2023-07-13 08:00:00 ET
Summary
- Rockwell Medical Inc, a microcap company, is gaining attention due to a compelling turnaround plan.
- The company is pivoting back to its core business, ceasing commercialization spending on Triferic.
- Despite this shift away from costly Triferic development, Rockwell's core business faces challenges; thin margins, and strong competition.
Investment Thesis
Rockwell Medical Inc ( RMTI ), a once overlooked microcap, now finds itself under investors' spotlight, largely due to its seemingly straightforward turnaround plan — ceasing spending on Triferic, a drug project that has strained the company's financial resources for decades with minimal economic returns.
The decision has undoubtedly relieved stakeholders, as demonstrated by the spectacular rise in the share price. Still, it also refocuses attention back on RMTI's core business, primarily dealing in Haemodialysis Acids and Bicarbonates. This sector is notorious for its razor-thin margins and peculiar market structure, where Fresenius Medical Care AG ( FMS ) controls supply and demand, creating challenging competitive dynamics. Most of RMTI's sales are attributable to a handful of customers, giving them substantial bargaining power. Historically, RMTI had to sell its products at a loss, restricted by harsh supply contracts that disregard inflation.
It was these very challenges that initially prompted the development of Triferic two decades ago. So, while a 'back-to-basics' approach might seem attractive, we must remember that the core business carries its unique set of challenges.
The positive market response to RMTI's turnaround plan is attributed to the cessation of Triferic's cash hemorrhage and its straightforward narrative. Still, amid the positive reaction to the new strategy, it's critical to maintain sight of the persistent hurdles RMTI must surmount.
In order to understand RMTI's market dynamics and current state, it's essential to delve into the history that formed these conditions.
The Path to Now: How We Arrived at Today's Crossroads
Back in 1994, at the age of 31, Robert Chioini was already a successful regional sales manager at Gambro Healthcare, selling dialysis concentrates for renal care clinics. Dialysis concentrates consist of widely-available chemicals such as sodium, calcium, potassium, and bicarbonates, typically produced using standardized formulations. They are often sold in 55-gallon drums (the blue container below) or four 1-gallon jugs in a cardboard package pictured below.
Medline.com
Like many accomplished sales managers, Chioini realized that he possessed the industry knowledge, connection, and sales expertise to spearhead his own venture. A year later, in 1995, encouraged by the ease of access to the basic chemicals used in the production of Dialysates, Chioini founded Rockwell Medical Supplies LLC, which later became Rockwell Medical Inc.
Aware of the commodity-like nature of dialysis concentrates, which helped him enter the market in the first place, Chioini set his sights on two parallel objectives. Firstly, he worked towards ramping up sales to reap the benefits of economies of scale. Secondly, he explored opportunities to make RMTI's products stand out to improve margins.
The opportunity for the latter emerged when RMTI obtained a license for a patent associated with iron delivery in 2001. This patent introduced the idea of delivering an iron-based chemical compound through the dialysis machine, replacing oral and IV iron for dialysis patients who often suffer from iron deficiency.
RMTI's legal and scientific consultants slowly laid the groundwork for pre-clinical trials for the newly-acquired iron delivery platform. Specifically, the consultants were tasked with selecting the appropriate iron complex. Although the 2001 patent introduced the concept of iron delivery through dialysis, it provided only a broad description of the iron complex, namely that it should be non-polymeric, soluble, and chemically stable.
A complex selected according to the invention is non-polymeric; soluble in an aqueous medium; chemically stable, thereby preventing the dissociation of iron ions from the anions under conditions according to the invention; and can be well absorbed into blood and the living body. Also provided are dialysate compositions including therein an iron complex selected according to the invention, and dialysate concentrates which may be diluted to yield an inventive dialysate composition.
Source: Patent No. 5,906,978
In 2005, RMTI made a choice (Patent No. 7,857,977 B2) — Ferric Pyrophosphate Citrate, later marketed as Triferic. Interestingly, this is the same compound that food processing companies use to fortify cereals and other food products with iron.
