drug developers: high risk, high potential reward · 2019. 1. 11. · portfolio, but london’s...

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11 January 2019

Drug developers: High risk, high potential reward

Biotech may be a nerve-wracking industry, but the potential rewards from successful companies could be attractive for those with an appetite for risk

Executive summary

■ Investing in biotechnology stocks at the clinical trial stage is undoubtedly high risk and it is impossible to say with confi dence that a company will be a winner until positive clinical trial results are confi rmed. There are, however, positive traits to looks for in companies that – while no guarantee of success – can help identify those businesses most able to manage setbacks.

■ Success of even the best run enterprises depends on commercial-ly viable scientifi c breakthroughs, so investors must be prepared to accept the risk of several total failures. The trade-off , however, is potential multi-bagger returns when that one winner comes off .

■ There are some risks that can be avoided such as companies that lose focus on their original goals, burn cash too quickly or take on too much by attempting their own commercialisation.

■ There are some tax advantages that can be taken advantage of, although the inheritance tax exemptions for some Aim companies can be lost when biotech shares are also listed on Nasdaq.

Complex products and the unfathomable acronyms used to name them often puts investors off the biotech sector. That’s fair – by picking companies that are easily under-

stood, investors hope to avoid crushing losses. While the science under-pinning the companies is complex, by learning to make sense of their business models – opportunities and risks – equity investors need not dismiss a sector that has the potential to unearth some major winners. Of course, biotech investment should only ever contribute a small part of a well-diversifi ed portfolio, but London’s Alternative Investment Market (Aim) is currently abundant with exciting small- and mid-cap companies.

Megan Boxall’s view:

Analyst: Megan Boxall

Alpha Editor: James Norrington

Alpha Production Editor: Sameera Hai Baig

Aim pharma for biotech IPOs

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Source: London Stock Exchange

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There are no two ways about it, investing in medical development stocks is risky. The problem is that the outcome is binary – either a drug trial will succeed or it will fail, there is no middle ground or consolation prize.

In 2014, scientific journal Nature analysed the rate of suc-cess for drugs which enter a clinical study (even getting there is a challenge – before being tested in humans, new medi-cines must hit rigorous safety targets in the laboratory). Na-ture found that only 32 per cent of medicines ever makes it to the final stage of a clinical trial (known as a third phase trial) and just one in ten ends up being launched by its developers.

Those are not attractive statistics for prospective bio-pharmaceutical investors because share prices have a nas-ty habit of plummeting in the wake of a failed trial. What’s more, the companies which experience disappointment often need to reduce their workforce, close research sites, consolidate business units and sell off therapeutic areas to preserve the core business.

But back that one winner and the other nine failures will be insignificant. No doubt investors in medicinal cannabis specialist, GW Pharmaceuticals (US: GWPH) will agree. The company listed on Aim in 2001 at 182p: 15 years and two positive clinical trial results later it cancelled its listing with a market cap of £2.6bn and a share price 366 per cent higher than at IPO. It is now ticking along nicely on Nasdaq with a market cap at the time of writing of $4.05bn (£3.18bn).

It’s true that prior to its positive clinical trial, few people would have said with confidence that GW Pharma was going to be a success. But the company always had posi-tive traits which could have been spotted by the seasoned biotech investor. For example, its novel therapeutic area (it was the first ever company to launch a medicinal can-nabis treatment) was causing excitement among medical practitioners, while its decision to target an area of signifi-cant unmet medical need (childhood epilepsy) meant it was treated favourably by regulators.

DiscoveryExamining data to identify

a potential new drug

Pre-ClinicalLab and

animal testing

Phase 1 ClinicalAssessing safety and

required dosage

Phase 2 ClinicalAssessing efficacy and side-effects

Phase 3 ClinicalEnsuring clinical

significanceDrug

launch

£££££25% chance of success

2+ years

££££30% chance of success

2 years

£££75% chance of success

1.5 years

££2 years£

5 years

Drug development pipeline


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Traditional valuation metrics can be used when a company starts making money. Those with quality revenue streams and strong growth

forecasts are top picks

7Make

money

Consolidation is currently fierce in the healthcare industry and it could

be the best option for some companies 6Be

attractive

Companies which attempt their own commercialisation

are best avoided5Don’t begreedy

Clinical trials are hard to predict, management history

can offer clues 4Don’t fail

Avoid the companies which stray away from their original plans and

spend money too quickly 3Stay

focused

Novel areas of medicine offer are a big opportunity for small and

mid-sized healthcare companies 2Target the

opportunity

Seven steps to success

Look for hot trends in science and upcoming changes in regulation1

Identify the potential


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Those are both traits which we included in our recent feature ‘Seven Steps to Healthy Profits’, in which we highlighted the characteristics which could – in theory – help trigger success for small and mid-cap biophar-maceutical companies. The chart below shows the five companies we flagged in the drug development sub-sector of Aim’s pharmaceutical and biotechnology index which displayed most of the favourable traits.

