assets that may generate equity monetization and royalty streams worth perhaps as much or more than the entire market cap of the company today.
It's likely that Harrow will be up tenfold or more in a few years. At 2x 2025 earnings, I believe the price is absurd, and the stock should be bought.
For further details see:
Harrow Health: Buy This Deep Moated Stock Ahead Of Massive Growth