Company: Cogstate Ltd.
Ticker: ASX:CGS | OTCQX:COGZF
Market Cap: $237.76M
In 2022, Alzheimer's and other dementias will cost the US nation $321 billion. By 2050, these costs could reach nearly $1 trillion. Big pharma companies like Eli Lilly, Roche, Biogen, Eisai and others are allocating huge R&D budgets to achieve a breakthrough in research focused on Alzheimer's disease. It is one of the few treatment areas still open that can deliver sustained growth for Big Pharma. However, CNS trials are notorious for their lack of success and high failure rate. In Sept 2022 Lecanemab was the only trial success in years.
In this article, I will share my investment thesis for an excellent picks and shovels play to get exposure to the CNS thematic without bearing the extreme risk of trial failures. The company is profitable, shows revenue growth (FWD) of 26.60%, EBIT growth (YoY) of 186.24%, return on common equity (TTM) of 27.49% and has the potential to become a 100 bagger over the next 10 years: Cogstate Ltd (ASX:CGS).
Structure
History
Solutions
Competition
Business model
Share structure
Valuation
Risks
The Central Nervous System (CNS)
Categorized as the body's Operating System, the nervous system is coordinating each human's actions, reflexes and sensations. When talking about the nervous system, we are usually referring to two main parts: The Central Nervous System (CNS) and the Peripheral Nervous System (PNS).
Staying with the computer comparison: Consisting of the brain and the spinal cord, the CNS would be specified as the processing center of the body. Consisting of all other neural elements, including the peripheral nerves and the autonomic nerves, the PNS
could be described as cables in a network/PC conducting electricity.
Source: OpenStax Anatomy and Physiology / Wikimedia
While the brain is protected by meninges (three layers of membranes) and the hard bones of the skull, the spinal cord is protected with the bony vertebrae of our backbones. The nerves and cells of the PNS are more vulnerable to trauma, as they are not enclosed by bones.
Without our nervous system, we cannot function and ultimately not survive. Unfortunately the nervous system is not free of illness. "Disorders of the nervous system may involve the following:
Vascular disorders, such as stroke, transient ischemic attack (TIA), subarachnoid hemorrhage, subdural hemorrhage and hematoma, and extradural hemorrhage
Infections, such as meningitis, encephalitis, polio, and epidural abscess
Structural disorders, such as brain or spinal cord injury, Bell's palsy, cervical spondylosis, carpal tunnel syndrome, brain or spinal cord tumors, peripheral neuropathy, and Guillain-Barré syndrome
Functional disorders, such as headache, epilepsy, dizziness, and neuralgia
Degeneration, such as Parkinson disease, multiple sclerosis, amyotrophic lateral sclerosis (ALS), Huntington chorea, and Alzheimer disease"
When discussing nervous system disorders in this article, I am mainly referring to degenerative diseases. The common theme in these diseases is the lack of a cure or in most cases even the lack of treatments to reduce cognitive decline.
A prime example of this is Alzheimer's Disease (AD), a disease which more than 6 million Americans are living with. Please find additional facts about AD shared by the Alzheimer's Association below:
By 2050, the number of AD patients is projected to rise to nearly 13 million.
In 2020, COVID-19 contributed to a 17% increase in Alzheimer's and dementia deaths.
In 2022, Alzheimer's and other dementias will cost the nation $321 billion. By 2050, these costs could reach nearly $1 trillion.
More than 11 million Americans provide unpaid care for people with Alzheimer's or other dementias.
In 2021, these caregivers provided more than 16 billion hours of care valued at nearly $272 billion.
90% of physicians say it's important to diagnose MCI due to Alzheimer's, but over half say they are not fully comfortable diagnosing it.
In 2021 the approval of Biogen's Aduhelm was the first glimpse of hope for AD patients. The drug promised halt of progression of AD, but due to the controversial approval process and questionable efficacy, doctors chose not to prescribe it to patients.
On Jan 6th 2023 Biogen and Eisai's AD therapy lecanemab (marketing name: Leqembi) received accelerated approval for Lecanemab (Lecembi). It now offers hope for those living with mild cognitive impairment or mild dementia, to reduce the cognitive decline. Far from a cure, but hopefully the first step into the right direction. In contrast to Aduhelm, doctors already signaled the intention to prescribe Lecanemab and Eisai set the wholesale acquisition cost at $26,500 per year. which is lower than the $28,200 charged for Aduhelm. The price for Aduhelm was originally set at $56,000, but reduced due to public outcry.
