The Life Sciences Report: You manage your firm's Sphera Global Healthcare Fund and are headquartered in Tel Aviv. How much exposure do you have to Israel?
Ori Hershkovitz: We have less than 1% exposure to Israel. We're completely global.
TLSR: I want to talk about small- and mid-cap biotech stocks today, but when you appeared in a Bloomberg TV interview, you talked about Roche Holding AG (RHHBY:OTCQX). Do you follow large biopharmas as well as small biotechs?
OH: Yes. It's hard for people outside the industry to grasp the complexity of biotech. If you look at Gilead Sciences Inc. (GILD:NASDAQ), Biogen Idec Inc. (BIIB:NASDAQ) and Celgene Corp. (CELG:NASDAQ), they mostly have chemical compounds. Most of the biological infrastructure, the manufacturing and development capabilities, lies with big companies like Pfizer Inc. (PFE:NYSE), Roche, Novartis AG (NVS:NYSE), Sanofi SA (SNY:NYSE), etc.
To answer your question, we look at the world through drug companies. This is what we know. This is what we do. If it's a manufacturer of a biological drug, a chemical compound, a vaccine, over-the-counters, generics, proprietary, ophthalmic injections—we cover it. Small, medium, large, Japanese, European, Indian, Chinese—we cover it.
TLSR: I understand what you're saying from a very high-up perspective. You need to follow large pharmas because they invest so heavily in small biotechs, and they are the ultimate licensees in most cases. But do you follow these as potential investments in the Sphera Global Healthcare Fund?
OH: Yes. Definitely.
TLSR: Your fund is long-short. How frequently do you find it necessary or expedient to be short?
OH: Our fund is predominantly long. It has been quite consistent over the last three years.
TLSR: I'm noting from your firm's website that your investment methodology is management-focused. In the biotech world, do you have to meet management and the chief science and medical officers before you're satisfied?
OH: That depends, but I would say the answer is generally yes. We do meet them, and we need to spend hours with them before we pull the trigger on an investment. That usually happens after we have known members of management for many years, though that's not always the case. When a company is new to the market, as in an initial public offering, or if its technology is a breakthrough, we may invest more quickly. Generally speaking, however, we have known the management of the companies in our portfolio for a long time.
TLSR: When you invest in a smaller company, do you need to see proof of concept in the lead program, or can you take a position in an earlier-stage public company, like a venture investor?
OH: It would be a very rare occasion for us to invest in a company before proof of concept, but on the very rare occasion where we feel the upside is exceptional, we might make an exception.
TLSR: Do you ever find yourself investing in turnaround stories?
OH: Oh, yes. Definitely. It's one of our favorite strategies.
TLSR: Do you have a turnaround company you could talk about?
OH: I would say that Salix Pharmaceuticals Inc. (SLXP:NYSE) is one of my favorite turnaround companies. We've always liked the gastrointestinal space as a niche market because there is not the high level of competition seen in other mainstream areas. Salix has a very good franchise. A couple of years ago, there was a buildup of expectations for its lead drug, Xifaxan (rifaximin), an antibiotic for bacterial infection in the intestines or for irritable bowel syndrome (IBS). When the U.S. Food and Drug Administration (FDA) refused to approve the drug without a retreatment trial, the stock tanked 35–40% and then stayed there for quite some time. There were a lot of downgrades; investors weren't willing to give the company any credit for its other assets. The story had been damaged and the stock was down—but not out.
We saw two things happening. The first was that doctors would have no alternative but to keep prescribing Xifaxan off-label for IBS. It was already approved for traveler's diarrhea and hepatic encephalopathy. The fact that that drug was not approved for IBS did not mean that the company wasn't going to sell hundreds of millions of dollars' worth of Xifaxan for this indication. The company continued to grow the market off-label.
"We look at the world through drug companies. This is what we know. This is what we do."
