Description

This will be a quick write up as it is time sensitive.  While not a “value stock” in the traditional sense, we believe Sarepta Therapeutics represents a compelling risk reward situation with an imminent catalyst.  (Please note that we did not originally intend to post this on VIC given the binary nature of the outcome, and have submitted a similar report to Seeking Alpha, although that has yet to be posted).

Sarepta will imminently be releasing 48 week Phase 2 data on its exon skipping drug, Eteplirsen, for the treatment of Duchenne muscular dystrophy, a disease that effects 1 out of 3500 kids.  We believe  Eteplirsen has a very high chance of successful approval by the FDA. 

While most analysts who cover the stock basically agree regarding the likelihood of FDA approval, their valuations all strike me as extraordinarily conservative.  On a risk-adjusted basis (as I discuss below), I think the company is worth between $44.50 and $47.50 per share.  It is hard for me to see how the stock should trade anywhere below $30.00, yet analyst price targets range from $9.00 to $26.00, and the stock closed today at $14.31.  So I think the stock is extraordinarily cheap right now.

I expect, based on preliminary results from a Phase IIb study and some extraordinary statements from the families of half of the patients treated in that study, that final study results to be presented on October 13 (though the company could release top-line results any day) will act as a catalyst to realize some of this hidden value.

[B]The Case For eteplirsen[/B]

eteplirsen is a treatment that has just completed a Phase IIb study for the treatment one group of Duchenne muscular dystrophy (DMD) patients, those who have genetic defects in what is known as exon 51.   I’ll go through the results of the study in a little more detail below, but the high-level overview is that, while the study was small (8 patients on the drug, including 6 who completed the study, and four patients in the control group), the results after 36 weeks of the 48 week trial showed a large and statistically significant improvement in the ability of patients to walk.  In addition, results from biopsy at 24 weeks demonstrated that eteplirsen does cause muscle fibers to make dystrophin, the protein that is missing in DMD patients, and there appear to be no adverse side effects. 

Most impressive of all, however, are the stories from the parents of three of the six patients who received the drug and completed the study discussing dramatic improvements in the mobility and quality of life of their children.  This is a disease where patients simply don’t get better without treatment, yet we have three whose improvement was remarkable enough for their families to speak out.

The study included 4 boys receiving a 50 mg/kg dose of eteplirsen, four receiving a 30 mg/kg dose, and four in the placebo control group (though the four in the control group began receiving eteplirsen after 24 weeks).  All were between 7 and 13 years old at entry into the study, and all group assignments were double blinded until at least 24 weeks.  Two of the patients in the 30 mg/kg group experienced rapid progression of their disease shortly after the trial began, were unable to walk at all after 24 weeks, and are therefore excluded from the 36-week analysis. 

On average, patients could walk 396 meters in six minutes when they entered the study.    The control and 50 mg/kg groups both experienced marginal decreases in walk test performance after 12 weeks (an average decline of around 4 meters).  After 24 weeks, the50 mg/kg treatment group average score equaled its score at the beginning of the test, versus a 28 meter decrease in the control group.  At week 32, the 50 mg/kg group’s average score fell by 3 meters from the start of the trial, versus a 63 meter average decline in performance of the control group.  By week 36, the 50 mg/km group score fell an average of 9 meters, versus an average decline of 78 meters in the control group.  The 32 and 36 week scores were both statistically significant.  The two boys remaining in the 30 mg/kg group experienced a decline of around 43 meters from their initial scores, still well below the control group’s 78 meter average decline, but not statistically significant.

I haven’t found any bears who are convinced that eteplirsen does not work, but there is a bear case here, founded on the small sample size.  Of course, more data is always preferable to less data, but the fact that the trial reached statistical significance with such a small sample size speaks to the large difference in performance between the treatment and control groups.  Nevertheless, the criticism that the control group performance simply may not adequately reflect the normal progression of DMD, thus skewing the results, is a reasonable consideration in interpreting these results.  The release of the data from the 48-week study should go a considerable way toward resolving the current uncertainty.

Second, eteplirsen-treated patients showed dystrophin (the protein that is missing in DMD patients) in their muscle fibers at the 24 week look, whereas placebo-treated patients did not (there was no 36 week biopsy, though there will be biopsy results at 48 weeks).  Had we not seen dystrophin production, I would have written off the walk test results as a statistical fluke despite their high significance.  At the same time, the presence of the protein alone isn’t sufficient in my view to show that the drug is an effective treatment, since what’s important is the presence of a functional version of the protein in the patient’s muscle cells.  The combination of the biopsy and the walking test results is much more impressive than either would be alone.