However, AD is just one of the many degenerative diseases mentioned above. In addition, demographic trends leading to an aging population, dementia and cognitive decline will be issues affecting a growing percentage of the population going forward. There is a high unmet need which of course has been identified by the pharma industry. Pipelines of big pharma and clinical stage biotech companies are showcasing a growing number of programs targeting indications like AD, Parkinson’s Disease, Multiple Sclerosis, Schizophrenia, etc.
From an investor perspective, this sounds like a sure thing, right? Just research some smaller CNS biotech companies, put some money in them and collect a nice 10 bagger two years later.
My experience with CNS stocks so far
The reality check to the last statement above is that CNS stocks have a very high failure rate. The reasons for this are manifold, but in my opinion the main reasons are:
It is hard to define an endpoint for these indications and show improvement. While cancer is an even tougher indication to go after, at least in cancer trials it is obvious that a drug has effect when there is partial or complete remission and the trial design displays a clear connection between the administered drug and the effect. In CNS this is not as easy to prove. In addition, biotech in general is a high failure & high risk type of speculation anyways. Finally, proving something in a strict FDA regulated setup is very hard, takes years and requires the constant infusion of money.
Moreover, my experience with CNS stocks has been sub optimal, to say the least. This is best illustrated by my "investment" in Cortexyme (now Quince Therapeutics | QNCX). I shared my thesis for the AD stock in August 2021. The stock gained in price after that and the expectation was, the pivotal trial data readout in Q4 would give final validation to the thesis. Unfortunately the opposite happened. Cortexyme failed to prove efficacy of their drug and the stock tanked from the peak of $105.89 (8/27/21) price per share to a price per share of $0.77 (1/13/23), a drop of -99.27% and total capital destruction. After the failed trial, the company pivoted to other indications and did a reverse merger with a company owning pre-clinical assets. It is called Quince Therapeutics now and faces the de-listing from NASDAQ, if the shareprice stays below $1.
Inhibikase Therapeutics (NASDAQ:IKT) is another CNS stock (focused on Parkinson's Disease), which listed in Dec 2020 and briefly traded at $9.80 only to start a straight downward trend that has lasted until today, dropping to a price per share of $0.60, a 93.88% drop! Again an example of total capital destruction.
At least my experience with IKT was not as bad as the one with QNCX, because I learnt from previous experiences and exited IKT when the first signs of trouble showed on the horizon.
After these experiences I never, ever wanted to touch a clinical stage CNS stock again, but then I came across Cogstate (ASX:CGS) via the Baby Giants Investing podcast. Cogstate has all the attributes I look for in a company and through my experience with CRTX I knew why Cogstate's testing and trial service offering holds value. In addition, Cogstate's venture into the healthcare business offers high optionality and a way to invest in the mega trend of aging population. In this article I want to share my investment thesis for Cogstate and why I believe that this company is an excellent picks and shovels play to invest in the CNS theme.
Cogstate overview
Cogstate (ASX:CGS) is an Australian company focused on Digital Cognitive Assessment.
"Cogstate’s innovative digital assessments are used worldwide to simplify the measurement of cognition. Our rapid, reliable, and sensitive computerized assessment of cognition provide valuable brain health insights for researchers, physicians, and patients."
It is their long term vision that their solutions become the go to cognitive assessment used by doctors and consumers irrespective of (cognitive) indication. CEO Brad O'Connor often mentioned making measuring cognition as easy as measuring blood pressure being Cogstate's north star.
The stock is under the radar still with only 690 twitter followers (1/9/23), not much chatter from retail investors and only 8 followers on Stocktwits (1/9/23). This might be the case because Cogstate is listed on the ASX and only has an iliquid OTC listing for the US. However, the majority of the company is based in the USA.
History
Cogstate was founded in 1999 based on the idea that a disease modifying treatment for AD was not far away. Based on this idea they deduced that because brain health assessments were very manual (and still are to this day) and depend on the skill of a physician, there is a gap between the lack of time and training to assess cognition of someone and for that person to benefit from the potential treatments. Technology would offer benefits like real-time data, analysis and be scaleable. That was the original investment thesis. However, they were right but way too early and had to pivot.
After proving the technology CGS found demand from pharmaceutical companies who were running global clinical trials and needed to measure cognition. Pharma companies need consistent assessments, as every assessment across a global trial should be the same. Classic cognitive assessment tests are biased in Language and culture, which is a challenge if you want to run a global trial. You can of course translate the test, but CGS' approach was to create a better test. Most of Cogstate's tests use game-like stimuli. To take the cultural bias out of it, they use stimuli that can be common across the world. To take the language bias out of it, they use questions that only require a yes or no answer. The secret sauce of the assessment is its simplicity.