We also saw that the market didn't give Salix credit for other products in its pipeline. Since the FDA's complete response letter (CRL) regarding the IBS indication back in March 2011, the stock is up 80%. I think it's a very good example of a turnaround story. Salix is gaining traction, getting more Buy ratings from sellside analysts and getting more credit for its research and development efforts in bowel disease. There's a turnaround story for you.
TLSR: Go ahead with another name.
OH: You asked me about investing in companies before or after proof of concept. In that regard, I want to touch on Cynapsus Therapeutics Inc. (CTH:TSX.V; CYNAF:OTCPK), with its Parkinson's disease (PD) candidate. Sometimes investors should invest early, and every now and then we come across a very early-stage story with an easier burden of proof. I'll explain.
There is a lot of focus on PD from the big pharmaceutical companies. We also know that there have been a lot of failures. A good example is the failure we saw at the end of April with Impax Laboratories Inc. (IPXL:NASDAQ) and GlaxoSmithKline (GSK:NYSE), when Glaxo returned all rights to Rytary (carbidopa + levodopa) to Impax. This drug candidate was designed to treat symptoms of PD, and its story is a good example of how hard it is to bring new drugs to market for this disease.
With Cynapsus, we have a very small company that is very early in the game with a very good and relatively derisked idea. There is a good, already-approved drug for Parkinson's called apomorphine, which rescues PD patients from their "off" episodes—motor-nerve disturbances with muscle stiffness and sluggish movement. These episodes affect quality of life of 25–50% of PD patients.
But apomorphine must be injected, and because it has a very high pH it causes bad injection-site reactions. The high pH also precludes the drug from being inhaled or swallowed. But patients need rapid relief from "off" episodes, and even with its limitations, the drug had sales of a couple hundred million dollars when it was under patent protection. The demand is there. If apomorphine could be reformulated as a noninjectable product, it could be a billion-dollar therapy. The value proposition for Cynapsus is that it has reformulated apomorphine as a thin-film sublingual product, APL-130277 (sublingual apomorphine), that does not have to be injected.
TLSR: This sounds like a good story, but investors don't seem to like it. The stock is down 35% over the past 52 weeks, and the company's market valuation is about $5 million ($5M). If this company has a potential billion-dollar drug, why do investors dislike it so much?
OH: I don't think investors dislike it as much as they just do not know about it. I think it's flying under the radar. It's very rare to see an ugly duckling, so to speak, that turns out to be a beautiful swan. But every now and then you encounter one of these duckling companies, and you know that it's possible. Sales of sublingual apomorphine strips could easily fall in the billion-dollar range—or even more—if market share is taken from other dopamine agonists used to treat PD.
TLSR: I'm wondering if Cynapsus' low valuation could be due in part to a lack of respect for drugs being developed through the FDA's 505(b)(2) regulatory pathway, under which older drugs are reformulated, as opposed to the new molecular entity (NME) or new chemical entity pathways proceeding through to new drug applications (NDAs).
OH: I agree with you in the sense that there should be more respect for NMEs than 505(b)(2)s, but I've seen 505(b)(2)s with market caps of more than $500M. I wouldn't say this is the leading cause of the valuation problem. I think that this is very early in Cynapsus' lifecycle, so it has to prove it can make the formulation stick, and work without any side effects. We will have a pretty clear image of where things stand by year-end, when the company's phase 1 results will be out.
TLSR: My understanding is that this phase 1 study is in healthy volunteers, probably graduate or medical students earning beer money. . .
OH: This is a good point. We don't need Parkinson's patients to show proof of concept because we already know the drug works. All Cynapsus must show is that it can get apomorphine into the bloodstream at a certain level. If that can be accomplished without injection-site reactions, then we would have a winner.
We also know there is demand for the drug. The two biggest risks in drug development are scientific risk and the commercial/demand risk. We know apomorphine works when it gets into the bloodstream, and we also know that the demand is there. The big question is, can the sublingual formulation maintain a level of apomorphine equivalent to the injection of apomorphine over a certain period of time. We will find this out in the phase 1 study by looking at the levels in students who are earning their beer money.
