Harrow Health (NASDAQ:HROW) has guided to at least $1B of revenue by 2027 based on their current portfolio of drugs. This begs two questions. First, what will that mean for shareholders if they execute? And I won’t bury the lede. It likely means something like a $200 share price. And second, will they actually deliver? The first question is easy enough to answer, just some arithmetic and a few reasonable assumptions. The second question is harder to answer, but I will share what I think. Read on!
HROW is a growth company
To begin with – and really, this is important – rapid growth at HROW is nothing new. Just look at revenue over the past nine years. Not only is it up more than 14x, it also grew every year except for the pandemic.
All numbers are in $millions, and 2023 is the midpoint of guidance.
A deep moat
HROW was born when its entrepreneurial CEO, Mark Baum, spoke with doctors in the eye care market, found their pain points – they were not happy! – and set out to solve them. Ophthalmologists had a lot to complain about, feeling poorly served by the existing group of producers, distributors, pharmacy benefit managers, insurers, wholesalers, and pharmacy retailers. In short, a confusing and inefficient network of middle men feeding on an opaque system.
Harrow was built in response to this, by listening to customers, as an efficient, transparent, and vertically integrated company with production, distribution, and marketing all under one roof. They are obsessively focused on understanding their customers’ needs, and this is a core competence of the company. Customers love them as a result, and their legacy compounding business, ImprimisRx, has grown rapidly in its little niche to become the largest ophthalmic compounding pharmacy in the US in only nine years.
HROW’s best of breed distribution and customer relationships are a deep moat, and in the compounded pharma space they are dominant. But the same factors, the distribution and customer relationships, have created an opportunity for the company to add branded pharmaceutical products [BPPs] into their repertoire. HROW’s move into BPPs makes obvious strategic sense, as they can acquire drugs for which they have a high degree of confidence their customers actually want, and then efficiently deliver those drugs to an existing customer base that has come to trust them. HROW has been very active, acquiring Iheezo, Vevye, a group of five drugs they’ve decided to call the “Fab 5“, and then Santen’s Branded Ophthalmic Portfolio.
It’s precisely because of this moat that HROW can acquire valuable drugs and generate extraordinary returns. That comes up a lot when I discuss HROW. Why can they buy this drug or that drug and create value? It’s a good question. And the answer is that the seller can’t efficiently sell into HROW’s customer base.
As an example of this, Japanese drug company Santen tried to market their suite of ophthalmic drugs into the US market. They hired a salesforce, developed customer relationships, slowly built up sales, and lost money the whole time. Eventually they gave up and sold to HROW in return for a small upfront cash payment, and, importantly, a substantial royalty.
HROW already has the customers, and they can just add another drug into the suite they are already selling to them. There’s not a lot of incremental expense involved, and there’s instant exposure to a huge market. What’s more, there are only two companies with major distribution in the ophthalmic market in the US, the other being Bausch and Lomb (BLCO). The other pharma companies have largely abandoned the space, leaving only two potential acquirers. So, remember that this moat – distribution and customer relationships – is what makes the accretive M&A possible. If you don’t understand this, you don’t understand the thesis.
And one more thing. When it comes to management credibility, look at what they have done so far. This business didn’t exist ten years ago. A CEO with a vision created it from nothing and grew it into the deep moated rapidly growing company it is today. Baum’s track record speaks for itself. So, remember that, too.
HROW 5-year guidance
HROW CEO Mark Baum writes a shareholder letter each quarter – as an aside, this is an excellent practice I wish all CEO’s would emulate – and in the Q2 2023 letter he discusses HROW’s 5-year financial goals (2023 is year 1 and 2027 is year 5) and offers guidance for 2027:
Simply put, we believe that – with our current product portfolio and continued strategic execution by the Harrow team – we can become a top-tier U.S.-focused ophthalmic pharmaceutical company capable of producing annual revenues of $1 billion or more – at very attractive operating margins… we now have the products needed to achieve our highest financial objectives. (Emphasis added)
Note that this guidance does not require any additional M&A. They already have the products needed for that. I’ll break it down with a bit more granularity below, but first I want to discuss what it means for shareholders if Baum actually delivers on what he says he will.
