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Tempering Insane Optimism with Due Diligence: Alan Leong on Niche Biotech Prospects
Interview

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Alan Leong Alan Leong has chosen to look for investments positioned in less obvious alcoves of the market. Interestingly, this concept could be a competitive advantage for retail investors. His niche markets include orphan, metabolic and animal companion medicine, as well as some less obvious indications for regenerative medicine. In this interview with The Life Sciences Report, the CEO of biotech analysis company BioWatch News cites four unconventional biotech and specialty pharma names positioned to generate significant returns for investors.

The Life Sciences Report: Alan, at BioWatch News you present investment ideas to your subscribers, bringing a "venture analyst's approach" to the due diligence process as you evaluate companies. What does that mean? Do you perform ground-up, original research on the technologies of very small public companies?

Alan Leong: We vet both private and public companies for our clientele. A lot of biotech is development-stage, and with any early-stage company, the burden is on the founding or management team. Management has much less history if the team is young, so our diligence becomes more art than science. Our analysis is grounded in our preferred values, as well as the company's business model and industry scope. You have to weight your analysis on other things beside just the technology. But you're right, we are looking at the technology, and we try not to stray too far from the wheelhouse.

TLSR: How do you evaluate the technologies? Do you go to peer-reviewed literature? Do you look at other companies developing related technologies? Do you consult clinicians?

AL: Those are all good starting points. Our first and second contacts with a company can come from anywhere. Then we read up, so we can have a workable conversation. Then, like a venture analyst or a fund manager, we ask a lot of questions to determine if the company will make our initial cut. Does the company fall within our scope? Is it a good addition for our clients? We provide interesting insights into the company for our clientele. It doesn't have to be a completely new analysis, but if we generate the right 5%, which is truly novel and meaningful, it provides value for our customers.

TLSR: The entrepreneurs and scientific founders of a company are always in love with their technology and approach or business model. They are married to their ideas. How do you challenge these entrepreneurs on their assertions?

AL: We hope they are married to their ideas. But I always ask: Who's your competitor? What's the competitive ecosystem?

There are always competitors, especially in biotech. If a company says it is the only one in the space, that's not what we want to hear. We want management that is firmly grounded in reality and understands that there will always be competitors for reimbursement and for the kinds of treatments physicians and patients seek. That's one example of how we challenge entrepreneurs in startups.

Sometimes I might simply ask management, "What do you think you are worth?" We hope every entrepreneur we come into contact with is very optimistic—maybe even insanely optimistic. That's their nature. Our job is to be pessimistic. But we want to be able to have a conversation that is reasonably sane after management gives an initial figure. I'll smile, and I'll say, "All right, let's get down to brass tacks. Tell me why your company should be valued this way." I'm looking as much into the quality of management's thinking as I am at the technology, because we may be betting that the company can lead its technology into commercialization and profit.

"Shiseido's investment in a collaboration with RepliCel Life Sciences Inc. is a form of validation for the company."

I also look for what I call clinical science and commercialization skills. There are a lot of great scientists in the lab, but that may not necessarily translate to commercialization. Really, it's a different mindset. Does a company want to build an expensive lab, with a dozen Ph.D.s, when a lot of the work can actually be done by undergrad and graduate students?

We are here to see others create a great business model, and to run companies that will do wonderful things for patients and bring great returns to investors by getting acquired or having another exit. We are testing for that. The earlier a company is, the more concern I have about whether management is naďve.

TLSR: You currently focus on companies that develop niche medicines. Do you think of that as your specific strength?

AL: Yes. Our focus on niches, from an investor perspective, is derived from two angles. The first is how to change the odds of return. Because drug development is such a tough game, we look at how a company's business model can change to its advantage. Years ago, I began looking at how the U.S. Food and Drug Administration (FDA) shows leniency, or grants certain advantages, from a regulatory perspective. The 505(b)(2) regulatory pathway to a new drug application (NDA) for repurposed drugs is one avenue. Another is orphan drugs, which are designated for small-disease populations in the U.S., numbering less than 200 thousand patients. Among the other niches we've found is pet medications, which has led us to a company called Kindred Biosciences (KIN:NASDAQ). I just spoke about changing business models: For example, the Kindred CEO says the market size for pet meds is lower than that for humans by one zero, but the cost of development has dropped two zeros, by virtue of the fact that odds for approval can be much higher.

