Solid update from Painchek. They manage to get around 60% market share in Australia, covering 120K beds.

Painchek is a very interesting startup focusing on the niche dementia/cognitively impaired market and made it clear that FY22 is centred on international expansion. Getting more CMS integrations in the UK was a big achievement as it unlocks 90,000 beds. History has shown us that even though the system is integrated, it does not mean that Painchek would fill 90,000 contracted beds quickly. It most likely takes 2-5 years to win the beds, with 2 years being very optimistic. 

They are a startup, so looking at the current financials is not a good strategy for assessing the long term prospects. The most important metric to measure Painchek's success is revenue retention during revenue growth. The new contract wins for Q4FY21 are not yet implemented and will be under commercial pricing, meaning they are finally moving away from the government trial. The key question is how many beds can they retain during the transition? If they can retain more than 95% that would be a win for the company. 

The current quarterly cash burn is around $1M per quarter with ~ $11M cash in the bank. So milestones that they must deliver by FY22:

1. Prove the UK business model and grow sales.
2. Enter Homecare through existing customers. 
3. Start commercializing the kid's app (not expect anything special until mid-2022).
   • I particularly like the fact that Painchek is in discussions with Cochlear to monitor Post Procedural pain for young children. I like the chances of this being a reality if there is evidence where Painchek is a better tool to assess the pain than doctors. 
4. Complete the FDA trial 

Overall, don't expect exponential revenue growth. However, they are proving themselves by reaching milestones like RAC bed growth. Unlike many startups with unproven products or no customers; they have customers and proven products. They have not grown them in international markets with larger addressable markets. 

From an investor POV, it's still a long way before they make meaningful revenues. Hence, Painchek is low weighting in my portfolio but they are a cool startup for the really long term investor (I am talking 2025+). Ageing population increases the TAM for Painchek so it's not a fixed number in residential aged care. I predict the share price to swing violently in both directions via news flow. An excellent trading stock.  

The startup doing well in their latest announcement as they recieved the 3rd tranche $1.25M from the government funded trial. The final tranche will be prorated depending on how many dementia specfic beds were acquired. Overall, good result and Painchek reiterated that Australia is a proof of concept with residential aged care. They have good amount of cash for the next stage in their lifecycle. 

We are all waiting on how they are progressing with Phillips and homecare as the next catalyst. The revenue opportunity is much larger but again we have seen that this industry is very hard to enter. Commercialisation is slow and the market rightly value the company as a startup. 

Reaching $200M+ valuation require double digit revenues in the millions. If past history has shown investors anything, Painchek takes their time with clinical trials before commercialisation. Hence, it is not for traders but long term investors who actually keep it in their portfolio long term.  

After the grant, I would assume atleast 75% of ARR would be retained given the aged care facilities paying for the app are the large players. The churn will come from smaller players until the government makes digital solutions like pain monitoring mandatory inside aged care facilities.  

Now that Painchek achieve this milestone, let’s see how quickly they can get customers using the app. I think they are starting with hospital before going straight to direct consumer. 

The final regulatory hurdle is to clear FDA for both adult and children’s app in 2022. After approval let’s see the rollout. If past history has shown us anything, the company is very slow to commercialise. 

Painchek is an interesting company providing a valuable service but struggling to get over the commercialisation hurdle. As explained previously, covid halted progress on their international sales growth. The primary risk for the business is execution. The technology is great, product is essential for aged care but commercialisation is slow. I underestimated how long it takes to win customers after clinical trial. This is a painful lesson to remember when investing in early growth health technology companies. 

We are seeing prolong delays with Phillips healthcare. The delirium trial is essential for Painchek to prove the product to Phillips. Upon completion, they could monetise facial pain monitoring by integrating with Phillips hardware. In my earlier valuation, I did not include revenue for homecare and hospital segments. However, I projected 1m beds by 2030. That assumption no longer makes sense when looking at the context of the national rollout.    

Thus, my initial valuation made assumptions that made them look better than what they are capable of achieving. Guessing when Painchek reach commercialisation has the same likelihood of throwing a dart 100m away and expecting a bullseye. Unfortunately, for a DCF you are basically trying to predict future cash flows. It’s the most flexible tool we have as analysts. Revenue uncertainty is very high so making slight errors in the forecast will change the valuation greatly. 