A $200 share price if management hits guidance
Since HROW has guided to $1B or more of revenue by 2027 based on the current portfolio of drugs – no M&A is assumed – it makes sense to ask what that would mean for the share price if they meet this guidance. In other words, what will the stock be worth in five years based on the existing portfolio of drugs?
First, they have guided to gross margins in excess of 80%. I’ll use 85% here, implying gross profit of $850M on $1B of revenue. SG&A will increase from the current $68M cash run rate, but there’s a lot of operating leverage in the business when one adds high price, high margin products, as HROW has done. With that in mind I model $200M SG&A in 2027, triple the current run rate. I include zero interest expense, since in my model they first pay down all debt with cash flow, and then buy back shares once debt is zero. And then I tax at 25%.
Fully taxed FCF in 2027 works out to $488M with these numbers, or about $12.80 per share at the current 38M fully diluted share count. However, this ignores the impact of share based comp, and does not include most of the $1.2B of cash generated through YE 2027. $200M is enough to pay off all debt and leave them with $50M of operating cash. The remaining $1B can be used for dividends, share repurchases, or more acquisitions. Here I model buybacks at an average repurchase price of $125, reducing the share count by 8M.
HROW has a generous share based comp program that is entirely tied to a rapid share price increase. In the scenario I am modelling, management will earn very large bonuses because the share price will go up a ton, perhaps 1M shares per year, or 5M over five years. Net of buybacks, the share count ends at 35M, and FCF/share is roughly $14. A $200 share price follows if the fully taxed FCF multiple is 14 or more, and $300 if the market likes fast growing, debt free, well managed HROW, and puts a 20 multiple on it!
One can make different assumptions and get a different answer. For example SG&A expense might be higher or lower, and the same thing is true for the multiple. Feel free to supply whatever numbers you like, but it will be very hard to get a share price that isn’t way up from the $16 it trades at as I write this.
For example, what if we double SG&A – clearly too aggressive – and reduce the multiple to only 7 times fully taxed FCF, half the 14 I assumed earlier? HROW would then trade at just over $70, more than 4 times today’s price. In this example, fully taxed FCF winds up at $338M in 2027, and the share count – now assuming an average repurchase price of $60 – ends at 33M, leaving fully taxed FCF/share at just over $10.
Those assumptions are overly pessimistic for any kind of base case thinking. A 7x multiple for a fast growing debt free company? Possible, yes, but not what one expects. And the stock would still be up more than 4x. So I feel comfortable predicting that the stock price would wind up somewhere in the range of $100 to $300. Call it $200, as a base case, if HROW hits that $1B revenue target in 2027.
In the Q2 2023 letter, Baum says that HROW’s $1B+ revenue in 2027 can be best thought of in five distinct “revenue buckets”, each of which will generate at least $100M, but some more than others. Here’s my take on what they think they will get from each.
$100M or more – The legacy business.
$100M or more – The Specialty Anterior Segment. This segment includes the Fab 4 (that’s the Fab 5 ex Triesence), Fortisite, and some of the drugs recently acquired from Santen.
$200M or more – Triesence. Baum has told investors that he expects “multiple hundreds of millions” from Triesence once the manufacturing issues are sorted out. $200M is as low as one can get and still have multiple hundreds of millions.
$300M or more – IHEEZO, and…
$300M or more – VEYVE. Baum says in his letter that IHEEZO and VEVYE are without question HROW’s two largest opportunities. If Triesence is at least $200M, I think that means IHEEZO and VEVYE must be at least $300M each.
I believe IHEEZO and VEVYE are our largest revenue opportunities – without question.
If we add up the contributions from each of the five buckets, we get $1B of revenue or more by 2027. As an aside, I think it’s likely going to be a lot more than just $1B. A case can easily be made for IHEEZO and VEVYE to peak at well over $1B in revenue each. I’ll save that discussion for another time, however.
So… to recap, there are five buckets, and HROW explicitly tells us that each is at least $100M. That’s at least $500M right there, not $1B. But they also tell us that Triesence will be multiple hundreds of millions. At least $200M, right? And they also tell us that IHEEZO and VEVYE are their largest revenue opportunities, so larger – “without question” – than Triesence. Presumably that doesn’t mean $1M more than Triesence, it means a lot more. And that gets us to $1B or more.