TLSR: Ori, I understand that this phase 1 trial is supposed to be completed by Q3/13. That's not long. If therapeutic-level bioequivalence can be demonstrated in these subjects, will this be the catalyst necessary to bring this stock up at least into small-cap territory?
OH: Logic would say that, but then again, these are the capital markets. From my point of view as an investor, would I increase my investment? The answer is that if I see injection-like concentrations of apomorphine in the bloodstream with the right pharmacokinetic/pharmacodynamic profiles in this trial, I would be on the buyer's side. If there are more buyers than sellers, the stock is going up.
TLSR: When should we get the results of this bioequivalence study?
OH: I'm in no hurry. I would say that by year-end the data will be out. If positive, we are looking at a winner. If Cynapsus was unable to attain the bloodstream levels seen with injection usage, then, as you guys in the U.S. say, "Houston, we have a problem."
TLSR: Let's do another one, please. You choose.
OH: Onyx Pharmaceuticals Inc. (ONXX:NASDAQ) is an oncology company, and its drug Nexavar (sorafenib), a tyrosine kinase inhibitor (TKI), is a joint venture with Bayer (BAYN:XETRA). Nexavar is a standard-of-care therapy for unresectable hepatocellular carcinoma (a type of liver cancer). It has been a player, although becoming smaller, in renal cell carcinoma (a type of kidney cancer). The joint venture with Bayer has pretty much paid for the development of Onyx's entire pipeline, which is pretty impressive.
"It would be a very rare occasion for us to invest in a company before proof of concept, but where we feel the upside is exceptional, we might make an exception."
The new major value driver at Onyx is a proteasome inhibitor called carfilzomib (Kyprolis), which was approved in July 2012 as a third-line treatment for multiple myeloma. Because it is a very good and safe drug, relative to alternatives, I think it will make its way up the therapeutic line both as a monotherapy and in combination with myeloma market leader, Revlimid (lenalidomide), from Celgene. A very big phase 3 study of lenalidomide + carfilzomib as a first-line therapy is currently underway. The data is due next year, and could be a big catalyst for Onyx. Carfilzomib is running only in the U.S. and generates about $150M/year in revenue, but is growing rapidly. The drug could be a blockbuster if it makes it to other geographies and into earlier lines of treatment. We'll see the drug go there. I would say Kyprolis will bring in $1 billion/year ($1B) in revenue within 5–6 years. It's a very exciting drug.
TLSR: There's more at Onyx. Go ahead and finish your case.
OH: Onyx has a newly approved product, regorafenib (Stivarga), another TKI on which it gets a 20% royalty from Bayer. That 20% accounts for about half of Onyx's profits. Regorafenib was approved at the end of last September for metastatic colorectal cancer, and at the end of February of this year it was approved for advanced and unresectable gastrointestinal stromal tumors that won't respond to other therapies. But again, regorafenib is going to move up the lines of therapy. Right now, it looks like a blockbuster. Royalties will probably be more than $200M/year.
The most exciting recent news that Onyx has recently disclosed is that it's getting an 8% royalty on Pfizer's biggest pipeline drug, a cyclin-dependent kinase (CDK) inhibitor, palbociclib. If approved, Onyx will receive an 8% royalty on global net sales. Palbociclib has shown remarkable data in estrogen receptor-positive breast cancer. It could be a $2–3B drug, and royalties could be in excess of $150M/year.
To summarize, Onyx has two joint ventures with Bayer, one of which is a drug selling about $1B/year. It has a fully owned drug, carfilzomib, that's been approved and looks like it will have peak sales of more than $1B. The company has royalties on an approved drug that is going to bring in free cash flow of more than $200M a year, and has a phase 3 drug with Pfizer that will bring in free cash-flow royalties of about $150M. Even though the company has performed tremendously in the last couple of years, we think it is still very much undervalued, trading with a market cap of just under $7B.
TLSR: With all that Onyx has going in its oncology franchise, it sounds like it should have a market valuation closer to Celgene's.
