Description

SUMMARY

Allergy Therapeutic is a small cap UK biotech company that is under-discovered by investors. 

Allergy has products in use and in development that target the causes of hayfever.

Why is it undervalued?

Allergy has two products in Phase III trials that could gain FDA approval later this year,  and an oral drug in earlier stage development that IF it ever reaches the market could a major blockbuster. The market is currently giving little value to the company’s pipeline even though it has two products in Phase III trials that have better than a 50% chance of approval.

We have met with the CEO of Allergy Therapeutics, Keith Carter. We have also met with the companies Chairman, Ignace Goethals, who is a 40 year + pharma executive who has worked in companies such as Eli Lilly and GlaxoSmithKline holding various top management positions. Keith Carter has virtually his entire net worth invested in Allergy and Ignace Goethals also owns shares.

BUSINESS OVERVIEW

Allergy Therapeutic is a fully integrated specialty pharmaceutical company with a profitable core business (approximately £20M in annual sales/€30M) which manufactures its own vaccines and has 87.000 patients using one of its allergy preventing medicines (mostly in Europe)

While this core business is a nice cash flow generator and has grown steadily since 2001 the potential of Allergy lays in a few new allergy treatment products in late-stage development. Allergic rhinitis (hay fever) is a large and growing problem with 150 million estimated to suffer worldwide.

Current Product Portfolio (mostly products spun-off by GSK in 1998/9):

Allergy Therapeutic currently has 4 products in its portfolio:

Diagnostics

Pollinex TA Mix Top (since 1980’s for Grass & Tree allergy and Ragweed licensed in Europe & Canada)

Oralvac plus: as name might suggest this is oral medicine being sold since 1994 and 10 million doses have been administered

Pollinex Quattro has been sold on a “name-patient” program since 1999. 87.000 patients have been dosed of which 84% for Grass and Tree allergy. Quattro stands for the fact that patients only need 4 injections prior to Pollen season instead of the usual 20-30 injections (or in some cases even higher)

In this write-up almost all my attention will go to Pollinex Quattro is this is the “true value” of the company.

This last product is sold in many EU countries on a “name-per-patient” basis. So the company knows who is taking it and can track the improvements. While the product isn’t fully registered yet EU law still allows this to be sold under strict rules and regulations. Since 87.000 people are already using this gives the product a strong safety record for more than 8 years.

To follow up what the results were Allergy did a study of 3000 people (out of the original 87.000) that wanted to participate.

After 2 years 93% were better to much better than before using the drug.

The study was certified by a legion of German doctors and appeared in various medical journals.

Now the big question is: how long does the treatment last? Do people have to come in every year to get the four shots or does it work longer? So far Allergy Therapeutic has found that the first three years you should come back and afterwards you will not have to come back (obviously there is one big caveat: time. Only after 5 or 10 years of waiting will we be really sure if the treatment is permanent or needs to be repeated more often after the first three initial years).

Should Allergy Therapeutic stop all its R&D efforts it would be nicely profitable for the last five years since its base allergy business (aka the name for patient sales) generates cash and grows between 5-10% over the last few years. Germany is the most important market, followed by Italy, Spain, Poland and Austria. It is also distributed in Holland and Canada.

Obviously it’s not very realistic to assume R&D efforts would be stopped to develop and get approval for Pollinex Quattro in the US.

Currently the company has 1 recently approved product in Canada (Ragweed).

What is Ragweed? Ragweeds (Ambrosia) is a genus of flowering plants from the sunflower family. There are 41 species worldwide.

There are two more products in Phase III development. One for Grass and one for Ragweed (US & Europe). Important to note with this last drug is that it has already been approved in Canada and, as discussed earlier, is in use on a name-per-patient basis in Europe (but doesn’t have official registration yet).

We believe there is some value in the Phase III portfolio but all the rest of the units we will keep a £0 in our valuation for conservatism as Phase I and Phase II products clearly are much more risky than Phase III. Nevertheless the company has a “Tree” allergy solution in Phase II and Oral Grasses solution in proof of concept phase. Initial results are encouraging but this will take at least 5-7 years to have any conclusion if this drug is commercially viable.