The story so far
HROW is a rapidly growing deep moated company that has shot up from $10M in revenue in 2015 to $140M in 2023.
The deep moat has enabled what looks to be highly accretive M&A, which is just now beginning to drive revenue.
HROW has guided to $1B of revenue in 2027, based on their current portfolio of drugs. Some of these drugs were recently acquired, but now that they own them, from here they are telling us they can achieve that $1B revenue organically.
They identified five revenue buckets. Two of these should produce at least $100M, one at least $200M, and two more at least $300M each. The total is $1B or more.
If they hit $1B of revenue, a share price in the range of $100 to $300 will likely result. Call it $200 as a base case.
Management has delivered impressive results so far, which should inform investors’ views on their credibility
Trust but verify
HROW management has built a deep moated business from nothing, and growth over the past nine years has been stellar. They have earned some trust, so when they guide to even more growth ahead, we should take that seriously. But is there a way to verify that this guidance is plausible, or that they are on track? I’ll tackle this bucket by bucket.
On track for $100M or more – The legacy business. This business did $20.3M in revenue in Q4 2022 and has been growing at a low double digit rate. $100M in 2027 is both plausible and on track.
Plausible for $100M or more – The Specialty Anterior Segment. The Fab 4 were delivering perhaps $35M to $40M of revenue at the time they were acquired, and the Santen portfolio perhaps half that. HROW has been clear they think they can grow these substantially. I have written about Fortisite before, so I won’t rehash the case for it here, but with 1M use cases a year and a $200 list price, any reasonable market share should make Fortisite a major contributor. This segment is likely at something like $60M per year today, and $100M by 2027 seems at least plausible. Since we don’t have any growth data yet, I can’t conclude that it is or isn’t on track, however.
Plausible for $200M or more – Triesence. This one is different from the others, since there is clearly demand for it, and the issue that must be overcome is manufacturing difficulties. Baum has expressed confidence that these will be solved, and there have been some early test batches. I cannot conclude yet that Triesence is on track, however, since it is not yet in production. It is certainly plausible that the difficulties will be solved, however, since Triesence was in wide scale production for years prior to 2021. And the revenue to be generated is easily at least $200M. There are 600k annual use cases identified in the shareholder letter for Triesence, and the lowest priced competitor charges $1500 each. Triesence is in very high demand and will likely earn more than a 50% market share – management has said as much – and while we don’t know the price they will charge, one can pencil in $1k and still be by far the lowest price option. $200M or more by 2027 is plausible. For that matter, so is $300M or even $400M.
Plausible for $300M or more – Vevye. See below.
On track for $300M or more – Iheezo. See below.
Vevye – $300M in sales by 2027 is plausible
There’s no way to conclude Vevye is on track since it has not yet been launched. Launch is expected before the end of 2023. Vevye is one of a new generation of drugs aimed at the potentially huge dry eye disease [DED] market. There are 16M DED diagnosed patients in the US, of which 9M suffer from moderate to severe DED. Less than 1.5M patients actually treat their DED today, because the older generation of DED drugs are far from adequate.
The first of these older drugs, Restasis, generated more than $1.5B in annual revenue at its peak, despite the fact that roughly 90% of patients who tried it wound up discontinuing after four months. Restasis had to be taken for six months before the treatment took effect, and it’s uncomfortable to use. The next drug, Xiidra, saw a similar fall off of about 80% of patients discontinuing use, with users experiencing side effects – pain on installation and a metallic taste (yes, these are eyedrops, but the taste is a side effect anyway) – and presumably these side effects outweigh the benefits for most patients. Xiidra still generated almost $500M is sales in 2022.
But there are two new drugs entering the DED market, Veyve and Miebo. Both were developed by European pharma company Novaliq, and in each case, Novaliq made the decision to partner with US companies, HROW for Vevye and BLCO for Miebo. I mentioned the logic for this decision earlier when I discussed HROW’s moat – I even asked you to remember it! – and when it comes to ophthalmic distribution, these are really the two companies that one can choose from who are actively focused on the ophthalmic space.