It’s clearly not a foolproof model. Diurnal (DNL) – one of the five stocks which came out at the top of our screen – has since failed a clinical trial and seen its market value more than halve. The group’s hormone therapy Chrono-cort, for relief from adrenal insufficiency in adults, didn’t perform any better than the current standard of care in phase-three study, meaning its potential for approval in Europe is uncertain. Hutchison China Meditech (HCM) – another one of our top picks – has also recently endured disappointment. Its cancer treatment Fruquintinib failed to perform any better than standard chemotherapy in a final stage trial.

These failures highlight a key difficulty with final stage clinical trials – approval is based on a pre-stated goal. That means that simply relieving symptoms of illness is often not enough: Diurnal and Chi-Med’s medicines failed because they didn’t perform any better than the current gold standard of care. Failures can also be a side effect of a surprisingly high placebo effect. In 2017, Circassia’s (CIR) shares fell 66 per cent in one day after its cat allergy treatment failed to perform significantly better than a pla-cebo drug – both had helped relieve symptoms.

But in all those cases, investors have not been left empty handed. Circassia has managed to realign its portfolio so it is now a challenger commercial pharma company with a specialist focus on respiratory drugs. Hutchison China Meditech has a large platform of medicines in its pipeline – one failure shouldn’t set it back too much. In fact, its chief executive Christian Hogg thinks that the approval of just half of the pipeline will turn Chi-Med into a $10bn

Name Market 1-yr price Catalyst in the Second source Cash – annual cap (£m) change (%) next six months of funding cash burn (£m)

Hutchison China Meditech (HCM) 2269.2 -40 Y – regulatory update Y – Commercial arm 273.801

Allergy Therapeutics (AGY) 147.04 -56 Y – initiation of P3 trial Y – Commercial arm 11.733

MAXCYTE (MXCT) 64.8 -21 Y – dealmaking Y – drug development partnerships 4.95

DIURNAL (DNL) 28.7 -74 Y – regulatory update Y - EU drugs sales 4.221

Realm Therapeutics (RLM) 8.5 -83 Y – new strategy Y - wound care royalties 4.7Source: S&P Capital IQ and company reports ($ reporters converted to £)· News flow: Companies with a potential pipeline catalyst in the next six months· Financial backing: Those which have a second source of funding· Balance sheet strength: Net cash higher than annual cash burn

Drug discovery


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company. Meanwhile, Diurnal managed to update and reassure its investors within a week of its trial failure. It is now planning a Scientific Advice meeting with European regulators before the end of the year and hopes it will launch Chronocort in 2019.

So, while failures can certainly be disappointing, they are not always the end of the road for well-prepared companies. Prospective biotech investors hoping to avoid complete disappointment should look for companies which have a decent back-up plan. It is also important not to rely on the potential success of one company. In-vesting in biopharmaceuticals is not a question of picking one horse and running with it. It’s a game of volume and patience and one that could pay off hand-somely for investors who can stomach the risks. Here we dig into the investment (and scientific) cases of some of London’s most promising drug developers.

1. MaxCyteThere are few words in the ‘About Us’ section of MaxCyte’s (MXCT) website which can be read without the use of a dictionary. ‘Flow electroporation for transfect-ing cells’ is not an activity which is regularly discussed by the average investor. Put simply, MaxCyte’s technology al-lows for pieces of new genetic code to be inserted into any type of cell with very little disturbance to the patient.

Gene therapy research has accelerated in recent years alongside the improvement in genetic profiling which has helped scientists identify the genes which cause Hun-tington’s Disease, Parkinson’s, Cystic Fibrosis and many other illnesses. This has led to a wave of research into targeted therapies which seek to correct the faulty genes. There is also a growing body of medicine which works by rejigging healthy parts of a patient’s body (such as the immune system) so it is better prepared to fight other diseases such as cancer.

But, despite the increase in research, few pharma companies have managed to successfully launch gene therapies – in fact, only two medicines have gained com-mercial approval to date. Many have come unstuck by the aggressive side effects caused when edited genes interfere with the body’s healthy cells rather than the poorly ones which have been targeted for editing.

