Thesis:

Mast Therapeutics represents an interesting risk reward opportunity with a potential 10x return and a large cash balance (in excess of market cap) to guard against significant downside risk. Because of recent structural selling pressure revolving around investors in a secondary offering, shares appear temporarily depressed and should rebound in the short term.

The best way to describe Mast Therapeutics is to look at is a contingent value right (“cvr”).  As of last Friday’s close you are paying $42.5mln for a biotech co. that has approximately $55 million in cash and has a phase 3 drug trial for the treatment of sickle cell disease (“SCD”) that has orphan drug status.  After last week’s equity raise the Company has enough money to complete the phase 3. If their lead drug is approved you can make a case that it’s worth approximately $3.00 to $4.61 per share in 3 years, or $2.30 to $3.50 or so today. 

The company just did a second round of financing that closed last Thursday (June 13^th).   They raised net $22.9mln (50 million shares at $.50/shr + a 5 year warrant that gets you ½ a share at $.65/share).  It looks like the current selling pressure is coming from some investors who were part of the deal.  Our read is that certain investors bought into the offering with a plan of flipping the stock and holding on to the warrants. This has caused short term stress on the stock which we believe is not warranted. 

Our belief is that once this selling pressure is over, the shares will lift. The company was trading around cash prior to the filing of the S-1.  It has been trading cheaply because of this financing overhang.  Now that this cloud has been lifted, the company should be given some value over the cash given the characteristics of their lead drug candidate.  Piper Jaffray and Canaccord Genuity were the bankers on the deal and both have agreed to pick up coverage shortly.   This should attract institutional interest in MSTX.   While we don’t know what the initial price targets will be, it is a safe bet that they will be well north of $.50 per share. Up until Friday morning, the company admittedly didn’t have enough money to see their lead drug through approval.  This has been a black cloud hanging over the stock for some time. Having invested in comparable companies over the past 10 years, it has been apparent that financing risks weigh heavily in these situations. Once removed, investors tend to focus on upside predictions from the sell side which often create environments where the company’s valuation can get ahead of itself.  With cash per share (undiluted) of about $.57/share (approx. $55 million) the cost of this particular CVR is dirt cheap.

Sickle Cell Disease (“SCD”):

The company was granted orphan drug status for SCD.   You can refer to their 8-K filed on June 5^th for a recent presentation on their drug pipeline.   Their lead drug, MST-188, is the most clinically advanced treatment for sickle cell disease.   If you want to dig into the science behind it all, along with all the competing drugs,  you should try to get a copy of Brinson Patrick’s September 2012 initiation report.  It is surprisingly thorough.

In a nutshell, Sickle cell disease is one of the most common genetic blood disorders.  Sickle cells are odd shaped cells that, when a person with SCD goes into vaso occlusive crisis, these cells create a log jam which impede the ability of red blood cells to move through blood vessels properly resulting in intense pain and organ damage.  Life expectancy for patients with SCD is only 40 years of age.  Surprisingly, there are no treatments to cure it today.   MST-188 is close to becoming the first treatment for SCD.

This drug had previously gone through a phase 3 trial. Due to capital constraints and other issues the phase 3 trial failed to meet its primary endpoints. It did, however, seem to work well in the pediatric population.  The 8K from June 5^th explains some of the issues surrounding the previous phase 3 trial and what the company is doing differently this go around. With this last raise, the company now has the funds to see the trial through.  For anyone who has ever invested in biotech companies, you’ll know that many drugs approved by the FDA make it through on their 2^nd or 3^rd go around.  In that sense, you might wager that this phase 3 trial is somewhat less risky versus others.

Phase 3 trial for MST-188 for SCD:

From the co’s 2012 10K:

A total of 388 patients, ages 8 to 17, who have sickle cell disease and are experiencing acute pain typical of vaso-occlusive crisis will be enrolled. Using a two-sided alpha of 0.05, the study has approximately 90% power to detect a 16-hour difference between treatment arms. Secondary endpoints will compare the rate of re-hospitalization for vaso-occlusive crisis within 14 days of initial discharge from the hospital and the occurrence of acute chest syndrome within 120 hours of randomization. The study will enroll subjects from approximately 40 medical centers, primarily in the U.S. Although predicting the rate of enrollment is subject to a number of assumptions and the actual enrollment rate may differ materially, we expect to complete enrollment in 2015.

The primary endpoint for this trial is a 16 hour differential between patients on MST-188 and patients on placebo.  Secondary endpoints include re-hospitalization within 14 days of discharge as well as occurrence of acute chest syndrome within 120 hours of randomization.

In the US, 90,000 to 100,000 patients are treated annually for SCD, at a cost of approximately $1 billion.  SCD is more common among the Latin and African American population and is even larger outside the US.

