Index Pharmaceuticals - new critical analysis

2018-04-29 16:34, Edited at: 2018-04-30 08:49

I analyse the risk adjusted value of Index Pharmaceuticals, including issues of non-medicine treatments, 2018 statistics of drug development success, market potential. The value of the share is estimated to be 13 SEK/share (now 6.1 in end-april 2018) and there will be study results in end-2018. Investing in the share can be seen as a form of gambling with favorable odds.

It is now one year since I wrote my last post on Index Pharmaceuticals (https://www.redeye.se/arena/posts/index-pharmaceuticals-index-pharmaceuticals-genomgang-av-sannolikhet-framgang). Here is an update with my views on the stock (this time in English). The stock is cheap, and I think that the market identifies some risks which is not covered by exising analysis, but the risks are exaggerated, which becomes apparent when they are quantified. 

Method: I use SvD Börsplus (Benson & Jendi, 2016) analysis of Index pharma as baseline. This is a risk-adjusted net present (rNPV) value approach, based on SvD Börsplus’s analysis. I have looked at their in-parameters, in particular the likelihood of approval, and adjusted it. SvD Börsplus assumes 25% chance of succeeding (LOA), and 1.4 BSEK in fair market cap. I contended last review that a better approval rate was 15%, which results in a fair value of 840,000,000 MSEK (13 SEK share price). 

New statistics of biotech success rates has been presented by MIT (Wong, Sia & Lo, 2018). They highlight that studies containing biomarkers have better LOA. They also single out inflammatory diseases in the statistics. CONDUCT’s primary endoints are partly biomarker-based. If we take the mean LOA we get 31% hit rate for phase II. The MIT statistics do not distinguish between NME (new molecule) (26% in Cobitolimod’s case) so we cannot formally compute the risk. An average between MIT & Bio gives cirka 14% LOA. 

On the flip side, we are now one year closer to the CONDUCT results. All rNPV values count with that there is a cost of having capital invested (so-called WACC). That cost decreases with 14% (14% is a standard value), somewhat sloppily calculated. 

I have kept SvD Börsplus’s assumption on 20% market share. It was very interesting to note prof. Atreya at the Capital Market Day 2018, saying that it is possible that the UC treatments may develop along the same lines as cancer treatments, going away from monotheraphy to the use of multiple drugs in order to reach better treatement. So while the market for cobitolimod certainly might be only 5-10%, it can just as well be 40% if it becomes part of a ‘cocktail therapy’, if it gets very strong results in the CONDUCT study, or if there will be successors with oral administration that also could target pancolitis. 20% seems therefore like a moderate guess. 

Competition is relatively tough in the area, both from substances earlier or later in pipeline, as well as substituting regimens, in particular fecal transplantation (FT). Fecal biotransplantation can be considered a regimen which is as unlikely to be successful as any drug - with the exception that they are biologics. Still, safety is an issue (Shi et al, 2016). Fecal transplantation is now in phase 2 and will be finished after the CONDUCT study (https://clinicaltrials.gov/ct2/show/NCT03273465). Their chances of succeeding is 15% according to BIO funelling statistics. What speaks against it is how to get financing for phase III. Therefore, I will rate it as 10% likelihood. There is 10% risk that a successful cobitolimod will be facing FT. And let say that there is a 50% chance that it reduces the market of UC. I have estimated the cobitolimod LOA to 15% previosuly. FT reduces it like this: 0.14*(1-(0.1/2))) = 13.25%, almost 1%. 

The question of diet (e.g. glutenfree diet) as a treatment of ulcerative colitis was rejected on multiple grounds in the capital market day (reasons: 1) Data are often mixing Crohn’s and UC here, and it seems more promising with Crohn’s. 2) Diet might help people with mild UC, but that is not the cobitolimod target anyway, 3) Reinisch had tried gluten-free diets on some of his patients and saw no difference. 4) Patients will do it anyway on top of medication). 

Furthermore, I have seen on Facebook that some investors are concerned with the relationship between Cortison and cobitolimod. This has been studied empirically by Index Pharmaceuticals and is today known to be a non-issue (source: correspondence with CEO. 

All in all, with these critical risk identifications but decreased WACC, we land at the following rNPV: (0.1325/0.25)(1,400,000,0001.14) = 845880000 MSEK market cap (13.5 SEK/share). 

I have not adjusted the valuation regarding the coming Phase III. If we look at other phase III firms on the Nordic exchanges, few of them have partnered after phase II (despite having the same stetegy as Index Pharmaceutials). At the same time, all firms has as their strategy to partner up after phase II. It can very well happen that Index Pharma decides to do Phase III on their own, and raise capital publicly. They may not do so out of necessity, but because the deals the can get after phase II comes at a higher discount than the risk of continuing alone. I am not an expert, but in that case I think that Index Pharmaceuticals will be able to proceed. They have strong owners, and there is good tailwind in that firms actually succeed in phase III (examples: Wilson is getting bought out at an attractive price, PledPharma has signed a partnership after Phase II but prior to the startup of Phase III). So while the stock may take a heavy hit short term (like Pledpharma), it will recover from that. I do not see any reason to adjust the rNPV because of capitalization issues. I would be more worried as a shareholder in other firms in phase II, but it requires some patience. Therefore it does not result in any risk adjustment. 

Note: This is a very critical estimate. There is also a number of positive factors and it would be easy to write a bull case scenario, which lands in 20-30 SEK/share: 

• There are many reasons to believe that Phase II is much more likely to succeed than the average phase II study (has been discussed elsewhere in Redeye analyses). 

• Index Pharmaceuticals has managed to publish on the mechanism of action, which makes it easier to negotiate deals and the FDA/EMA also like this, and easier to affect the practitioners. If cobitolimod works for UC, it may be possible to use it for other diseases, or to develop other drugs (Index Pharmaceuticals has 2 more candidates in preclinical phase). 

However, my objective has been to present the cautious case - which is still very attractive. The stock is now at 6.1 SEK/share. I strongly expect further rise in the share before study results. Sooner or later in 2018, a lot of small investors will realise that they can buy shares for 6, 7, 8 SEK and statistically get 50% returns. Biotech stocks can be used as a form of gambling. If you bet at stocks of this type and have the odds right, you will get good returns.

Disclaimer: I have a long position in the stock, accumulated during the last year. Read my arguments and judge whether they make sense on their own. I do my level best to address weaknesses, and am curious to hear from you if you see further risks. 

References

Benson, P., Jendi, J. (2016). Trist att följa index, kul att följa Index Pharmaceuticals. https://www.svd.se/trist-att-folja-index-kul-att-folja-index-pharmaceuticals (behind paywall)

Shi, Y., Dong, Y., Huang, W., Zhu, D., Mao, H., & Su, P. (2016). Fecal Microbiota Transplantation for Ulcerative Colitis: A Systematic Review and Meta-Analysis. PLoS ONE, 11(6), e0157259. http://doi.org/10.1371/journal.pone.0157259

Wong, C. H., Siah, K. W., & Lo, A. W. (2018). Estimation of clinical trial success rates and related parameters. Biostatistics.