In addition, even though physician assessments are high quality, they are not very scaleable. Those who need cognitive assessment need a highly trained neurologist and there are not enough of those. What CGS wanted to do is offer the best of both worlds: Consistency of assessment that doesn't require expert administration. CGS' answer is to bring intelligence into the test/software program. Thus the assessment doesn't have to be done by a highly trained neurologist, but can also be supervised by a nurse or admin staff.
When Cogstate started out they had to prove the "little computer program" was as reliable as a trained physician. After running studies with 1,000s of patients, today they are an industry leader and "provide rapid, reliable, and sensitive computerized digital assessment of cognition and support electronic clinical outcome assessment (eCOA) solutions. They also offer quality assurance services for clinical trial endpoints that combine innovative operational approaches, advanced analytics and scientific consulting."
Solutions
Cogstate offers solutions in two key vertical market segments: Clinical Trials and Healthcare.
Clinical Trials: Services and solutions to accelerate drug development decision-making regarding the safety and efficacy of therapeutic candidates
Healthcare: Regulatory cleared medical device to detect cognitive impairment and change in patients
Below I will give a short overview of these segments.
Clinical Trials
The sale of technology and associated services to big pharma and biotech companies has been Cogstate's main revenue driver during the last 17 years. Valuable insight into study outcomes are given by Cogstate’s sensitive, rapid, and reliable computerized digital cognitive assessments to clinical trial leaders. Cogstate's test can detect subtle drug related changes in cognition and increase the sensitivity and specificity of the measurement of human cognitive processes. In addition, full-service solutions across the entire clinical trial lifecycle are offered by Cogstate.
Cogstate's solutions are used in many global AD trials run by big pharma. This offers constant catalysts as the big trials have upcoming data readouts. Examples of this include Eisai, Roche and Eli Lilly.
Source: "Cogstate Presents at MicroCap Leadership Summit 2022"
On Sept 28th, 2022 Eisai announced "Lecanemab met the primary endpoint (CDR-SB: Clinical Dementia Rating-Sum of Boxes*) and all key secondary endpoints with highly statistically significant results". This announcement made the CGS stock jump from 1.40 AUD to 2.21 AUD in only two days!
The good news kept coming and on January 6, 2023 Lecanemab was granted accelerated approval as a treatment for AD by the U.S. Food and Drug Administration (FDA) in the U.S. These two developments were major derisking events for the CGS investment thesis and increased the probability of success of their healthcare business.
Healthcare
Cogstate has developed tools specifically designed to aid healthcare professionals with regular and standardized testing to assist in the early detection of cognitive decline that could be related to the area of dementia (among others). In 2020 to further develop and commercialize digital brain performance assessment tools, Cogstate and Eisai Co. Ltd closed a partnership. As part of this collaboration they launched “NouKNOW™,” a digital tool for self-assessment of brain performance based on the cognitive tests in the Cogstate Brief Battery™.
In contrast to the clinical trials segment, the target group for NouKNOW are not only the people with AD but rather everybody who is afraid to get AD, meaning the target group is everybody at certain age threshold, for example 60.
Competition
In addition to the manual assessments having to be done by specialized physicians mentioned above, there are multiple companies active in the cognitive assessment space. Some examples are Cognetivity and Neotiv. However, both are pre-revenue and both don't have a commercial partnership with a big pharma company pushing their assessment and approach via a direct 2 consumer channel.
Let's dive into the business model of CGS and find out why currently it is a compelling time to scale into this stock.
Business model
Currently the majority of revenue (60%) is contributed by the clinical trials segment.
Source: CGS Annual Report 2022
CGS manage the assessment of cognition in CNS trials. Indications in those trials include AD, PD, MS and even non-CNS indications in oncology (when there are worries that chemo is leading to cognitive impairment). The team is currently involved in 123 clinical trials and 34 of those are AD related. AD is not the majority of trials but they are really large trials. One of the largest is a 3,500 participants trial which will run 8 years and is worth more than $30M in contract value.
In respect to R&D, AD is where oncology was in the 80's: really just starting. To get a better understanding of diseases, the level of R&D will increase dramatically over the next 10 years. This in turn opens up a huge opportunity for CGS' healthcare business.
Most people don't actively assess brain health like they do for example cholesterol. What CGS aims to achieve is similar to the thinking behind devices like Apple watch: Give data to people so they can understand something is wrong, schedule a doctor's appointment, do more in-depth tests and then maybe go on medication. Currently there are not enough neurologists or other experts to turn this vision into reality. AD is under diagnosed because people don't test brain health. CGS cognitive assessments will act as the filter that ensures a trained physician is only involved with patients who need further assessment.
