BioStem Technologies (OTCMKTS: BSEM) Coverage Initiated at Zacks Investment Research

The below report was authored by Brad Sorensen, CFA, Zacks Small Cap Research. You can find the original report here.

 

BioStem Technologies BSEM is changing the skin graft market by using the natural properties of perinatal tissue. Revenues are rising and we value BSEM at $6.40 using the discounted cash flow method and a 20% discount rate.

Outlook

BioStem Technologies is a leading innovator focused on harnessing the natural properties of perinatal tissue in the development, manufacture, and commercialization of allografts for regenerative therapies.

We see evidence the demand for the BioStem technology is growing and believe that growth, combined with the efficiency changes made by management, will propel BSEM higher. 

Current Price (09/19/22): $3.80

Valuation: $6.40

Summary

We are initiating coverage of BioStem Technologies OTCPK with a valuation of $6.40 per share.

BioStem Technologies, Inc. is a leading innovator focused on harnessing the natural properties of perinatal tissue in the development, manufacture, and commercialization of allografts for regenerative therapies. The company states its mission is “to discover, develop and produce the most effective regenerative medicine products in the world,” and we believe that the company is well on its way to achieving that goal—providing to investors what we believe is an opportunity to invest in a company that is both providing a vital service to the human population and providing economic value to shareholders when doing so.

Skin grafts are an often-overlooked procedure, until you or someone you know needs one, and then it becomes a vital operation. According to UT Southwestern Medical Center, over 100,000 skin grafts are performed in the US each year, and, according to the Center, that number would likely be higher if tissue was more available to be grafted. Skin grafts can be needed for a variety of issues according to Icahn School of Medicine at Mt. Sinai, including:

• Infection causing skin loss
• Burns
• Cosmetic or reconstructive surgeries
• Other surgeries that need skin grafts to heal
• Venous ulcers, pressure ulcers, or diabetic ulcers

Addressing the last bullet, diabetic ulcers, according to University of Michigan Health Service, approximately 15% of patients with diabetes will develop foot ulcers and unfortunately are the leading cause of lower extremity amputations in the United States—with 14%-24% of those patients who develop a foot ulcer having such a procedure.

Skin grafts are vital in situations such as this, and many others, and while the grafting procedure is not new, BioStem has developed a technology that we believe will vastly improve the process and provide better outcomes for patients. 

The Biostem Solution

BioStem addresses the important skin graph issue by focusing on elements of perinatal tissue and the body’s innate biology to repair or reverse damage caused by a broad range of degenerative diseases. The company’s proprietary approach, called Local MicroEnvironment ActivationTM, or LMA, uses combinations of small molecules, cytokines, and other growth factors to activate the microenvironment within the body to create communication for repair in the tissue. Allografts (tissue graft from a donor of the same species) are processed through the company’s proprietary process known as BioRetain® . This process focuses on preserving the tissue’s endogenous biological properties while maintaining the structure and matrix found in fresh perinatal tissue, which is recovered from healthy pregnancies that go full term. 

To understand why this process of using perinatal tissue is superior to the traditional method it’s important to examine what occurs during the grafting and healing process. First, the local microenvironment is defined as the immediate environment surrounding a cell, or group of cells, which contains physical and chemical signals that can either directly or indirectly influence cellular behavior. The company notes that development, growth and repair of tissue is largely dependent on microenvironmental conditions. Changes in the microenvironment including alterations in mechanical forces, chemokines, extracellular matrix and growth factors directly impact cellular recruitment and activation.

The local microenvironment includes:

• Extracellular matrix. Similar or dissimilar cells that are in close proximity.
  • The extracellular matrix is a three-dimensional network consisting of extracellular macromolecules and minerals, such as collagen, enzymes, glycoproteins and hydroxyapatite that provide structural and biomechanical support to surrounding cells.
• Cytokines, growth factors, extracellular vesicles, and small nucleic acids.
• Local physical properties of a tissue.

The importance of each individual factor depends on the nature of the cell or tissue. The combination of these factors ultimately influences the behavior of the cells and tissue in the local microenvironment. The nature of the interaction between the local microenvironment and cells is bidirectional. This means that as tissue remodels, it can produce, rearrange, and realign the extracellular matrix components. Similarly, the extracellular matrix itself can regulate and transform the activity of cells.