We've also been looking at areas that present the opportunity for investment in future trends. Some years ago, we looked at two trends—personalized medicines and targeted cancer drugs. In personalized medicines, we were brought back into orphan drugs, which definitely are a niche.

"We want management that is firmly grounded in reality and understands that there will always be competitors."

A few years ago, I used the term orphanization of drug development (though I'm not the only person using that term). Many diseases are really several diseases. Syphilis was originally clumped in with schizophrenia, until it was separated out. As one expert has said, diabetes is perhaps 150 different underlying diseases that share glucose intolerance as a problem. If you could segment all of those underlying conditions out, they might all be orphan diseases. Likewise, lung cancers and breast cancers can be genetically defined into subgroups. The day is coming in which we will be able to pick a very specific niche or cluster and provide very effective treatments for more defined diseases.

We also identified trends in metabolic syndrome and regenerative medicine. This is why we looked at Esperion Therapeutics (ESPR:NASDAQ), with its metabolic syndrome/cholesterol focus, and autologous stem cell company RepliCel Life Sciences Inc. (RP:TSX.V; REPCF:OTCQB) in regenerative medicine.

TLSR: Since you've mentioned some names, would you go ahead and address some stocks?

AL: Glad to. My first nervous bet in the orphan disease realm was BioMarin Pharmaceuticals Inc. (BMRN:NASDAQ). My question was, could the business model with orphan drugs be robust enough that a small biotech could weather the storm and become successful? Today BioMarin is a very successful company treating very rare diseases. I think it's illustrative of what can happen in this kind of market. Five years ago its market cap was about $2 billion ($2B) or so. Today, it's a solid mid cap of more than $9B.

TLSR: Tell me why you like the company and what your growth theory is.

AL: BioMarin has an annual run rate of about $600M, and a handful of drugs approved for smaller markets. There's a bit of a lull in the action right now, but we'll soon see a number of drugs emerge from late-stage development. Vimizim (elosulfase alfa), for a rare disease called Morquio A syndrome, was approved in mid-February. The guidance is anywhere from $500–700M in revenue from those patients the company has already identified. The company has four more small-disease or orphan-designated drugs approved. It has four other later-stage drugs, three of which are in Phase 3, and we'll hear pivotal results for most of them in 2015—which is just amazing when you think about the normal rate of drug development in a mid-cap company. I call this cluster of drugs—Vimizim and the four that are coming—the "Big 5," because they have the ability to transform the company. It may be the last time in BioMarin's history that it will see this kind of impact. You're looking at four or five drugs that could triple revenue, or even more. It's truly transformative.

TLSR: We've had an amazing year in biotech, even with the share value lost since the end of February. The NASDAQ Biotechnology Index is up about 46% over the last 52 weeks, while BioMarin is up about 10% during that same period, meaning that its relative strength has been weak versus the indices. Do you see an opportunity for investors to take advantage of a potential breakout pattern triggered by the pivotal news coming out next year?

AL: Yes. Most of the clinical milestone catalysts, which are important to BioMarin investors, are coming in 2015. That means the stock could be flat for a while. Investors normally have a timeframe for moving stocks of about one year or less. The news on BioMarin is out there, but it's beyond the time horizons of some investors. If you're going to buy BioMarin, you're absolutely going in for a time horizon of one year or more.

TLSR: Not all the disease indications being addressed by BioMarin are rare. Its PARP (poly ADP-ribose polymerase) inhibitor, BMN-673, in Phase 3, is being tested in small cell lung cancer and metastatic breast cancer. Could this be a huge driver beyond the orphan disease space?

AL: Yes. The indications are huge when you get to diseases like lung cancer and breast cancer. The question is how large the drug can be when it addresses specific genetic mutations. My suspicion is that BMN-673 will definitely go orphan, because its breast, and especially lung, cancer indications are genetically defined. This goes back to what I said about the orphanization of drug development, as we narrow down disease indications with new, more definitive targets.

TLSR: You mentioned RepliCel in regenerative medicine. Tell me your growth theory for this company.

AL: RepliCel came onto our radar when we were at the Biotech Showcase and JP Morgan Healthcare Conference back in January. The company is very early in development and caught our eye for a couple of reasons.

