AVITA Medical (NASDAQ: RCEL) remains one of the most attractive investment opportunities in the Solt DB coverage ecosystem and the stock market at large. The business has a relatively unobstructed path to $100 million in annual revenue in the next few years, which would mark a sharp improvement from expected revenue of $30 million in 2022. Importantly, the business could achieve profitable operations soon after hitting that milestone.

If the company executes, then revenue from burn treatments and soft tissue reconstruction alone could eclipse the $100 million mark. Of course, the biggest near-term market opportunity remains stable vitiligo. It boasts a serviceable addressable market (SAM) opportunity – the portion of the total addressable market (TAM) opportunity that can be reasonably captured – larger than burns and soft tissue reconstruction combined.

Commercial success will require building new commercial infrastructure and earning robust reimbursement coverage. Management may not even launch ReCell in stable vitiligo until the U.S. Food and Drug Administration (FDA) approves an automated, third-generation device now in development.

Before we all get carried away with market launch, we need to focus on the upcoming data readout from the pivotal clinical trial. It represents the biggest source of uncertainty for AVITA Medical stock, but a successful outcome could earn the business a sharply higher market valuation for good.

Stable Vitiligo, Explained

Vitiligo is a skin condition characterized by patches of skin that lack pigment. These patches, called vitiligo lesions, often appear as pale skin. The contours can change over time. Although the skin condition doesn't impact health, it can take a devastating toll on an individual's quality of life.

In July 2022, the FDA approved a topical medication called Opzelura that demonstrated the ability to repigment vitiligo lesions and help individuals achieve stable vitiligo, which is characterized by lesions that don't change in size. Repigmentation isn't perfect and individuals need to continuously apply the cream to maintain results, but Opzelura is the only approved treatment option.

AVITA Medical intends to use the ReCell System to treat stable vitiligo with a one-and-done treatment. The process is similar to any other use of the device:

• A dermatologist makes an abrasion on a vitiligo lesion ("recipient site") with a CO2 laser. This is the only part that differs from treating burns or a soft tissue injury, which already have an existing wound.
• A patch of pigmented skin is harvested ("donor site"), expanded in the ReCell device, and then applied to the vitiligo lesion.
• When the recipient site heals it will have similar pigment (hair, too) to the donor site.

It's important to point out that Opzelura can help individuals achieve stable vitiligo, which means Opzelura can increase the number of individuals who qualify for treatment with the ReCell System.

Stable Vitiligo Study, Explained

AVITA Medical designed a clinical trial in stable vitiligo before the coronavirus pandemic, but struggled to enroll individuals during lockdowns and before vaccines were widely available. The FDA agreed to allow a smaller, less complex study. That could come back to haunt the company if results are underwhelming.

• The clinical trial originally aimed to enroll only 23 individuals, but eventually ended up enrolling 49 individuals.
• Each participant had multiple vitiligo lesions treated – at least one with the ReCell System and at least one with placebo – to increase data collection and speed. That means the "n" in statistical significance calculations will represent the number of lesions, not the number of individuals.
• The expansion ratio in the clinical trial is 1:20, which means the skin harvested from the donor site will be 5% of the surface area of recipient site. This is a relatively diluted treatment compared to past ReCell studies in stable vitiligo, some of which used a 1:5 or 1:10 expansion (and also as high as 1:30).
• All lesions in the study will receive narrowband ultraviolet B (NB-UVB) therapy, which represents the current standard-of-care for vitiligo. It's akin to comparing an experimental cancer drug to chemotherapy.
• The primary endpoint of the study is the difference in responders between the ReCell group and the placebo group. A lesion is considered a responder if it achieves at least 80% repigmentation at Week 24.
• There are numerous secondary endpoints that may not be included in the initial announcement, but could have a significant impact on commercial success. These include patient, physician, and independent feedback on subjective measures such as color matching, satisfaction, and so on.

At a high level, the clinical trial will be successful if ReCell achieves a statistically significant improvement in repigmentation compared to NB-UVB treatment alone. There's not much regulatory wiggle room on this one. Failing to meet the primary endpoint will likely require AVITA Medical to conduct another study, possibly with more concentrated donor expansion (1:15 or 1:10).

On the one hand, the ReCell System has been used in many stable vitiligo studies in the last 15 years and the product has earned approvals on multiple continents.

On the other hand, the study design creates challenges. A 1:20 expansion is relatively diluted and defining responders as at least 80% repigmentation is relatively high.

A study completed in 2019 used a 1:5 or 1:10 expansion ratio. Over 80% of individuals showed "good response" and 17% showed complete or near-complete remission at Week 24. Unfortunately, the minimum repigmentation level required for a "good response" is much less than the 80% in the current study.

The primary endpoint is proving superiority to the standard of care, which means helping 20% of individuals achieve at least 80% repigmentation could still be considered successful. Would a 20% chance at a better life be meaningful for patients? That's what I care about as an investor.

Whether or not dermatologists come to rely on ReCell in the market might depend on the secondary endpoints such as patient satisfaction. Additionally, multiple secondary endpoints will attempt to measure repigmentation in four categories: 0% to 25%, 26% to 50%, 51% to 79%, and 80% to 100%. It's reasonable to expect most ReCell-treated lesions to end up in the 51% to 79% repigmentation group.

The data readout -- expected any day now -- will have a significant impact on the share price.

Management has expressed confidence almost to the point of hubris. Whereas executives of drug developers usually issue carefully-worded statements ("if approved"), AVITA Medical management seems to take approval for granted. Although the ReCell System has earned global approvals in stable vitiligo in the past, I'm not sure the current study design will result in a slam dunk outcome.

I've long stated that this study represents the biggest source of uncertainty and the biggest potential for a negative surprise. We'll all find out soon.

Price Targets

(No change.)

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 September 1): $155 million / $6.19 per share
• Attractive valuation: $300 million / ~$10.00 per share
• Consider prioritizing: <$250 million / ~$8.33 per share
• Feel good adding up to: $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.

Further Reading

• Clinicaltrials.gov study details for stable vitiligo
• July 2022 press release announcing FDA approval of Opzelura for vitiligo
• August 2022 company update discussing SAM and TAM
• August 2022 company update discussing soft tissue reconstruction results

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