Novaliq spent $80M developing Veyve, and HROW paid only $8M up front for the North American rights. The real money to be made for Novaliq will come from the 12% royalty that HROW will pay them. This is a win for both Novaliq and HROW. Neither HROW nor Novaliq have much at risk, and both are exposed to a great deal of upside, as the combined offering takes advantage of Novaliq’s valuable drug and HROW’s distribution. Note that BLCO probably would not have been allowed to buy Vevye due to antitrust considerations, as BLCO already owns both Miebo and Xiidra.
At this point I’m going to add a bit of complexity to the discussion. There are two types of DED, aqueous and evaporative. Estimates vary, but something like 75% is thought to be evaporative, and until now no drugs existed to treat EDED. Miebo is a compound that sits on the eye and prevents evaporation, but it has no active ingredient to treat ADED. Vevye – remember, these were both developed by Novaliq – is a very similar molecule to Miebo, but with Cyclosporine dissolved in it. The latter treats ADED, and the former treats EDED. So, Vevye treats both forms of DED, and Miebo treats EDED. Miebo may be more effective on EDED – the molecules are similar but not identical – and may still win in the EDED marketplace. However, since Miebo has no active ingredient to treat ADED, Vevye is likely to win that market, as it is the only drug with fast onset of relief and high patient comfort.
The TAM for these drugs is truly huge. While fewer than 1.5M patients currently treat their DED, that could be because of the unsatisfactory nature of the drugs that have existed up until this point. There are 16M diagnosed patients with DED in the US, 9M of which have moderate or severe DED. With better drugs, it may be that more of them will choose to treat their disease. And the price point is mouthwatering. Miebo recently listed at $779 per month. And while the list price is not the price the companies actually receive, even after discounts it may be $5k per year once the drugs are covered by insurance. Each 100k patients represents perhaps $500M of revenue, and 100k is about 1% of diagnosed patients with moderate to severe DED, of which perhaps 2M suffer from ADED (the actual proportion of ADED vs. EDED is not known, and estimates vary).
It’s easy to envision Vevye wildly exceeding $300M in annual sales. My personal expectation is that it will, and that Vevye is likely a $1B+ drug eventually. We shall see. For now, however, I feel comfortable concluding that $300M or more in sales for Vevye is certainly plausible.
Iheezo – $300M in 2027 sales is plausible and on track
HROW bought IHEEZO in 2021 from Sintetica, which was looking for a US distribution partner and retains a 5% royalty. Iheezo is a surface ocular anesthetic that allows for pain free cataract surgery and intravitreal injections with no other anesthetics needed. It has patent protection through 2037.
At the time of purchase, Iheezo was not yet FDA approved, and was still somewhat speculative. But since then absolutely everything has gone right, starting with early FDA approval in September 2022. Early approval was a great sign that regulators were positively disposed to the drug, but even so, the market was positively surprised when Iheezo received a J-Code and then received transitional pass through status from Medicare & Medicaid.
The addressable market for Iheezo is huge, with 12.5M cataracts and intravitreal injections in the US each year. Iheezo is listed at $544 per procedure, but after various rebates and discounts it comes to about $400 per procedure to HROW. The TAM is about $5B. Each 1% of market share represents $50M in revenue, and HROW currently does business with roughly 20% of prescribers, a number which grows each year.
Iheezo has a number of important advantages over the current generation of drugs, but not all doctors actually know this yet. In fact, the main criticism one hears is that most doctors think what they are using now is “good enough”. Baum addresses this concern in the Q2 2023 shareholder letter:
When our team began market research on IHEEZO, some advisors said, “I really don’t think I need this product because what I am doing for ocular anesthesia is okay.” When we pressed about what their respective ocular anesthesia protocols consisted of, our belief in the future success of IHEEZO gained strength. Responses from these advisors included myriad protocols, with most using multiple different anesthetics during a series of applications – all with inconsistent durations of anesthetic effect. Inconsistent anesthetic durability or reliability isn’t good for the doctor and surely isn’t good for the patient! Discussions about the importance of an anesthetic caused many of our advisors to realize there was an opportunity for a more reliable ocular anesthetic and one that could create practice efficiencies. (Emphasis added)
If one speaks to ophthalmologists or reads expert network interviews, one will likely come away with a few conclusions. The first is that they are typically open to trying Iheezo, but they are not exactly excited by it. They may appreciate some aspect, such as the fast onset time – 90 seconds vs 10 minutes – that may improve workflow. But one never hears that this is the product they have been waiting for, or that the sooner they can get started, the better. They are open to it, but not excited.
