Markman on the Markets: Cytori Therapeutics Up 40% and Headed Higher

On Dec. 21, 2009, we introduced Cytori Therapeutics Inc. (Nasdaq: CYTX) to Money Morning readers as a "special situation" stock worthy of consideration. The stock has surged more than 40% since then.

A big reason for that move was that the company received approval from the U.S. Food and Drug Administration (FDA) to start marketing a product called PureGraft that prepares a patient's fat tissue for reinjection into the body for cosmetic procedures. Technically, this was what the industry calls a 510(k) clearance, which is the equivalent, for medical devices, of clearing Phase III trials for a drug.

So, what exactly is PureGraft and why is it so important? For those questions, I turned to one of my sources on the company, an investor and analyst who asked not to be identified.

Most importantly, he notes, the announcement proves that Cytori can get 510(k) approval for a fat-grafting product. But it also allows Cytori salespeople for the first time to begin talking to plastic surgeons, dermatologists and the like about an approved product. That means they can begin setting the groundwork for selling the company's much larger and more expensive Celution systems once they get FDA approval for that device.

PureGraft is a sterile plastic bag that enables a manual process of separating fat tissue from blood, saline and other unwanted materials. The process, which amounts to a series of filters, allows a doctor or nurse to get consistent results from fat grafts in a way that is much faster and more efficient than competing techniques. This is not a real high-tech process, and there is no enhancement of the cells as there is with the Celution system. To view a video on the process, click here.

Analysts believe the PureGraft system will sell for $350 to $400, and is a consumable likely to have 90% gross margins.

PureGraft is just one step along the path for Cytori. The next generation system up for approval is called CellGraft, which is specifically targeted at plastic surgeons and dermatologists for whom the existing Celution machine is overkill. For most cosmetic plastic surgery procedures, such as body contouring, cells don't need to be as stringently extracted for mixing back with fat for an enhanced graft. The Celution output is a very clean mixture of stem cells and regenerative cells, and that output is best aimed at high-end procedures for heart patients and other therapies requiring the best care.

CellGraft will be similar to Celution in size, but on top instead of a centrifuge will be a seesaw-like device that will inject saline solution plus enzymes to digest the fat and prepare its output for cosmetic surgery applications. That process will take 40 minutes, versus more than hour for Celution.

The cost of the CellGraft system is expected to be under $75,000 - versus more than $100,000 for Celution - and the cost of disposables will be $800-$1,000 and carry 80% gross margins. (Margins are lower than for the PureGraft bag because Cytori has to purchase the enzyme from a large pharmaceuticals maker.)

So PureGraft can be seen as one step in Cytori's evolution to a multi-product, sales-force-driven company selling systems and high-cost, high-margin disposables.

This is great timing, because non-cell enhanced fat grafting is just taking off, and until PureGraft was approved it's been hard for doctors to get consistent results. This is why PureGraft is a game-changer not just for the company, but for the industry as well.

Going forward now, Cytori can sell into the plastic surgeons office both the PureGraft disposables and a Cell Brush - a ratcheting needle injecting device that has a one-time cost of $400. Cytori didn't market the cell brush previously because it did not have a sales force, and it did not make sense to build one for a single-use device. Now sales people have two products in their briefcase to talk to plastic surgeons about, and they can sell them with FDA approval.

Combine this with the recent great results on the European breast cancer interim trial data that we talked about last month, and you can see the opening of new markets, new applications and most importantly, new sales.

The most exciting development on the horizon is the results of cardiac test data, the program called Apollo. The first round of data should be coming in the first half of this year, and if it is positive as I expect, it will further define the upside for this company that is leading the charge in regenerative medical therapies.

Analysts believe that adipose-derived regenerative cells can be beneficial not just in the repair of cardiovascular muscles and in breast reconstruction and augmentation but also in periodontal disease, spinal disc regeneration, wound healing, dermal filler and urinary incontinence. All combined, this is a gigantic market opportunity.

The key question will be which ones Cytori keeps to itself, and which ones it will decide to pursue with a partner. So far, the company has not given up the rights to any therapeutic applications, and the further it can travel this path the higher its ultimate value. My upside target for the shares over the next few years is $40-$50, though it will have to clear a lot of hurdles before then.

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