When blended with dialysis concentrates, this product could tackle the prevalent issue of iron deficiency among dialysis patients. The patent, however, was a theoretical proposition and required clinical trials and FDA authorization. Still, things were looking good at the time. By 2003, RMTI achieved a break even on a net-income level.
Despite the initial optimism, the excitement soon faded. Net income margin peaked at a meager 1.2% in 2004. Although sales increased, margins remained subdued, hovering just above break-even between 2003-2005, primarily due to high shipping costs and lack of differentiation.
These dynamics prompted the long and arduous journey of developing Triferic, which lasted nearly two decades, during which RMTI spent more than $180 million on R&D alone, not to mention a substantial amount of capital expenditure and other operational costs linked to the Triferic platform.
The company's journey during these two decades was far from smooth, proving to be an emotional rollercoaster for all involved, oscillating between anticipation and despair. By 2016, analysts had stopped coming to the company's earnings calls. In 2018, the board booted the CEO and co-founder, and since then, the company has had four different CEOs.
When RMTI finally announced the suspension of its efforts to commercialize Triferric last November, the decision was understandably met with a sense of relief rather than disappointment.
Despite a significant effort through which we spoke to every major player in this therapeutic area, both big and small, we were unable to identify a partner willing to license or acquire this product. It is with this information that we have made the difficult decision to discontinue Triferic in the United States and eliminate the expense, ultimately saving money for Rockwell going forward.
Source: Mark Strobeck, CEO, Q3 2022 Earnings Call
Core Business: Unfavourable Market Dynamics
The US dialysis concentrate market operated without an independent national supplier for decades. RMTI emerged as the first, offering concentrates as its primary business in a market dominated by dialysis clinics that produce their concentrate supplies. (Note: RMTI sells other ancillary dialysis products such as tubes and needles)
Until 2005, RMTI's main competitors were two of the top three dialysis clinics producing in-house concentrates for their clinics; Gambro AB and Fresenius Medical Care AG & Co KGaA .
In 2005, DaVita ( DVA ) acquired Gambro's US dialysis clinics. Interestingly, DVA didn't acquire Gambro's concentrate business. Instead, a few months after the deal with DVA, Gambro exited the US dialysis concentrate market. This move reinforces my belief that the model of an independent national dialysis concentrate supplier lacks long-term viability.
Since then, RMTI stood as the only national US company focusing primarily on concentrate provision, despite many life sciences companies with the capacity to produce dialysate concentrates.
The lack of competition in this $380 million market stems from the sector's peculiar structure. Two customers control 75% of the dialysis clinics in the US; DaVita and Fresenius Medical , with nearly equal market share. Out of these two, only DVA is open to buying acid concentrates, given FMS's self-reliance. FMS is the largest supplier of dialysis concentrates.
As the second-largest supplier, RMTI has undoubtedly carved a niche for itself. However, a crucial question remains unanswered, whether this niche, despite its sales success, translates into a profitable venture.
RMTI has three principal customers; DaVita, Baxter International ( BAX ), and Nipro Medical, a subsidiary of Nipro Corp ( NPRRF ), making up roughly 80% of the total sales. Intriguingly enough, Baxter and Nipro, despite being dialysis concentrate manufacturers themselves, are among RMTI's clientele. I believe this somewhat unconventional business arrangement could be a result of RMTI's specialization in the liquid concentrate market, distinguishing itself from its competitors, who predominantly produce powdered concentrate.
The use of powdered concentrate holds logistical advantages, predominantly its reduced transportation and storage costs. Therefore, RMTI's decision to specialize in the heftier liquid concentrate form while generating sales puts it at a logistical disadvantage, a factor that hampers its profitability in a market notorious for razor-thin margins.
To navigate this logistical minefield, RMTI relies on its subsidiary, Rockwell Transport LLC, to manage its distribution. However, transport costs have been a consistent challenge for RMTI.