Sublingual vs. Subcutaneous

Allergy Therapeutic is not the only company trying to develop a drug for allergy sufferers as the market is large. There is an estimated 153 million people (in world’s 7 biggest Western markets) that have allergic reactions in the pollen season. The CEO of Allergy Therapeutic believes it’s a $12 billion market and only 4% is using allergy vaccines.

Several studies over the last two years show that 81% of all suffers are moderate to severe and 88% of patients want therapies which work over the long term (obviously…)

Even people who are treated currently are unhappy with the outcome and 61% report poor or partial control of their symptoms.

Many analysts, and other companies, are promoting the use of sublingual (products taken orally) as promising. Keith Carter disagrees as the facts are not on their side:

71% of patients have serious side effects (sore mouth, itching, rash, burning feeling in mouth). Carter believes sublingual drugs are hyped too much and might disappoint eventually.

While injections (subcutaneous) aren’t free of side-effects they are more limited as they just related to the injection part (sore arm, redness of skin locally where injection is applied) versus more irritant problems with sublingual drugs. The main players here are ALK Abello and Stallergenes. (both have 3-4x the market cap of AGY).

There was a large report by Piper Jaffray which argues the opposite. It is close to 100 pages so interested investors should try to get a hold of it.

Pollinex Quattro:

Pollinex Quattro’s approval and ultimate sales success in the US and Canada will obviously determine the future success of this company.

Allergy Therapeutics has several advantages over current allergy treatments:

Ultra short course (only 4 shots vs 20-30 shots in current treatment) and best in class profile as the drug only has to be taken 3 weeks in advance of pollen season. Judging by the results in Europe it is also beneficial to patients (FDA trials this year will have to prove that as well in order for it to get approval)

Pollinex Quatro’s Oral drug is also in development but it is in very early stage development and we don’t ascribe any value to it. Still early trial results are encouraging and some analysts speculate this could be a blockbuster if it ever reached market.

Currently AGY is in the biggest clinical trial ever in Phase III testing (EU+US) and has set up a global programme with 15 centres in Canada, 67 centres in US, 10 centres in UK and 4 centres in Austria.

Clearly any biotech company is not without risk but we think the risk profile is reduced significantly since the product has worked in 87.000 patients since 1999 in several EU countries with good feedback from patients + the Ragweed product has been approved in Canada already. Obviously the FDA will not use these results from Europe and Canada as “science” but has told the company it will take them under consideration. The FDA requires separate studies in a controlled (drug vs placebo) environment.

FDA recently allowed Allergy Therapeutic to need only 1 Phase III pivotal trial (instead of 2) which is good as it saves time and more importantly money.

Partnering deal

Since this is a small-cap biotech company that is spending cash on R&D lots of investor interest has gone to how the company could do a partnership with a large pharma company. Currently the company has two plans: Partner up or if needed go to market themselves in the US. The CEO said doing a partnering deal was the least of his worries.

It is our understanding from speaking to the CEO and Chairman that AGY could sign a deal today if it wanted to. Clearly many market participants are keenly focused to see how much money Allergy Therapeutics could get in any kind of deal.

Allergy Therapeutics recently announced it enlisted the help of specialized life sciences boutique bank, Burrill & Company, to assist in the opportunities open to the company.

Competition

As mentioned before Allergy Therapeutic is not the only one coming out with new allergy treatment drugs. ALK Abello and Stallergenes are large competitors focused on sublingual market.

At the time of expected launch in 2008/2009 there will be a product already on the market that is being marketed by Schering Plough in a deal with ALK Abello. This should be good for overall use of allergy treatments at this will be a direct to consumer advertising campaign.

Best sell-side analyst:

Gary Waanders (immunologist by training, used to be at KBC Peel Hunt now works at Nomura) he really knows the products. If you have a chance, you should try to get a hold of his reports. He is very bullish with a long-term target of over 7 pounds per share.

Management

CEO Keith Carter joined the company about five years ago when they were in dire shape. Prior to joining Allergy Therapeutic he was an investment banker with Nat West specialized in pharma. The unit (which now is Allergy Therapeutic) was spun out by GSK in 1998. The due diligence phase had been badly done and the company had a lot more debt than previously thought. So the company was in survival mode from about 2000 to 2003 and had a very bad capital structure. Carter wasn’t CEO until 2004 and helped turn things around for the better. Carter said that he would have preferred to stay a private company but the need for financing was there and the easiest was doing an IPO in 2005. Carter has a degree from Cambridge University.

