Biotech selloff leaves Wall Street disillusioned

After 5 years of a raging bull market, more than 140 IPOs and tens of billions in proceeds, there is a debate on whether the violent selloff in biotech stocks is a hiccup or the beginning of a real correction. I have no idea where the sector is heading in the coming weeks but it seems like the overall sobering experience coupled with this month’s selloff changed Wall Street’s perception around biotech. Investors are finally realizing drug development is fraught with uncertainty and that biotech is an attractive but not infallible segment, which is why I expect the correction to continue in 2016.

Biotech valuations are still rich and factor-in limited risk (e.g. clinical failures, longer timelines, biosimilars, drug pricing etc.). Even after a 15-21% fall, biotech is a huge outperformer with an average 5-year performance of 170% for major indices. This is dramatically better than the 67% delivered by NASDAQ over the same period. Such outperformance is justifiable to some extent by real progress, sometimes true breakthroughs (HCV, immuno-oncology, gene therapy etc.) but there is still a discrepancy between real commercial value and valuations.

This valuation gap isn’t new, however, for the first time it is accompanied by a fundamental change in sentiment around biotech as a sector. To me, this is an important warning sign because of all sectors, biotech probably has the highest dependency on sentiment rather than hard numbers.

The wave of biotech IPOs in 2013-2015 is probably the best example for how infallible biotech was in the eyes of investors, especially generalists.  Biotechs have a dream factor very few other sectors do and this enabled companies to raise huge amounts of money in IPO proceeds at high valuations, sometimes with limited or no clinical data.

Initially, biotech IPOs were perceived as a huge success story, cementing biotech’s position as Wall Street’s favorite sector. But in the second half of 2015 the picture started to change as rosy projections hit reality. Despite some phenomenal exits like Receptos and ZS Pharma, most biotech IPOs now have negative returns and even stars like Agios (AGIO), Bluebird (BLUE) and Sage (SAGE) gave back most of their gains. 2015 was still a record year in terms of number of IPOs and overall proceeds but the performance of class of 2015 has been dismal (try to come up with one winner…).

Traumatic experience with DMD stocks

Last month I wrote about how hematology stocks were punished after failing to meet unrealistic expectations. The same is true for DMD stocks Biomarin (BMRN), Sarepta (SRPT) and PTC Therapeutics (PTCT) but in this case the exaggerated expectations relied on shaky fundamentals to begin with. It is hard to believe that at some point in 2015, investors assigned more than $5B to these programs despite various issues and uncertainties which were known at the time.

The desperate need for new DMD drugs coupled with a permissive regulatory environment enabled DMD companies to “sell” their drugs as breakthrough treatments for a devastating disease with a high likelihood of approval. In retrospect, all three drugs had very weak clinical packages but this didn’t bother investors who relied more on wishful thinking and incomplete, vague disclosures rather than clinical evidence.

Biomarin’s drisapersen, which came by way of the 2014 purchase of Prosensa, was the first to fall. Biomarin acquired Prosensa after drisapersen’s P3 failure, which was blamed on trial design issues. Biomarin convinced investors that there was enough evidence in the failed P3 (based on subset analyses) and smaller P2 studies to get the drug approved based on the “totality of the data”. Another term people often used to describe the drug was “approvable” as opposed to “effective” or “proven”. The support Biomarin got was almost religious as investors relied on the company’s successful track record (“they know what they’re doing”) in the field of rare diseases while ignoring obvious questions (see one example from Adam Feuerstein).   

FDA’s review of the drisapersen package was brutal. As part of an advisory panel last November, FDA reviewers easily tore apart every claim and data mining presented by Biomarin, who probably relied too much on anecdotal testimonials of patients and their families. The panel voted overwhelmingly against the drug and last week a formal complete response letter followed.

Sarepta is about to receive a similar treatment from the FDA based on briefing documents released last week (see Feuerstein’s review). The company’s DMD drug (eteplirsen) is a direct competitor to Biomarin’s drisapersen but in contrast to Biomarin, Sarepta would like the FDA to approve eteplirsen primarily based on a 12-patient randomized trial that demonstrated a clinical benefit. Until last week, eteplirsen was perceived as better positioned because functional improvement (6-minute walk test, 6MWD) was accompanied by increased dystrophin levels in muscles (this was not observed with drisapersen) and fewer side effects. But FDA’s analysis revealed many issues making the data set inconclusive on top of being very limited. It turns out that after 3 years of treatment, dystrophin levels reached only 0.9% of normal values and the functional benefit is tricky at best. Eteplirsen’s FDA panel is taking place this Friday.

PTC submitted ataluren (Translarna) for FDA approval earlier this month. Ataluren, intended for a different subset of DMD patients (caused by nonsense mutations), also failed to demonstrate a clinical benefit in a large P3. Nevertheless, the company would like to approve the drug in a subset of patients with baseline 6MWD of 300-400 meters where a statistically significant effect was observed. This subset represents less than half of the patients in the study and PTC claims this subset analysis was prospectively defined with the FDA. (Let’s see how the FDA describes it)

Ataluren’s P3 was designed based on subset analyses of a prior failed P2. PTC looked for patients in which ataluren demonstrated clinical benefit and applied these criteria in P3. After seeing the P3 data, the company now asks the FDA to rely on a new subset analysis. This casts serious doubt on the entire study and it remains to be seen whether this analysis stands up to scrutiny.

Biotechs still offers tremendous value proposition

It is important to make the distinction between biotech companies and their stocks. Most high profile biotechs are decent companies with a solid scientific foundation and as a group they continue to make progress regardless of stock performance. As was the case with other technological leaps, I am sure biotech will eventually deliver, it will simply take more time and actual reward may be significant but more modest than initial expectations. Fundamentally, things have never been better for the drug development industry which now has both the development tools and financial resources to advance the field.

