Description

Idea: Aerie Pharmaceuticals is a biotech story with no revenue and cash burn which is going to ramp up significantly as the company builds out its sales team and switches from the clinical stage to commercialization stage. Management continuously issues equity and has issued large amounts of convertible notes which will be dilutive in the future. It is in development, more or less, of one drug which targets Glaucoma, this drug has not proved superior in past trials and the company has previously failed NDA. Furthermore, while the broad biotech market has seen significant upswings over the past five years, more so than may be justified, Aerie, even in the best case scenario, has materially worse prospects than most other biotechs (even in their baseline scenario). Essentially, it is trading like a lottery ticket with no real prize at the end. 

Background: Aerie Pharmaceuticals is a late stage research biotech company which is in phase III trials of Rhopressa which is an eye drop for glaucoma sufferers. The company is in development of really just Rhopressa, with another drug candidate simply a combination of Rhopressa with an existing drug on the market. The company has no revenue stream currently, as it is solely a clinical trial stage pharma. The drugs intended purpose is to lower pressure in the eye, and its unique characteristics involve the ability to treat patients with already lowered pressures, as existing drugs are less effective once the pressure in the eye (IOP) drops to the low 20’s mm Hg. Patients diagnosed with glaucoma tend to initially have IOP’s below 25 mm Hg, at higher IOP’s many drugs already exist to treat Glaucoma. Timolol, a reference “beta-blocker” competing product, was “slightly more efficacious than Rhopressa, but similarly showed loss of efficacy at lower baseline IOPs.” The drug is not intended to be a primary solution to treat Glaucoma, as it does not actually reduce pressure better than existing drugs, rather when paired with existing drugs on the market, it is possible to lower IOP’s even further. “There’s a good likelihood that, if approved, Rhopressa will be additive to other IOP lowering agents. It’s a different mechanism of action, so you are attacking the pressure issues from three sides.” The company is planning to file an NDA in September of 2016. With average approval time of ten months, we are looking for, at the fastest, a Q2 2017 product launch.  

Clinical Trial: The drug has suffered issues in the clinical process and is at best as good as Timolol, its comp in clinical trials: “The drug received mixed phase III results in 2015. In the Rocket-1 trial reported in April, the agent could not match the beta-blocker, Timolol maleate, in lowering IOP in patients with baseline IOP below 27 mm Hg. In September, the company noted the product proved non-inferiority compared with Timolol in Rocket-2, in subjects with baseline IOPs greater than 20 and below 25 mm Hg.” In a recent conference call, the CEO noted they were disappointed with the trial data but were confident in the drug’s ability in lower IOP’s.  

Market Size: The company is touting the addressable market size of the drug to be $2.1bn as this is the existing size of the Glaucoma IOP reducing drug market. The problem is, this market is made up of many different drugs, and many different competitors, and it is made up of prostaglandin drugs, which address a more core problem in Glaucoma sufferers. Essentially, the market is touting the potential market size of its drug to be $2.1bn when in fact that is the total addressable market size.

There are six main drug types on the market currently, totaling $2.1 bn in sales (for U.S, Europe, and Japan). The largest drug type on the market are Alpha Agonists. The company is comparing itself in clinical trials to Timolol, which is a Beta Blocker (the second largest drug type on the market, which collectively makes up $375 million). To be conservative I’ll use the alpha-agonist market size as a comparison.  

So let’s take the absolute most popular drug in the market - Alpha-agonists, with a $515 mn market size, and let’s find the largest drug maker in the space - Pfizer.  

Ok great, we have the largest drug type for glaucoma and the largest company in that drug space and let’s see what the market size is for Xalatan, Pfizer’s alpha-agonist glaucoma treatment.  It is about a FY2016 $350 million. This number acts as what I would say the absolute maximum market sizing Aerie can ever get for its drug, keeping in mind it doesn’t have the R&D, the cost structure, the market positioning, the distribution, the manufacturing, the sales team, or the brand name of Pfizer … and keeping in mind it doesn’t even work as well as this drug.  

To a top line of $350 mil, I apply 10% COGS, 25% doctor’s commission (this is how they will fuel initial sales), $87.5 million sales expense (this is well-defined by the company), $10 million R&D, $32 million G&A (which I am not inflating, just using past data), then I slap on a 30% tax rate (most sales will be in U.S) and we get $1.58 FY2018 eps, or ~9 P/E at last close price of $14.16. This is assuming no dilution from equity issuances, comp, or convert notes.

I just want to reiterate that this is really the absolute best case scenario I can spin the stock, I am giving it the market size of Pfizer’s drug which operates in a larger market (alpha-agonists) than any other drug in the glaucoma market.  I am also accounting for no marketing expense, and no CapEx to build out manufacturing. I am also saying that Aerie goes from 0 to 100% market penetration (not by market share, I mean like no ramping up of revenues).  

In actuality, I would say the market size is more around $100 million, as the smallest drug type on the market currently has a market size of $117 million, and I’d place a little bit of a discount as they ramp up sales over the years with a smaller sales team an inferior drug (or as good at best).  