One, the cells are derived from cells in the hair follicle. Two, the company is competing in less crowded niches—baldness or alopecia, and tendinosis. It's very interesting that these hair follicle-derived cells appear to have advantageous properties when applied to healing tennis elbow, Achilles tendinosis and similar complaints. The early results are interesting and positive.

"The day is coming in which we will be able to pick a very specific niche or cluster and provide very effective treatments for more defined diseases."

RepliCel is going to launch two Phase 2 trials this year. For those thinking of investing, the company is in a low-cash position, and is risky. RepliCel behaves like a private company in a lot of ways, because it is raising money to fund some of the next trials. One of the scientists involved with the technology, Kevin McElwee from the University of British Columbia, has an excellent reputation, not just among scientists but also among clinicians who are into hair restoration. Usually, companies joining the regenerative medicine space target major organs and systems. RepliCel, on the other hand, is going after niche indications that give it a much clearer playing field. There was one direct cell therapy competitor, the Aderans Research Institute, out there in the baldness space, but it abandoned the field a few months ago.

TLSR: RepliCel's technology is autologous. The cells are harvested from the back of the patient's scalp, and are expanded and processed ex vivo. The harvest and readministration of these cells by injection for alopecia, given that it is a two-step procedure, is about even in clinical complexity to hair plug therapy. Will this therapy for baldness be superior to hair plug therapy, which we know can be painful for the patient?

AL: All things being otherwise equal, patients will be more sold on RepliCel's therapy than on the hair transplant procedure. With a hair transplant, the physician typically has to implant thousands of units from one part of the head to another. That requires incredible dexterity and takes several hours. In fact, that is why robotics are getting involved—the physician endures incredible repetitive strain. In addition, physicians are digging out not just follicles but a little bit of muscle, too, and placing that into the patient.

Another thing that makes RepliCel's therapy attractive is that, if you look at surveys or talk to people who are losing hair, the concept of having these injections is very palatable. This possibly could expand the market. Finally, if you look at surveys, the percentage of men who say they would give up a significant portion of their wealth to have their hair restored is astounding.

TLSR: Back on May 20, the company said its licensing partner, Shiseido Company Ltd., was opening a new cell processing facility at the Kobe Biomedical Innovation Cluster in Japan. Does it make sense to process and expand those cells so far away?

AL: Shiseido, a major cosmetics company, is licensing RepliCel's hair regeneration technology in the largest parts of Asia. It has more than $7B in revenue. In Japan, companies that get involved in pharmaceuticals aren't like the ones here. For instance, you have major pharmaceutical companies that also make beer, and cosmetic companies doing major research. Shiseido's new facility is not just a tiny laboratory. It represents a major cell therapy investment. Shiseido's investment into the collaboration is a form of validation for RepliCel.

TLSR: In mid-June, RepliCel announced it had closed on the third and final tranche of a nonbrokered capital raising that it originally announced at the end of March. Each unit sold for $0.75, and that includes one warrant that could be exercised for $1/share in the first year and $1.25 in year two. The total of these tranches was only about $3.9M, which is not a lot of money. How much dilution are RepliCel investors in for in the future?

AL: It's a good question, because the dilution could be serious. RepliCel is trying to raise cash in fits and gulps to get it through the next set of trials and raise the company's valuation. I think that's part of the rationale behind why the Phase 2 trials are confined in terms of geography. The company wants to put out strong proof of concept and raise the valuation while still making progress on the commercial side. There's no doubt about it: There's a balancing act going on here. RepliCel is also trying to raise money through unconventional sources, including governmental sources of funding. We shall see.

TLSR: Alan, I have read that 11 of 12 patients in the Phase 1 Achilles tendinosis trial had what the company calls "satisfactory outcomes," but those were with adipose-derived cells and not with cells derived from the patient's hair follicles, which will be used in Phase 2.

AL: That's correct. The tendinosis indication has had the Phase 1 proof-of-concept study performed, but the Phase 2 study will incorporate some tweaks to the procedure.

TLSR: Is the lead indication at RepliCel Achilles tendinosis or alopecia?

AL: If you asked the company's CEO, David Hall, I think he would say he's looking at both of them. Right now, you would have to pick alopecia as positioned to be RepliCel's lead indication, because a) it has the Phase 2 data, and b) it has the alliance with Shiseido, which also will be advancing work in its labs back in Japan.