OH: I'm actually quite surprised that Bayer, Pfizer or Celgene hasn't bought it yet, but I think that will be the case in the future.
TLSR: You have a small-cap company, with a $72M market valuation, in your portfolio—Arrowhead Research Inc. (ARWR:NASDAQ). It has some of the most sophisticated science I've seen. If you want to tell that story, I'd love to hear it.
OH: Arrowhead is very intriguing. It popped up on our radar because it has a backburner obesity candidate, and we were looking for one. But once we took a look at the company, we found that it also has a very interesting hepatitis B (HBV) drug, ARC-520, in development. The story shows how investors can be looking for something specific in a company and then find themselves investing because of something else.
"It's very rare to see an ugly duckling that turns out to be a beautiful swan. But every now and then you encounter one of those duckling companies, and you know that it's possible."
Basically, siRNA (short-interfering RNA) was once the hottest thing on the Street, and a lot of companies bought into it. But the technology was essentially thrown out by the large caps when they were doing megamergers. Arrowhead picked up its program from Roche for close to nothing, and began looking at the best products to develop on the basis of that siRNA technology. The company chose what everyone has been choosing—oncology—but also, very interestingly, it decided to go into virology.
We've seen a lot of money being made in hepatitis C (HCV). We saw how fast the market came to recognize the value of a solution to HCV. Looking at the numbers, HBV also affects a large population that is either underserved or offered suboptimal solutions. We like the way Arrowhead perceives the market and the way it thinks about developing ARC-520.
TLSR: Arrowhead has drugs in clinical trials, one of which is partnered and in phase 2. But ARC-520, which got your attention, is not in the clinic yet. As with Cynapsus, you are a very patient hedge fund investor here.
OH: I would like to give that impression, but, unfortunately, it's not true. Arrowhead and Cynapsus are the exceptions, not the rule. If you look at what happened in the HCV world, then you understand that Gilead bought a phase 2 company, Pharmasset Inc., for $11B. When Pharmasset had phase 2 data, it was already trading in the billions.
TLSR: Are you thinking that HBV will have the kind of uptake from the medical and investor community that HCV has demonstrated?
OH: I'm saying it might have that type of uptake. But I can guarantee that viral infections get very high valuations if they work early on in studies. There is an ability to see a drug's effect and achieve an endpoint very early in the process that is distinctive in virology. In Alzheimer's disease, you have no idea if you have a winner until you open the phase 3 results, which is after you have spent half a billion dollars in development. In hematology, and virology in particular, the drug is administered, and if the viral load drops and doesn't come back, you have a winner. No more than 10 patients are needed to see this effect. That effect must be replicated in a large number of patients to see if the safety is there, but if it is, the investment is multiplied many times.
TLSR: With Arrowhead, you're giving a lot more value to the HBV drug than you are to the unpartnered oncology product that's in phase 1, or to the unpartnered obesity product in phase 1, or to the phase 2 program partnered with Cerulean Pharma Inc. (private). In your mind, the value driver here is the HBV product, because the company can show proof of concept so quickly during development. Is that your investment theory?
OH: Yes. If HCV is any indication of the valuation Arrowhead should achieve, it should be at least a couple hundred million dollars.
TLSR: You're also following another company, Galapagos NV (GLPG:BSE). Is that one of your favorites?
OH: Yes. We've held Galapagos for some time. We have watched its phase 2 program in rheumatoid arthritis, partnered with AbbVie Inc. (ABBV:NYSE), and were intrigued by the early but impressive efficacy and the lack of safety issues with its JAK1 inhibitor, GLPG0634. Given the fact that its anti-tumor necrosis factor (anti-TNF) product Humira (adalimumab) makes up about 80% of AbbVie's profits, there is a lot of pressure on AbbVie to find a replacement for Humira when it loses patent protection. Humira is a $10B drug, and the Galapagos drug, with acceptable anti-TNF-like efficacy and without the high-density lipoprotein (HDL) side effect, could be the replacement. GLPG0634 is orally bioavailable, not an injectable biologic like Humira. Also, when we analyzed the terms of Galapagos' agreement with AbbVie, there was little doubt in that if the drug does work, AbbVie would have little or no choice but to exercise its option to buy Galapagos.