And the second conclusion is that they may use a whole host of anesthetics currently, and they think that’s good enough. It’s this fact that made me bold Baum’s comment in the quote above. One example I encountered was a cataract surgeon who would use an oral sedative, then eye drops, and then an anesthetic injection into the eye. And all that could be replaced by just Iheezo. Pain free with just eyedrops. And really, ask yourself this. As a patient, do you really think it’s good enough to take an oral sedative that makes you groggy, then eye drops, and then a needle in your eye? Is that really good enough, when you could just have three eyedrops instead?
And the third is that doctors are not always up to speed on the financial incentives awarded by regulators for using Iheezo. One that I know of thought a J-code lasted six months, instead of through patent expiration in 2037. And even if they do know about J-codes, they haven’t always done the financial math. They are doctors, not accountants, so this is perfectly understandable.
But the math is compelling. A high volume surgeon might perform 3k cataracts a year. Iheezo is free, replacing current anesthetic drops that cost the doctor perhaps $20 per use. Not only that, regulators also pay the doctor about $30 per use of Iheezo as an explicit financial incentive to encourage its use. This is why the pass through and J-code are so important! So the financial incentive to use Iheezo is roughly $50 per procedure – $20 in cost savings plus the $30 incentive payment – which works out to perhaps $150k per year to a high volume surgeon. This point is not well understood by many doctors.
On the other hand, there are some high volume organizations that almost certainly do understand, and care about, the economic incentives. Three high volume cataract surgery centers who are likely switching to Iheezo were written about in this article in Ophthalmology Management. There are more than 10 surgeons at each institution. Vance Thompson Vision, for example, has 11 surgeons (along with many optometrists) and does a booming business in cataract surgery. A surgeon will often make use of two operating rooms, allowing staff to prep patients, and can perform 30 surgeries in a day. A busy surgeon can expect something like 3k cataract surgeries per year.
A single center like Vance Thompson likely performs more than 30k cataract surgeries per year. At $400 each, that one center represents $12M of annual Iheezo revenue. And the financial incentive to the institution is not small. At $50 each, this works out to $1.5M per year of what is essentially free money. As long as Iheezo is at least as good as what they were using before – and it’s better, to be clear – there’s really no reason not to switch.
Chris Bender, the anesthesia director at Vance Thompson Vision, is quoted in the article I linked above:
After many years of innovation in the intraocular lens (IOL) space, he applauds Harrow for an advancement in anesthetics. “There has been a tremendous amount of movement in lens options but very little in anesthetics until now,” he continues. “I say bravo—and we are excited to be using something new.” (Emphasis added)
Other institutions that have commented favorably about Iheezo in journal articles include the Cleveland Eye Clinic, the Center For Sight in Florida, and Harvard Eye Associates in California. Each of these has ten or more surgeons. And, intriguingly, a surgeon at private equity owned EyeCare Partners [ECP], an institution employing 280 doctors, posted an absolutely glowing review of Iheezo, calling out both greater patient comfort, and a reduced need for anesthetic injections into her patients’ eyes:
I had the chance to finally try #IHEEZO, a low-viscosity topical ocular anesthetic by #Harrow. It worked great for my patients today and many patients didn’t even need the intracameral anesthetic I typically use. I’m looking forward to continuing to try this product for my patients. Patient satisfaction and comfort are extremely important to me and to be able to provide safety and comfort for my patients who are undergoing surgery through new innovation is exciting as an ophthalmologist.
Iheezo is a better drug for patients, it’s better for workflow, and the financial incentive to adopt it is clear. Each 1% of market share is about $50M of revenue, and HROW customers today include 20% of prescribers. I think it’s clear that $300M in revenue is plausible.