Third, there appeared to be no adverse side effects from treatment.  The other exon 51-skipping treatment in development, by Prosensa (licensed to GlaxoSmithKline) appears to cause proteinurea (proteins in the urine).  While proteinurea is a small problem compared to DMD, the data so far give eteplirsen the edge in safety considerations.

Finally, we have impressive anecdotal evidence from study participants.  Of the six patients receiving treatment, the families of three have gone public with their stories of how their children improved dramatically while on the trial.  I’d encourage everyone looking at Sarepta to watch these news reports:

[a href=”http://www.kfvs12.com/story/19411932/clinical-trial-shows-promise-for-jackson-12-year-old-with-duchenne-muscular-dystrophy”]Justin Trovillion[/a]

[a href=”http://www.youtube.com/watch?v=LblpXPbJMqU”]Billy Elsworth[/a]

[a href=”http://www.wcax.com/story/19277658/2-vt-brothers-battle-deadly-disorder-only-1-can-get-treatment”]Max Leclaire[/a]   Max’s parents are the most outspoken of the three families that have come forward (they have another son with DMD whom they are desperate to get onto the drug after seeing Max’s improvement.  They’ve made some startling comments, such as “elevator stuck at school... max skipped down full flight of stairs, burst out doors while teachers stared in awe…. he almost doesn't remember why he uses an elevator (we still make him for safety),” and “"My husband noticed first at the airport…. He said, 'I think he's on the drug and a high dose.' Max opened one of the McDonald's milk jugs with the sealed top. He never had that sort of grip strength."

I have never seen a trial where one half of the treatment group has gone public discussing the improvement in the patient’s lives.  Sarepta, as you can see from their [a href=” http://www.parentprojectmd.org/site/DocServer/Sarepta_Letter_to_Patient_Community_082812.pdf?docID=13303”letter to parents[/a], is not looking for publicity among parents because the company doesn’t have the manufacturing capacity to start a compassionate use program.   My bottom line is that DMD patients over seven years of age simply do not get better, and here we have three out of six whose families have made their improvement public. Jerry Mendell, the principal investigator (and a well respected scientist who does not work for Sarepta and is putting his reputation on the line) publicly stated that he saw “an unprecedented treatment effect” in the study back this up.

 [b]The Catalyst[/B]

The investigators will present results from the full 48-weeks of the study at the World Muscle Society Congress in Australia, which runs from October 9 through October 13.  They have submitted a placeholder abstract without data, and Sarepta management has indicated that October 13 is the likely date of the talk.  Given the importance of these results to the company, it’s likely that the company will release the top-line numbers in a press release before the meeting.  We could see this any day.

[b]FDA Issues[/b]

Assuming that the positive results from the 36-week look hold up in the 48-week results, which I think is very likely given the information we’ve seen so far, Sarepta hopes to file a new drug application seeking approval from the FDA to market the drug based on the results of the Phase IIb study.  They will discuss this with the FDA staff at the end of study meeting that should take place later this year.  If the FDA indicates that it would review eteplirsen on the basis of the Phase IIb data, then we would likely have a decision from the FDA late in late 2013.  If not, then the NDA will have to wait until Sarepta runs a Phase III trial, which would push a decision off by a little more than a year.  Note that, even if Sarepta files an NDA using the Phase IIb results, under FDA guidelines they will still need to conduct a confirmatory Phase III trial.

So—again, assuming the study results hold up after 48 weeks—will the FDA review eteplirsen based on very good results from a single, small trial?  There is no doubt, the FDA likes all of the data that it can get, and, for most drugs, requires at least one positive phase III trials before approval.  The small sample size in Sarepta’s current trial is a strong factor militating against approval without an additional study.  Nevertheless, assuming the 48 week data confirms the positive results seen at 36 weeks, I think the FDA will review eteplirsen on the results of the Phase IIb trial, for several reasons:

First, as discussed above, the results are dramatic. 

Second, there is no other effective treatment for these patients, who suffer rapid declines in function and early mortality.   The FDA also recognizes that, given the cost constraints, it needs to evaluate drugs for rare conditions based on reduced data sets.  A few examples of FDA approval based on small studies are the approval of Alexion’s Soliris for a second condition based on 13 patients and the approval of Novartis’s Afinitor for tuberous sclerosis based on positive results in nine patients in a 28-patient open label study. 

Third, Congress has taken action in this year in the Food and Drug Administration Safety and Innovation Act and the Creating Hope Act to encourage the development of new treatments for rare diseases and for childhood diseases.  Both acts had strong bipartisan support.

Fourth, my firm’s diligence suggests that physicians who treat muscular dystrophy are enthusiastic about being able to prescribe eteplirsen.  This is usually a pretty good indicator of how the FDA will react.