My initial valuation is a valuation gone wrong. All my assumptions have to be rechecked: 

• 1m beds (15% global penetration rate) by 2030 (how could they get there?) 
• Operating margin of 70% in 2030 makes no sense. As the company gets bigger they need more staff. I can see gross margins being 70%+ but not operating margins.  
• risk free rate no longer 0.5% it is 1.5% or whatever the 10yr government bond rate is. 
• Perpetual growth rate of 6% is faster than inflation from 2030 onwards, so it has to be a special business to reach that. I very much doubt that to be the case. 

In saying that, I have not considered the other business lines that are primed for commercialisation - homecare, hospital and (children's app + children's hospital). Pretty much have to do sum of the parts valuation without going over board with the assumptions.

I will put my thoughts on the valuation section. Please see attachment on the DCF snapshot. I am still making bold claims of the future but thanks to DCF, it is worth less today. Most of the revenue growth happening from 2025 onwards. The stock price will remain volatile for quite a while. You can get away trading this stock. 

Painchek achieved regulatory clearance on the universal painchek app that caters to not only cognitive impaired patients but also for patients that can verbalise their pain. The company is taking the medical device route for any new products and I guess that explains the slow growth. It is frustrating for shareholders as new products need approval before use, even if the product is technology based. Despite this, it is a good sign for existing customers as now all residents can be monitored using Painchek. The care industry has struggled with pain management reporting and I can see Painchek being useful for that need on a broader market. 

My new valuation will have to take residents who can verbalise pain into account. Especially looking at the % of residents per care facility with cognitive impairment and how much more revenues Painchek can extract per customer. I still feel the larger markets are hospital and children. Therefore long term, bulk of he valuation should come from segments not penetrated by Painchek. There’s also a webinar coming up, so more questions should be asked.

Painchek Released the Q2FY21 report and now I have to really think about what I am investing. 

Rethinking the business from first principles during covid; we can see that they have difficulty selling the product (Painchek pain assessment) to Residential Aged Care. You cannot visit the centre due to the obvious reason, and they are not interested in procurement when the virus is ongoing. They had to train and sell online which they pivoted well. Training online, however, is quite a challenge for small RACs, as they do not have the best resources. We have seen churn from the smaller players and the larger players are delaying the purchase. The Department of Health is extending the trial for some of the RACs who have not utilised the app due to the pandemic. For the early RACS that were on the free 12-month trial are now turning into paying customers. We shall see what the churn is when they have to start paying Painchek. From Painchek's estimate, the larger customers are finding a lot of benefits.    

Pilots for Homecare are ending in January Q3FY21 which is good news, so we can now think about what the revenue arrangement would look like. From their deck, Homecare is a much larger market and key early catalyst for the business. What does that mean revenue wise? "Commercial models established for market launch in Q1 C2021". Really would like to see more colour on that commercial model. Is it revenue share from a Homecare Package? Less uncertainty with Canada as Alayacare is spearheading that initiative for Painchek, but still what's the business model? From past presentation decks; Painchek says "Annual Market Value at $7 monthly subscription per dementia patient living home". Will this be the same when they work with home care providers? They are also deploying pilot in the disability area (specifically NDIS through Nulsen Group). The NDIS market is lucrative with around 392,000 active participants and $16.1 billion paid by the NDIS for participant support in FY20. Soo much uncertainty on revenue generation from this segment, but will give a crack on the valuation front.  

Universal Pain Assessment Solution - Now this was from the AGM, and it was discussed in detail. The objective is to use the Pain dashboard to monitor how the cognitive impaired / dementia patient is doing? The solution is useful for pharma companies as they do not want to misdiagnose dementia from pain. Hence, the Phillips trial is quite useful to see whether Painchek AI can work in a variety of environments. Expected global launch in Q3FY21. 

There are much more details in the quarterly regarding the number of beds and the % of beds part of the government trial etc... They do talk a lot in excruciating detail even though their ARR run rate is now $3M. I think it is fair considering Painchek is soo early-stage and more information is needed to predict cashflows. 

This will be a tough revaluation, will take quite a while haha. 

