As they say, don't bury the lede. So…

• AVITA Medical (NASDAQ: RCEL) might be the most attractive investment opportunity in the Solt DB coverage ecosystem right now.
• It has a 7.5% target allocation in my portfolio, which is my second-largest growth investment behind Relay Therapeutics (at a 15% target allocation).
• It has one of the largest discrepancies between the current share price and target prices in the Solt DB coverage ecosystem. The gap has recently exceeded 100%, leaving a pretty good margin of safety.

The medical device company expects to announce data readouts from two clinical trials, one in soft tissue repair and one in stable vitiligo, in the second half of 2022. There's no way to know when study results will be reported, but AVITA Medical reports second-quarter 2022 operating results after the market closes on Thursday, August 11.

Let's review the opportunity and provide price targets ahead of the next business update – just in case.

The ReCell System, Explained

AVITA Medical developed the ReCell System, which comprises a medical device and enzyme solution. A small patch of healthy skin is harvested from an individual, placed in the liquid enzyme solution, and separated into individual cell types. The mixture can be sprayed onto a skin wound to accelerate healing, reduce scarring, and shorten length of stay for inpatient procedures, saving costs for patients and health care systems.

How does the ReCell System work? Think about the last time you had a cut or scrape. At a microscopic level, your skin cells were pulled apart from each other. A minor cut or scrape may only pull apart cells in the top layer of skin (epidermis), whereas a deeper cut may impact multiple layers of skin (epidermis and dermis).

We all know what happens next. Your utter some profanities, bandage it up or get stitches, and wait for biology to do its thing. There are over half a dozen different types of cells that play a role in skin healing. However, healing rates are impacted by the free edges of the wound, or the new surfaces created when your skin cells were pulled apart.

• In healthy skin tissue, cells can communicate with each other, traffic nutrients and wastes, and execute their individual functions.
• In damaged skin tissue, all of that goes to shit.

Your body heals skin wounds from the free edges inward. It can be difficult or impossible to move all the correct skin cells to the correct places at the correct time. This is how scars form. Your body healed, but not perfectly due to biomolecular traffic jams.

The ReCell System overcomes the free edge by supplying all the correct cells to the entire wound, not just the free edge, to increase healing efficiency and accelerate healing time.

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The ability to overcome the free edge opens opportunities to treat burns, chronic wounds (ex: diabetic ulcers), traumatic injuries (ex: car accidents), deep cuts (ex: incisions from surgery), rare skin diseases, and more.

A Make or Break Second Half

AVITA Medical has full U.S. Food and Drug Administration (FDA) approval for treating burns in adults and pediatric patients. It took time to put all the pieces in place, but the business is well positioned for success:

• The ReCell System is used in over 80% of U.S. burn centers and over 90% of U.S. burn surgeons are trained to use the device.
• It has broad reimbursement coverage, including a new Medicare code that can be used in outpatient treatment settings (i.e. hospitals or clinics that send patients home after treatment).
• It recently inked a distribution deal with Premier that could provide ReCell devices to thousands of U.S. hospitals and medical centers.
• A second-generation device was recently approved by the FDA. It reduces the number of process steps by one-third, only requires one set of hands (some steps previously required two people), and 94% of surveyed users believe the improvements will reduce their workload.

The most recent full-year 2022 revenue guidance expected growth of only 19% compared to 2021. That's a little disappointing considering the U.S. burn market represents a $260 million revenue opportunity for the business, which is only scratching the surface with $30 million in expected revenue this year. However, management has been waiting for some of the above pieces to fall into place before expanding into higher volume outpatient treatment settings. A "walk before you run" situation.

Successful expansion into outpatient treatment centers could drive 50% revenue growth in 2023 – and that's just in burns. The ability to generate additional revenue next year hinges on two upcoming data readouts.

Soft tissue reconstruction: This study reached full enrollment of 65 patients in January 2022. The Biomedical Advanced Research and Development Authority (BARDA) agreed to help provide financial support for the study in March 2022. Soft tissue reconstruction / repair is a broad term that covers skin wounds from car accidents, industrial injuries, bacterial infections, and more.

There's a significant overlap between this indication and burns. Both are often treated in trauma centers by the same surgeons, which means the commercial infrastructure (sales and marketing teams) is already built and the kits are already sitting in inventory awaiting approval. Both use the same protocol. Both have the same reimbursement code, which means reimbursement is already in place for soft tissue reconstruction. This indication can generate revenue the same day approval is granted -- and scale rapidly from there.

Soft tissue repair represents a significant market opportunity with an estimated serviceable addressable market (SAM) opportunity of $450 million. That could expand to at least $1 billion if procedures outside of high-volume trauma centers are included.

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Stable vitiligo: This study reached full enrollment of 23 patients in December 2021. In this indication, the ReCell System is being used for aesthetic purposes. Vitiligo is characterized by patches of skin that have lost pigmentation. There are no health consequences of the skin disorder, but it can have a significant impact on quality of life.

