Mario,
Axonyx (ticker AXYX) is a biotech company that has disappointed the market and is
now trading at a discount to its net cash. The company’s drug portfolio, including
3
main drugs targeted at Alzheimer’s Disease (AD), still possesses huge upside
potential, and yet the stock trades as if the drug portfolio is worth less than
zero. We
believe that over a holding period of 12-24 months, the downside risk if things go
poorly for the company, should be minimal from current price levels, while the
upside potential if things go well for the company, is 2x to 10x. The ratio of risk
relative to reward is the most attractive of any stock in our portfolio currently,
and
as such we’ve made it the largest stock position in our personal and managed
accounts.
First, we’ll focus on the downside risk in AXYX stock:
Material events will occur over the next 12 months with respect to each of AXYX’s
three main drugs, so for purposes of our downside analysis, we are only focused on
that period of time – the idea being that if these events over the next 12 months go
poorly, we want to know (1) how much cash will be left and (2) how much value, if
any, will remain in the drug portfolio?
There are 53.7mm shares outstanding. At a stock price of $1.35/share, MV is
$72mm, and net cash is $75mm (so the market has currently assigned a value of
negative
$3mm to the drug portfolio, which as we will explain later, is a “stupid”
valuation).
AXYX has no debt, but does have about $6mm of current liabilities, which is
roughly offset by the market value of an investment AXYX holds in a public company
called
Oxis, so we just round off and view the $75mm of cash as “net cash”. We believe the
company should burn no more than $20mm of cash over the next 12 months, so at that
time net cash would still be $55mm or a bit over $1.00/share. (This is a reduced
burn rate, relative to the most recent actual burn rate, reflecting reduced spending
on clinical trials over the next 12
months.)
So, let’s look at two different bad-case scenarios:
a) The absolute worst case scenario for AXYX over the next 12 months is that all
three of its main drugs are permanently killed (a truly extreme, and very unlikely,
case). At such point, the company should still have $1.00/share net cash, and
presumably the option value embedded in the remainder of its pre-clinical portfolio
should
be worth at least zero, so we believe such absolute worst case by mid-2006 yields a
$1.00/share price.
b) The next-most-bad scenario should be that (1) AXYX’s lead drug (Phenserine) may
become worthless (to be clear, this is NOT what we expect), but that (2) AXYX’s
other 2 main drugs (Posiphen and BNC) move through their Phase I trials and on to
Phase
II, at which point they would still possess considerable option value. Trying to
be rational but still quite conservative, we would argue that these other 2 drugs
should still be assigned some positive value – let’s say somewhere between $50mm and
$100mm ($.90 to $1.80/share), given the massive untapped market that each drug is
targeting.
Thus, to summarize the downside scenario, we believe that even if most everything
goes wrong over the next 12 months, AXYX stock should still be worth between $1.00
per share (just representing net cash) and $2.80 per share (net cash of $1.00/share
plus up to $1.80/share representing option value for the two remaining drugs). So
our downside argument boils down to this: If we can buy a stock for $1.35 which
should still trade for $1.00-$2.80 per share one year from now even if the company
disappoints during that period, then we are satisfied that our downside risk should
be
minimal.
Next we’ll take you through a brief summary of the AD drug market in general, how
AXYX’s three main drugs work, recent major developments for AXYX’s drugs, and
finally some reasoning as to our potential upside estimates for AXYX.
The AD drug market:
This market is extremely interesting, in that the number of AD patients is large
and growing quickly, but the existing drugs on the market only marginally improve
certain symptoms of the disease and do not stop or even slow the progression of AD.
Doctors prescribe the approved drugs for AD because they’re a lot better than
nothing,
but they’re far from satisfying.
There are two classes of approved AD drugs on the market – several AChE inhibitors
and one NMDA-receptor agonist. Both of these classes of drugs tweak brain
chemistry to get brain cells to function and communicate more effectively in the
wake of the
damage caused by AD, but neither class impacts the AD disease process itself.
Overall, while an AD patient is on these drugs, his cognition generally continues to
get worse, but just at a slower rate than it would if he wasn’t taking them!
The AChE inhibitors are the market leaders, and there are three of these on the
market today. The market leader is Aricept, doing about $1 billion in annual
sales,
Exelon does about $500 mm in sales, and Reminyl does about $250 mm in sales.
(Technically, AChE inhibitors help the brain maintain higher levels of the
neurotransmitter acetylcholine; they accomplish this by inhibiting the brain’s
production
of a chemical called acetylcholinesterase which chemical actually clears out
acetylcholine from the brain – that’s why they’re called “inhibitors”, as they
inhibit the
production of a chemical which otherwise clears out the “good” neurotransmitter.)