The treatments for AD that are worked on currently are far from a magic pill that brings you from a status where there is already damage to your health by AD back to completely like you were before. The current treatments in development all have the focus of stopping the decline. Early identification is key, as the treatment can help in that situation and offer a meaningful benefit for AD patients.
The opportunity for the CGS business changes significantly once there is a treatment option, because then people would want to know if there is something wrong and can take a pill to get better.
The total addressable market (TAM) is huge: Just the world population of people over the age of 60 are expected to double to about 2.1 bn by 2050. The opportunity then evolves from people with AD (clinical trials segment) to people worried about getting AD (healthcare segment) -> everybody who is aging is part of the TAM.
The commercial terms agreed upon with Eisai are quite compelling and include double digit royalties to be paid to CGS on all revenue and a minimum payment of $46M.
Source: CGS investor update Dec 2021
Since they were founded in 1999, CGS has built up a moat based on scientific protection of the data and validation of the technology rather than on patents. According to Brad O’Connor, someone wanting to build up what CGS is currently offering would likely need 7-12 years' amount of validating clinical evidence before they could catch up. To this day CGS has been the key collaborator in 600 per reviewed publications.
Share structure
Insider ownership according to SeekingAlpha: 34.60% (60.02M shares)
173.46M shares total. There have not been any splits during the time CGS has been public.
Overview of the 20 largest equity holders:
The CEO Brad O’Connor has been part of the company for more than 16 years and owns 3.4M shares (2%).
The biggest holder used to be David Dolby (One of the two sons of Ray Dolby). He recently resigned as non-executive director and awarded his shares to the Dagmar Dolby fund.
Eisai also invested and holds 6.8% of the company's equity.
Valuation
Capital Structure (2/7/2023 based on SeekingAlpha data):
Market Cap: $237.76M
Total Debt: $1.41M
Cash: $30.60M
Enterprise Value: $208.44M
Some relevant metrics on valuation, profitability and growth pulled from SeekingAlpha (2/7/2023).
Valuation metrics:
P/E GAAP (TTM): 32.32
Price / Sales (TTM): 5.27
Price / Sales (FWD): 4.56
Profitability metrics:
Gross Profit Margin (TTM): 58.48%
EBIT Margin (TTM): 24.42%
Net Income Margin (TTM): 16.70%
Return on Common Equity (TTM): 27.49%
I recently read Chris Mayer's book "1oo baggers" and Chris focuses on high return on equity and capital as key metrics. They are attributes of stocks that became 100 baggers, especially those that showed double digit growth. CGS shows a clear trend of top and bottom line double digit growth.
Revenue Growth (YoY): 37.73%
Revenue Growth (FWD): 26.60%
EBIT Growth (YoY): 186.24%
In a recent interview Brad O'Connor stated that during the next 12 months the management will make the decision on starting a share buyback program or paying dividends. With a 30M net cash position that will be even higher in 12 months, and in the absence of an acquisition or strategic build of technology, they will look at something like a buyback which would set a floor on the price. However, it also has to be considered that the top shareholders own 80% of stock. If CGS buys back too much equity, it could become too iliquid to be considered investment grade.
Risks
Even though Cogstate is already profitable and not nearly as risky as a clinical stage biotech stock, there are of course risk factors to consider.
Eisai opportunity doesn't work out
Lecanemab is accelerated approval "only" for now. Regular approval could still fail
Lack of investment in CNS trials due to too many failures
Biotech bear market continues, leading to many small biotechs being unable to get sufficient funding to run trials
Conclusion
In conclusion, Cogstate is an excellent picks and shovels play for investors who want to get exposure to the growing R&D spend in CNS indications without bearing the extreme risks of clinical trial failures. Moreover, an investment in CGS is also a way to invest in the mega trend of the aging population.
Clinical trials business offer exposure to growing R&D spend
Eisai deal & Lecanemab accelerated approval derisked the investment thesis
Favorable valuation
High double digit top- and bottom line growth
Tight share structure
High RoE
Potential share buybacks
100 bagger potential (over 10 years)
Finally, CGS is a long term investment for me. It has a lot of attributes Chris Mayer describes in his book "100 baggers". I started to scale into CGS in March 2022. Currently it is a ~3% (at cost) of portfolio position. My plan is to further scale into the position over time, when I have cash and there are dips/favorable prices. The aim is to build it to a 5% (at cost) position max or scale out (if there are fundamental changes at the company), this will depend on management execution.
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Disclaimer: This blog post is purely my personal opinion and is not financial advice. Please do your own research, before taking investment decisions. I am long CGS. No payment was received in exchange to write this article. Investments in securities and other financial instruments always involve the risk of loss of your capital. The forecast or past performance is no guarantee of future results.