TLSR: You said you were following another niche, that being metabolic syndrome, and mentioned Esperion Therapeutics. Could you go ahead and talk about this company?

AL: I think Esperion will be part of an emerging wave of therapeutics in the metabolic syndrome or metabolic disease space.

We often talk about people with "bad cholesterol" or glucose intolerance, and now the literature and physicians are beginning to clump that into a general metabolic category. What you will see in the future are therapeutics that control more than one aspect of metabolic syndrome. Also, I think we will see kinder and gentler side effects.

Two things are very interesting about Esperion. One is its founder, Executive Chairman and Chief Scientific Officer Roger Newton. He was CEO at the original Esperion, which was acquired by Pfizer Inc. (PFE:NYSE) in 2004 for $1.3B. He's known as the codeveloper of Lipitor (atorvastatin), which is the best selling drug in history. Lipitor is a statin used to lower bad cholesterol, or low-density lipoprotein (LDL).

"Most of us know people for whom pets are just like family. . .and they'll spend on them almost like family."

Esperion's lead product is ETC-1002, a first-in-class small molecule drug for once-daily oral administration. It's designed to reduce bad cholesterol without the side effects associated with statins. The drug is hoping to be a statin add-on or a statin replacement. We've seen a number of clinical trials so far, with some very consistent results. The side effects are much milder relative to other cholesterol-lowering drugs. ETC-1002 also promotes a robust lowering of bad cholesterol, from 27% to 43%, and also modest blood pressure reduction, as well as a modest increase in glucose tolerance and modest weight reduction. The drug could potentially be administered to diabetics with high cholesterol, a population on which it could have the highest impact. I should say, this diabetic/high cholesterol population won't be the group of patients ETC-1002 goes out the gate with, but it's interesting.

TLSR: I thought ETC-1002 was intended only for statin-intolerant patients—for instance, those who develop muscle pain or liver toxicity. But I'm hearing you say this product could be used in a wider range of patients, as maybe a first-line therapy. Is that correct?

AL: I don't think the company will say this, but it is definitely going for approval as a statin add-on, and then for people who are statin-intolerant. That makes sense in terms of an approval pathway. Then the company can peel off new indications, such as diabetes, which would be huge. If the results we've seen in Phase 1 and 2 hold up in pivotal studies and after approval, most observers will speculate about expanding the label.

TLSR: Esperion's stock has been relatively flat, very much like BioMarin's. However, the market cap is much smaller, at just under $238M, versus about $9B for BioMarin. Esperion's shares could be moved by investors coming into the stock if good news is forthcoming. What are the near-term catalysts for Esperion shares?

AL: It has two Phase 2 trials ongoing, and the data will come in Q4/14. These are the near-term catalysts. All seven studies, in Phase 1 and mostly in Phase 2, have come back aces. Then the company will begin sitting down with the FDA to initiate its Phase 3 pivotal program the following year.

TLSR: I note that the Phase 2b study, known as ETC-1002-008, is double blind, with 322 patients. Shouldn't we get some definitive hints on efficacy with this number of patients?

AL: Yes, this study should give us interesting confirmations. Results have been very positive in earlier studies, but you can always be surprised in biotech. With this number of patients, it could be confirmatory and could tease out subtleties and delineate subgroups. It will help answer questions like how to prioritize primary indications, and maybe secondary indications, later on.

TLSR: You mentioned another niche that I, as a dog person, found very interesting. The company is Kindred Biosciences. Tell me about it.

AL: Kindred Biosciences is a small biopharmaceutical company in Burlingame, California, that is developing medications for pets. Its mission is "to bring to dogs, cats, and other animals the same kind of humane, effective, and safe therapies that people enjoy."

The company identifies drugs that have already worked in humans and applies these to dogs, cat, and horses. This technique should lead to faster development times and higher success rates than pursuing completely new, untested compounds. The company has three lead drugs focused on dogs that are in pivotal trials, and hopes to have one or more on the market by 2015.

The company has seven other products in development, including several biologics. The company is committed to maintaining a pipeline that supports an aggressive schedule. The pipeline is coupled with an executive management that has extraordinary experience in developing meds for humans and especially animals.

We believe the company is firmly positioning itself for growth and eventual acquisition.