These existing AChE inhibitors have been approved based on clinical trial data
showing that the cognition of patients on the drug declined somewhat more slowly
than
that of AD patients who were taking a placebo. Some tests of AChE inhibitors show a
short term increase in cognition, before the cognition continues downward on the
typical decline seen in AD patients. When the patient stops taking these drugs,
cognition quickly falls to the level it would have been expected to be at if the
patient
would have never taken the drug. Thus, while these AChE drugs have all been
approved
on this basis and there is a lot of data to show they do affect cognition, the
effects are not dramatic – on average they delay the decline in cognition by about
six
months, relative to if the patient wasn’t taking the drug at all. And this is the
best that the major drug companies have created thus far to deal with a huge and
devastating problem.
How AXYX’s drugs work and why they are so interesting:
AXYX’s lead drug Phenserine is an AChE inhibitor (just like the existing drugs on
the market), but importantly also appears to have (through a separate mechanism,
having nothing to do with AChE inhibition) a groundbreaking disease-modifying effect
on
AD through its ability to modify beta-amyloid (Ab). Ab is a protein fragment that
accumulates in the brains of AD patients and results in the formation of so-called
beta-amyloid plaques. We all produce Ab, but AD patients either produce too much
of
it, or their ability to rid the brain of it is impaired, so they end up with too
much of it, which ultimately destroys normal brain cells. It is widely believed
that
excess Ab build-up is a major contributor to AD.
In addition, AXYX has created another drug called Posiphen which is an isomer of
Phenserine – it’s the same chemically but is structurally the mirror image of
Phenserine. In Posiphen they have eliminated the AChE effects of Phenserine,
leaving it
with only the anti-Ab effects. Note that all AChE inhibitors have side effects,
such
that there is a limit to the dosing levels, so it is possible that Phenserine, at
its maximum safe dosing levels, may reduce Ab sufficiently in certain patients but
not
sufficiently in others. Posiphen could be a more powerful reducer of Ab levels,
because it does not have any of the side effects of an AChE inhibitor and thus can
potentially be dosed at higher levels.
It would be a gigantic breakthrough to actually come to market with a drug that
could materially reduce Ab build-up, since today there is no way to stop or even
slow
the progression of AD otherwise. We don’t know that either Phenserine or Posiphen
will come to market and become the next major AD drug breakthrough, but we believe
they each have a reasonable shot at it, which creates major option value which is
not
even vaguely priced into the stock at today’s levels.
AXYX’s third major drug is BisNorCymcerine (BNC). Conceptually BNC works
similarly to the AChE inhibitor drug class, in that it is intended to increase the
levels of
certain neurotransmitters in the brain. (Technically, BNC helps the brain maintain
higher levels of the neurotransmitters butyrylcholine and acetylcholine; it
accomplishes this by inhibiting the brain’s production of a chemical called
butyrylcholinesterase which chemical actually clears out both butyrylcholine and
acetylcholine from
the brain – that’s why, once again, it’s called an “inhibitor”, as it inhibits the
production of a chemical which otherwise clears out the “good”
neurotransmitters.)
Butyrylcholinesterase is essentially a sister to acetylcholinesterase, and is
found in high concentrations in the brains of patients who have died from AD. Like
the
AChE inhibitors, a BChE inhibitor on its own wouldn’t be expected to slow or stop
disease progression, but would help manage the symptoms. There are some reasons to
believe that an effective BChE inhibitor could be more important than the AChE
inhibitors, since the concentration of butyrylcholinesterase is about 10 times
higher than
the concentration of acetylcholinesterase in advanced AD patients. Additionally,
BNC may possess the same Ab lowering effect as Phenserine and Posiphen, so BNC could
also be a dual acting drug.
Recent Phase III Clinical Trial on Phenserine:
AXYX’s lead drug (the furthest along in clinical trials) is Phenserine. AXYX’s
strategy with respect to Phenserine, has been to get it approved by the FDA and on
the
market first as only a standard AChE inhibitor, with effects on cognition at least
as good as other AChE inhibitors, and a side effect profile no worse than other AChE
inhibitors. If not for its potential effect on Ab, Phenserine would be the 4th
drug in its class on the market and would likely capture an unexciting market
share.
Phenserine has received a lot of press in the AD community, has been heavily
researched by AD scientists, and its proven ability to substantially reduce Ab in
the lab
and in animal models is well known. Thus, while Phenserine would likely not
initially bear a label for its affect on Ab (because it will require substantial
extra
time and money to run all the necessary clinical trials), the company believes that
Phenserine could capture a significant share of the AChE market because many doctors
who treat AD patients would be aware of the potential Ab effect (even though not yet
proven in humans) and would likely prescribe it rather than other AChE inhibitors on
the theory that Phenserine would be at least as effective as the other AChE’s on
symptoms, with the possibility that it could also actually have a disease-modifying
effect.
