Description

At a market cap of only A$15 million/US$11 million for a company with a clinical (Phase I completed) immune-oncology asset, on an absolute basis we believe Australia’s Imugene (IMU.AU) is one of cheapest biotechs in the global stock market.  The valuation is a clear anomaly when compared to other cancer immunotherapy companies and is particularly striking given that IMU’s compound involves a known target (HER-2) suggesting that it is less risky than a completely novel drug.  The story is not perfect as I will explain, but at the current valuation the risk skew is in an investor’s favor.  While far from a precise analysis, near term catalysts exist that could cause the stock to double; with clinical success there is a path to a greater than 5-fold return in three to four years after Phase II data.  Downside is difficult to quantify but it is likely not a complete wipeout as one might expect given: 1) opportunity to pursue multiple indications, 2) potential tax assets that are more valuable in Australia than in the U.S. because they do not expire, and 3) a resourceful management team that has acquired its way out of trouble before and may do something creative to diversify in advance of a data inflection point. 

Business Description

I will keep this intentionally brief and in English (vs. scientific).  For those interested, a company presentation is available here:  http://www.imugene.com/investor-center/investor-presentations .  There are also links to paid research reports on the company’s site. 

Imugene participates in arguably the most interesting part of biotech today: cancer immunotherapy.  Once a backwater littered with many late stage failures and even a clinical success that fizzled commercially (Dendreon’s Provenge), the sector received a shot in the arm (pun intended!) with the approval and success of checkpoint inhibitors (BMY’s Yervoy and now MCK’s Opdivo).  As a result, there has been a frenzy of deal activity within cancer immunotherapy.  Some deals are even getting done before a drug reaches human trials.  The notion that the body’s own immune system can be harnessed to fight cancer is certainly attractive and the lower toxicity profile of most immunotherapies is a significant positive for patients.  Ultimately, many industry experts believe the most effective treatments will be a combination of multiple immunotherapies that simultaneously work in independent but synergistic ways.  The challenge will be cost as immunotherapies are expensive as individual therapies and combinations would potentially be priced beyond the realm of affordability.  We believe the next generation of drugs will attempt to solve this economic problem by including combinations in one drug.  Jumping ahead for a moment, Imugene’s drug is also a combination of multiple expensive immunotherapies. 

The Company’s drug is called HER-Vaxx and it targets a subtype of tumors that express a receptor for HER-2.  When HER-2 is overexpressed, which happens about 25% of the time in certain cancers, the tumor is more likely to spread and/or recur.  I will skip the detail on the mechanism of action.  Initial Phase I data is in breast cancer (important because it shows the drug is safe) but the next trial will be a Phase IB that rolls into a Phase II in gastric cancer because the bar is lower given less treatment options.  There is excellent evidence that HER-2 is an important and useful target as Roche’s Herceptin has approximately $7 billion in annual sales.  HER-Vaxx came to the company through the late 2013 acquisition of European biotech BioLife for A$4.5m of stock and an 18% royalty on future sales of HER-Vaxx (it could also be viewed as a worldwide license agreement).  Previously, the Company worked on a “meltlet” drug delivery platform that it stopped developing and has nearly completely written-off.

Greatly simplifying, Imugene’s Her-Vaxx can bind to the HER-2 receptor in three places while Herceptin and its eventual successor Perjeta can only potentially do so in an expensive combination (estimated at $188k for an 18-month course of therapy).  More binding sites mean is should work better.  Imugene also believes there are other benefits to the structure of its combination.  That said, here is the elephant in the room: Roche is currently running a Phase III trial in 780 gastric cancer patients in which participants receive chemotherapy and either Herceptin alone or Herceptin + Perjeta.  Roche’s data is expected in early 2022 (almost seven years from now).  This trial is a problem for Imugene because it means that Roche will be able to sell the combination before HER-Vaxx is approved.  As a result, the potential market in gastric cancer will be smaller although HER-Vaxx will be cheaper so it will capture some share if successful.  The good news is that even though its Phase II is unpublished, Roche advanced its combination into Phase III.  Moreover, if the Roche trial is successful, there will be a much greater likelihood that HER-Vaxx will be successful (although the investment horizon I am contemplating would be prior to 2022). 

