The biotech sector is having a brutal summer, with major indices (IBB, FBT, XBI) down 15-20% from their July highs. Even after this decline, valuations for most biotech stocks are still rich and need to come down by an additional ~25% in order to become reasonably priced. As my working hypothesis includes a correction (with significant fluctuations) going into 2016, I still plan to have a significant cash position and complement it with leveraged short bio ETFs.
Although I am bearish on the sector as a whole, I intend to keep a significant (>50%) exposure to smid-cap biotechs that I find attractive, focusing on companies with near term fundamental milestones such as data readouts and partnering/acquisition announcements. Stocks that fit this description are Exelixis (EXEL), Trevena (TRVN), Esperion (ESPR) and Array (ARRY).
Exelixis – partnering discussions may turn into an acquisition
With what appears to be an impressive survival benefit (see my take here) in a pivotal trial in renal cancer (the METEOR trial), Exelixis’ cabozantinib has potential sales of $600M using conservative assumptions (limited penetration in RCC, no expansion to other indications). The company plans to present detailed results from the trial at ESMO/ECC 2015 (September 25-29). Based on last month’s press release the data should be outstanding with a significant PFS benefit over the market leader (Novartis’ [NVS] Afinitor) and an impressive survival trend that will have to be corroborated at a second analysis next year.
Cabozantinib’s safety profile is the drug’s main disadvantage so it will be important to see whether the safety profile will be deemed acceptable by physicians in light of the clinical benefit. Investors are also concerned about competition with BMS’ (BMY) Opdivo, which also demonstrated superiority over Afinitor in the same patient population.
Exelixis’ CEO indicated the company is in partnering discussions for ex-US rights for cabo. As Exelixis plans to submit U.S. and EU regulatory filings in early 2016 (the study was conducted in US and EU sites), the drug may receive approval in Q3 2016. By then, Exelixis must have a partner in place to launch cabo which will initially compete with Opdivo (expected to be launched on the same time frame).
The strength of the METEOR data (better PFS than the market leader, a strong survival trend) and the scarcity of novel oncology drugs should enable Exelixis to strike a lucrative licensing deal while retaining commercial rights in the US. The company’s modest market cap of ~$1.3B also makes it an attractive acquisition target, so partnering discussions may end up as an acquisition bid from a partner with an established oncology salesforce. Assuming peak sales of $600M in RCC for cabo, $50M in MTC (medullary thyroid cancer) for cabo and $100M for Exelixis’ stake in cobimetinib (MEK inhibitor partnered with Roche), Exelixis should generate $750M in annual revenues excluding any upside from other indications. Using a modest sales multiple of 4 results in a $3B acquisition price. Adding additional opportunities for both drugs may push the price tag to $3.5B.
Potential acquirers may be companies with a presence in GU cancers that do not compete directly with cabozantinib or companies with an interest to expand their oncology franchise. The prior group includes Bayer and J&J (JNJ), the latter group includes Gilead (GILD) and Celgene (CELG).
Trevena – Important readout in September
Next month, Trevena will report Phase 2b results for TRV130 in post-operative pain. The trial is comparing 2 doses of TRV130 to morphine and placebo. While TRV130 will likely be superior to placebo, superiority over morphine in terms of efficacy and/or safety is crucial for commercial success. In contrast to previous studies that evaluated fixed doses of TRV130, this trial uses patient-controlled analgesia (PCA) administration of TRV130 and morphine. This means that patients can control how much drug they receive up to a pre-defined limit.
On its recent earnings call the company disclosed a decision to increase the dose after an interim look at the data. This caught investors by surprise (although the company previously disclosed the trial has an adaptive design). Some interpret the company’s decision to dramatically increase the dose (from 0.1mg to 0.35mg every six minutes) as an attempt to improve efficacy (pain relief) after a disappointing efficacy interim readout.
The decision to escalate TRV130’s dose can stem from insufficient efficacy, good tolerability or both. My bet is on option #3 because management sounded upbeat at a recent investor conference (which means the trial is not a complete flop) but on the other hand if the low dose of TRV130 had been superior to morphine there would have been no need to dose-escalate. Next month’s results will have a dramatic impact on the stock as they will either validate or disprove Trevena’s bull case of a safer, more effective opioid.
Esperion – Regulatory clarity sets the stage for a deal
Esperion is down 55% from its 52-week high following what investors perceived as a restrictive label for Regeneron’s (REGN) Praluent, as Esperion is pursuing a similar strategy to that pursued by Praluent (patients who require additional LDL-C reduction because they cannot tolerate or do not respond to available options).
Praluent’s case has both positive and negative implications for Esperion’s ETC-1002 but the positive implications (approval based on LDL-C reduction prior to cardiovascular outcome data) trump the negative ones (Initial label is restrictive). The long term potential for these drugs remains huge as the label could get broader with outcomes data.
Last week, Esperion disclosed input from the FDA following an end of phase 2 meeting. FDA’s feedback was in line with expectations and therefore laid the basis for a registration program that mirrors that of PCSK9 inhibitors. ETC-1002’s LDL-C effect (25-30%) is less robust compared to PCSK9 inhibitors (50-60%) but as an oral drug with a robust effect on hsCRP as well as other potential beneficial mechanisms it may take a significant market share.
Commercializing ETC-1002 will require a huge marketing footprint to support clinical trials in tens of thousands followed by marketing efforts covering tens of millions globally. Esperion can and intends to start a registration program for ETC-1002 but it is unlikely to complete it, making an acquisition likely already at this stage. Potential bidders include companies with a cardiovascular salesforce without a PCSK9 program like Merck (MRK) and AstraZeneca (AZN).
Array – ex-US partnership expected by year-end
Array is expected to announce an ex-US partner for its lead programs binimetinib (MEK) encorafenib (BRAF), which the company got from Novartis. In order to keep the two programs Array is obligated by anti-trust regulators to find a partner that can support a global development program. The company said it expects to have a partner by year-end.
Providing a time limit to partnering activities is somewhat unusual but this deadline is probably related to its agreement with Novartis. Binimetinib is in three phase 3 trials, the first of which (NRAS+ melanoma) is expected to readout in Q4 2015. This may make partnering discussions with a year-end timeline tricky although a potential partner will probably be interested in indications beyond NRAS+ melanoma that represents a modest commercial opportunity.
Array’s modest market cap of $773M may also turn partnering discussions into an acquisition although the company’s broad partnered pipeline may be viewed as a disadvantage. Potential partners/acquirers are global companies with an oncology franchise (and a focus on solid tumors) without MEK or BRAF programs. The list includes Pfizer (PFE), Merck and Lilly (LLY).
We are selling one of two positions in Seattle Genetics (SGEN). The company’s market cap ($5.16B) adequately captures the new label for Adcetris as a maintenance treatment and the company’s proprietary pipeline may take time to generate meaningful catalysts.
Portfolio holdings – August 23, 2015