Fifth, diligence also indicates strong support in the muscular dystrophy parent community, which is small but well organized, for an early review (if you want to see why, just watch the patient videos from this trial above).

Sixth, the FDA will face considerable political pressure to act quickly.  Remember, these are Jerry’s kids.  It’s hard for me to think of a more sympathetic group than suffering and dying children, or a rare condition that has such a high public profile as muscular dystrophy.  I’m a pretty cynical guy and a stickler for statistical purity at the FDA, and, even setting aside my firm’s pecuniary interest, I still want these patients to have the treatment option as soon as possible.

Finally, given the the absence of adverse side effects in the Phase IIb study, there seems to be little risk that eteplirsen will harm patients who receive it.

The only real downside to an early review by the FDA is that, if the drug is approved, ethical considerations would make it impossible for the Phase III study to have a placebo control arm (there will be a confirmatory Phase III study even if the FDA indicates that it will review eteplirsen based on the Phase IIb results).  This is less of a concern in a DMD study than it is in most other conditions, since the prognosis for patients is uniformly bleak, and therefore it should be obvious from a single arm study whether eteplirsen is effective.

While I would still be a bull if I thought that the FDA would definitely require a Phase III study before review (and my valuation, below, does not assume an early review), I think the prospects for FDA review next year are strong.

[B]Valuation[/B]

For the most part, the analysts who cover Sarepta and I are on the same page regarding the likelihood that eteplirsen will ultimately be approved (and will be approved on an expedited basis by the FDA).   In my opinion, however, their valuations are well below where the market values a company with a drug that shows the potential of eteplirsen.

There are around 12,000 DMD patients in the United States.  Of these, around 13% have defects in exon 51, the genetic defect that eteplirsen treats, or around 1,560 US patients.   Once approved, I’d expect eteplirsen to penetrate about 70% of that market, or around 1,092 patients per year.   Analysts speculate that eteplirsen will be priced between $250,000 and $450,000 annually.  This is consistent with the experience of Alexion, which sells its Soliris treatment for neuromyelitis optica, another rare disorder, for $500,000. Using a base case of $350,000, that gets us to peak sales in the US of just over $327 million.  Note that this does not take into consideration the possibility that eteplirsen will significantly prolong the lifespan of DMD patients, who typically die by their mid-20s; if the drug does increase lifespans, then the number of patients alive at any given time will increase).

Sarepta is currently in preclinical studies to use the same technology for exon 45 and exon 50 defects, which together are about as prevalent as are exon 51 defects.  The company estimates that 85% of DMD patients could ultimately benefit from exon-skipping technology, which accords with my understanding of the mechanisms of DMD (if anyone is interested in discussing this further, leave a comment and I can go into the science in detail).  While there are several steps from pre-clinical studies to a marketed drug, conceptually there is very little difference among the different genetic defects that lead to DMD, so a technology that helps patients with an exon 51 defect should be adaptable to others.

Finally, investors need to consider sales outside the US.  Although Sarepta still has an appeal available, the European Patent Office has upheld a patent by Prosensa (licensed to GlaxoSmithKline) for exon-skipping treatments for exon 51 and 46 in DMD, which could prevent marketing eteplirsen in Western Europe.

Taking it all together, assuming that the technology that underlies eteplirsen is effective as it appears to be from the Phase IIb results we’ve seen so far, it’s hard for me to see how peak sales for Serepta’s DMD program would fall below $1.0 billion per year.  

Alexion is a good example of a similar company that is around three years ahead of where Sarepta is now (four years if the FDA requires a Phase III study before reviewing eteplirsen), with one approved product and several strong candidates in the near-term pipeline for rare diseases.  Analysts projections for peak sales for Alexion cluster around $2.5 billion per year.  With a $21.6 billion market cap, this works out to a current price of 8.65 times peak sales. 

Giving Sarepta the Alexion multiple on $1.0 billion of peak sales would value Sarepta around $8.7 billion.  Of course, we need to discount this.  Using a 20% discount rate and assuming that Sarepta is four years behind Alexion, that values Sarepta’s DMD program around $4.2 billion.  We need to take a further haircut to reflect the increased approval uncertainty, since Alexion has one approved drug versus none so far for Sarepta.  That’s an art rather than a science, but let’s set that at 2/3.  This values Sarepta’s DMD program around $1.4 billion.

