Neothetics (NEOT) is on the road now to fund the continued development of their injection-based approach to fat loss.  It’s a smallish deal of $4.3M shares with a $13-15 price range. Three mid-market banks - Piper Jaffray, Guggenheim, and Needham - are on the cover. Post-IPO there will be ~14M shares outstanding for a market capitalization of ~$200M at the mid-point of the range. [A transcript of the IPO roadshow is in process but the NEOT IPO roadshow slides are available.]

Neothetics aims at the midsection of “thin people who want to be thinner” with a set of 20 injections that stimulate local fat burning. The company sees the first part of their market opportunity among the 750K people in the US already getting some kind of aesthetic therapy by injection. After that they estimate there are 1M more who would consider injections for the first time to deal with stubborn fat deposits.

Pricing is expected to be $1500 from the company and $3000 to the patient – substantially less than liposuction and on par with other device-based treatments. The Phase 3 pivotal study is planned for 2015 with an NDA targeted in 2016 for potential approval and market launch in late 2017. Taking a very cavalier swag at this market one gets to about a $1.5B annual opportunity over the long term. But Neothetics is not the only game in town.

The Power and Pain of the Needle

This isn’t the first needle-based fat loss therapy IPO. Kythera (KYTH) offers an injection-based therapy for fat removal – specifically for the chin area which is difficult to attack via exercise. KYTH completed their IPO in October 2012 and is still pre-revenue. It’s done fairly well though since pricing at a top-of-the-range $16 the stock has been a $30 to $40 range for months.

Going back to the KYTHERA IPO roadshow slides their mechanism of action (MOA) is also different. They actually destroy fat cells instead of just accelerating the metabolic process to shrink them. They present a large body of evidence making it clear that their process does work – as long as you want to go through a regiment of injections, and suffer some “pain/burning, swelling and numbness” as part of the process. These are part of the experience based on the results of their European Phase III trial. In the parlance of the drug industry these are not really considered “adverse events” since they are basically just discomfort. So full speed ahead with the needles.

At the current price KYTH is capitalized at $770M which suggests investors are fairly positive on their prospects. This observation is based on the fact that management sees the “potential to reach long-term annual sales of $500M+ in the US” for their lead drug ATX-101. In addition to U.S. revenue the company is eligible to receive milestone payments of about $300M, and will get “mid- to high-teens” royalties from Bayer who holds the RoW rights to the drug. (Bayer is a great partner to have in terms of validation and ability to execute.)

The Neothera process is gentler on the patient with far less reported discomfort like pain/burning. This makes intuitive sense since their MOA is more about spurring fat cells to shrink their stored fat rather than a destructive inflammatory process.  The comparison in terms of value is harder to make since that “half a belt loop” is much harder to see than chin fat.

The positioning against liposuction is not really valid for NEOT. Management points out that their procedure isn’t for “fat people” which are a significant portion of the existing market. The real competition will be non-invasive procedures from companies like Zeltiq (ZLTQ).

KYTHERA plans to expand the target areas for their treatment but they are focused on other “localized fat” areas like arms, knees, back and “pre-axillary” areas. In other words these two companies are very complimentary both in terms of their MOA and target areas. They will be marketing and selling to much the same group of physicians. Seems like a great M&A opportunity which could provide a margin of safety for investors in NEOT.

Considering the Cold

ZELTIQ (ZLTQ) with their “cool-sculpting” device spot freezes areas of the body to spur fat loss. ZELTIQ has been controversial since their IPO in July of 2011 but eventually continued traction in the market allowed them to complete a secondary in November of 2013 and reach a $1B market capitalization. [ZLTQ IPO roadshow slides. We also have the ZLTQ Follow-On roadshow slides.]

ZELTIQ has some advantages over both KYTHERA and Neothetics for growth investors:

• They have revenue – expected sales for 2014 are $172M compared to $111M in 2013.
• Attractive gross margins are on the verge of making the company profitable. Non-GAAP earnings will be positive this year and both GAAP and non-GAAP earnings forecast for 2015 and beyond. Analysts are expecting non-GAAP EPS of $0.41 on $253M in revenue for 2016.
• The MOA is based on subjecting fat cells to low temperatures. Fat cells are more sensitive to cold than skin, nerve and muscle cells. The exposure triggers the death of fat cells. In addition to being non-invasive the procedure is far easier to generalize to other target areas than the drug-based methods. As such the ZLTQ method offers a broader range of options for doctors, patients and ultimately investors who want to tap into the growth of cosmetic procedures for fat reduction.

The drawbacks to a ZELTIQ include the need for a practice to dedicate space to the machine and a longer process time. However it compares extremely well to liposuction and a “no needles” message resonates with many consumers, especially neophytes.

ZLTQ stock has had a good run recently and at $27 is trading at just over 6x revenues. So it’s not cheap here but the company is executing well and appears to have many years of growth ahead of it.

Conclusion

Neothetics has a mechanism of action that seems attractive – stimulate the normal metabolic process to reduce fat from inside cells. The question comes down to market opportunity, potential market-share and business model. It’s too early to build an informed model but the MOA seems like it could be “opened up” to broader application in the very long term. That would make NEOT a very interesting stock.

The biggest issue facing investors in the medium-term is that NEOT is still two years away from commercial launch. KYTHERA shares have held up very well during the past two years of clinical trials but they came public with a much more potent set of banks with J.P. Morgan, Goldman Sachs and Leerink Swann on the cover.

Perhaps the most intriguing aspect of NEOT is how complimentary it is for an existing company like KYTH. It would be hard for KYTH to acquire NEOT at a substantial premium to the proposed IPO price we’d see it being much more likely if NEOT is priced well-below the range or declines post-IPO – both very possible results here. Bayer might also be interested in helping KYTH with M&A funding if the deal included RoW rights licensing to them.

[Looking at this market one conclusion is to go back to owning ZLTQ as a more "here and now" solution to cosmetic fat reduction.]

The bottom line is that NEOT is a lower-quality deal with years to go before commercialization of what could be a $1.5B per year market greatly contested by existing players. The filed price range seems a little high in terms of risk/reward.