There's no wound to heal, so doctors create one. An abrasion is created on skin without pigmentation, harvested skin cells are sprayed onto the area, and pigmentation is restored. It's expected to be a one-time treatment.

Stable vitiligo represents a large SAM of $750 million, although the total market opportunity could exceed $5 billion.

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You'll notice the qualifier "stable" included in the name, which means depigmented skin patches that haven't changed in so many months. That represents a smaller opportunity than the entire population of vitiligo patients, but there are tailwinds.

Incyte Corporation recently earned FDA approval for Opzelura, which became the first and only product approved to treat vitiligo. It's a topical cream comprising a JAK inhibitor that works by repigmenting affected skin patches. It also helps patients with vitiligo achieve stable disease. In other words, Opzelura expands the market opportunity for the ReCell System.

Stable vitiligo is where the caveat mentioned in the headline resides for investors. A 23-patient clinical trial is ridiculously small. The FDA signed off on the study design, but it does inject some uncertainty into the upcoming data readouts. Regulators could want to see more data, which would force another study to be run and delay an approval decision by at least 12 months. Not the end of the world, but far from ideal for the business.

The ReCell System has earned regulatory approvals on multiple continents for burns, soft tissue repair, stable vitiligo, and other conditions. It's been used to treat over 15,000 patients globally. Investors know the product works, but that doesn't mean the small study will live up to the statistical rigor of regulators. If there's a negative surprise in the second half of 2022, then results from the stable vitiligo study are likely to be it.

What's an Attractive Entry?

The current risk/reward for AVITA Medical is considered favorable. This is considered an investment-grade Growth (Speculative) position. Current entry targets for the company are as follows:

• Current valuation (market close August 8): $196 million / $7.84 per share
• Attractive Near: $300 million / ~$10.00 per share
• Prioritize Below: <$250 million / ~$8.33 per share
• Avoid Above: $400 million / ~$13.33 per share

The business reported 24.96 million shares outstanding as of May 1st, 2022. The valuation estimates above are based on a year-end total of 30 million shares outstanding, which accounts for a public stock offering resulting in 20% dilution.

I expect AVITA Medical to end 2022 with a market valuation near $400 million, which assumes the market begins to price FDA approvals into the share price.

If shares pop after the upcoming data readouts, then investors can expect AVITA Medical to announce a public offering of common stock to raise up to $50 million in gross proceeds. That's the lowest-hanging fruit from a fundraising perspective. Other possibilities include debt financing or cash payments from a collaboration.

• Debt financing could be a viable option for the business because the ReCell System is generating high-margin revenue. Right now. In the real world.
• It would make sense to find a commercial partner for the stable vitiligo indication. AVITA Medical doesn't have the commercial infrastructure in place to optimize that market opportunity on its own. Bringing in a larger, wealthier, and more experienced partner could be a win-win situation. AbbVie (via Allergan) could make sense, or a half dozen lesser-known non-drug leaders in dermatology. A collaboration could yield an upfront cash payment of up to $100 million.

The best-case scenario for the next 18 months might look something like this:

• AVITA Medical announces successful clinical trial results in both soft tissue repair and stable vitiligo in the second half of 2022.
• The FDA approves the ReCell System in soft tissue repair on an accelerated timeline (due to medical need) and in stable vitiligo by the end of 2023.
• The Biomedical Advanced Research and Development Authority (BARDA) releases the remaining $17.9 million from the original contract as it purchases more ReCell devices for the strategic national stockpile, albeit for soft tissue repair indications. The amount would be realized as revenue before the end of 2023, pending manufacturing capabilities.
• The company finds a commercial partner for stable vitiligo and grabs an upfront cash payment of up to $100 million.
• The cash infusion is used to accelerate key initiatives for the core business, including outpatient treatment expansion for burns and soft tissue repair, expanding manufacturing capabilities, and starting a clinical trial evaluating the ReCell System in chronic wounds (a massive market opportunity).
• The company finds a commercial partner for its anti-aging / aesthetics ambitions, which will need to be developed using the lengthier and more expensive drug pathway (phase 1, phase 2, phase 3…). This would result in an additional upfront cash payment to AVITA Medical.

None of the above is outlandish wishful thinking. AVITA Medical could deliver on each before the end of 2023. Successful execution (even if one or two of the above don't materialize) would set the business on the path to generate at least $100 million in revenue by 2024 or 2025. That could earn a market valuation of $800 million to $1 billion depending on accepted valuation multiples on the other side of the recession. The company is valued at less than $200 million today.

Ol' Maxxie's Position

AVITA Medical has a target allocation of 7.5% in my personal portfolio. It represents my second-largest Growth position behind Relay Therapeutics (at a target allocation of 15%).

Further Reading

• February 2022 press release announcing FDA approval of second-generation ReCell device
• March 2022 press release announcing supply agreement with Premier
• March 2022 press release announcing BARDA funding for soft tissue reconstruction study
• July 2022 press release announcing FDA approval of Opzelura for vitiligo

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