Source: George S. Mack of The Life Sciences Report (2/4/14)
A new generation of oncology treatments is moving through clinical trials toward the market. These proposed products are revolutionary in both their approaches to disease and their expected efficacy. Raghuram “Ram” Selvaraju, armed with his background as a drug developer, has followed dozens of highly innovative small- and mid-cap biotech companies, many of which he originally spotted as micro caps. In his second of three interviews with The Life Sciences Report, the head of equity healthcare research at Aegis Capital Corp. highlights two names with huge growth prospects.
The Life Sciences Report: Ram, let me start with a technical sector question, one that I am sure is on every investor’s mind. I’m noting that the New York Stock Exchange’s AMEX Biotechnology Index (BTK) is up more than 110% in the past two years (to Jan. 23). The NASDAQ Biotechnology Index (NBI) is up 127% in that same period. Have we seen the bulk of the move in the biotech sector? Or is it possible that, because we had such a long dry spell before this bull market began in late 2011, we could have a lot more upside left?
Ram Selvaraju: That’s a difficult question to answer quantitatively, because as much as I would like to think I have a crystal ball, I don’t. However, I can say that, based on the indicators that I look at—a combination of macroindicators as well as sector-specific indicators—the current situation is effectively 60–70% the former, meaning we have seen the bulk of the run-up in the biotech sector, and 30–40% the latter, meaning we did have a very substantial dry spell. We had a situation for nearly two years (2008–2009) where the initial public offering (IPO) window was completely shut. Consequently, we had a period of two to three years (2010–2012) during which only the most well-capitalized, well-funded, politically connected and diversified companies managed to go public.
If you look at historical valuations, the biotechnology sector has been defined purely by price:earnings multiples, or even price:sales multiples. You’ll see that the biotech sector, as compared to where it’s traded historically, doesn’t look particularly overvalued. I think that, while the bulk of the run-up is behind us, we could see another 20–30% appreciation across the board over the course of this year.
In addition, I believe the IPO window is going to remain open for biotech companies. But investors are going to continue to be discriminating. They are going to continue to select companies with diversified pipelines, companies that are at or near commercialization stage, companies that have capital-efficient approaches to drug development and companies targeting large margins that focus on a specialty sales model, where they can get revenue without having to spend a massive amount on selling, general and administrative expenses.
TLSR: You are primarily a small-cap analyst. But you follow some interesting mid-cap companies that you’ve tracked from their small-cap days. Do you like to recommend that investors ultimately trade mid caps in for new small caps, or do you recommend they stay with companies they have grown up with, where they understand the value drivers?
RS: When you have a high-quality company and you have a chance to get in on the ground floor, the important thing to remember is, don’t sell out too early. If it’s a great company, and you sell out before the company has the chance to grow up into the next Celgene Corp. (CELG:NASDAQ), you leave a lot of money on the table.
To the investor who’s discerning, who’s had good success with a particular name, and who has good visibility into what the future of the company is, I say hold on. That’s been my advice to investors putting their money into Acorda Therapeutics Inc. (ACOR:NASDAQ), and they’ve done extremely well. I started covering Acorda when it was $2/share. It’s $31/share today. It was also my advice to investors who put their money into Medivation Inc. (MDVN:NASDAQ). When I started coverage, Medivation was, on a split-adjusted basis, a $2.25 stock. It is an $85/share stock today.
I advise investors to take their gains at the appropriate time because, as you know, nothing lasts forever. In the biotech industry particularly, where companies fall in and out of favor, it is important to remember that when you see a healthy gain in a company’s stock price and you don’t see a long-term future for that company—or you see a future where that company could have its position supplanted by new-generation or next-generation technology—you should take profits. But, when you see an opportunity like the one that investors had with Celgene, you’d better recognize it and hope that you are fortunate enough to ride the train all the way to the top.
TLSR: Investors should look at the competitive landscape at all times and see what could supplant these existing therapies—is that what you’re saying?
RS: Essentially, investors must question the nature of the opportunity. They not only have to look at the competitive landscape, but they also have to look at the company’s drugs and understand what they are. Are they best in class? Do they have a sustainable competitive advantage? If the answer is yes, the drugs are likely to remain so for a significant period of time.
Also, you have to ask if a company is worth holding on to as it matures into a commercial entity, with multiple products on the market and a diversified revenue stream. Can it attain a level of sustainable profitability?
