We upgrade AVO to OUTPERFORM with a fair value of 155 GBp. The company has significant growth potential in the nascent Proton therapy ("PT") industry. The dented growth trajectory from the industry leaders in PT signals the limitation of the conventional cyclotron technology in PT. We are encouraged by AVO's technology to benefit from this bottleneck through delivery of a better and easier-to-install technology with its PT Linac. Execution on scaling up production will easily lower machine prices and therefore represents a significant opportunity to expand margins on the services business, which will remain at a higher price level. We are also encouraged by an upgraded management team, which is experienced in installations, service and sales - OUTPERFORM.
The PT incumbents, IBA and Varian are far ahead of its competition dominating the market with a combined market share of more than 70%. However, besides pricing, all PT players share one significant hurdle for fast adoption rate. The cyclotron technology involves lengthy and complicated building preparation. Heavy cyclotrons and large concrete bunkers make the installation a major building project, which is, regardless of pricing, often a big hurdle. AVO could carve out a significant advantage with their modular system, which could in theory allow a much faster and easier installation almost comparable with conventional Linac. AVO could tap into a new market for mid-sized hospitals, which could be a significant volume play.
The advantage of AVO’s technology being faster and less complicated combined with a cheaper production process could give the company a fast head-start with a future margin expansion opportunity driven by an attractive service revenue stream.
While the current debate in the clinical community is about pricing and clinical evidence, we believe that the above-mentioned installation hurdles are more significant in holding back a faster adoption rate. In this update report we have compared cost of cancer treatments, which makes PT look less expensive over a longer time period compared to drug-based approaches. We feel that the pricing element will become even less of an issue once the read out of trials comparing PT vs. Radiotherapy ("RT") in 2020 brings clinical evidence to light. Should PT machines stay at the $15m price band by 2030, margins could look significantly more attractive for the whole PT industry.
AVOs management team has changed the equity story significantly compared to 2016. While the patents and the promising technology was already in place then, the company has added veterans of the PT industry from science, engineering, installation, application experience and compliance. We feel that the success of the industrialisation is entirely hinging on the top professionals.
We assume a PT conversion rate of 15% by 2030, which would make it a c.$8.0bn market ($4.5bn for 380 machines in that year sold and $3.5bn for the service of all machines installed up to 2030 (c.2,900 PT vs. c.16,500 conventional PT machines)). PT is amongst the most attractive subsectors in Medtech, which grows significantly above the sluggish Medtech sector with low single digit top line growth. Medtech as a whole has lost its steam due to lack of innovation, which was followed by price pressure from payers, who no longer pay top dollar for commoditised devices and instruments.