AGY’s board consists of 3 non executives and 4 executives. The chairman of the board is a Belgian man called Ignace Goethals (60 years old) who has had an extensive career at several large pharma companies. He owns 2.2% of shares outstanding. He has an MBA from the University of Chicago.

Keith Carter owns 3.2% of the company and has almost his entire net worth tied up in the company. Total insider ownership is about 14%. There are 83M shares outstanding and 10M options. The options were granted a few years back when the company was in survival mode and needed to retain people.

Risks

It needs no explanation that a biotech company like AGY carries many risks

-risk of product not passing Phase III

-funding risk (the company can run out of money)

-partnering deal doesn’t happen and no money to set up own sales force in US

Top 3 shareholders

Fidelity owns 15%

Glaxo Smith Kline owns 12.3%

AXA Investment Managers own 7%

Recently there was an announcement that MDY Healthcare (a specialized biotech firm) took a stake in the company.

Valuation:

Allergy’s base business is worth about 70 pence per share. Hence you are paying 34 pence for the entire development portfolio. Currently most analyst put a value between £1.6 and £2 on it. While we can do many fancy calculations on X times sales etc eventually FDA or EU approval is needed on at least one of their drugs to justify any type of valuation for the company.

Allergy Therapeutic has revenues, core earnings in its EU business but high R&D expenses so on the bottom line it is loss making. It has no real book value as most of its value is in the intellectual property that makes up the drugs in its portfolio.

CEO said he thinks the fair value is closer to £1.7 now. If the Oral product comes online that’s closer to £2. If products are approved obviously that changes everything.

We asked the CEO what keeps him up at night and he responded that he was frustrated by the low value of the company vs. competitors awarded on the stock market and he would have preferred the company to be private as he wouldn’t have to deal with conference calls, analysts, etc.

He also worried about successfully completing two Phase III trials at the same time. The partnership agreement was the least of his worries.

Piper Jaffray is negative about the company and has Peak Sales for Pollinex Quattro of:

£50M in Europe

£100M in US & Canada

Piper Jaffray says the $2000 dollar per series of 4 shots is too expensive. Carter said the cost wouldn’t be $2000 but anywhere between $750-1750. KBC is using $500-750 in their estimates. The CEO’s best estimate would be $1200 eventually. It has to be a price in the US where physicians make money, and reimbursement insurance providers save money. Carter thinks such a price can be reached. Gross margins would be about 90% and cost to sell would be $100 at top end of range. Currently patients pay over $2500 for medication that isn’t very efficacious.

Carter believes the Allergy Therapeutic story isn’t very well understood by investors and that over time people will realize that the story is now more de-risked than only a year ago with two products in Phase III trials. Personally Carter believes there is a 60% chance both products in Phase III make it to market. Allergy’s Chairman, in a separate conversation, told us that from his 40 year pharma experience vaccines have a 95% chance of approval once they reach Phase III. The risk would be that this year there is a mild pollen season and the testing going on currently shows no advantage over placebo.

CEO spends most of his time on partnering opportunities, interim statements and financial compliance, business developments.

Conclusion

Allergy Therapeutic is a medium risk/high reward name. Its current market cap gives value to its core profitable European ‘name-per-patient’ business but almost no value to its products in late stage development. AGY came to the market at 72p and has traded between 65p to 135p ever since. Currently at 104p and many upcoming announcements in the next year we think the risk/reward is rather favorable.

The acceptance of the Ragweed product in Canada and two phase III trials have significantly de-risked the story versus only one year ago.

Here is how we see it:

Mkt Cap is £100M

Core Business is worth £70M (or about +/-70pence per share in value)

Drug development pipeline is worth +/-£150M (obviously we still need approvals, it remains a biotech company after all but generally it is believed that once products can get approval in Phase I, Phase II and get accepted by FDA for Phase III the track record is good)

This leaves us to conclude that the fair value of Allergy is closer to £2 today.

(+/-100% upside from today’s price).

Should the products get approved later this year all will depend on the pricing of the product can get in the US and Europe. Assuming anywhere between $500 and $2000 (per dosing) gives a valuation range between £3 and £7 per share, or 3x to 7x times the current share price.

This has already been a lengthy write-up and I apologize if I have repeated too many things more than once. I will leave the rest for in the Q&A.

Catalyst