Down in the Dumps
By Mark Glassman Published: February 1, 2006
Today on SmartMoney
FEBRUARY HAS NOT been kind to Cyberonics (CYBX: 27.95, NA, NA%) investors.
The Houston medical-device company's fiscal third-quarter results released Feb. 8 showed wider losses from a year ago, which prompted management to seriously dial back expectations for the next two years. A week later a Senate Finance Committee report revealed that a senior Food and Drug Administration official pushed the company's only product through the approval process for a new use despite objections from his entire staff. Near month's end, Cyberonics' stock was flirting with 52-week lows.
But some analysts have written off February as a mere cold snap and say it's only a matter of time before Cyberonics heats back up. "We're supporting it because it's a huge opportunity," says Ryan Rauch, an analyst at Jefferies & Co., an investment bank in New York.
A substantial patient population with nowhere else to turn offers reason enough for the bullishness. Cyberonics makes the only FDA-approved medical device for treatment-resistant depression. Of the roughly 20 million depressed Americans, about four million won't respond to cognitive, behavioral or pharmacological treatments. Cyberonics' implantable device called a Vagus Nerve Stimulator, or VNS, functions like a pacemaker for the brain, delivering electrical impulses to a nerve implicated in mood regulation.
The device was originally approved in the U.S. in 1997 to treat epilepsy. After anecdotal evidence from epileptics suggested VNS therapy might be useful in treating depression, Cyberonics began a clinical trial with severely depressed patients to see if its device alleviated depressive symptoms. The results were mixed. Depressed patients with the functioning device didn't show statistically significant improvements over the device-less control group. However, when the control patients were also given VNS therapy, a subsection of the combined group showed an improvement.
If that science seems fuzzy to you, you're not alone. FDA researchers questioned the adequacy of the data but were overruled by a superior, according to the Senate staff report. The FDA says such overrulings are common. Federal legislation can reverse FDA drug and device approvals, but the more immediate consequence of the report is that it gives ammunition to Senate efforts to block federal reimbursement for the device.
The FDA grants more leeway in approving medical devices for uses in which there is no existing treatment. "There's an argument to be made that one of the things the Cyberonics device will do is lower the suicide rate [of severe, chronic depressive patients]," says Jan David Wald, an analyst with A.G. Edwards & Sons. "The patients they're dealing with are patients that really don't have any other recourse. A slew of drugs have failed them, and now what's left is an attempt to see if the device will work."
There is, however, the sticky matter of insurance coverage to consider. Cyberonics' device has yet to be included in a national insurance plan as a treatment for depression, resulting in huge out-of-pocket expenses for patients. The device implantation costs about $25,000, plus $1,000 a year for "dosing and programming," according to the company. In some areas, hospital fees have driven that price even higher. "Until such time as [Cyberonics] starts getting national coverage decisions from the third-party payers, it's going to be exceedingly difficult for them to ramp up sales," says Mark Landy, an analyst at Susquehanna Financial Group, a brokerage in Bala Cynwyd, Pa.
Regional branches of insurance companies have already approved reimbursement for the procedure, but only on a case-by-case basis. Reimbursement delays have made the VNS device a tough sell for Cyberonics sales reps, while lengthy struggles for coverage have discouraged psychiatrists from recommending the treatment, say analysts.
Matthew Pitera, a psychiatrist in Brick, N.J., says he has 55 patients awaiting the procedure, none of whom has received approval from their insurance companies. He has stopped recommending it to patients because he doesn't want to offer false hope of reimbursement, much less an expensive, unproven cure: "I don't have the heart to tell somebody, 'It's going to cost you $40,000, [and] you're going to be the first patient we've done it on.'"
What will it take to bring insurers on board? Medicare reimbursement at the national level could catalyze other third-party payers. Also, additional published data on the device from the company are crucial, says Steve Brozak, an analyst with WBB Securities, a brokerage in San Diego. "I do not know if there is any one thing [that will earn Cyberonics national coverage] other than the passage of time and meaningful peer review publications that show results," he says. "The words 'total remission' are the things that you need, given the checkered events that have taken place."
Still, there's optimism for Cyberonics investors. Every insurance claim won at the local level is precedent-setting and makes the next case that much easier. "Our due diligence indicates that the barriers to reimbursement, compared to 90 to 100 days ago, are less," says Rauch of Jefferies. He added, "If there is no reimbursement barrier, we think Cyberonics is a $50, $60, $70 stock."
Even without national reimbursement, Cyberonics is poised for growth. Although the company's guidance no longer includes national insurance coverage for VNS's new use (the main factor in the stock's recent decline), management still expects heady revenue growth. "With no national coverage policy, no improvement in our productivity or the cycle times and conversion rates of patients going [on a] case-by-case basis," year-over-year sales growth for the nine months ended Jan. 27, 2006 was 13.8%, says Chairman and Chief Executive Robert "Skip" Cummins. He predicts that sales for the fiscal fourth quarter ending April 2006 will be about $34 million and revenues for the April 2007 quarter will reach $51 million. Analysts surveyed by Thomson First Call expect sales of $35 million for the quarter ending April 2006. The company has $100 million in cash and a $40 million credit line that remains untapped.
Competitors, however, are not sitting still. While Cyberonics slogs through local insurance decisions, other companies are working on similar devices. Analysts say Boston Scientific (BSX: 24.93, 0.00, 0.0%) and Medtronic (MDT: 54.70, 0.00, 0.0%) are developing competing VNS units that could receive national coverage more quickly if they appear to be more effective. That kind of competition would be an enormous setback to market penetration and "pose a terrifying challenge for Cyberonics," says Brozak of WBB Securities.
But if February has taught Cyberonics anything, it's how to cope with a challenge. |