On the transportation side of things, I think, we're trying to identify maybe some of the – for the quickest movement, some of the routes where we may be able to book some additional revenue with the trucks that are traveling empty that we haven't finalized that analysis yet, but we're getting close.
Source: Russell Skibsted, CFO, CBO, Q1 2021 Earnings Call
Rockwell has three manufacturing facilities in Texas, South Carolina, and Michigan. Only the Texas facility is ISO-13485:2016 certified.
International Partnerships: More Hype Than Profits
Triferic is an FDA-approved iron replacement therapy, distinguished by its unique delivery method. It's mixed with the dialysate and then administered to hemodialysis patients. Further building on the same platform, RMTI developed another iron replacement therapy, Triferic AVNU, designed for intravenous 'IV' injection delivery.
Although RMTI has suspended Triferic commercialization in the US, the company allows its international partners to continue their efforts abroad, given that these partnerships require minimal capital from RMTI itself.
International partnerships require very little capital and operational resource expenditure from Rockwell and have the potential to generate near and long-term revenue for the company
Source: Mark Strobeck, CEO, Q3 2022 Earnings Call
These international endeavors are yet to yield meaningful economic benefits, despite the fact that some of these partnerships have held regulatory approval for years.
Canada
RMIT's clinical trial for Triferic Dialysate and Triferic AVNU ran across the US and Canada, with US approval obtained in Q1 2015 and Q1 2020, respectively. Beyond the US, RMTI management had plans to commercialize Triferic Dialysate in Canada.
We have also executed a distribution agreement to market Triferic in Canada, where we anticipate commercial availability in 2019 after regulatory approval.
Source: 2016 Annual Report
In April 2021, RMTI announced it gained marketing approval for Triferic AVNU.
The approval of Triferic AVNU by Health Canada is the first international regulatory approval for our intravenous therapy and marks important progress for our strategy to bring Triferic to markets around the world,” said Russell Ellison, M.D., M.Sc., President and Chief Executive Officer of Rockwell Medical. “There are more than 20,000 Canadians undergoing dialysis. We expect Triferic AVNU to be an important new treatment option for dialysis clinics and the patients they serve.” Rockwell Medical has a distribution agreement with RMC Health Care, Inc., through which Rockwell Medical will receive a transfer price based on Triferic AVNU sales in Canada.
Source: RMTI Press Release Dated April 27, 2021
However, plans to commercialize Triferic dialysate have been quietly dropped. In April 2022,, RMTI filed its annual report for the year ended 2021. On page 17, RMTI states that it terminated its distribution agreement with its partner in Canada and is looking for a new distributor.
However, upon examining Health Canada, which functions similarly to the FDA in the United States, I found that the status for Triferic AVNU is listed as "Cancelled Pre Approval," which implies that the market authorization for the drug has been revoked before it received approval for sale. Moreover, there are no records of Triferic Dialysate on the Health Canada website.
Health Canada
The hurried exit of RMTI from the Canadian market is a cautionary tale to investors — enthusiasm doesn't guarantee a successful outcome. Despite the fanfare around current operations in China, Chile, Turkey, Peru, and Korea, it's crucial to remember that introducing a failed drug into international markets carries significant uncertainty.
Korea
On September 9, 2020, RMTI shares surged 15% following the announcement of an exclusive agreement with Jeil Pharma, a leading biotech firm in Korea, to develop and market Triferic in the Asian Republic. In January 2022, RMTI announced that its Korean partner obtained regulatory approval for Triferic Dialysate. This accomplishment led to the commencement of product commercialization in July 2022
In July 2022, Jeil Pharmaceutical commercially launched Triferic in South Korea.
Source: RMTI 2022 Annual Report
Jeil Pharma acknowledges its association with RMTI on its corporate website. The Ministry of Food and Drug Safety- Korea also lists Triferic in its 2022 Drug Approval Report .