GlaxoSmithKline licensed a JAK1 inhibitor from Galapagos a couple of months ago. Not only is the technology interesting, but there might be a bidding war for Galapagos. We were not surprised to see AbbVie take another option on another indication from Galapagos in May, and I think we'll see more deals for the company's JAK1-specific technology.
TLSR: Is there another company you wanted to address? Your choice.
OH: I'd like to mention WuXi PharmaTech Inc. (WX:NYSE). While covering the pharmaceutical sector, we saw a lot of the clinical trials shifted to China. There were credibility issues with contract research organizations (CROs) and clinical trials in India and Russia. If you remember Medivation Inc.'s (MDVN:NASDAQ) Alzheimer's drug blow-up, it was based on Russian trials. Indian trials are also not considered very reliable; if you remember, AstraZeneca Plc (AZN:NYSE) in-licensed a drug from Targacept Inc. (TRGT:NASDAQ) based on Indian results. That did not work out.
But the Chinese CROs have been able to keep their reputations intact. We didn't want to buy a 100% Chinese CRO, so we came across WuXi, a large CRO that has half of its operations in China and half in the U.S. It is large in terms of market cap. It has no debt, which we like. It's rated in the U.S., which fit the bill. We think that more and more trials are going to be held in China. WuXi's business is growing: It's a beautiful, unleveraged business, and we like it.
TLSR: If you wanted to mention one more, I'm happy to hear it.
OH: ViroPharma Inc. (VPHM:NASDAQ) is very interesting. Its Cinryze (C1 esterase inhibitor [human]) for attacks of hereditary angioedema (HAE) is the only product that has been tested and approved as a prophylactic for HAE. Another C1 esterase inhibitor called Berinert, which being produced by CSL Behring Ltd. (CSL:ASX; CMXHY:OTCPK) and is approved and sold in the U.S., is only approved as an acute HAE product, a much smaller market than the prophylactic indication, which is a chronic therapy.
ViroPharma's shares have been depressed due to the fear that CSL may run a trial with its C1 inhibitor product as a prophylaxis once its orphan-drug exclusivity ends in September 2015. But we don't think this will be the case. There is already a very good solution on the market in Cinryze. The point is, I don't think CSL will have the option of using a placebo in a trial for a life-threatening disease.
CSL might do a noninferiority trial with ViroPharma's Cinryze. But I don't think a lot of patients with life-threatening disease will go into a trial when the best outcome they can hope for is noninferiority. Finding students going after beer money to participate in a phase 1 trial for healthy volunteers is one thing, but if patients have HAE and might die, that's something else. I think both CSL and the FDA are faced with a conundrum without a solution. In any case, a trial would take a couple of years. We are two years from when Cinryze's exclusivity expires, and CSL has not started the prophylactic trial. That tells me there is a problem in designing the trial, or it would have started already.
TLSR: Ori, are you telling me that you see ViroPharma's Cinryze as being alone in the marketplace as a prophylaxis beyond its own exclusivity period?
OH: Way beyond, yes.
TLSR: I have enjoyed this very much. Thank you.
OH: Thank you so much. Cheers.
Ori Hershkovitz has been with the Sphera Fund since 2006, and serves as managing partner and head of pharmaceutical research. From 2001–2006 he was with Leader & Co. Investment House, where he was Israel senior pharmaceutical equity analyst. Between 1998–2001 Hershkovitz was an equity analyst at Ilanot Batucha Investment House. Hershkovitz has a bachelor's degree in business administration and finance from Tel Aviv University.
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1) George S. Mack conducted this interview for The Life Sciences Report and provides services to The Life Sciences Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Life Sciences Report: Cynapsus Therapeutics Inc. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.
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