TLSR: Based on what you’ve just said, I’m guessing that you recommend growth investors keep a mix of mid-cap and small-cap stocks.
RS: Yes. I see no problem with an investor investing in a company when it’s still a micro-cap stock, and continuing to hold that stock even when it’s appreciated dramatically. I have lots of friends in the hedge fund industry who’ve owned a stock since it was a micro cap and now it represents 20%, 30%, maybe even 40% of their overall portfolio. But they don’t scale back because they believe the company has significant upside to come. They don’t believe that replacing their position with a position in another company is going to yield them the same growth with the same low-risk profile, multiple sources of revenue and sustainable profitability.
TLSR: The last time we spoke, in early December, you discussed the evolution of oncologic diagnostics, which has become an exciting industry in its new genomic configuration. It’s not humdrum diagnostics, as we once thought. Today, I’d like to hear you address new directions in oncologic therapeutics. What trends do you see in cancer therapeutics that could excite investors?
RS: We are at the cusp of a real sea change in oncology. New cancer therapies being brought to the forefront have the potential to offer substantially greater efficacy than anything we’ve seen in the past. We are seeing things emerge in cancer therapy that lead us to hope that, in all honesty, over the course of the next five to seven years, we could aspire to a cure for cancer. And if a cancer does return, and it’s more aggressive or metastatic than before, we could have new weapons to address those things.
There are four interesting areas that I’m following closely. I’m looking at the advent of targeted therapies, the advent of antibody-drug conjugates, the advent of cancer immunotherapy and—something that is new and really all that oncology researchers talk about these days—the advent of checkpoint inhibitors.
TLSR: Ram, briefly address the checkpoint inhibitors. It’s an interesting area because we know that tumor cells can mask themselves or hide from the immune system.
RS: We’ve already seen the advent of cancer immunotherapy, which is very important because oncology researchers have figured out, after years and years of research, that tumor cells have evolved ways to trick the immune system into thinking they are not even there. There are checkpoint pathway substances produced by tumor cells that act as brakes on the immune system, like the parking brake on a car. These substances allow tumor cells to fool immune cells into thinking that they shouldn’t be active. If immune cells are about to go on a rampage, killing all the cancer cells in their path, the cancer cells produce these substances to prevent the activation. A lot of research has gone into the development of molecules—mostly antibodies at this juncture—aimed at dealing with these checkpoint pathways.
One checkpoint target that has been widely featured at various oncology-focused clinical and scientific conferences is an antigen called PD-1, which is produced by cancer cells and effectively turns off immune cell activation. Several companies are developing antibodies against PD-1, including Merck & Co. Inc. (MRK:NYSE), with MK-3475 in non-small cell lung cancer (NSCLC) and other cancers, and Bristol-Myers Squibb Co. (BMY:NYSE) with nivolumab, also in NSCLC. Roche Holding AG (RHHBY:OTCQX)is also developing a checkpoint inhibitor, MPDL3280A, in NSCLC.
The idea is that administration of these antibodies can reactivate immune cells by taking the brake off, which then allows the car to roll forward. You’re able to get a robust activation signal against the cancer cells.
TLSR: Can we talk about some companies? Cancer stem cell therapy is a very hot idea right now. Can you start with that?
RS: You may have seen that Stemline Therapeutics Inc. (STML:NASDAQ) stock has appreciated substantially during January. This represents a reawakening to the fact that this company is the only cancer stem cell-focused company that actually has an abbreviated path to market approval with its lead drug SL-401 (recombinant human interleukin-3 coupled to a truncated diphtheria toxin payload that inhibits protein synthesis). You and I talked about this last July.
This drug is focused on a niche hematological malignancy called blastic plasmacytoid dendritic cell neoplasm (BPDCN), which affects a very small number of people and, as such, essentially qualifies as an ultraorphan disease. Therefore, SL-401 potentially qualifies for breakthrough therapy designation. An abbreviated pathway to approval could position the drug to be priced at a very premium level, meaning hundreds of thousands of dollars per year, just like other drugs currently available for other ultraorphan diseases.