Well well Painchek getting in to Canada expands the market by $20M. It is very similar size to Australia. The company should have market cap of $120M, but maybe due to demand the market cap can rise. 

I was expecting this announcement on December. Glad I was wrong and happened earlier. Now I can trim with a return. 

Painchek sent out their quarterly last Friday night and it was not good. 

• The contracted bed uptake grew slightly 
• Homecare pilot launch on January (I thought it was happening this quarter) So it is delayed by a quarter.
• Phillips not much progress on the delirium trial due to COVID 
• Children's app - surprisingly good news here with an expected TGA application during Q3 FY21 just using pain faces. This is to enter the early child monitoring market. 

Overall, it was a very disappointing result and makes up quite a lot of weighting in my strawman portfolio. Will lower the weighting. Have to revalue the business at the end of next quarter to see if things are progressing slowly or if it is a one-off quarter. Prior assumptions are challenged by this quarter's performance. 

Since my last valuation, a lot of interesting things happened.

• Firstly, the change to the negotiated terms of the government trial. Due to COVID-19, the 100k cognitive impaired beds is pushed out to March 2021. Painchek will still get paid, but they have more breathing room for execution on the final 75k cognitive impaired beds.
• Secondly, they have made in-roads in the clincal trials with Phillips and home care.
• Thirdly, they have informed the market that they send a pre-submission to the FDA on how they would conduct the regulatory trial. We are yet to get feedback from FDA, so Painchek decided to target Canada and have commenced the regulatory trial through a partner. 
• Finally, the clincial trials for the child app came to a  halt due to COVID-19, but the results for facial monitoring was encouraging.

It's quite a lot to take in, but Painchek is starting to branch the business out. This straw is a summary on how they plan to execute their strategy. My valuation 4 months ago made assumptions on just the (Enterprise) Residential Aged Care business. They have made plans to enter (Consumer) through home care, shared care and direct to consumer (using partners). In the (Enterprise) patient monitoring for patients suffering with delirium through Phillips and baby monitoring through Melbourne's Murdoch Children Research Institution (MCRI). In the Enterprise side, Phillips is not the only one, but also Siemens and GE are also interested to see progress after Phillips collaboration. 

To make it easier to follow, I broke down their strategy from an Enterprise and Consumer perspective. 

Enterprise 

• Residential Aged Care (RAC)
  • As of March 2020, working with 175 customers where 588 RAC facilities are contracted. Approximately 50,000 beds are using the software generating ARR of $2.26M after the government trial concludes. Around 30,000 beds from 50,000 are cognitive imparied and are included in the government grant. 
  • Achieved CE & TGA clearance. With CE mark their strategy is to penetrate Europe through UK. Currently, they have partnered with Pearson Centre Software to distribute the license to aged care homes in UK. 
• Hospital Patient Monitoring Systems 
  • Painchek aims to integrate their software to hospital patient monitoring systems. Phillips is the largest provider of hospital monitoring systems. Thus, Phillips have dominance in the hardware and now their strategy is in the software.
  • With this in mind, Phillips created Healthworks to partner with startups to integrate software to Phillips hardware. Phillips research team is working closely with Painchek to make it happen. From the quarterly, "The focus of the study is around facial assessment of pain and delirium detection. PainChek has recently finalized and provided technical specifications. Philips’s research team has agreed on the logistics of incorporating PainChek’s technology in the study and technical specificities provided" 
  • So currently, this part of the business is still in R&D phase, but it is a massive catalyst for the business, if management execute on integration. 
• Hospital pre-verbal children 
  • "A research agreement with Melbourne’s Murdoch Children’s Research Institute (MCRI) was signed in June 2019 to conduct a clinical trial of a PainChek® Infant App with 100 infants." 
  • At the time, COVID-19 halted the clinical study and Painchek is unable to give guidance on this. 
  • Recently, Victoria announced another lockdown so this aspect of the business will struggle to get going for the short-term.
  • Their strategy is after getting FDA de Novo clearance for the Adult (dementia) app, to   

