Description

SUMMARY

Opportunity.  The biotech sector has performed terribly this year, down ~22% versus a 25% gain for the S&P 500.  Hedge funds have been burned by biotech this year, making them reluctant to buy new ideas in the sector (WSJ link).  The biotech carnage makes it a good time to examine the space, and I’ll discuss Kodiak Sciences, Inc. (KOD). (WSJ link). 

Short-Term Valuation.  I like to start with valuation, and in the short-term, if KSI-301’s second-half-of-Q1-2022 Phase 3 results do not demonstrate a substantial improvement over Eylea, KOD’s stock will get creamed.  If the Phase 3 trials bear out the KSI-301 data from the Phase 1 results (2/3 of patients to 6-month dosing intervals), we should expect KOD to trade back to $150-$200/share (where it traded earlier this summer) or higher.  If KSI-301 only demonstrates a modest improvement over Eylea, it will be difficult to handicap KOD’s share price because Eylea has an established position among physicians as a workable solution despite the aforementioned drawbacks (and KSI-301 will then land in similar territory as pre-commercial Faricimab).  Buying KOD is essentially a bet that the Phase 3 results will likely look like the Phase 1 results, and at KOD’s current price the odds are heavily mispriced.

Table 1: Short-Term Value Proposition

If you believe those odds and payouts (and if you could theoretically place the bet repeatedly), the Kelly Criterion suggests betting over 50% of your bankroll.  I advise less!

Long-Term Valuation.  While hardly the only possible scenario, I can see a path to KOD being a ~7x over the next 5 years.  KOD is targeting a $15B market (looking a few years out); it could have the best product in the space and achieve a 40% share in ~5 years; and biotechs like KOD tend to be valued around 5x sales (valuation for a modest ~5% growing biotech, looking 5 years out for KOD).  This implies a $30B market cap for KOD (7x the current market cap).  For this to occur, KOD’s soon-to-be-announced (late Q1 2022) Phase 3 results must resemble its Phase 1 results, and KOD must execute operationally.  This scenario probably has a slightly greater than 50% chance of happening, making KOD an attractive purchase today in expected value terms.  Regarding the 5x sales figure, I plan to update that comparable analysis shortly and am happy to address it in the comments.

Insiders.  And those close to the company have doubled down.  Founder/CEO Dr. Perlroth (7.9% shareholder) has enough faith in KSI-301 that he was levered to the results, appearing to have borrowed during a divorce to avoid selling KOD shares.  Also, reputable pharma-focused investment firm Baker Brothers owns 28.5% of KOD—a 5.8% position according to its 13-F (link).  Felix Baker chairs the Compensation Committee.  Baker Bros. has continually bought to date (including at higher-than-current prices) and also struck an unusual royalty agreement with KOD back in December 2019.  

Disclosure.  In full disclosure, I should highlight that I have been spending far more time on GLXZ, a +20% position.  If this writeup understandably doesn’t appeal given the downside risk, it may at least provide an interesting look into macular degeneration—the most common cause of severe vision loss among +50-year-olds—and its treatments.  For the policy-oriented, evaluating KOD’s market position provides a sort of microcosmic look into why US treatment costs relentlessly escalate despite technological improvements.

That’s the short, VIC-friendly summary.  This is a long one for those interested, and I’m happy to field questions in the messages and welcome any feedback.  Buyer beware—just because it’s long doesn’t mean it’s good (apologies for the length!).

TOPICS

• What is Macular Degeneration and How is it Treated?
• KSI-301 Timeline and Technology
• Competition
• Potential Acquisition Target
• The Market for Macular Degeneration Treatment
• KSI-301 Trials
• Safety
• Manufacturing
• Insiders
• Analysts
• Recent Stock Movement
• Conclusion
• Risks

WHAT IS MACULAR DEGENERATION AND HOW IS IT TREATED?

wAMD.  Macular degeneration can be “wet” (usually leading to vision loss) or “dry” (more common and less severe).  KSI-301’s main use case is to prevent wet macular degeneration and but has potential for preventative use in dry cases.

Wet macular degeneration comes in a variety of forms: wet age-related macular degeneration (wAMD, ~62% of market), diabetic macular edema (DME, ~33% of market), and retinal vein occlusion (RVO, ~5% of market).  I’ll describe wAMD, although KOD has designed its trial sets to enable KSI-301 to address all forms of macular degeneration.  The wet age-related macular degeneration (wAMD) is caused by a leakage of blook and fluid into the macula from abnormal growth of blood vessels near the retina.  It tends to affect over-50-year-olds (but often substantially older).  If untreated, wAMD causes progressive and permanent vision loss—namely reduced central vision, blurry/blind spots, distortions, and so forth.  My 94-year-old grandmother has it, and when I showed her how to use a Roku, she would get close to the TV and tilt her head to look out her periphery.  The average wAMD patient is 80 years old.  Perhaps the spouse can take the patient for the eye injections, but the spouse may have age-related health issues as well.  So the treatment burden for wAMD current frequent dosing intervals is substantial.  And with the frequent patient visits, the clinics are filling up.

