Give me some skin
Biotech firm LifeCell was tops this year among the fastest-growing stocks we picked in 2005. Analysts expect more growth to come.
By Jon Birger, Fortune senior writer

(FORTUNE Magazine) -- Imagine having had the good fortune to buy Stryker shares in 1990, before artificial joints became the standard of care for worn-out hips and knees and the stock soared 20-fold over ten years. Well, small-cap-stock guru Mary Lisanti thinks a biotech company named LifeCell (Charts) is on a similar road to stock market stardom. "Theirs is a product you could build a very big company on," says Lisanti, who manages Adams Harkness Small Cap Growth fund. "There are just so many uses."

The product is AlloDerm, and those uses--which range from cosmetic lip augmentation to repair of complex hernias and foot ulcers--are what earned LifeCell 16th place on FORTUNE's 100 Fastest-Growing Companies list last year and prompted us to recommend LifeCell's stock. Shares have risen 28% since then, the best performance among the picks on the 2005 list.

AlloDerm is a quasi-natural substitute for skin and human tissue. It has become widely accepted among doctors in LifeCell's key markets: The stuff is used in about 20% of major hernia procedures and post-mastectomy breast reconstructions. Over the past three years the company's sales and earnings have grown at annualized rates of 45% and 92%, respectively, and Lisanti thinks LifeCell can maintain a Stryker-esque run of 40% to 50% annual profit growth.

One potential hitch: supply constraints. AlloDerm's key ingredient is human skin harvested from the cadavers of tissue donors. LifeCell strips out genetic material that could lead to immune-system rejection and then transforms what remains into a strong, infection-resistant human-tissue substitute that the body gradually adopts as its own. Problem is, there's a limited supply of raw material. There are 22,000 tissue donors every year in the U.S., and LifeCell harvests tissue from 6,000 of them, says Piper Jaffray analyst Raj Denhoy.

That's why LifeCell has much riding on XenoDerm, which it hopes to introduce in 2007. XenoDerm is a version of AlloDerm derived from the skin of pigs. If it performs well, supply limitations on LifeCell's growth would be removed.

XenoDerm would also allow LifeCell to unleash its salespeople on the cosmetic surgery market. AlloDerm is already used in rhinoplasty and lip augmentation and to eliminate rippling in breast enlargement. But LifeCell does not actively market AlloDerm for cosmetic use. "Tissue banks generally do not want their donated tissue used for cosmetic purposes," explains Needham & Co. analyst Ed Shenkan.

AlloDerm--and eventually XenoDerm --may reduce another breast-augmentation problem: hardening around the implants. About 15% of patients experience this problem, says Dr. Karl Breuing, a plastic surgeon on the faculty of Harvard Medical School. If XenoDerm proves to be effective and affordable, Breuing thinks surgeons will preemptively use XenoDerm to prevent hardening. That would create a huge new market for LifeCell, says Shenkan, since there were 290,000 breast enlargements in the U.S. last year, double the combined number of breast reconstructions and complex hernia repairs.

Moreover, added LifeCell CEO Paul Thomas on a recent conference call, XenoDerm is "the real platform" for LifeCell's international growth: "There are various market and cultural factors that make the adoption or use of a human-tissue product problematic in certain markets."

LifeCell's 45 price/earnings ratio is high. But with its strong growth rate, the company's PEG ratio (P/E divided by projected growth rate) is 1.1, relatively low for a biotech stock. Kevin Maynard, an analyst with the ABN Amro/Veredus Aggressive Growth fund, is impressed by LifeCell's habit of beating its earnings projections: "We're still early in terms of where these guys can grow."  Top of page