Competitors: Existing drugs on the market are “prostaglandin” drugs which are very effective. Rhopressa is not trying to match the effectiveness of these drugs, or even become a substitute drug, it is targeting a very specific use-case of potentially adding a few extra mm Hg’s of IOP reduction at existing low IOP levels in patients (<25). It is estimated that 80% of the addressable glaucoma sufferer market is already at the 20 to 26 mmHg level, and these patients are already on prostaglandin drugs to begin with.  

Insights:

• Transition from research stage to commercialization rate will increase burn-rate of cash. The company has estimated that its sales team alone will cost $275k per representative (and as they are aiming to build a team of 100 reps, this represents an annual $27.5 mn of added expense).  

• Actual marketing of the drug will similarly increase burn-rate.  

• The company has previously failed NDA approval for other drugs addressing the Glaucoma market.  

• Share count has been rapidly expanding, increasing ~1.7 M from 24.3 M in September 2014 to 26 M in September of 2015. I expect this to continue as well, and be majorly dilutive to existing shareholders.  

• They are hemorrhaging cash, but the stock sales and issuance of convertible notes has muddled this view. For the nine months ended September 30, 2015, the net loss was $54 million, up from a net loss of $31.6 million in the same period for 2014. In the 2015 period, they made $47 million from sale of stock (that is nearly 10% of the market cap of the company), and in the same period 2014, they made $124 million from the sale of convertible notes.  

• Insider Selling: Mehra Anand, a director, has been exercising options (at $5 per share) and sold at ~430,000 shares at $~34 per share in April of 2015. Meanwhile, a lawsuit was filed against the company because: Rhopressa was not performing as well as timolol and would not lead to commercial success for Aerie Pharmaceuticals Inc , and that as a result of these allegedly false and misleading statements and/or omissions, Aerie Pharmaceuticals Inc securities traded at allegedly artificially inflated prices between August 6, 2014 and April 23, 2015, with its stock price reaching a high of $35.39 per share.

• Importantly, on April 23rd, the company announced Phase 3 trial results which were disappointing,  sending the stock from over $35 to $12 in a day. 

• The firm running equity offerings for Aerie is also covering the stock. It upgraded the stock from hold to buy in May of 2015.  

• Another firm, with a buy rating of $48, made a market in the securities of Aerie Pharma.  

• Also, management receives a disproportionate amount of compensation, in the most recent quarter the stock based compensation was $2.7 million for administrators and only $.6 million for R&D. This seems odd considering they are in the research phase, and have not begun to commercialize yet / have not partners or really any “business” attributes. 

• They put out a ton of PR to investors which is not such a great sign, it seems they are focusing more on raising the stock price, selling equity, and paying themselves compensation than running the company. 

Consensus View: As noted previously, Sell-Side has buy ratings on the stock, but they have conflict of interests with the firm.

Why Opportunity Exists:

• Sell-side has buy ratings, but as noted they also have a conflict of interest dynamic.

• This stock has run-up on the back of the broad biotech market and has significantly worse prospects than some other biotech (even when comparing upside scenario for Aerie to baseline to other biotech).

• The market cap of the stock is only 385M and most hedge funds,and accumulating a significant position would prove difficult with about $7M worth of stock traded daily, at 10% of float traded daily, it would take 30 days to accumulate a 5% short position in the company.   

Anti-thesis:  

• Miscalculated market size, it turns out almost all existing PGA users choose to also buy Rhopressa as an additional drop to their routine, and thus the market sizing would be significantly larger than anticipated. In essence, the fact that it is secondary could increase its market share, rather than be detriment to it. I find this unlikely, but if it is approved across major insurance labels and Medicade with almost no co-pay there is little reason why it wouldn’t gain market share.  

• It is possible that there is some as-of-yet undiscovered indication for the drug which increases its addressable market size.

Sign-posts: 

• Equity issuances

• Convertible bond issuances

• Insider selling

• Continued disappointing clinical trial results

Catalyst

Idea/Catalyst:

• The company continues to issue stock, diluting existing shareholders, and artificially increasing financial position. This is done through secondary market share repurchases by a suite of underwriters, in addition to potential convertible debt offerings as has been completed in the past. This will cease to happen more and more as the stock depreciates in value (from previous dilutions) and the company will no longer be able to finance its operations this way and will need to raise more debt.  

• The company is moving into commercialization mode, and they have no existing revenue stream. This means that revenue will only ramp up when the product is first approved in Q2 of 2017 (a while from now keeping in mind), and costs will increase with it as they acquire sales and marketing teams.  

• Nearly 400,000 shares will be able to be purchased by December 2019 under the existing warrants in place, the strikes range from 223,000 shares at $.05 to $5.00 for the rest of the shares. This would prove incredibly dilutive to existing shareholders.  

• Further dilution will be seen from the compensation plan, which has options on 4.3 M shares with a weighted average exercise price of $12.33 (below current price).  

• Current cash position is only $106 M, with an additional $48 M in short term investments, with a current burn rate of nearly $20 M per quarter (excluding non-material non-cash expenses, and financing activities, and assuming no ramp up of expenses as the company transitions to commercialize its products) the company will have nearly no cash by its launch of Rhopressa in Q2 2017 (6 quarters from now at ~$20M each, is $120M in expenses).  

• Of course, the FDA may not approve Rhopressa, which I am not counting on, but this is a actaually a likely scenario given the company’s previous failures and Rhopressa’s recent Phase III trial issues with only small sample sizes (n=~150).