DME is like wAMD but stems from diabetes and is the leading cause of blindness in working-age people in the developed world.

Cause of wAMD.  Unlike other diseases with multivariate causes (e.g., Alzheimer’s), the cause-and-effect circumstances surrounding wAMD are well understood.  Physicians treat wAMD with the injection of medications called anti-VEGF agents (vascular endothelial growth factor).  High levels of VEGF in the eye link to the formation of the abnormal blood vessels that cause much of the damage in wAMD.  Anti-VEGF agents combat the disease process and reduce the damaging effects of these leaky abnormal blood vessels.  They are also able to effectively stabilize vision in many patients.  But damage is typically difficult to reverse.

KSI-301 TIMELINE AND TECHNOLOGY

KOD Technology.  KOD invented its Antibody Biopolymer Conjugate (ABC) technology in-house.  Dr. Victor Perlroth advanced the science from 2009-2015 before it was ready for clinical use.  The key concept started with the unique biochemistry of phosphorylcholine—a stable biocompatible material that binds water irreversibly.  Dr. Perlroth came across the scientific concepts while doing VC in 2008.  Then the question became: If you could hook up polymers of phosphorylcholine to small molecules or large molecules, could you develop drugs that would last a lot longer?  If so, where would this approach be most useful?

Reason KOD Chose the Eye.  The eye seemed compelling.  In 2008-2010, it was clear that the anti-VEGF medicines—Lucentis, Eylea, and off-label Avastin, the same ones we have now—don’t last long in the eye.  There had been many efforts to create technologies that would extend the duration of the drug.  So the eye was a logical place to roll out the technology.  (Other potential candidates include the cerebrospinal fluid and the joints since a molecule injected into that space will leave relatively quickly.  As a counterexample, you don’t need to extend the half-life of something delivered intravenously that keeps pumping in the drug).

KSI-301 Relative Strengths.  Then KOD spent many years refining the design of KSI-301 and has no partnerships—owning 100% of its intellectual property.  The final product does a number of useful things to make the medicine last a long time in the eye.  It offers:

• Improved access to the tissue;
• Half-life extension;
• Biocompatibility (safety); and
• Rapid systemic clearance relative to the large molecule size.

Management KSI-301 Description.  Here is a six-minute presentation from KOD’s Chief Medical Officer describing the technology (link).  The underlying technology can potentially have applications outside treating macular degeneration, but in this writeup I’ll focus on the main product, KSI-301. 

KOD estimates that if you inject a person with top-competitor Eylea and one with KSI-301, three months later the KSI-301 recipient will have 1,000x more concentration of KSI-301 than Eylea (but there’s a lot of variability among patients, including how long the clinical effect lasts).

Long-Term Goal.  Longer term, KOD would ideally like to become “the Gilead of ophthalmology”.

KSI-301 TIMELINE AND TECHNOLOGY

The Players.  The trials pit KOD’s KSI-301 against Eylea, aiming to show that KOD’s molecule lasts much longer before the patient has to get a shot in the eye again, while delivering the same effectiveness.

When KOD comes to market, the main competition will include Eylea, Lucentis, Faricimab, possibly a high-dose Eylea.  Dr. Perlroth thinks the future will be an Eylea, Faricimab, KSI-301 marketplace.  The design of the KOD trials allows KSI-301 to differentiate itself.  When comparing KSI-301 to Eylea, the key features are safety, vision, primary endpoint efficacy, curve shapes, and durability.

Table 2 below characterizes the competition.

Table 2: KOD Competition

For a sense of how KSI-301 stacks up against Faricimab, here is a quote from a recent expert interview: “[The KSI-301] results were pretty exciting.  I think that would kind of like go up to six months.  So that will be, I think, the new standard of care, gold standard because Faricimab, I think it's more like a four-month drug.  And KSI-301 is unique.  It's not really a bispecific antibody, like the other one is.  It is a very large polymer that stays in the eye for a long time.  And it seems to be well tolerated for all three diseases, macular degeneration, diabetic retinopathy, and retinal vein occlusion.  And there are Phase 1Ib trials right now.”