MaxCyte’s technology should therefore make it easier for pharma companies to launch their gene therapies. The platform can deliver the edited genes directly into the targeted cells to ensure they don’t have an unwanted impact on other parts of the body. The group licenses out its genetic molecule delivery platform and provides cell-engineering expertise to help “accelerate the discovery,

MaxCyte

Ticker MXCT

Index Aim

Sector Pharmaceuticals & biotechnology

Current price (p) 190

Market cap (£m) 64.8

52-week high (p) 284

52-week low (p) 185

Cash ($m) 18.8

Financial year-end 31-Dec

Company website maxcyte.com

MaxCyte share price

0

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100

150

200

250

300

350

2016 2017 2018 2019

Source: Bloomberg

p


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development and manufacture” of its partners’ medicines. For example, the group has partnered with US-biotech

pioneer CRISPR therapeutics, which is using one of the most exciting developments in modern medicine (CRISPR gene editing) to develop medicines for rare diseases and cancer. MaxCyte will supply its technology to CRISPR in exchange for milestone and licencing revenue.

These partnerships bring in revenue while MaxCyte works on the development of its own suite of novel cancer drugs. The first of these – currently only known as MCY-M11 – recently began trials in humans. The drug is one of the first targeted gene therapies being tested in solid tumours. Pre-clinical lab testing found that the drug displays “anti-tumour activity”.

MaxCyte is not a traditional UK-listed biotech start-up. Founded in Boston in 1999, the company initially sought to commercialise its cell-engineering technology in the blood clotting market. In 2003, the company began licensing out the technology to other pharma companies and by 2012 was generating annual revenues of over $5m. Four years later it listed on Aim with a market capitalisation of £30m.

Since the IPO, revenues have continued their strong upward trajectory as MaxCyte attracts more partnerships with large pharma companies. In the last five years, sales rose at a compound annual rate of 28 per cent. But in the same time net losses have risen, particularly in 2017 when the group began increasing investment in its own drug platform. At the half year stage (to June 2018), manage-ment reported net losses without in-house drug invest-ment of $2.2m, but total losses of $4.8m (from $4.3m in 2017) when the trial costs were added in. Human drug trials are very expensive: between 2016 and 2017, operat-ing cash outflows at MaxCyte rose from $2.3m to $9.7m.

Still, the group remains well funded with net cash at the half year point of $18m. If the current rate of cash outflow is maintained, the group should have about two years’ worth of cash left. But investors should be wary about the likely uptick in research and development costs – as clinical trial pathway progresses, expenditure accelerates quickly.

MaxCyte Cash (current): £15m Cash exp (FY2018): £8.7m

12-months Sales Net loss Operating cash to 31 Dec (£m) (£m) outflow (£m)

2013 4.4 -0.6 -0.4

2014 4.4 -1.1 -1.2

2015 6.1 -0.9 -0.1

2016 9.1 -2.5 -1.7

2017 10.9 -7.7 -7.5Source: Factset (although Maxcyte reports in dollars, Factset converts figures into sterling)

“Maxcyte is not a traditional UK-listed biotech start-up”


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2. Allergy TherapeuticsAllergy Therapeutics (AGY) is easier to understand than many of its Aim-traded biotech peers. Its science is un-questioningly impressive, but its goal is far more relatable than many: make life simpler for allergy sufferers.

It’s an attractive marketplace. An estimated 8 per cent of people in western societies suffer from hay fever – an allergic response to an airborne substance such as pollen – and 6 per cent of children are allergic to at least one food substance.

But, despite the large and growing population sizes, al-lergy is a largely underserved part of the pharmaceuticals market. Treatment options currently include antihista-mines such as Claritin, steroids such as Beconase, or eye drops. But these are all over-the-counter medicines, used for alleviating symptoms, not tackling the underlying causes of the illness.

That’s something regulators in the US are trying to change. The Food and Drug Administration (FDA) is attempting to clamp down on the unregulated allergy medicines market in the US with a view to promoting novel, long acting treatments. The need for better medicine (and awareness) has been thrown into sharper focus by high-profile tragedies where consumers have suffered fatal anaphylactic shocks from eating food containing allergens.

Immunotherapy has the potential to revolutionise the allergy industry by providing long-term relief for patients. It works by gradually de-sensitising the patient’s immune system to the allergens that trigger symptoms. Immuno-therapy can eventually lead to lasting remission from allergy symptoms and may even play a role in preventing the patient developing other allergies.

But, while allergy immunotherapy is not a new concept (it was first discovered in 1911), it is not widely used for allergy sufferers. One of the problems is that it involves exposing a patient to allergens over a long period of time, which is both time-consuming and uncomfortable. Allergy Therapeutics’ has spent several years perfecting the dose of its own course of immunotherapy which has the po-tential to alleviate long-term symptoms in just four doses.

