Initiating Coverage of Verisante Technology, Inc. VRS.V - Analyst Blog

Brian Marckx, CFA

INITIATING COVERAGE

We are initiating coverage of Verisante Technology, Inc. (VRS.V , V.VRS ) with an Outperform rating and a $2.10 near-term price target. See below for access to our full 21-page report on the company.

Verisante’s Aura appears to be more accurate and faster than the current gold-standard in the diagnosis of skin cancer, an annual market that could eventually be worth billions of dollars. Verisante expects to introduce the device in markets with some of the highest prevalence of skin cancer which, along with a razor / razor blade business model, could result in sales and earnings ramping very rapidly.

While several significant milestones must be met before Aura will launch, based on our conversations with management we feel comfortable that sufficient progress is being made and believe it is reasonable the device could launch in Canada, Europe and Australia by early 2012. Clinical trials in support of FDA approval could also begin in 2012. If all goes to plan Aura could enter the U.S. market in late 2013.

In the meantime Verisante will need to continue to raise financing. They have been successful at raising add-on financing since going public in late 2009 and management has indicated that they believe they can continue to do so based on continued strong investor interest.

INVESTMENT THESIS

Market Size
We estimate the combined “early adopter” (i.e. – low hanging fruit) markets in Europe, Canada and Australia could be worth over CDN $200 million in net device sales (~11k dermatologist practices x CDN $21k per device). The recurring revenue opportunity could conservatively be worth over CDN $100 million every year (this assumes only 4 scans per day for every 2-physician dermatology practice). Entry into the U.S., while likely years away, increases Verisante’s total dermatology practice market by another 50% (in device sales and recurring revenue).

And while the GP segment will likely be significantly more difficult to penetrate, at almost 30x the size of the dermatology practice market, it represents a multi-billion dollar opportunity.

Unmet Need
The current “ABCD” technique, while still considered the gold-standard in the diagnosis of skin cancer, is antiquated, unsophisticated, slow and been proven through numerous clinical studies to be fraught with error (especially with early stage skin cancer). Aura looks to be significantly more accurate and exponentially faster in the diagnosis of melanoma and has the potential to save lives, reduce the number of unnecessary biopsies and lower overall healthcare costs.

Sparse Competition
Analysts were smitten with the opportunity for MelaFind, based mostly on the size of its potential market and a clear need for a better tool in the diagnosis of skin cancer. MelaFind’s efficacy is now largely in doubt and even the most bullish of analysts seem to be hedging their bets.

Although there are other technologies that have either been recently introduced or are in late-stage development that would directly compete with Aura, the market still remains almost completely up for grabs. And based on the huge market size and what we expect to be certain competitive advantages (speed, versatility for all types of skin cancer, greater accuracy, smaller probe), we believe Aura will be very well received and expect sales to ramp very quickly following launch.

Technology
The basis for the technology incorporated into Aura was discovered by the winner of the 1930 Nobel Prize in Physics. An award-winning team from the BC Cancer Agency made improvements to the existing near-infrared Raman technology, making it feasible for incorporation into a portable device for the accurate and early detection of skin cancer. This patented technology is the backbone of Aura.

Business Behind The Technology
A great technology does not necessarily make a feasible business. We think Verisante has both. Verisante handles very little in-house and instead mostly in-licenses and outsources. This keeps fixed costs low, mitigates risk and maximizes expertise of major functions.

The company’s low-cost base, razor / razor blade business model and the opportunity afforded by the ex-U.S. markets alone should allow Verisante to turn cash flow positive in relatively short order. We model Verisante to post positive earnings by 2013. And while U.S. clinical trials (expected in 2012) will require significant capital, we think this is manageable from a combination of operating cash flow from sales to ex-U.S. markets and external financing.

Entry into the U.S. market (we look for late-2013) could help push revenue up to CDN $36 million in 2014.