According to the company, LMA refers to the positive impact that the allograft elicits on the application site’s cells and tissues. This activation occurs through several mechanisms:

• Stromal support and scaffolding
  • Perinatal tissue allografts can provide the scaffolding for endogenous and introduced cells to connect and develop.
  • Scaffolding may be in the form of dehydrated tissue offering a physical base for the endogenous cells to interact.
    • The molecules within these scaffolds, such as collagen and fibronectin, promote the foundation for regenerative activity.
• Direct growth factor delivery
  • The LMA concentrates on growth factor ligand concentration.
  • Upon application, growth factors within the perinatal tissue allograft are immediately available to surrounding cells and tissues.
    • These growth factors bind to receptors on the surrounding cells and local tissue, establishing a signaling cascade within the tissue to begin regenerative activity

• Exosome signaling
  • Extracellular vesicles that carry protected RNA, miRNA and some proteins.
  • Exosomes are taken up by the tissues (endocytosis) or fused, where they release the regenerative factors required to start development.

Understanding the science behind the BioStem process made us wonder why this process wasn’t developed sooner, given the apparent advantages for patients in increasing the odds of an effective and efficient graft. However, we are glad that this process has finally been developed and are confident that it will gain increasing use in a variety of applications as BioStem expands its sales teams, which it is currently in the process of doing—and by gaining increasing acceptance from Medicare-another process being pursued according to company management. 

The Products

Before we get into more details on how BioStem is going to increase sales of its products, we first need to understand what products are being promoted.

BioStem’s primary product is Vendaje®. Vendaje® comes in several different forms and sizes and is a human connective tissue matrix comprised of amniotic tissue. This amniotic tissue is processed using the company’s proprietary BioRetain process, mentioned above, which creates a dehydrated human amniotic membrane allograft. The company describes a six-step process that enables the amniotic tissue to preserve its natural integrity:

• Minimally Damaging Disinfection
  • The membrane is submerged in an effective bactericidal, tuberculocidal, fungicidal and virucidal solution to eliminate pathogens.
• Manual Hematopoietic Reduction
  • Blood and blood-producing components are removed by hand without scraping or scrubbing to preserve the membrane structure.
• Cold Isotonic Cleansing
  • A series of washes in a clean, low-temperature, pH-balanced solution with gentle stirring removes remaining debris while minimizing tissue and growth factor breakdown.
• Gentle and Gradual Dehydration
  • Slow drying of the membrane using physiological temperature preserves tissue structure and natural growth factors, while also preventing damage from freezing or high temperatures.
• Precise Cutting Die Placement
  • Manual placement of cutting dies helps ensure optimal tissue quality for each individual allograft.
• Low-dose, E-Beam Sterilization
  • Grafts are individually packed and terminally sterilized to an assurance level of at least 10-6 via electron beam, avoiding harmful biproducts or excessive irradiation associated with other methods The company notes that the company’s sterilization assurance level is generally accepted for pharmacopeial sterilization procedures, with a probability of not more than one viable microorganism per one million sterilized items of the final product.

Additionally, Vendaje® allografts are held in place via hydrostatic tension, have a five-year shelf life and can be stored at ambient temperatures—all enormous advantages in the transplant arena.

Placentally-derived human amniotic membrane (AM) is a source of pro-healing growth factors and anti-inflammatory cytokines and has successfully been used in regenerative medicine for over a century. Vendaje® is the result of the modernization of this science. According to the company, early users of AM for wounds and post-surgical applications noted how the membrane seemed to disappear and integrate with the patient’s own tissue without a host reaction. This apparent immune neutrality is a result of mechanisms that suppress and modulate the immune system.

The amniotic membrane forms the innermost layer of the human placenta and acts as a protective barrier for the developing fetus.

Structure of the Amniotic Membrane

Vendaje is currently provided in three different forms:

• Vendaje-- is intended for homologous use as a protective covering.
  • Additional advantages of Vendaje allografts:
    • held in place via hydrostatic tension and may be used in an open incision or placed as a dermal substitute.
    • aseptically processed and terminally sterilized via e-beam irradiation.
    • have a 5-year shelf life and can be stored at ambient temperatures.
• Vendaje AC—also intended for homologous use as a protective covering and comprised of dehydrated amniotic/chorionic tissue.
  • The combined amniotic and chorionic membrane advantages:
    • The combination of amnion and chorion is thicker and higher in tensile strength than allografts containing amnion alone. It is also richer and more varied in growth factors as well thanks to the higher quantity of growth factors present in the chorion layer.