2022 Approved Drug List Showing Triferic (Ministry of Food and Drug Safety- Korea)
However, a cursory look at Q1 2023 financial data reveals that the South Korean market's contribution to revenue was a scant $5,200, highlighting the significant challenges that RMTI continues to grapple with in achieving meaningful international market penetration.
Jeil Pharma Acknowledging Rockwell Partnership on Corporate Website (Jeil Pharma)
India
Unlike many emerging economies, India requires that new drugs, even those approved by the FDA, undergo clinical trials within the country before approval. This has led many biotech companies to incorporate Indian patients in clinical trials. Take, for instance, Eli Lilly's ( LLY ) 2019 trial for Lasmiditan, where 100 of the 1600 participants were from India.
RMTI's initial focus on the US has undoubtedly influenced the study's design. This decision now carries ripple effects as the company changes its course to focus on international markets, reminding it of the challenges of turnaround initiatives and the difficulties faced when shifting directions.
The Central Drugs Standard Control Organization "CDSCO" oversees drug approvals in India. Industry pundits might note the existence of waivers and exceptions in the amended 2019 Drug and Clinical Trials Rule, which gives the CDSCO the power to grant exceptions for drugs approved in certain regions. However, these waivers target medicines with a solid market presence in their countries. This is not the case for Triferic.
RMTI entered a licensing agreement for Triferic in India with Sun Pharma in January 2020, preceding the agreement signed with Jeil in Korea. However, while Jeil has entered the commercialization phase, data from India's clinical trial registry shows that a clinical trial for Ferric Pyrophosphate Citrate was only registered in June 2022. As of now, no patients have been recruited for the study.
Clinical Trials Registry- India
Additionally the approval process for the ethics committee is still ongoing.
Clinical Trials Registry - India
China
In China, RMTI started a collaboration with Wanbang Biopharma, a subsidiary of Shanghai Fosun Pharmaceutical, back in 2016. Last year, RMTI announced that its China partner completed the enrolment of 400 patients in a phase III study for Triferric. However, tracking the progress of this partnership on the ground has proven challenging.
Despite thorough research using various keywords and combinations on the Chinese Clinical Trial Registry, my attempts to locate the specific trial related to Triferic have been fruitless. RMTI wasn't available for an immediate response regarding the status of Triferic's clinical trial in China.
Peru and Chile
RMTI partnered with Quimica Europea in Peru and Commercializadora Biorenal SpA in Chile in 2017 to commercialize Triferic in South America.
Marketing approval was achieved in Peru in 2019 and in Chile in 2020. Since then, the challenge of including the drug in national formulae persisted.
As I frequently point out in my articles, the healthcare sector is characterized by a herd mentality, following a group of key opinion leaders responsible for setting the Standards of Care and Practice Guidelines. Whichever health care provider adopts Triferic would make a lone pioneer in this scenario. (Note: Current standard of care for Iron Maintenance in dialysis patients is Venofer, produced by Vifor Pharma.)
Gross Margins: Multi-Faceted Challenges
RMTI's gross margins have declined in recent years for several reasons. First, rising inflation has significantly affected RMTI, especially given its long-term contracts with its largest customer DaVita. These contracts limit RMTI's ability to raise prices annually to offset inflation, demonstrating DaVita's considerable power over RMTI. Given the substantial implications of these contract restrictions, RMTI management tends to create fanfare each time it is renegotiated.
Another factor eroding RMTI's gross margin has been the write-off of inventory related to Triferic and Calcitriol, which resulted in exceptionally low margins between 2017-2022. (Note: We haven't talked about Calcitriol for brevity and focus. Long story short, RMTI didn't know how to manufacture Calcitriol, mirroring its narrow manufacturing capabilities)
Concerns over margins persist even when we exclude the exceptional circumstances of the recent period when the gross margin was impacted by inflation and the write-offs associated with discontinued drug operations.
For example, the average gross margin between 2000 -2015 (before the commercialization of Triferric) stood at a relatively low 12% mark, demonstrating the inherently thin profitability of RMIT's core business.