With that in mind, I plan to keep my short positions (BIS) which consists  ~20% of the portfolio. I still intend to be selective and have positions in companies with solid clinical data and depressed valuations as they are likely acquisition targets.  Names I like include companies with clear clinical PoC in P2s like Esperion (ESPR) and Trevena (TRVN) as well as companies with positive P3 data with a relatively high likelihood of regulatory approval such as Exelixis (EXEL) and Amicus (FOLD).

Portfolio holdings – Jan 18, 2016

Biotech portfoio - 18-1-2016

biotech etfs - 18-1-2016

66 thoughts on “Biotech selloff leaves Wall Street disillusioned

  1. Hi Ohad,

    What will happen to Sunitinib after checkpoint inhibitors potentially displace it in first line metastatic RCC therapy? Would you say that a positive Cabosun result would be sufficient to put Cabo ahead of Sunitinib in the schedule?

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  2. Hi Ohad,
    regarding GNCA:
    They will publish 12 months results for 003 in genital herpes later this quarter.
    I thought the 6 monts results were quite good – what were your thoughts?
    What would be good results for the 12 months data?
    And do you find the ATLAS plattform interesting – (if you can comment)?
    Also: Regarding TRVN – Dou have an opionion on TRVN027 in acute heart failure?
    Thnks Ike

    Like

  3. Hi Ohad,

    Do you have an opinion on Beigene? They’really IPO’ing today in a tough market with a bunch of drugs in their pipeline with proven MOA. Are their drugs differentiated in any way, in your view?

    Thanks,
    sherk

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  4. Also, you had mentioned at one point an interest in Atyr (LIFE), but that the stock was too expensive. With the recent crash, the stock is much cheaper, now…cheap enough to consider?

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  5. $EXEL A positive CaboSun can lead to approval for medium to high risk patients without a P3 since it is not completely replacing Sunitib for the initial treatment, and the eventual competition will be Checkpoint inhibitors, Checkpoint inhibitors plus VEGF inhibitors, and they might not all work for medium to high risk patients, and also might be more toxic especially the combinations so this will give Cabozantinib space in first line treatment. If Cabo plus Nivo comes positive then it can compete in that space more completely. But for the meantime it could be possible to displace Sunitib for medium to high risk patients in 1st line therapy, and since there is synergy between Cabo and Nivo, Nivo after Cabo would also be a positive for patients. What do you think ?

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  6. hi Ohad (EXEL):

    Why didn’t they publish the topline data of the OS data of Cabozantinib?

    Do they try to hide that the HR and the OS results are not as good as the nivolumab data?

    In September they seemed to have a better HR (0.67 vs 0,73)… this allegedly advantage now gone?

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  7. Hi Ohad.
    How spot on you were when you decided to buy months ago BIS at $20s to hedge your portfolio. I remember at that time you forecasted that BIS would reach $50 by mid 2016. Well, not mid 2016 but in January 2016 BIS reached $49.27 so we can say your BIS target has been reached. Do you expect that after reaching this high, is time now for IBB to start a lift? or by contrary you believe BIS will continue to go higher by mid 2016.
    Congrats
    lgonber

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  8. Beokeh (EXEL) – Will try to publish on Sunday what I think the data will look like and the implications. In general, i think this is great news for EXEL and that cabo is going to become a dominant RCC drug in PD- failures.

    Wildbiftek (EXEL) – I think it will take more than a P2 to overthrone Sutent as the TKI of choice in RCC.

    Ike – Hard to speculate re: GNCA. Yes I think harnessing the ATLAS platform for neoAg discovery is an exciting opportunity.
    Re: TRVN – I have zero expectations for TRVN027, my investment hypotheis relies solely on their selective opioid receptor inhibitors.

    Sherk (BEIG) – Agree, their IPO is very impressive and a positive indication. Don’t know their programs too well but couldn’t find anything really exciting in their clinical programs. On paper they claim to have certain technical advantages over approved agents but it’s hard to predict how they will translate clinically.

    Re: LIFE – Yes I still like the biology very much, valuation has come down considerable, close to cash levels. Definitely on my watchlist although I haven’t bought.

    curiousgeorge (EXEL) – I don’t think a positive P2 will be enough to displace Sutent although a positive CABOSUN will certainly help cabo in later lines imo.

    Ville (EXEL) – I guess they didn’t want to jeopardize presentation at ASCO 2016. This is not unusual, done with Opdivo for RCC also for cobi in melanoma. I don’t think this is a negative sign (neither is it positive).

    With respect to overall market conditions, very hard to predict. My feeling is that the sector needs months to stabilize so I plan to get back in around mid-2016.

    lgoner (BIS) – Thanks! I think valuations are becoming reasonable but it’s hard to predict market volatility, people exaggerate in their reactions in both directions so the brutal correction may have a long term impact on biotech. Bottom line, I am not selling my BIS position but certainly not adding for now.

    Ohad

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  9. $EXEL This is a second interim look, and not the final analysis for OS, and they spent some p value and got statistically significant OS.

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  10. $EXEL Also, don’t you think the population for Meteor was more advanced than the Checkpoint trial so we cannot really compare the duration. CaboSun might be more informative of OS for later lines as u say.

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  11. curiousgeorge (EXEL) – Agree. The fact they saw such a strong trend and reached stat sig. at the 2nd analysis implies the signal is robust. Based on PFS, yes it looks like METEOR has a slightly tougher patient population but let’s wait to actual OS data.

    Bouschka (AAVL) – Agree and think they are now a diversified gene therapy play, too bad they are so early. They are still traded under cash so definitely a name to watch towards mid-2016.

    Kevin (PIRS) – Sorry ,don’t know them well.

    Ohad

    Like

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