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How to identify a medical stock offering blockbluster returns: Part 3

One of the problems faced by shareholders in biotech/medical start-ups is thinking that product development is the be-all and end-all, but it’s not.

After successfully developing a product, and all the hurdles that entails (which can be found in Part 1, and Part 2 of my article series), a company still has to sell its product.

Cynata Therapeutics Ltd (ASX: CYP) and Phytotech Medical Ltd (ASX: PYL) might look fantastic because they’ve shot up recently, but the truth is they have a very long way to go.

Once a company finishes initial development, selling is a whole new ball game, for several reasons:

  • A company has to convince specialists it has a great product

This is theoretically done by using experimental results, which ideally prove that one product or device is better than the alternatives.

Unequivocal proof is rare however and usually comes much later in the process, after initial sales have commenced.

And then investors face the risks, a la Sirtex Medical Limited (ASX: SRX), of finding that a product isn’t suitable for purposes you’d thought it would be.

Some companies then must convince specialists to use a new, fairly thinly tested product that is only successful in certain circumstances, on certain types of patients.

This is hard enough without including the potential for ‘commission-style’ rewards or inducements for practitioners in return for selling certain kinds of products.

It is difficult to evaluate how widespread this practice is due to its opaque nature, but suffice to say that many medical products are well entrenched and don’t like new kids on the block.

  • Selling globally is difficult

If your product is developed in a certain locale, it is very difficult to get overseas practitioners to test or research it, since it is not published in their medical journals (or even their primary language).

This is why overseas partnerships are very important to research companies, and often announced as market-sensitive developments.

The best specialists routinely read foreign journals to stay up to date, but it still requires a concerted effort to get an Australian product developed by Australian scientists onto the global stage.

  • Even if you finally start selling your product…

You could wind up like Admedus Ltd (ASX: AHZ), which isn’t growing revenues fast enough to pay for itself despite the apparent success of its CardioCel heart patch.

Once CardioCel sales began, Admedus grew revenues by roughly 13% and 7% in 2013 and 2014.

First half 2015 revenues have risen a more promising 17%, but the company continues to post massive losses despite increasing ‘gross profits’ (revenue minus cost of sales) each year.

Admedus lost $2.4 million after tax in 2013, $8.2 million in 2014, and a staggering $11.4 million after tax in the first half of 2015 – reportedly due to the costs of launching CardioCel worldwide.

From recent reports, it appears Admedus has spent big on hiring employees recently – with wages and salaries for 2014 costing double the outlay in 2013. Other items to catch my eye were high spending on consultancy and travel costs in 2014.

All these factors are typical of a company hoping to drastically increase its global presence, but to my mind Admedus hasn’t successfully justified the need for such spending with the potential for sales increases.

The high cash outlays have also hurt investors, with dwindling reserves prompting Foolish contributor Owen Raskiewicz to sell his shares, a decision that the subsequent capital raising and decline in share values apparently vindicated.

You can’t expect miracles overnight, but with Cardiocel having been used in 1,200 patients (according to Admedus’ website) despite being on the market for a while now, uptake of the product appears to be quite slow.

The potential market for Cardiocel and Admedus’ long-term pipeline of other products (including a Herpes vaccine in phase 2 trials and pre-clinical tissue engineering trials) buys the company more time in my portfolio, but if the rewards don’t follow through, Admedus will be shown the door.

If a company can’t capitalise on its first successful product, there’s no point holding on for long years until others come to fruition.

This illustrates the fact that successful development of a product does not guarantee a capital gains bonanza for investors. Almost always, the hype turns out to be just that.

Even more foolish (lower case ‘F’) is when investors chase companies like Admedus and ignore other opportunities delivering double digit revenue growth – with the added benefits of financial stability, growing profits, and a dividend.

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Motley Fool contributor Sean O'Neill owns shares in Admedus Ltd. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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