It is powerful for experts to suggest that KSI-301 can become the new standard of care.  Macular degeneration will be a $15B market, and biotechs like KOD tend to trade for ~5x sales.  In 2011, Lucentis had ~100% of the market.  Then Eylea received approval, and within 3 years Eylea captured 41% of the market—showing that a new drug can gain share fast.  I would argue that Eylea was less of an improvement over Lucentis than KSI-301 is over Eylea.  And retina is an attractive market because of complex drug development (there have been a number of failures in recent years) and big spoils to the winner.  

POTENTIAL ACQUISITION TARGET

Focusing on Manufacturing While Openly Discussing Acquisition Potential.  When discussing competition, Dr. Perlroth said, “We're highly independent as a company.  So we have a tremendous amount of optionality as we look forward.  I think that's an important thing to recognize.”  Still, KOD is betting big with manufacturing ramp-up efforts and not banking on an acquisition upon approval.

THE MARKET FOR MACULAR DEGENERATION TREATMENT

KOD Trial Design.  wAMD currently affects an estimated 2 million people in the US, EU5, and Japan.  To capture the widest audience possible with KSI-301, KOD ran an “almost unprecedented” number of studies for its application.  It aims to secure a broad label, meaning that they want to gain approval for reimbursable use of KSI-301 to treat all key forms of macular degeneration (wAMD, DME, and RVO).  To this end, KOD is running 5 trials, with the goal of showing non-inferiority when pitted head-to-head against Eylea.  In other words, KOD wants to show that KSI-301 provides the same gain in vision as Eylea while requiring fewer doses.  For example, in KOD’s Phase 1b study, ⅔ of treatment-naïve patients with wAMD, DME, and RVO went +6 months between KSI-301 injections in the first year—compared with Eylea’s median of 10 injections per year (with, say, ⅓ of patients being monthly or worse; ⅓ 6-8 weeks; and ⅓ 10-12 weeks—which is too frequently for patients to make it to the clinic).  While patient needs will vary, Dr. Perlroth hopes for KSI-301 to end up with a predominantly 5-6 dosing interval profile in order to take over the macular degeneration market.  He views that as the “goldilocks zone” where the intervals are long enough to ease the patient and physician burdens but not too long since physicians like to see their patients.

Table 3: KSI-301 Trials

SAFETY

KSI-301 Trial Design Bolsters Its Safety Profile.  After the widely publicized gene therapy safety issues, the field has assumed a renewed focus on safety.  KOD believes that its use of phosphorylcholine (biocompatible materials) and fully humanized native-form full-length antibodies benefit KSI-301’s safety profile.  The large, water-based molecule enables a comparatively long half-life and strong safety profile.  Dr. Perlroth gave a technical explanation for those interested (link, 6:00).

KOD decided to run its trials on treatment-naïve patients—a big methodological improvement compared to the trials run by competitors that lends credence to the KSI-301 results.  By avoiding using a preselected group, KOD demonstrates that it has not biased the population for frequent flyers or for people who don't need very much treatment.  Instead, it resembles the actual human population.  Dr. Perlroth seemed to intimate that competitors monkey with the trial populations to benefit their results.  

Gene Therapy Safety Issues Existed All Along.  Finally, there is a misperception that competitors suffered late-stage trial failures.  Dr. Perlroth refuted that notion, indicating that the competitor trial failures actually occurred early on, in the first 20 or so patients (first 5 patients with gene therapy).  He has indicated little inflammation risk for KSI-301.  KOD has treated enough patients in trials to date to gauge the inflammation risk, and inflammation risk has not surfaced yet.

DME Outperformance as a Key Sign of KSI-301’s Safety.  Also, KSI-301’s relative outperformance in DME (for example, KSI-301 beats top competitor-to-be Faricimab handily in DME) speaks to its safety profile.  DME patients tend to have worse immune systems and preexisting inflammation because their high blood sugar levels damage the blood vessels in the eye, causing them to become leaky.  In other words, DME patients are predisposed to inflammation.

MANUFACTURING

Big Pre-Commercial Bet by Ramping Manufacturing.  KOD has already invested substantially in productive capacity.  This means KOD can potentially hit the ground running and sell “millions of doses” KSI-301 once the Phase 3 results come in (more than 10 million).  They are targeting: Y1 20% of the branded market, Y2 33% of the branded market, and Y3 40% of the branded market.  Dr. Perlroth says they’re aiming for prefilled syringe production capacity at or close to launch.  As of Sep 2021, they’re in good shape to have the manufacturing and regulatory pieces come together at the same time by late-2022/early-2023.

ANALYSTS

Of Two Minds.  The analyst community appears to be of two minds about KOD.  They’re more conservative than me; however, they also acknowledge the massive potential for KSI-301 if things go well.