In March 2005, AXYX announced the results of its initial Phase III trial on
Phenserine, using the same endpoints as the other AChE drugs use (a series of
cognition
tests). In the trial, Phenserine failed to show a “statistically significant”
improvement in cognition versus placebo. The average cognition level of the
patients on
the drug was better than those on the placebo, but not enough better to be
statistically significant. (Interestingly, in past clinical trial results for the
other AChE
drugs, the improvement in cognition is quite small versus the placebo, so in reality
the difference between an improvement which is “statistically significant” and an
improvement which is not statistically significant, is also quite small – meaning
that a very small change in the outcome of the trial might have caused Phenserine to
show “statistically significant” improvement in cognition versus
placebo.)
These March 2005 trial results are what has created the present opportunity --
AXYX stock dropped from about $5, to around its current level of $1.35 upon this
announcement (also note that the stock had been over $7 in late 2004).
It is important to examine what happened in the Phase III trial, and what the
company is now doing with Phenserine. The company is convinced that the trial and
its
results were flawed, and that Phenserine itself is an effective drug. In summary,
the trial was confounded by a better than expected response in the placebo group.
In
these trials, you are comparing the rate of decline in cognition of patients on the
drug versus a group of patients who are not on the drug. AD patients are supposed
to be getting worse over time, yet in this trial, the placebo patients who didn’t
get
any drug actually improved initially, and at the end of the 6 month trial were
about flat compared to the starting level. This unusual behavior of the placebo
group
made it a lot harder for Phenserine to show improvement relative to placebo. The
results may have been unfavorably influenced by the following: (1) AD patients on
the
placebo may have received more attention and better care as part of a clinical
trial, than they would otherwise, and for that reason alone they may actually have
suffered less cognitive decline than expected, (2) there was a large amount of
variability
in placebo response, which made it tougher for the drug group to be statistically
better, and (3) this was a multi-center trial, being held in various sites in
Europe, and different centers had very different placebo responses. (A lot of data
on
this trial was presented in March and is available on the company’s website).
Note that this issue of getting a “placebo-like response” in trials for AD drugs
is not unique, and in fact other existing approved AChE inhibitors have had failed
clinical trials due to this issue, before ultimately getting approved. In fact,
more
so than in any other medical specialties, it is not uncommon for a neurological drug
to have a failed trial before later overcoming such setback and getting
approved.
Ongoing Phase IIb Clinical Trial on Phenserine:
In addition to the now-completed Phase III trial, AXYX has been conducting a
separate Phase IIb trial on Phenserine, primarily to measure changes in Ab, and in
March
2005 AXYX announced preliminary interim results covering a sample (about 25%) of the
patients enrolled in this ongoing Phase IIb trial.
Based on this small sample (the first 37 patients out of a total of 150 enrolled),
the patients experienced a substantial decrease in Ab, but the company cautioned
that the results were not statistically significant, given the small sample size and
the variability in starting and ending levels. However, coming on the heels of the
Phase III “lack of statistically significant” results, we believe the market
misinterpreted the meaning of this Phase IIb information. The company actually
believes
that this was encouraging information, as such a small sample size was not ever
expected to yield statistically significant results, but the market focused on the
words
and the dry tone of the press release (written by cautious lawyers in light of
recent,
and typical, shareholder lawsuits), so we think this led many investors to believe
this trial was failing also, while in reality the interim results are a positive
snapshot showing that the early data is leading towards something
important.
(To be clear, note that if a drug can reduce Ab, which in turn may slow or stop
progression of the disease, that this in itself wouldn’t actually improve cognition,
but presumably would prevent cognition from getting worse. AXYX is only hoping that
the 6-month Phase IIb trial will show a material change in Ab. Longer term trials
will be needed to determine how reductions in Ab correlate to stabilization in
cognition.)
The full data set on this Phase IIb trial is expected to be available in late Q1
or early Q2 of 2006. If the trend from the first 37 patients extends to the full
data set, the results would likely be statistically significant, which would be very
exciting since it would validate the huge option potential of Phenserine. By
implication, it would also be very encouraging for the super-charged Posiphen, since
Posiphen should have an even larger impact on Ab.
Current Company Strategy:
Given the failure of the Phase III trial, AXYX disclosed its updated strategy for
Phenserine in April 2005. The new plan for Phenserine is to develop an extended
release or slow release version of Phenserine, which will allow AXYX to deliver a
higher dose of Phenserine. As noted earlier, all the AChE drugs have certain side
effects (nausea being most common) which are linked to the peak amount of the drug
in
the bloodstream just after administration, yet the efficacy of the drug is linked to
the total amount and duration of drug exposure. The idea is that by developing an
extended or slow release version of the drug, the peak is smoothed out, so a larger
dose can be administered which should increase the total amount and duration of drug
exposure. The company believes that when a new Phase III trial is conducted, using
this higher dose, the results should be very clear that Phenserine works as well as,
or better than, existing AChE inhibitors. The reformulation process and some Phase
I safety trials on the reformulated version, should be complete by early 2006.