Investment Positives

Science Makes Sense Given Success of Herceptin

Combination Therapy Would Offer Better Economic Model Than Combining Two Drugs (Even if Herceptin Goes Biosimilar)

Already Known to Be Safe in Humans Given Existing Phase I Data

Long Patent Life (Currently to 2032, expected to 2036)

Opportunity to Expand Into Other Indications Like Breast Cancer, Pancreatic Cancer and Ovarian Cancer

Management Diversification Worked In The Past and Could Continue

Investment Concerns

Roche Will Get to Market Before IMU

Benefit Will Be Incremental Not Transformational Since Tumors Can Downregulate HER2 Over Time (Just like Herceptin)

Currently Not Fully Funded to Complete Phase II – Then Will Need a Partner

Major Inflection Point Three Years Away

Single Product Company (albeit with multiple indications)

Thinly Traded Australian Nano-Cap

Australian Currency Risk

Valuation

I do not like to rely on comps and deal activity in biotech because they are imprecise but they illustrate Imugene’s valuation anomaly as virtually all companies that are going concerns have higher market caps and there are ample examples of checkpoint inhibitor deals for me-too compounds (many pharma companies are pursuing PD-1 now for example).   For the purposes of a bottom up framework, the assumptions used in the company’s sponsored research (available on its site in the investor relations section) are directionally realistic ($75k price in the US, low market penetration given the Roche alternative although slightly higher in Europe as Herceptin is not as widely used there).  Based on deal activity, the assumption of a $25m upfront payment on a partnering deal post Phase II in 2019 (Imugene gets 82% of that) and a 12% ongoing royalty are also in the ballpark. (There might also be additional milestones at approval and launch but I have not included those)  At the risk of garbage in/garbage out, let us assume $50m potential after-tax cash flow (30% tax rate in Australia) and after the 18% royalty to Biolife beginning in 2024 and continuing through 2036 (end of expected patent life) with no terminal value.  Let us now first discount back to the present at an unrisked 7% discount rate before risk adjusting it.  I have also assumed that the company raises A$10m at the current $0.01 to complete the Phase II which is tantamount to 43% dilution and a total post-money share count of 2,330m shares outstanding.  From there, to get to the current market value, back into the market’s implied chance of success of the trial.  With this set of assumptions, the market is implying a 10.0% chance of success today.  This is quite low for a company with Phase I safety data, especially given Roche’s decision to advance its Hercpetin/Perjeta combo to Phase III.  Even at 20% which is arguably still low, the stock would double.  Using this same framework, if the Phase II data is sufficiently exciting to warrant a partnership in 2019, then at that time the no-longer risk adjusted upfront payment and a 50% risked cash flow (discounted back to 2019 @ 7%) would yield a price eight-fold higher than today. 

What happens in a downside scenario where the Phase II fails?  At that time, the company will have an after-tax NOL carry-forward of $6m which does not expire although it could be subject to an annual limitation if there is a change of control (similar to the U.S.). Obviously this is only worth something if Imugene has a path to profitability but Imugene management made the smart acquisition of HER-Vaxx and has a lot of time before Phase II data to diversify itself.  Finally, even if HER-Vaxx fails in gastric cancer, the HER-2 receptor appears in breast, lung, ovarian and pancreatic tumors so the market will likely give some credit for those potential applications, particularly if the company can conduct a Phase IB dosing study in one or more of these indications prior to Phase II gastric data.  Overall, from a A$15m market cap starting point, the amount of clinical success that is priced in is very low.     

Catalyst

Initiation of Phase IB open label trial and receipt of data

Progression to Phase II

Capital Raise to fully fund Phase II

Phase II data