Table 4: Analysts

 When you talk with them, they say that they haven’t spoken with anyone who thinks the KOD Phase III trials will be a bust, and they don’t seem to disagree with stuff outlined in this writeup.  Yet they don’t appear to be willing to take the next logical step of handicappingly the stock accordingly.  Analysts almost never tend to put out +100% upside reports.

INSIDERS

Baker Brothers (28.5%).  Baker Bros. is a highly reputable pharma-focused investment firm that owns 28.5% of KOD (a 5.8% position according to its 13-F).  Baker Bros. has bought a bunch of shares at lower levels, but also bought substantially at higher-than-current levels, as shown in the table below.  Given Baker Brothers’ exceptional +20-year healthcare investing track record and Felix Baker’s personal expertise and position as a board member, one can infer a pretty high probability of the drug working.  Despite a losing win-record, Baker Bros. has managed to post outstanding returns since 2000 via prudent position sizing.

Table 5: Baker Bros. Recent Insider Purchases

KOD royalty deal.  In December 2019, Baker Bros. struck a $225M royalty deal with KOD to receive 4.5% of the royalties, capped at $1,012.5M (4.5x the investment).  The deal called for $100M upfront and then $125M based on KOD meeting certain objectives, such as 50% enrollment in the KOD’s first two KSI-301 pivotal clinical studies.  Considers the implied IRRs given the timing of the revenues and 4.5x cap, one has to have a fairly confident view of success to underwrite such an investment.  Discussing the royalty deal, Dr. Perlroth exhibited sound, shareholder-friendly judgment, “In thinking through how best to finance our accelerating clinical, manufacturing, and commercial plans for KSI-301 and our ABC platform, royalty funding is meaningfully less dilutive than equity and preserves both our future financing and strategic flexibility... This royalty financing provides the foundation to fund the KSI-301 development program through our 2022 Vision of pivotal read-outs in retinal vein occlusion, wet age-related macular degeneration and diabetic macular edema and our anticipated Biologics License Application (BLA) and supplemental BLA submissions.”

Nevertheless, despite reaching the required milestones, KOD turned down the remaining $125M in July 2021 (thereby shrinking the eventual royalty to Baker Bros.) because KOD felt it didn’t need the cash due to its strong balance sheet.

CTO Victor Perlroth (7.9%).  As mentioned at the outset, founder/CEO Dr. Perlroth is 100% committed to the company.  In fact, he is >100% committed financially, being levered to the results.  He owns 8% of the company and hasn’t sold any shares despite his California-based divorce (50% of the company).  A September 6, 2019 8-K indicated that he gave up 600,000 shares plus $12M of walking around money, representing half of his stake in KOD, and unless he had $12M laying around he would have had to borrow.  Nice move since KOD went from $11.60/share on 9/6/2019 to $64.47/share three months later.

CMO Jason Erhlich (0%).  In 2008, he was looking for something to do for a year.  Emmet Cunningham suggested he do a fellowship with Genentech.  Erhlich then spent a year working on Lucentis’s clinical trial—everything including statistics, regulatory, safety, protocols, drug development strategy.  The first program he ran was a Phase 3 study for Lucentis for DME.  Erhlich has mechanically sold the stock upon receiving it as compensation. 

RECENT STOCK MOVEMENT

Biotech Selloff.  During H2 2021, KOD has looked like the perfect short.  Between now and the release of the Phase 3 trial results in Q1 2022, the company had to immediately report any substantial safety issues.  If things went wrong, KOD will put out an announcement and the stock will plummet.  If things continued to go well, the stock had no reason to rocket upward until the results are released—at which point the degree of success will depend on the efficacy of the drug.  

In recent weeks, KOD sold off in lockstep with the biotech selloff.

CONCLUSION

Talking with the street and investors close to the company—and in some cases those with the credentials to read the trial data with a sharp eye—there is little skepticism over whether KSI-301 will hit the market.  The safety record so far is pristine while being run on trial-naïve patients, and KSI-301’s longer dosing intervals represent a big step up from existing options—in a market where that is important due to the two-sided misery of receiving regular shots in the eye and backed-up clinics.

Going back to the favorable roulette analogy, KOD looks like a bet with good odds and payouts in the coming month.  The combination of the (1) looking under the hood of Faricimab’s overhyped results, (2) KSI-301’s strong safety profile (exemplified by the particular outperformance in DME), and (3) insider activity support the setup.  If successful, it may take a few weeks or months for the market to digest the results.  Longer term, KSI-301 has the potential to become the gold standard of care—as the expert network interview indicated.

