We first began researching Vapotherm* in January of 2019, long before anyone would have ever dreamed that events taking place in 2020 were possible. The company had only recently gone public (in November of 2018) and had achieved about $42 million in sales the previous year -- well below the estimated break-even for the business of between $120 million and $150 million.
What attracted us to learn more about the business was the potential for Vapotherm's technology, a non-invasive delivery system for high-velocity respiratory support, to create a paradigm shift in ventilation treatment for patients having difficulty breathing on their own and potentially displace mask-based NIPPV as the standard-of-care (NIPPV stands for "non-invasive positive pressure ventilation" which uses a mask with positive pressure to assist patient breathing much like the CPAP masks used to treat sleep disordered breathing).
There are a variety of reasons why Vapotherm's "Hi-VNI" technology (Hi-VNI stands for "high-velocity nasal insufflation") is a valuable tool for treating undifferentiated respiratory failure, including the fact that a significant percentage of patients simply do not tolerate a mask, as well as the fact that Vapotherm's solution uses small-bore nasal cannulas (or cannulae) inserted into the nostrils, which enables the patient to eat and drink more easily (tasks that are impossible for a patient wearing a mask).
An important aspect of the story involves the delivery of high-velocity oxygenated air in order to help clear lungs of carbon dioxide during respiratory failure: the fact that their device delivers heated, humidified, oxygenated air at higher velocities differentiates Vapotherm's Hi-VNI product (the Precision Flow device) from traditional high-flow nasal cannulas (HFNC) with which many physicians are already familiar (Vapotherm's Precision Flow is considered a specific type of high-flow nasal cannula device: the differentiating factor is the fact that Vapotherm's delivers high-velocity oxygenated air).
When we spoke with Vapotherm's CEO Joe Army (in early 2019), he used his favorite metaphor of clearing a work bucket full of mud with a hose (a very effective comparison for understanding how high-velocity air clears out the carbon dioxide). If you put a hose in the bucket of mud and gunk, and turn on the water, the water flow will eventually clean out the mud. However, Joe explains, if you put your thumb on the end of the hose opening, the same amount of water will still be flowing through over the same amount of time, but that same volume of water will now flow with much greater velocity and clean out the bucket more rapidly and effectively.
The same principle applies to the high-velocity oxygenated air: delivered at higher velocity, it will swirl around in the nasal cavities and flush out the old CO2 more rapidly and more effectively than will low-velocity gas.
The following chart, adapted from this study published in the Annals of Emergency Medicine in January of 2018, shows that Hi-VNI reduces CO2 in patients at least as effectively as the current standard-of-care (NPPI: the positive-pressure mask).
At that time, Vapotherm was working hard to get their Precision Flow device into more emergency departments to help with patients in the ER needing breathing assistance, but the company actually got its start back in 1999, long before its IPO, focusing primarily on applications in the neonatal intensive care units (or NICUs), helping doctors and nurses who treat premature babies and other newborns in need of respiratory assistance (their products started finding their way into the NICU in 2000).
We were impressed by a new product that Vapotherm was developing for the NICU: they recently won approval in Europe for a product called the Oxygen Assist Module for their Precision Flow system which provides automated delivery of oxygen to keep babies in the desired blood oxygen level (SpO2) range, and has been shown to do so more precisely than with human monitoring and adjustment alone.
As part of our research, we spoke to an experienced NICU doctor, who told us that "breathing is the single most-common reason for a baby to go to the NICU," and explained why keeping the infant in the desired range between too much oxygen and too little oxygen is so important (too much oxygen can lead to too much blood vessel and tissue growth behind the retina of a newborn, leading to possible retinopathy and vision damage).
We also spoke with an experienced ER doctor who had not previously heard of Vapotherm, and so we arranged for him to assess their Precision Flow, and he told us that in his assessment it was an "impressive product with a lot of potential" and "very easy to use."
Based on our own research into the company's filings, our conversation with doctors and with the company itself, our conversation with analysts, and our assessment of the potential for the company's technology to create a change in the standard of care, we took an initial position in Vapotherm for our clients in June of 2019.
As with many other companies with innovative technologies which we expected would create change in their industries, but which we felt might take some years to gain traction, the pressures of the COVID crisis that became most serious beginning in early 2020 dramatically accelerated the adoption of Vapotherm's Hi-VNI technology in emergency rooms and other healthcare settings.
In their most-recent earnings call, from May 5 of this year, CEO Joe Army explained that Vapotherm's business had been "significantly and sustainably transformed over the past quarter." He said:
At the beginning of the pandemic, high-velocity high-flow oxygen therapy was not viewed as a first-line therapy for treating the respiratory distress experienced by many COVID-19 patients, as physicians believed patients requiring more than supplemental oxygen would need to be placed on a mechanical ventilator. Now, the CDC, WHO, and NIH, the Society of Critical Care Medicine, the American College of Emergency Physicians, the Chinese, German, Italian, and Australian Thoracic Societies, and hospitals that are getting hit with the COVID-19 surge around the country all recognized our technology as an appropriate first-line therapy. In the pre-pandemic world, the development and alignment of these guidelines would have taken a lot longer to come together in my opinion.
He noted that thus far in 2020, the company's global installed base of products had grown by more than 3,500 units, whereas it grew by only 2,500 throughout the entire year of 2019 (revenues in 2019 were around $48 million, as the company made some major changes to the salesforce and sales strategy). Sales in 2020 are expected to top $84 million.
Perhaps most notable on the call was an actual patient story that Joe Army shared at the end of his prepared remarks, about a 54-year-old male patient in New York City who came into a hospital intensive care unit in a state of respiratory distress and an oxygen saturation rate in the low 60% range. Army said:
This low saturation rate is very dangerous for patients. Our sales rep learned that the patient's doctor wanted to intubate the patient and put them on a ventilator. But this patient refused to be intubated. Our sales rep was there at the time, assembling the new Precision Flow units that had just been delivered. The doctor grabbed one of the units and put the patient on at 40 liters at 100% oxygen. Our sales rep learned that within ten minutes, the patient's oxygen saturation rate was at 95%. his work of breathing was reduced, his respiratory rate had declined, and he now seemed to be sitting comfortably in his bed. Our sales rep shared with me that from his perspective, this patient went from almost being put on the mechanical ventilator and potentially dying, to being put on Vapotherm and being discharged home three days later to recover.
It is examples like this one which help explain why our long-time approach has always been to focus on analyzing and evaluating and predicting the future of individual businesses, rather than on trying to predict markets.
It also illustrates a fact we have observed over and over again during this recent crisis (as well as during previous periods of economic strain): that when a longer-term narrative regarding the direction that an industry will go in the future is the correct narrative, times of stress will often accelerate that narrative, by providing the catalyst for change to happen now (change that would have eventually happened anyway, but might have taken more time under conditions of less stress).
We could not have predicted what the first half of 2020 would look like when we were researching and eventually buying equity in Vapotherm during the first half of 2019, but we believe the above discussion helps illustrate what we call "the power of narrative investing."
* At the time of publication, the principals of Taylor Frigon Capital owned securities issued by Vapotherm (VAPO).
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