Consumer                

• Home Care/ Shared Care
  • "PainChek has recently started a number of pilot trial sites with the PainChek “Shared Care” App in the Australian Home Care market. This includes a pilot in Victoria with a large international broker of home care services and with two of our existing aged care clients" 
  • "The PainChek Shared Care version is unique as it allows people caring for the client in the home environment to conduct pain assessments during home care visits and allows other family members to continue the pain assessments in between the carer visits"  
  • This is a very interesting part of the business, as more people with elederly family members will consider home care going forward after the findings from Royal Commission to Aged care. Painchek aim to use partners like "Mable" and "My homecare" to get consumers using the app.
  • I think the pilot would be halted due to the recent lockdown. Also, it is still not commericialised and it is hard to put a guidance on this. Probably get more clarification in the Financial year report. 
• Infant App
  • This depends entirely on how the MCRI study progress. Without data it is hard to get the TGA clearance for direct to consumer.   

In terms of valuation, my estimates will have to change when the FY20 report come out. I predict only the RAC business and Phillips collaboration to be of importance. With restrictions easing in Netherlands (where Phillips headquartered) there would be more progress made on logistic.

Since Painchek is a medical device company, these trials are essential to validate the product. Please be aware that due to COVID-19, most trials are pushed back. Hence, it is one of the most speculative health tech stocks in the market. In terms of price action, it is very volatile.

I am going with my gut and hold this for the long-term. It could very well be a mistake as they are very early stage but if their execution is successful, the business would have moat-like characteristics. 

I recently took my time and attempted to value this company using Damodaran's valuation course. This is what I came up with $0.45. The valuation is almost likely to be wayy off but it's my guess on how they could perform just with the enterprise app during the next decade. 

For valuing growth company with negative FCFF, I looked at next 10 years and made the following assumptions.

1. First assumption I made is 1 million beds globally by 2030 which is a 15% penetration rate worth $50M of revenue in 2030. I worked backwards to get a CAGR of 32% Estimated that revenue in 2020 to be $3.2M with apporval of government grant for FY20. 

2. I assume that since it's a SaaS business the margins will be high so a 70% margin in 2030. Also, if they were to grow, they would need to increase reinvestment as they mature. 

3. For young companies, it is really hard to work out reinvestment as usually that would be (Net capex + change in WC) but I can't forecast it well as compared to sales/cap ratio of 3 in year 2030.  

4. Worked out Cost of equity using COE = rba risk free rate + levered Beta*(equity risk premium) apparently equity risk premium is (company + Country). I split revenue by country and did a weighted average to work out country risk. I assumed that as the company matures the equity risk premium go down by 0.25%. 

    a) levered Beta = unlevered beta * (1+(1-tax)*(debt/equity)) (I used Yahoo finance for unlevered beta by doing a simple average on 12 comparable health tech company betas. 

    b) Intentionally made cost of equity high in the begining by attaching a 5% premium on top of country risk premium as it is a young company.    

    c) cost of debt to stay the same as I feel the company won't make profit tlll 2022. Afterwards, I did (1-tax).   

5. Valued operations using = EBIT*(1-tax)*(1-stable reinvestment rate)/ (cost of capital - stable revenue growth rate) 

6. Total value = value of operations + cash - debt - unexpired equity options 

1/12/19

https://canaccordgenuity.bluematrix.com/sellside/EmailDocViewer?encrypt=5b833e89-45dd-4c81-94b6-4124c5de1b7e&mime=pdf&co=Canaccordgenuity&id=canaccordgenuityaustralia@canaccord.com.au&source=mail

Very interesting analysis done by Cannacord that summarises what has happened with Painchek soo far. What I find interesting though is the amount of time spent to create the analysis. If you go to page 19, you can see under investment recommendation, the time of production being November 24, 2019, 22:25 ET and the time of first dissemination: November 25, 2019, 00:15 ET. Basically they spent exactly 1hr and 50 mins to create the 19 page report. Pardon my language but fk me that's really quick to make an investment recommendation. I could have just read company announcements and run a DCF template to create this.  

What I am saying is Cannacord did an excellent job explaining what has been said and they have made DCF forecasts on PCK's revenue projection. However, I actually question the forecasted revenue projections. EBITDA positive in 2022 is bit of a stretch to me. There has to be soo many things to go right to justify their forecasted earnings. Soo I think the report is good to get you up to speed with what has happened but it should not be compared for valuation. 