RISKS

Label Risk.  KOD has designed its trials to garner a wide label for KSI-301.

• Risk of not getting a wide enough label to cover wAMD, DME, and RVO.  Dr. Perlroth places a lot of emphasis on the importance of getting a wide label to be the molecule for every patient.  Eylea had to hassle with changing the label to get reimbursement for monthly dosing.
• A narrow label for long-interval usage could be really bad.  If KSI-303 were to get a label for once-every-3-month usage, for instance, that makes taking market share difficult.  Then, if a doctor uses KSI-301 and decides more treatment is needed after 1 month, the 3-month label precludes reimbursement on both (a) increased usage of KSI-301 and (b) another treatment.  This could be really bad because it would deter doctors from using KSI-301 in the first place (if a practice is sophisticated and aware of the economics).

Safety (Inflammation).  While KOD has treated enough patients with KSI-301 in trials to date to gauge the inflammation risk—and inflammation risk has not surfaced yet—there is always a risk that safety concerns could surface in the larger Phase 3 population.  If any major safety concerns surfaced during the Phase 3 trials, however, KOD would have had to disclose them.

Marginal Incremental Improvement over Eylea (like Faricimab).  Faricimab’s Phase 3 results exceeded market expectations, with 45% of patients achieving 4-month interval dosing.  Though, as discussed, that headline result is misleading with the typical patient requiring nearly as many Year 1 doses as the incumbent Eylea.  Still, these results raised the bar for KSI-301.  However, KOD’s battery of trials aims to position KSI-301 as the go-to treatment option for all doctors and insured patients.

Delays and Eylea Biosimilars.  Eylea biosimilars (similar to generics) are coming.  Dr. Perlroth has alluded to a sense of urgency to get KSI-301 to market so that physicians get used to it while it’s head-to-head with Eylea and Faricimab on price but better on performance.  Delays could push KSI-301’s commercialization out closer to when the Eylea biosimilars come to market.

Distribution Risk.  If the trials are successful, KOD will then encounter distribution considerations, which I highlight below.  Still, these are solvable issues that KOD can either work out on its own or by getting acquired by a large pharma company with big distribution capabilities—a potentiality Dr. Perlroth has alluded to many times.

• Practice composition and incentives.  For Lucentis, a small number of practices comprise most of the volume; Eylea is more broadly distributed across a wider set of practices.  Genentech (Roche) has used tiered discounting to incentivize doctors to use more of it to get better pricing (and make higher margins).  As Dr. Perlroth put it, “You [the physician] don’t want to lose money by deciding to pull KSI-301 out of a refrigerator for the patient.”  KOD seeks to strike “the right balance” (pricing and distribution policies, presumably).  Dr. Perlroth sees KOD using a mix of policies (egalitarian pricing and pricing that incentivizes volumes).
• Lucentis and Eylea “work well.”  Dr. Perlroth says, “We’re coming in with molecules Lucentis and Eylea that work well, but where there’s a critical unmet need that exists.”  They’re making a molecule to combat Eylea to be the “first-line agent”.  But Dr. Perlroth acknowledges that doctors trust the existing products.
• Potential low-dosage payment challenges: Insurers (may want lower annual per-patient costs) and doctors (get paid on a fee-for-service basis).  There is a Catch-22 in that KOD’s KSI-301 treatment reduces the number of injections, and if retinal doctors were to, say, get paid the same fee for service, they would make less money using KSI-301 vs existing options.  KOD is aware of this and is negotiating with insurers (“payers”) to pay doctors the same annual rate for treatment that they would receive if they continued using higher dose options.  (This dynamic is the public policy reference I made at the outset: these perverse incentives are a microcosm for continually escalating healthcare costs.)  According to Dr. Perlroth, “The better the molecule does clinically, the easier and more powerful the discussion is with the payers.”  But this remains an unresolved consideration at this point.
• International distribution.  KOD is not as far along with ex-US commercialization, but they have spent some time and efforts on that recently.  If the various trials hit their marks, KOD will need to plan its international distribution.

Biden.  The recent regulatory scare regarding pharma pricing is fresh, and I'm afraid I don't have much to offer.  For those considering playing KOD over the next quarter, the recent scare is probably priced in and/or not critical to the thesis if you believe the odds and payouts I assumed in the intro.  I welcome any feedback in this area.  Apologies for not having more on this.

Short Interest.  KOD’s heavy short interest 11% of float at time of writing poses a risk in the sense that there are big wagers that KOD’s Phase 3 results will underwhelm.  In the event of good results, however, the high short interest will likely serve as a catalyst.

Catalyst

• Q1 2022 announcement of DAZZLE Phase 3 results.
• Shorts covering.