Cancer diagnostics and razor-blade business models

Here we take a look at the Medical Diagnostic industry, and the Pengana High Conviction Fund’s largest holding in the company Photocure – which has been a wonderful performer for us over the last 2 years.

The investment team likes Medical Diagnostic companies as a lower-risk way to invest in the Health Care sector than many drug companies. The reason is because the clinical trials required to bring a diagnostic to market are much quicker and cheaper to run than the trials required to bring a drug that treats an illness to market. For instance, in a cancer trial you might have to run a trial for 5 years – a Diagnostics trial might take 1 year. So it is an attractive place to look, and this was a particular undiscovered company that we picked up 2 years ago.

Photocure makes a diagnostic for bladder cancer. The main product is called Cysview, which is injected into the bladder and the liquid is absorbed selectively by cancer tissue and glows pink when it’s illuminated with a light source. This allows a surgeon to remove the full bladder cancer, all the more important due to bladder cancer’s very high rate of recurrence at about 60% within one year. So this reduces the risk of the cancer developing further.

The business model for the company is very similar to the razor and razor blade business model, which we all know as a wonderful business. (You initially sell a low margin razor, and then you sell many years of high-margin razor blades.)

In the case of Photocure, the ‘razor’ (which is the light source) costs about $80,000. In fact, in this case, it is made by another company called Karl Storz, and the ‘razor blade’ is the liquid component which costs about $1,000.

The company has been very successful in Europe, however, it hasn’t economically benefited the company so much because it uses a distribution partner there who takes much of the revenue and profits. However, subsequently, the product has been launched in the U.S. where Photocure has its own sales force. So to the extent it’s successful in the U.S. it will be really transformational for the revenue and profits of the company. Currently, in the US, Photocure has about 2% penetration of its market and it’s a big Market: potentially $1.3 billion.

In Europe, the penetration has already reached 30% in Germany, up to 80% in Scandinavia. So we think there’s a really sizable opportunity ahead for the company.

It’s still very attractively valued in our view, at a $200m market value. Next year, the revenue for the company should be about $35 million, with a $1.3 billion dollar market opportunity ahead.

The other good piece of news, is that over the last year the company has really managed to increase the number of ‘razors’ it has in the market. It now covers about half of the major Urology centers in the U.S. which should stand it in very good place to see rapid acceleration in the growth of its liquid ‘razor blades’.

James McDonald - Pengana High Conviction Equities Fund