If you want to look at the trial, go to http://clinicaltrials.gov/ct2/show/NCT01737814?term=ANX-188&rank=2

If you want to look at age cohorts, healthcare encounters, re-hospitalizations etc, you can go to            http://jama.jamanetwork.com/article.aspx?articleid=185633.   Tables 1 and 4 are helpful.  The sample is only about 20,000 patients mind you.

Partnerships:

The sickle cell arena has a few earlier stage companies with different approaches to treating SCD and a few have signed some lucrative partnership deals.  Glycomymetics for example, which just completed its phase 2, signed a deal with Pfizer in late 2011 that is potentially worth $340 million.  Why didn’t Mast sign a licensing deal instead of raising capital and attempting to go it alone? It is difficult to know exactly. Poloxomers were developed in the 70s, so it’s not a novel compound, nor is it patented.   It is possible that the lack of novelty has led to big pharma’s disinterest. Maybe it’s as simple as management deciding to try to own it all and not to partner it. 

In the end, all that will matter is whether MST-188 reduces the vaso occlusive crsis or not. If it does, it will be the only approved drug for the treatment of SCD.  With the orphan status, MSTX will have a 7 year exclusivity period and will be well ahead of other potential treatments. If it does indeed work, incremental commercialization capital will be much cheaper than today (or come through an ex-US partnership), and total dilution to shareholders owning a platform drug should be much less dilutive than partnering it early and giving away the upside for follow-on indications.

Another potential area of upside is the launch a Phase 2 trial for MST-188 for Acute LimbIschemia in the back half of this year.  In addition, they are looking at getting government funding for the development of MST-188 for the resuscitation of shock after major trauma.  If successful these endeavors will go a ways toward proving out the platform and making it more valuable to big pharma.

They could also partner MST-188 for SCD outside of the US. It is actually a bigger market outside the US and any partnership outside the US could bring in a sizeable licensing deal.  This trial has international centers which should help with any potential ex-US partners.

In addition, in 2012 the Food and Drug Administration Safety and Innovation Act was signed into law.  The Act was set up to encourage or facilitate the development of drugs for patients with rare diseases, including by expanding the priority review voucher system to rare pediatric diseases and encouraging the FDA to implement more effective processes for expedited development and review of new medicines intended to address unmet medical needs for serious or life-threatening diseases or conditions using a broad range of surrogate endpoints (directly from the co’s 10K). Per the CEO, this voucher has value.  Prior to this last equity raise, monetizing this voucher was another potential option to raise money.  I don’t think any company has sold one of these vouchers yet and the fact that the company went the route of raising dilutive equity may speak to the value of the voucher.  It may, at some point prove valuable. At this point, we value it at zero.

Valuation:

This is the $64,000 question.  If MSTX’s drug is ultimately approved for SCD, the market value will likely reflect an unrealistic NPV.  That would be one of the periods best suited to selling shares in the company.  Looking back at VNDA (when Fanapt was approved) and TSPT (when Intermezzo was approved), the best times to sell were prior to the drug’s launch. 

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Per Brinson Patrick’s report, there are 36,000 annual pediatric hospitalizations for VOC.  Using their model for % of pediatric population taking MST-188 but using $5,000 per treatment (vs their $3,000) and a 20% discount rate you get:

I adjusted the share count to reflect the 2 milestones due to CytRx, but not the warrants.

If you assume that the drug works across all age categories, you could get peak sales of $365mln and an NPV of $4.61 per share.

Of course, these are all assumptions. It is very difficult to discern what the ramp will look like. It is meant more to give you some goal posts when thinking about future revenues.  It will be interesting to see how Canaccord or Piper will model it when they initiate coverage.

Brinson Patrick assumed $3,000 per treatment. Per conversations with the CEO, we get the feeling that $5,000 may be more accurate.  It will depend on the data, ie, how well the trial goes. If the drug becomes the standard of care, it will have a lot more pricing power than if it is just a drug to reduce pain.

Share reconciliation:

Basic shares outstanding (post offering) 96.3.  Warrants with exercise prices of $.65, $1.10 and up stand at 41.48mln.  CytRx contingent shares are 12.48mln and stock options (vested thru 2012) are 3.5mln for a total of roughly 154mln shares.  Cash from exercise of the warrants would add another $33mln or so in cash.

Risks:

The most obvious risk is if the trial fails. 

Conclusion:

You have a stock depressed due to recent financing that could be first to market, with orphan drug status, for a rare disease. In addition, you have potential other indications as well as the ability to partner MST-188 for SCD outside the US that could be substantial. With the expected initiation of coverage from Piper and Canaccord, you may see some institutional interest that could drive shares higher….at least to the point where the market gives the company a value in excess of its cash.

Catalysts

-          Structural selling pressure recedes

-          Positive Phase III results

-          Sell side initiations

-          Investor realization of stock trading well below net cash (post secondary)