There are four institutions, that I am aware of, that have been quoted in journal articles offering favorable commentary about Iheezo. These high volume centers likely represent $50M of annual Iheezo sales that may already be in place as I write this. And if ECP is at least considering adoption, that one institution could push sales over $100M. We are only four months into the Iheezo launch, and it seems likely that sales just at institutions that I am personally aware of – hardly an exhaustive survey of the entire market! – are already pretty encouraging. I conclude that Iheezo at $300M revenue in 2027 is not only plausible, it’s also on track.
We don’t need $1B in revenue for great performance
This article is about management’s $1B+ 2027 revenue guidance. I’ve already said that in my view they will hit a much higher number, with both Iheezo and Vevye plausibly exceeding $1B each. But it’s also worth pointing out that we don’t need $1B in revenue to succeed.
For example, let’s suppose that both Iheezo and Vevye wind up being total flops. I don’t expect that to be true at all! But even if it is, the other three buckets add up to at least $400M of revenue, and they won’t need a big increase in SG&A to get there. At 85% gross margins, and perhaps $80M SG&A – the current run rate is $68M, and Triesence basically needs no sales effort, the demand is there already – FCF after tax is $195M, or about $5 a share on the current 38M share count. At a 14x multiple, the stock would be $70, up more than 4x in less than five years.
I’ve completely ignored Melt
I have discussed HROW’s 46% equity stake and 5% royalty in Melt before. Melt is a potential blockbuster drug, and because it’s development is financed by outside investors, it’s a free option. I have not included it here because it’s not part of management’s guidance, which is the topic of this article.
But make no mistake, Melt is a big deal. And it could easily be a third $1B+ opportunity for HROW, along with Iheezo and Vevye. Here’s what Baum says in the Q2 shareholder letter:
Regardless of the exact timing of when revenues for a Harrow product begin to mount or grow, the key for our stockholders is that we now have the products needed to achieve our highest financial objectives. (In addition, if our former subsidiary Melt Pharmaceuticals is successful in turning MELT-300 into an FDA-approved product during this Five-Year Strategic Planning cycle, we may be able to add even more revenues to the mix because, aside from our large equity position and royalty rights on MELT-300, Harrow has a right of first refusal on Melt’s commercial rights!)
In this article I have explored the implications for HROW shareholders if management meets the guidance targets they have set. Obviously the big long term risk is that they not only won’t meet that guidance target, but fall well short of it. For example, if Melt, Triesence, Iheezo, and Vevye all produce zero revenue, HROW revenue would be stuck at perhaps $150M, or 15% of the $1B guidance. At an 80% gross margin, and $67M of SG&A – the current run rate – and $24M of interest expense, the company would produce less than $0.60 a share of FCF after taxes. At a 10x multiple, the stock price could go to $6, meaningfully down from the roughly $14 it trades at as I write this.
I think this risk is fairly low, since there are so many bites at the apple, so to speak. All four drugs producing zero revenue seems a bit pessimistic. But it is at least possible.
In addition, management has guided to revenue of $135M to $143M in 2023. So far in Q1 and Q2 revenue has totaled only $60M, and the company will have to deliver at least $75M in the second half of the year or risk missing guidance. Revenue is expected to grow substantially during the year, but if it doesn’t, the company could miss guidance and the stock would likely trade down, regardless of whether the long term future is bright or not.
HROW has guided to at least $1B of revenue by 2027. The consequence of success, if they execute, is a price of perhaps $100 to $300 a share of HROW stock at that time if they hit $1B of revenue exactly. My personal expectation is that they will exceed $1B, and if they do, the share price estimate would need to adjust up accordingly. However, investors can still expect a great outcome even at a much lower revenue level. For example, $400M revenue is consistent with perhaps a $70 a share.
HROW breaks their revenue into five distinct revenue buckets, adding up to a total of $1B or more. In each case, I consider the targets to be plausible. Importantly, we also have meaningful early indications that one of their potentially blockbuster drugs, Iheezo, is likely on track to deliver the excellent results management is expecting.
I consider HROW to be a once in a decade opportunity. I often say things like the price is too low, and the stock should be bought. That’s true here, too, no doubt about it. More than any stock I’ve ever written about.