Earlier this year, management reported that its long-awaited phase two study into its grass allergy vaccine had been successful. The trial managed to discover the appro-priate dosage of the drug, meaning it has now finally been given the green light to begin a phase three trial during the next pollen season. This pivotal study has been a long time coming – in 2015, the drug failed a phase two dosage trial meaning plans for the large phase three study had to be put on hold.

Allergy TherapeuticsTicker AGY

Index Aim


Current price (p) 13.8

Market cap (£m) 88.3

52-week high (p) 32

52-week low (p) 13.6

Cash (£m) 15.5

Financial year-end 30-Jun

Company website allergytherapeutics.com

Allergy Therapeutics share price

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2014 2015 2016 2017 2018 2019

Source: Bloomberg

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Allergy tapped the market for £10.6m in July (great timing following the slew of positive trial results) to fund its final phase study, which is expected to widen annual pre-tax losses to £9.3m in the year to June 2019, compared to £6.9m in 2018. The group receives further funds from its decent commercial platform which sells allergy medi-cines in Europe. Revenue growth has far outpaced the wider allergy market in recent years and, in 2019, group operating profits leapt 26 per cent to £9.3m thanks to the strong demand.

But despite a decent financial performance, Allergy’s success is still hinged on its final phase clinical trial. The risks have been slightly reduced by a recent long-term study published by the scientific journal Immunotherapy which found that the group’s drug reduced the symptoms of hay fever for between three and six years. But, as with all drug development companies, investors should proceed with caution.

3. C4X Discovery Traditional, small molecule medicines are created using chemistry. Scientists combine different chemical ele-ments in a laboratory to end up with a medicine which can be used to treat a broad range of patients. By contrast, large molecule drugs have live particles at their core. This newer strain of medicine – which can be used to target more specific disease subsets – uses biological science.

C4X Discovery (C4XD) has carved out its own niche in the medicines industry – instead of biology or chemistry, it has physics at its core. The group has developed a suite of algorithms which can determine the shape new drugs should be if they are going to bind to disease causing proteins and be as effective as possible in treating specific illnesses.

It’s mind-boggling stuff which can be best understood by pushing your mind back to school science lessons. Remember those patterns of lines and hexagons which had names such as C6H12O6? They are drawn in two dimensions and they help scientists and doctors under-

Allergy Therapeutics

Cash (current): £15.5m Cash exp (FY2018): £3.5m

12-months Sales Net loss Operating cash to 30 Jun (£m) (£m) outflow (£m)

2013 42.0 0.7 2.2

2014 43.2 0.1 2.1

2015 48.5 -13.1 -11.8

2016 64.1 -2.5 0.2

2017 68.3 -7.5 -3.8Source: Factset

“Revenue growth has far outpaced the wider allergy market in recent years”

C4X DiscoveryTicker C4XD

Index Aim


Current price (p) 64

Market cap (£m) 37

52-week high (p) 150

52-week low (p) 55

Cash (£m) 5.6

Financial year-end 31-Jul

Company website c4xdiscovery.com


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stand and record the structure of molecules. If you’ve ever read the intellectual property file of a drug (not something I’d recommend), you’ll see a host of hexagonal drawings which represent the chemical structure of the drug in question drawn in 2D.

The problem is 2D images aren’t much use in live hu-mans who are three dimensional and made up of three dimensional cells. That means that, historically, the drugs can only be drawn in retrospect – the medicine is built through trial and error and then its shape and chemical structure recorded in a two-dimensional drawing.

The C4X algorithms allow scientists to see the shapes of small molecule drugs in 3D, which gives them a far better understanding of how they bind to the disease-causing pro-tein. This means building new drugs doesn’t need to be trial and error – scientists use the algorithms to draw a theoreti-cal 3D shape of a new drug for a specific illness which is used as the starting point for laboratory and clinical trials.

This process should improve the chance of success of a clinical trial, thus saving a pharmaceutical company time and money. It also allows small molecule (or chemical) drugs to be targeted to specific disease subsets. Manage-ment at C4X think that’s beneficial at a time when global healthcare organisations are desperately trying to extract costs amid rising demand for medicines.

Like MaxCyte, C4X licenses out that technology to fel-low drug developers hoping to identify interesting new medicines. In recent months, the group has signed two new partnerships and announced that its work with fel-low listed group, E-Therapeutics (ETX) has identified novel biological pathways for the treatment of Parkinson’s Disease. Both companies think that the work, “has the po-tential to transform the treatment landscape for patients”.