Further, the company is yet to show a capacity to enhance gross margins with increased scale. Between 2000 and 2015, margins remained relatively flat, despite revenue growing seven-fold, from $7.5 million in 2000 to $55 million in 2015. This stagnant gross margin contradicts the theoretical assumption that margins should expand with increased operational size.
Valuation
Deciphering the true value of RMTI is a challenging task. Despite operating for 26 years, the company has been profitable in only three. The recent cessation of its aggressive R&D spending on the now-discontinued drug development program has instilled hope among investors, triggering a stock price surge. Yet, while this change signals the potential for better financial performance moving forward, it's vital to recognize the second critical factor that has contributed to RMTI's historical underperformance: the challenging economics of its core business.
RMTI doesn't report segregated accounts for its dialysate and Triferic segments, leaving us in the dark regarding the company's true potential. However, in Q1 2022, management confessed that their core business had been leaking money for years, verifying what many pundits suspected.
We are reengineering our dialysis products business, which will generate a gross profit for the first time in several years. This is a business that Rockwell was originally founded on. This is a business that we believe may be able to generate a modest amount of cash flow to help fuel our growth opportunities for FPC
Source: Russell Ellison, CEO, Q1 2022 Earnings Call
These dynamics are evidence of qualitative challenges in RMTI's core business that aren't captured in Quant platforms, including Seeking Alpha's Quant System. Although Seeking Alpha's Quant Ratings are invaluable in screening potentially-incredible investment ideas, it is critical to incorporate non-quantitative dynamics that could impede the investment hypothesis. In the context of RMTI, this includes a structurally-disadvantaged core business facing challenges competing with local suppliers, suffering historical losses, and unbalanced consumer/supplier purchasing power stemming from a highly concentrated market.
To evaluate RMTI, we're left with a somewhat optimistic approach: adopting average net margins from varying commodity-like sectors that ignore RMTI's company-specific challenges mentioned above. These ratios, derived from Professor Aswath Damodaran's blog on NYU Stern School of Business portal, range from a conservative 2.5% in the telecom sector to a more promising 8% in specialty chemicals, with farming settling at around 5.7%. Applying these figures to RMTI's projected revenue of 80 million translates to a potential net income between $2 million and $6.4 million.
Thus, even under a rosy scenario of RMTI reaching profitability and successfully navigating through the company's specific challenges, we struggle to justify its valuation.
How I Might Be Wrong
Looking through RMTI's past earnings calls and press releases, I concluded that the design of its clinical trials might have impeded its ability to successfully commercialize Triferic in the US. The trials weren't designed to allow comparisons with competitor products, nor demonstrate potential reductions in ESA usage, the main selling points to investors. Thus, while management touted Triferic's potential benefits and superiority to investors, they couldn't play the same compelling tune to opinion leaders and customers. When they tried, RMTI received a warning letter from the FDA on October 2019, warning against false advertising and misleading information.
If Triferic could be marketed as a cost-reducing iron maintenance therapy that reduces dependence on expensive ESA (RMTI management claims Triferic reduces ESA usage by 37%), there could be a substantial market opportunity. That requires a more flexible drug label than the FDA granted RMTI in 2015. Thus, one can imagine the possibility that RMTI's international partners design their clinical trials in a way that ensures obtaining more accommodative labeling.
Yet, there is no indication the RMTI's partners who obtained regulatory approval, or those conducting clinical trials, have explored or are exploring this angle.
Summary
RMTI faces a challenging turnaround as it seeks to refocus on its core business of dialysate concentrate production amid adverse market dynamics and stagnant profitability, the same issues that propelled the company into venturing outside its primary business domain.
The potential opportunities on the horizon provide some optimism. These include the possibility of its international partners securing more flexible labeling for Triferic and navigating through obstacles like high shipping costs, inflation, and long-term contract constraints.
However, investors must remain cautious given RMTI's precarious financial situation and unproven ability to execute its plans.
For further details see:
Rockwell Medical: New Course Amid Market Challenges