In addition, Stemline Therapeutics, in late September of last year, disclosed that it had demonstrated the activity of SL-401 preclinically in chronic myelogenous leukemia (CML). This is the disease that Novartis AG’s (NVS:NYSE) Gleevec (imatinib mesylate), a receptor tyrosine kinase inhibitor, was originally developed to treat. Gleevec is currently a $4 billion ($4B)/year franchise scheduled to go off patent in 2015, but its substantial size as a commercial franchise clearly demonstrates what an important market opportunity CML is.
Because Stemline appears to have a drug that is active in CML and, more important, works as a single agent as well as synergistically with Gleevec—and a drug that demonstrates activity against CML cells that are resistant to currently available tyrosine kinase inhibitors—we think there’s substantially greater upside to the stock than investors imagine. The stock’s recent rebound is primarily due to investors reawakening to the fact that the company is well financed for the next two years and could, in fact, have a drug on the market next year for the niche ultraorphan BPDCN market.
We have a $70 price target on Stemline, which is the highest on the Street. We believe investors are undervaluing the company’s unique positioning and not giving it sufficient credit for what could potentially be a game-changing therapy in CML.
TLSR: You believe investors are undervaluing this stock because they are focused on the BPDCN indication, which only represents 2,000 patients each year, and don’t understand the potential for CML?
RS: I don’t believe any value is being ascribed to Stemline’s SL-401 in CML. Stemline doesn’t have an active clinical development program in CML as of yet, but we expect it to start one before the end of this year. The preclinical CML data were presented by a researcher from the MD Anderson Cancer Center at a very small conference in Portugal last year. No buysider (money manager or money manager analyst) that I know of attended that conference. The company did not get the attention it would have at the American Society of Clinical Oncology (ASCO) meeting, where everybody shows up and potential therapies become common knowledge in the biotech investment community.
TLSR: Even with its 56% increase in share value during January, I’m noting Stemline still only has a market cap of $400 million ($400M).
RS: Yes. But prior to this recent run-up, Stemline was the cheapest publicly traded cancer stem cell company in the market. We believe it ought to be the most highly valued of this group. ComparingOncoMed Pharmaceuticals Inc. (OMED:NASDAQ), Verastem Inc. (VSTM:NASDAQ) and Stemline Therapeutics, we think Stemline should have the highest valuation because it’s the closest to commercialization, and could come to market first with a drug commanding ultraorphan-level premium pricing.
TLSR: Ram, I find it interesting that SL-401 is thought to increase in efficacy with subsequent administrations. This is quite the opposite of what we see in most oncology therapeutics.
RS: That is absolutely correct. We’ve seen this before, in a related drug called Ontak (denileukin diftitox;Eisai Inc. [ESALF:OTCPK]), which was originally brought to market by Ligand Pharmaceuticals Inc. (LGND:NASDAQ). Ontak, like SL-401, demonstrated the ability to increase in efficacy as more cycles were administered. In addition the safety profile—its tolerability—improved as more cycles were administered. Because it’s an immunotherapy, the immune system of the cancer patient was essentially becoming more acute, more trained.
TLSR: Ram, in your notes you’ve made a point of describing SL-401 as a targeted therapy. Tell me about that.
RS: SL-401 is effectively delivering a toxic payload, in this case diphtheria toxin, specifically to the cancer cells. SL-401 contains the receptor-binding domain of interleukin-3 (IL-3), which homes to tumor cells andcancer stem cells that specifically express the interleukin-3 receptor (IL-3R) at high density on their cell surfaces. The cells internalize the diphtheria toxin, which kills the cells off.
SL-401 also activates the immune system against the cancer cells. In particular, if you administer this therapy in multiple cycles, it tolerizes the immune system to its presence just as Ontak did. The more cycles you administer, the lower the frequency of adverse events, including injection site reactions, as well as the higher the likelihood of getting a positive response on the cancer front. This is the best of both worlds.
TLSR: You talked about Medivation as a company you have followed from micro cap to mid cap. It has a product on the market, Xtandi (enzalutamide), which was approved for prostate cancer in August 2012. From what you’ve said today, you still like this company, right?
RS: Yes. I continue to like the company because it still has substantial upside from its current $6B market cap. You get the alpha (upside) without the beta (volatility or risk). We recently raised our price target from $100 to $125, and remain the most bullish on the Street regarding the company. Our research has consistently been ahead of the curve on this name, demonstrating our industry-leading knowledge base in the prostate cancer area.
