Shorting The Blood Supply - Go Long Cerus (CERS)

Too bad blood banks are not publicly held, they, on and off, would be great shorts. Today an article in the Wall Street Journal highlighted the ongoing difficulties a critical supplier, the American Red Cross, was having keeping the FDA happy. (http://online.wsj.com/article/SB125807531639846383.html.) A couple of days ago the same publication published a piece on how swine flu was inhibiting people from donating or eliminating them from the population of potential donors. You would think in the twenty first century technology could solve the problem of donor contaminated blood.

It can -- and it is in Europe - not in the United States, just yet. The technology is found in the INTERCEPT system invented and marketed by Cerus (CERS). Simply put, INTERCEPT systems clean blood for eventual use as blood platelets, eliminating virtually all known pathogens - including HIV and swine flu. INTERCEPT systems make the collection (and tracking) of blood platelets nearly donor independent. Each collection of donor blood requires a disposable product used by the INTERCEPT system, so the company has a razor and blade business model with sales and margins expanding in an almost geometric pattern once a system is installed at a blood facility.

The product is approved in many European countries, is being deployed in earnest in France and on the verge of deployment in Germany. And typically the regulators there are tougher, on blood, than regulators here.

Cerus put together what they thought was a successful Phase III trial for INTERCEPT in the US a few years back, hit their primary endpoint and, statistically, their endpoints for safety as well. A subset of patients had a pulmonary problem on a very short term basis that did not push them past their final safety objective. No matter - some weenie at the FDA, and I am one of the few big fans of that overworked and under-resourced agency - said no good and the company turned its back on the US and focused on Europe.

On Monday, Cerus is back before the FDA presenting a Phase III trial design that looks pretty good to me. The panel will meet Monday and Tuesday and say yes or no. I believe they will get a green light to begin the trial, and given the success of the product in Europe, it is hard to imagine they will fail again in the US. What about another weenie at the FDA? Not this time - the current commissioner, Margaret Hamburg, is a former Commissioner of Health of the City of New York and has great expertise in pandemic preparedness. It is hard to believe she would let this one get away from her agency again - assuming they have told her about the panel meeting. This is, after all, Washington.

Approval of the trial design and, over time, a successful trial are major catalysts for the stock. But the company should become cashflow positive - real cashflow, not accounting cashflow - late next year without any help from US sales and has a bright future in Europe alone.

There are other positive wild cards for the company and the stock - things that could happen, which, as citizens, we do not want to happen. If swine flu or another pathogen gets in the blood supply, the FDA could exercise the powers they just used to give emergency approval for Peramivir (a treatment for flu) from Biocryst (BCRX) and do the same for INTERCEPT. Emergency approval is that, before final data and staff approval are in. Cerus management is not currently pursuing this - God knows why. Or, management could wake up and ask the Department of Homeland Security for funding for facilities or the trials - something Homeland Security is doing for Biocryst. Ditto on the God knows why comment. Both of these are real if remote possibilities dependent on a national emergency with the blood supply similar to the HIV tragedies of the 1980s.

Another wild card is the Pentagon - they have, in the past, let several contracts to Cerus for research but are barred from using INTERCEPT - remember, it is not approved by the FDA. They collect blood in the field that is not treated with pathogen inactivation technology. You think one or two of our soldiers might have an infectious disease, such as HIV, the soldiers unaware of the problem, soldiers giving blood that is not treated? Can you imagine the headlines if a pregnant Iraqi woman gets tainted blood and mother and child contract HIV from American supplied blood?

A last positive wild card is finding a marketing partner in the US if they get approval for INTERCEPT by the FDA. This makes sense - we are a big country with a fragmented blood industry - and a partnership with a major player would be a big deal for the company and the stock.

Yes, all wishful thinking but isn't that what you are supposed to do with emerging companies set to dominate their market? And they will - once an INTERCEPT system is in place, there is essentially a moat around that blood supplier and only a new, radically better technology - something no other company has or seems to be working on - could break through. Cerus has a multi year lead over competitors and once in place will stay in place, reinforcing their razor and blade business model.
Back to the present - Cerus is also working on early trials to modify its technology to treat whole blood, a huge market.

Oh, how big is the current Cerus? About $4.8MM in sales in Q3, probably $25-$27mm in sales next year, losing money but probably have positive cashflow by yearend 2010.
So, a very short term catalyst is near - next week's panel to approve or disapprove their trial design. Over time, and independent of US approval, quarterly sales and earnings are fundamental catalysts that will drive the stock. And any contamination of the blood supply, here or elsewhere, something I see as bound to happen, somewhere, sometime.

For purposes of disclosure, I am quite long Cerus.