Discosure: I hold PCK shares but not only for the reasons outlined in the report. In my earlier straw I forgot to explain that digital pain mangement will be a structural trend. It will take around 10 years for digital pain management industry to mature. My reason for holding is that PCK can grow quickly before maturing in 10 years time. This is a growth play on my part despite valuations being very extreme at the moment. My horizon is 10 years for PCK and I do not expect them to hit EBITA positive in the next 3 years. However I can be wrong and that's why I am holding it for now. I may aswell be wrong and make a return than missing out in this opportunity in the next 10 years. 

Painchek Ltd (ASX: PCK) is a health technology company that uses artificial intelligence to assess, score pain levels in real time and update medical records in the cloud. Put simply, caregivers record a 3 second short video of the patient’s face and Painchek analyse the images to detect presence of pain from 9 micro expressions. The current target market for their pain detection app are dementia suffers and future target market are children who are yet to verbalise.

Residential aged care market for dementia patients 

Globally, it is estimated 47 million people are currently living with dementia and it is expected to grow to 75 million by 2025. Dementia is currently the second major cause of death globally (after cardiovascular disease) and is projected to become the leading cause of death during this period. In Australia, there are 950 Residential Aged Care (RAC) operators who manage a total of 2,700 RAC’s with 210,000 resident beds. Around 400,000 people live with dementia in Australia of which 115,00 are within RAC.

Currently, Painchek have signed one-year subscription agreements with 140 RAC facilities. Their business model is to make $5/month average revenue per licensed bed (ARLB) across RAC customers and range from $6-$10/month based on the usage of active residents. They grew from 3 customers with 65 license beds in January 2018 to 23 customers with 2380 license beds in February 2019. The numbers give a strong indication for the potential exponential growth in RAC customers during the international expansion phase.

Why I like Painchek shares

Firstly, they have made significant progress in their international expansion in Asia Pacific, Europe and US where the projected market size would increase from 500,000 healthcare professionals in Australia to 14.5 million.That is a 2900% increase in market size allowing better commercialisation opportunities. They entered their first international market through a distribution agreement with UK’s Person Centred Software which provides mobile care monitoring for over 1200 care homes across the UK. They penetrated European market after clearing CE Mark regulatory hurdle. The European market have potential of 8 million healthcare professionals who could use PainChek. They have also entered the Asian Pacific market after gaining regulatory clearance in Singapore. The Asia Pacific market has currently 23 million people with dementia. Currently, Painchek is in the FDA regulatory clearance process for US market entry (representing 70% market share). Management have forecasted that they will be granted FDA approval in 2020. The recent US patent approval for its pain assessment invention allow PainChek to protect the intellectual property of its invention in the United States and provides a platform for growing the brand in international markets. The US market have potential of 6.5 million healthcare professionals who could use PainChek.

Secondly, they are entering multiple market segments which cross over and expand Painchek solutions beyond dementia care and aged care segments. They can enter multiple segments as their software can be used by multiple healthcare professionals to validate and revalidate pain levels. Painchek refer this as their “Shared Care” model which allows healthcare professionals to provide consultation for patients in their own home as oppose to a RAC centre. Expanding market segments give rise to the pre-verbal children market where management forecast a 400 million market opportunity that far exceeds the Adult (dementia) app market. They have successfully developed the facial recognition capability for the children’s app and is expected to launch in Q4 2019.

The Bottom line

Painchek is expanding their service offering to different market segments due to the flexibility of their facial recognition algorithm and they are expanding globally for better commercialisation opportunities. Despite being loss making company, they have made significant progress towards commercialisation and have government backing in the form of $5M grant from the Morrison government to facilitate the implementation of the pain recognition app in the Australian RAC centres. Also, Painchek have strong defensibility characteristics with IP protection, cutting edge technology and difficult market entry barriers for potential competitors. Competitors face regulation in US (FDA App de-Novo application), Europe (CE Mark clearance) which comprise 70% of market share in the dementia market.

Management Experience

Managing director and CEO Philip Daffas is a highly accomplished global business leader (Ex Cochlear) and people manager with an international career spanning more than 25 years with leading blue-chip healthcare corporates and novel technology start-up companies. In my opinion, Philip is ideally placed for Painchek’s international expansion phase.