An alternate comparable is Synageva Biopharma (GEVA), which is developing an enzyme replacement therapy for the treatment of two rare diseases, lysosomal acid lipase deficiency and cholesteryl ester storage disease.  As with Serepta, Synageva has no currently approved product, but has presented very promising results from a small Phase II study (they will begin their Phase III late this year or early next year), with a pipeline of other compounds and an interesting drug development platform.  Analysts put peak sales for their lead product in the $1.0 billion per year range.  With Sarepta looking at a potential market about the same size, with a similar probability for regulatory success, and discounting by one year at 20% (on the assumption that Sarepta needs to do a Phase III study before FDA review), that puts the value of Sarepta’s DMD program at 83% of Synageva’s $1.3 billion market cap, or $1.1 billion.

We need to be a little careful with Sarepta’s capital structure, because the company has issued warrants in several financings.  There are 22.6 million shares outstanding, plus options and warrants to purchase another 7.0 million shares, so the diluted sharecount is 29.6 million shares.  So I value the company’s DMD program at just over $40.00 per share using ALXN as a comp and just over $37.00 when comparing to GEVA.  Biomarin Pharmaceuticals (BMRN) is the other obvious rare disease comparable, but it’s much harder to do a direct comparison to Sarepta, given Biomarin’s licensing agreements and its development relationship with Genzyme.

On top of this, we need to add the roughly $50 million that Sarepta will receive upon the exercise of options and warrants, the value of the exon-skipping development program outside DMD (my estimate is $100 million, the value of given the promise that it has shown in DMD).  The value of the rest of the company is small compared to my view of the value in the DMD program, but the company’s market capitalization of around $80 million before we saw the 36 month DMD results is a decent proxy, less around $10 million for cash burn since then, and less another $20 million to reflect uncertainty from the Department of Defense stop work order in the company’s Ebola program.  Finally, if the FDA approves eteplirsen, the company probably will receive a transferrable priority review voucher from the FDA, which would accelerate FDA review of one drug by four months.  While this would have limited value in Sarepta’s hands, an additional four months of sales of a blockbuster drug on patent would have real value.  I’ve seen some speculation that this could be worth around $100 million, but, given that nobody has traded one of these vouchers yet, I’m much more conservative, putting a $25 million value on this.  That’s $225 million on top of the value of the DMD program, or $7.60 per diluted share, giving me a total valuation of $44.50 to $47.50 per share for Sarepta.

 [B]Risks to My Thesis[/B]

Any of the following would make me reconsider my analysis:

(1)    48-week results that do not live up to my expectations based on what we’ve seen so far in the Phase IIb trial and the public statements from the families.

(2)    Negative comments from the company following the end-of-study meeting with the FDA.

(3)    Pushback from payors regarding price (but ask yourself this—would you want to be the Scrooge insurance company that forces children to stay in wheelchairs?)

(4)    Strong positive results from Prosena’s competing product.

(5)    Adverse intellectual property developments.

In addition, there is no doubt that Sarepta will need to raise additional money to continue its research and development, including the funding of a Phase III study for eteplirsen.   If the final Phase IIb data is good, I would expect the company to raise capital after that data is released (and I don’t think they would have any difficulty doing that).

The company also has an at-the-market equity offering (ATM) agreement in place to sell up to $40 million of stock through Citadel.   Citadel’s advertised trading as a percentage of volume hasn’t gone up since the company signed the ATM agreement in early September, and I have no other reason to believe that the company has issued any stock under the ATM, so I assume that the company has not yet issued any stock under the program.  While the ATM would only cover a few day’s volume, it is still an overhang, with the possibility that Citadel might sell stock into any bump up in the stock price.

While I do not expect the market to suddenly converge to my valuation, I hope that the upcoming release of the final Phase IIb results will cause investors to give more consideration to the relative valuation of Sarepta’s DMD program.

[B]Recent Weakness[/B]

Sarepta is trading down about a dollar from its September 18 price.  I suspect the decline relates to the registration statement the company filed on September 19, registering the just under 5 million warrants outstanding.   Since the company is quite straightforward in its reporting of outstanding options and warrants, this shouldn’t have been a surprise to anyone.  In any event, I have always had the warrants built into my model.  If I’m correct about this, then the decline from the registration of the warrant stock should be transient.

The stock suffered a similar fall early this month, after the ATM program announcement.  Although the overhang from this program, and the need to raise additional capital, is real, the company’s capital needs are also clear to anyone who has followed the story.

Disclaimer: This report is neither a recommendation to purchase or sell any securities mentioned. The author and/or his/her employer may or may not have a position in any security discussed in this report. Further, the author and/or employer may buy or sell shares in any company mentioned, at any time, without notice. The information contained herein is believed to be correct as of the posting date. Readers should conduct their own verification of any information or analyses contained in this report. The author undertakes no obligation to update this report based on any future events or information.

Catalyst