TLSR: These products are not reimbursed like human medications, and in most cases the prescriptions are going to be filled by the vet as part of the service performed in the office for the animal patient. These newer, unique products will raise the vet bill significantly, and could make services appear price-inflated to the animal owners. Do you foresee any hesitation or resistance from the animal physicians based on pricing pressures?

AL: Industry observers believe this is the time for introducing pet med companies into the market. First, the cost of manufacturing drugs has dropped considerably. This is coupled with a strategy for selecting drugs that already work in humans or have a history of animal testing. In addition, a significant proportion of pet owners are relatively price-insensitive for pet treatments. For example, Kindred CEO Richard Chin stated that a company survey implies that 30% of pet owners will pay $2,000 or more for vet services; 20% will pay $5,000 or more. You can even segment it further, and examine horse owners for price insensitivity.

If we do the math, it appears there is considerable room for market expansion. Not every pet owner will spend like this, but a large enough proportion will be happy to pay for better treatments. Most of us know people for whom pets are just like family. . .and they'll spend on them almost like family.

TLSR: Alan, in addition to publishing BioWatch News, you teach commercialization and entrepreneurship to students at the University of Washington, Seattle. You have won some teaching awards, and I note that many of your former students have gone out and formed companies. How many businesses are we talking about?

AL: It's over 100 businesses now. I am very fortunate.

TLSR: Do you have reunions with these alum? Have you formed a cadre or think tank?

AL: The name of the organization formed by the alumni is Dragon Curve. A number were computing students, and they named it after a fractal.

The key to good teaching is to have great students who are smarter than you. I guarantee that most of them are smarter than I am. Their businesses run the gamut from gelato to biotech, and from this experience I've found two things to be very important. One is that new entrepreneurs need advisers. But the other, which is more important, is that they need to form a cohort, where they can advise each other. It is amazing what gets passed between these different businesses. What could a gelato business say to a biotech, and what could a biotech say to someone who makes beer or wine? It's a lot more than anyone could guess.

TLSR: Have any of the companies formed by your alumni gone public?

AL: Companies have been acquired by publicly traded companies. But no, no company is publicly traded. At least so far.

TLSR: It sounds like many of these companies have gotten angel funding. Do they now get Series A or Series B funding from venture capitalists?

AL: The group is maturing, and a few have gone that way. For instance, Spiral Genetics (private), which is in the bioinformatics space, was founded by former student Adina Mangubat, who raised Series A funds from venture capital (VC) firm Draper Fisher Jurvetson in Silicon Valley. Spiral Genetics is now working on Series B. I should say I'm an advisor to this company. Former student Martin Zych works at Zephyr Health Inc. (private) and it raised $15 million ($15M) from another well-known Silicon Valley VC firm, Kleiner Perkins Caufield & Byers. Matt Scholz over at Immusoft Corp. (private), where I'm also an advisor, also received funding from Peter Thiel's Breakout Labs.

TLSR: Thank you, Alan. It has been a pleasure speaking with you.

AL: Likewise. Thank you.

Alan Leong is the cofounder and CEO of BioWatch LLC. The company's services and monthly journal, BioWatch News, are for those who invest and have a fascination with seeing what’s next in the biotech industry. It features individual companies and also introduces readers to edgy topics and sectors. Past issues featured alopecia, metabolic syndrome, the future of biotech and pet meds. Before BioWatch, Leong was cofounder of Biotech Stock Research (BSR), a boutique service for life science investors. He published more than 1,500 pages for BSR and wrote more than 45 main feature stories, plus numerous alerts, company updates and annual reviews. Leong has also been an award-winning instructor within the University of Washington system, teaching courses in entrepreneurship, technology forecasting and early-stage investing.

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DISCLOSURE:
1) George S. Mack conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: RepliCel Life Sciences Inc. Streetwise Reports does not accept stock in exchange for its services.
3) Alan Leong: I own, or my family owns, shares of the following companies mentioned in this interview: BioMarin Pharmaceuticals Inc., Esperion Therapeutics, Kindred Biosciences. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: BioWatch featured RepliCel Life Sciences Inc. in a recent issue. BioWatch is making a limited time offer for purchase of that specific issue, plus an upcoming issue on regenerative medicine, similar to an offer BioWatch soon will make public. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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