Combined Amniotic and Chorionic Membrane

• Vendaje Optic-consists of only the amnion layer of the placental membrane.
  • This single layer of amnion measures between 20-50 microns thick, making Vendaje Optic ideal for delicate ophthalmic applications.
  • The covering can be applied directly to the eye without the use of additional hardware or sutures

It is also important to note that these products are designated as Human Cell, Tissue, and Cellular and Tissue-Based Products (HCT/P) by the U.S. Food and Drug Administration (FDA), are minimally manipulated, and are produced in accordance with the FDA regulations for Good Tissue Practices.

The Company

The uses for these products are numerous and we believe that patients and doctors are going to be increasingly demanding the technology that is offered by BioStem when they learn of the advantages in application, acquisition, storage and effectiveness.

Obviously, obtaining and maintaining quality tissue is vital to the solution that BioStem is providing. After discussions with management we believe the company has solid processes in place for both acquiring and insuring the quality of the donated tissue. The perinatal tissue-derived allografts are produced in accordance with the FDA regulations for Good Tissue Practice. Additionally, BioStem is accredited by the American Association of Tissue Banks, which is the organization that set standards, inspects facilities and accredits tissue banks in North America.

BioStem works with five collection agencies to get the placental tissue needed, which, as mentioned and avoids any potential ethical questions, is only recovered from pregnancies that go to full-term. Additionally, the company does a full background check on the mother to help ensure that the sample used will be as healthy as possible. We questioned management about the ability to keep up with the anticipated increase in demand for the company’s products and they noted that there were no supply problems with placental tissue, hospitals have an abundance of it, but also commented that short-term supply bottlenecks have been a challenge for more “common” materials such as saline solution due to continued supply chain issues—a situation, we understand through conversations with industry insiders, that is in the process of correcting itself.

The company’s growth trajectory is already pointing upward and we expect it to accelerate given increased word of mouth as well as the advancements the company is planning to implement in terms of marketing and operations. Revenues for the quarter ended June 30, 2022 were just over $2.1 million, which was up over 100% versus the same quarter a year earlier which saw revenues of just over $900,000. Additionally, net income, a metric we love to see for a company in this space and at this stage in the green, showed a profit, with the company reporting $200,000 in net income versus a loss of $370,000 a year earlier—all very positive trends. Additional financial highlights include a robust $1.37 million in cash on hand as of June 30, 2022 and the further deleveraging of the balance sheet by converting $3.3 million in liabilities to common stock during the first six months of the year.

In conversations with management, we also became excited about the strategy outlined to increase sales and improve operations. The company is transitioning from indirect to direct sales, which we believe will provide for a more focused, motivated and consistent message, while the company is also investing in promoting its message by updating its branding and relaunching its website. Company management has also made the decision to invest in its sales and ordering platform and noted that they were “very optimistic about the business-to-business platform,” believing it to be a “game changer.” Operational process that were outsourced are now being brought in house and documentation is moving to electronic.

Finally, the company is developing new products, which management couldn’t expand on yet, but we’ll be watching for the announcements, and plans to publish in a medical journal, while also working on getting Medicare codes for the Optic and AC products, with those expected to come in the first quarter of 2023.

Valuation

As seen above in the financial discussion, BioStem has recently been growing revenues at a rapid rate—and we believe that will continue into the near future with the changes to marketing and sales processes helping to fuel those gains. When it comes to valuing BSEM, we want to lean toward the conservative side, leaving room for upside surprises. As such, we estimate that revenues will grow 30% annually for the next three years and then level off at a 10% growth rate. We also assume that margins remain at around 82% and grow other expenses at 5% per year. We wouldn’t be surprised if that margin number could be slightly higher as efficiencies and scale increase but we want to remain fairly conservative in our estimates.

We also don’t assume any new product additions that may be possible, largely due to the fact that we have no information on those products and would be unable to make an even educated guess at what they would mean to the business, but acknowledge that it represents a potential upside call to the BSEM stock. Given all of that, we apply a 20% discount rate to future cash flows and a 5% inflation rate and end up with a valuation of $6.40 per share. That valuation, which we believe is conservative, represents a nice premium to the recently traded price of around $3.00, meaning that we believe BSEM is worth a strong look by investors with a slightly higher risk tolerance. 

Risks

• Supply issues could cause margin compression or fewer sales.
• If sales don’t ramp up as expected, funding could become an issue.
• Increased competition could lead to fewer sales or increasing price wars.
• Current management could leave.
• As with any micro-cap stock, a lack of liquidity could hurt investors’ ability to sell shares at the stated market price. 

Projected Income Statement & Balance Sheet

Historical Stock Price

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