Meanwhile, the group’s in-house drug development arm (which has nine novel drug candidates) has hit a significant milestone. In March, opioid addiction special-ist Indivior (INDV) agreed to license its early stage drug (currently known as C4X3256). Indivior will continue with the development and (if trials are successful) get exclusive global rights in exchange for a $10m upfront fee and mile-stones of up to $294m.

This deal sent C4X’s revenues up to over £7m in the year to July 2018, from a mere £143,000 in the previous twelve months. That also means operating cash outflows fell dra-matically to £400,000, from £6.6m in the previous year. Still, research and development investment in the group’s other early stage assets means analysts are not forecasting net profits for at least the next three years. But the group recently raised £10m from a placing, meaning it is well-funded for the time being.

C4X Discovery share price

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100

120

140

2014 2015 2016 2017 2018 2019

Source: Bloomberg

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Beware the partnership modelOne of the great attractions of both MaxCyte and C4X is their licensing businesses. Partnerships with fellow phar-maceutical companies validate the groups’ technologies and provide them with a revenue source which means they are not entirely reliant on funds from shareholders. But investors should be aware that partnerships with large pharma companies are not always straight forward.

In 2015, Oxford BioMedica (OXB) signed a deal with Swiss Pharma giant Novartis to provide the delivery mech-anism for its new gene therapy. At the time, the medicine – which is now known as Kymriah – was undergoing late stage clinical trials in young leukaemia patients.

Throughout the development process, Novartis’ licensing sales sent OXB’s revenue soaring, but as demand ticked up ahead of a large phase three trial and eventual commer-cial launch, the deal put undue strain on OXB’s financial position. In order to satisfy the terms of the contract, the company spent £26m to expand its Oxford-based labora-tory which forced management to take out a loan with Oberland Capital. Then, the loan had a minimum annual interest rate of 10.5 per cent, paid quarterly and by Novem-ber 2016, the group had drawn $40m of its $50m facility. The terms of the loan also meant that OXB had to keep a minimum of $10m in cash on its balance sheet (tough for a cash guzzling biotech company), which forced it to return to the market in September 2016 to raise £10m. Costs of the placing were 15 per cent of the net amount raised.

It’s true, things all worked out well in the end. Novartis’ therapy was given the green light from regulators in Europe and the US and became the first ever commercially available gene therapy for cancer sufferers. OXB’s revenue has benefit-ed from commercial sales of Kymriah and the group turned its first pre-tax profits in the first half of 2018. The success-ful deal with Novartis also caught the eye of more leading pharma companies, handing the group two further licensing contracts, which contributed £20.6m in gross income in the first half of 2018. But shareholders had to endure many years of stress and multiple fundraisings to get to this point.

C4X

Cash (current): £5.6m Cash exp (FY2018): £14m

12-months Sales Net loss Operating cash to 31 Jul (£m) (£m) outflow (£m)

2013 0.6 -1.1 -0.8

2014 0.3 -3.1 -3.2

2015 0.3 -5.3 -6.0

2016 0.1 -6.8 -6.6

2017 7.1 -1.1 -0.4Source: Factset

Oxford BioMedica share price

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200

400

600

800

1000

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2014 2015 2016 2017 2018 2019

Source: Bloomberg

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Investor appetite for healthcare stocks is on the rise, accord-ing to Schroders’ 2018 Global Investor Study. Two-thirds of the 20,000 people from 30 countries who were interviewed for the study said they were interested in investing in a thematic fund that focused on healthcare – higher than any other trends.

That shouldn’t be too surprising as healthcare can be an at-tractive investment: it’s universally relatable and, as long as the human population is expanding, it will be in high demand. Rap-id scientifi c progress of the last few years also means the global pharmaceutical industry has shifted – rather than develop their own products from scratch, many big pharma companies are turning to smaller, more nimble biotech groups for their early stage research, leading to an increase in consolidation.

In the UK, there’s also the added benefi t of tax relief from investment in riskier companies. Enterprise Investment Schemes (EIS) or Seed Enterprise Investment Schemes (SEIS) are government initiatives designed to encourage investment in small companies which are developing novel, or niche prod-ucts. Many companies listed on Aim also qualify for Inheritance Tax Relief, including all three of the companies profi led in this piece. But it should be noted that a dual listing will cancel the IHT exception and many UK-listed biotech stocks also chose to raise money on Nasdaq.

A market hungry for investment


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drug developers: high risk, high potential reward · 2019. 1. 11. · portfolio, but london’s...

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