Medivation is a risk-mitigated opportunity for investors. Although there is no such thing as a riskless investment, we think the risk profile of this company relative to its upside is very attractive. Xtandi is a leading drug for the treatment of prostate cancer, and it may also have applicability in breast cancer. I’ll invoke the following metric: If you look at the market sizes of these two cancer types, they are gigantic. Gigantic. There are millions and millions of people who suffer from prostate cancer and breast cancer. These are two of the largest markets you could have in oncology, and Medivation could potentially target both of them with the same drug.
TLSR: That’s very compelling. How about the near-term valuation?
RS: I know you’re familiar with Pharmacyclics Inc. (PCYC:NASDAQ). In mid-November, Pharmacyclics got its drug, Imbruvica (ibrutinib), a Bruton’s tyrosine kinase inhibitor, approved for certain niche hematological malignancies. In our view, the total market potential for Imbruvica is a fraction of the market potential for Medivation’s drug Xtandi. Imbruvica is also partnered with Janssen Pharmaceutica, a division of Johnson & Johnson (JNJ:NYSE). So it’s not as though Pharmacyclics owns 100% of Imbruvica. But Pharmacyclics enjoys a market cap right now of roughly $10B.
In my view, Medivation, partnered with Astellas Pharma Inc. (ALPMF:OTCPK) on Xtandi, should be trading at par with Pharmacyclics. If you compare the two companies in terms of commercial phase and relative maturity, Medivation has the edge. Its drug was approved more than a year before Pharmacyclics’ drug, and it has an established sales and marketing force in the U.S. It should report positive earnings per share for the first time in Q4/13. It is likely to be sustainably profitable over the course of this year and beyond. Medivation should trade at par with Pharmacyclics just on the basis of relative valuation.
Medivation is as attractive an acquisition candidate as Pharmacyclics, if not more attractive, because of the size of the markets Medivation targets. We believe that there is probably 60–70% upside in Medivation, even from these levels. We consider our $125 price target to be inherently conservative.
TLSR: It’s interesting to see this product being studied in so many prostate and breast cancer indications, including triple-negative breast cancer, which by itself could be a tremendous market. Are there data to support the hypothesis that this could be important as a triple-negative breast cancer therapy?
RS: The androgen receptor, the target for Medivation’s Xtandi, is overexpressed in 70% of breast cancers, not just triple-negative breast cancer. The company is targeting triple-negative breast cancer first because that’s the shortest path to approval from the U.S. Food and Drug Administration (FDA). Nothing else works in triple-negative breast cancer.
In my view, there is potential in triple-neg, similar to what we saw in chemo-refractory, hormone-resistant prostate cancer—the worst of the worst. Xtandi has also demonstrated activity in chemo-naïve prostate cancer, and the company has trials running in hormone-sensitive prostate cancer. Medivation is starting with the worst-of-the-worst breast cancer patients, who are not treatable with any of the existing therapies. The company will then move into earlier-stage populations that are estrogen receptor- and progesterone receptor-positive as well, since the androgen receptor is expressed on 70% of all breast cancer types, regardless of what the other receptor expression is.
TLSR: Ram, you’re always generous with your amazing bank of knowledge. Thank you.
RS: Absolutely. Thank you so much.
Raghuram “Ram” Selvaraju’s professional career started at the Geneva-based biotech firm Serono in 2000, where he discovered the first novel protein candidate developed entirely within the company. He subsequently became the youngest recipient of the company’s Inventorship Award for Exceptional Innovation and Creativity. Selvaraju started in the securities industry with Rodman & Renshaw as a biotechnology equity research analyst. He was the top-ranked (#1) biotech analyst in The Wall Street Journal’s “Best on the Street” survey (2006) and went on to become head of healthcare equity research at Hapoalim Securities, the New York-based broker/dealer subsidiary of Bank Hapoalim B. M., Israel’s largest financial services group. While at Hapoalim, Selvaraju was regularly featured in The Wall Street Journal, Barron’s, BioWorld Today, and Reuters/AP. He was also a regular guest on the Bloomberg TV program “Taking Stock,” appeared with Bloomberg TV’s on-air correspondents Betty Liu and Gigi Stone and was a guest on CNBC’s “Street Signs with Herb Greenberg.” He is currently an analyst with Aegis Capital Corp.
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