At around the time the Phase I trials for the reformulated version of Phenserine
conclude, the full Phase IIb trial results for the existing (non-extended release)
version of Phenserine should be available. Thus AXYX’s hope and belief is that less
than 12 months from now, they will have accumulated sufficient data from these
studies to show that (1) the existing (and thus relatively low dose) version of
Phenserine
has the ability to reduce Ab in humans, which would be a huge and distinctive
development, and (2) they have created an extended release and thus higher dose
version
of Phenserine which should enable it in a future Phase III trial to have a
statistically significant impact on cognition and be approvable as an AChE
inhibitor. At such
point, Phenserine should be recognized as a quite valuable property by major
pharmaceutical firms, since (1) AChE inhibitors are already an established drug
class with
an existing market, and (2) the Ab lowering effect would be truly novel and would
differentiate Phenserine from the existing AChE’s and could ultimately allow
Phenserine to be marketed as a disease modifying agent.
AXYX does not have a sales force (in fact, it has an incredibly small
infrastructure), and AXYX believes its competitive advantage lies in developing
early stage
neurological molecules and taking them through Phase II. AXYX expects that by the
first half of 2006 it will have the data to be able to put together an attractive
out-licensing deal with a major pharmaceutical firm who would likely pay AXYX
upfront
payments, milestone payments, royalties, and fund the next Phase III trials on the
reformulated version of Phenserine.
As well as developing Phenserine, AXYX will continue to develop Posiphen and BNC.
Posiphen and BNC should enter Phase I trials, in late 2005 and early 2006
respectively. Assuming the Phase I trials go well, both should be in Phase II
testing in
2006. Despite these being early stage drugs, they could draw a lot of attention
in
the near term in that if the Phase IIb trial successfully shows that Phenserine can
lower Ab, then AXYX will essentially have three drugs (Phenserine, Posiphen, and
BNC) in a new drug class which addresses what is generally considered the key issue
in
stopping or slowing Alzheimer’s. That would be a huge development. (Conversely,
if the Phase IIb trial fails to show that the old immediate release formulation of
Phenserine reduces Ab meaningfully, it’s still quite possible that the reformulated
higher dose version of Phenserine, and/or Posiphen, and/or BNC, will meaningfully
reduce Ab.)
In Closing:
Effectively the stock market has completely written off AXYX due to the failure of
a Phase III trial of its lead drug, yet the market has misunderstood that this drug
is far from dead and still has huge potential value. Additionally, while AXYX’s
two other main drugs are early stage, each could be important Alzheimer’s drugs over
the coming years, and as such we believe they should be attributed some material
positive value as well.
Management knows its stock is substantially undervalued, but like all small
biotech companies, they feel the need to conserve cash rather than use it to buy
back
stock. On a related note, we are encouraged that Steve Ratoff, who was formerly the
Chairman and interim CEO of Cima Labs (which was sold in 2004 to Cephalon under his
leadership), opted to join the AXYX board in May 2005, and about two weeks after
joining Mr. Ratoff purchased 250,000 shares in the open market at around current
prices.
Interestingly, only a few weeks later, he was appointed Chairman of the Board. Mr.
Ratoff is an experienced pharmaceutical company executive – in addition to his Cima
role and other senior level positions (such as CFO of Brown-Forman), he was CFO of
the Pharmaceutical Group of Bristol Myers Squibb. We believe he is getting involved
only because he sees a lot of potential here (he’s not looking for a “job”), and he
has indicated that his objective is to maximize shareholder value. Assuming that
the company succeeds with its drug development as outlined above, we believe he will
guide the company to a lucrative out-licensing arrangement or outright sale.
Assuming instead that the company fails in its drug development, we believe he won’t
allow the company’s cash to waste away, and will instead preserve as much value as
possible. Thus, Mr. Ratoff’s presence helps validate our low risk/high reward
thesis.
Neither we nor anyone else knows at this point how AXYX’s drugs will ultimately
work out. And 12 to 24 months from now, we still won’t know how they will
ultimately
work out. What we are betting on, however, is that looking at a range of possible
outcomes, AXYX stock is simply grossly mispriced. If events develop well for AXYX
over the next 12 to 24 months, the stock price should rise a lot to reflect this
fabulous potential, and if events develop poorly, we think the stock should fall
little
(or perhaps even rise a little). This means AXYX, at $1.35/share (and probably at
meaningfully higher levels as well), represents outstanding risk/reward. We aren’t
making a long term illiquid venture capital-type bet that AXYX’s drugs will
ultimately change the world for AD treatment, but instead we’re making a bet on a
liquid
stock whose price could rise dramatically in a short time period.
Given that the market has assigned a negative EV to the drug portfolio currently,
consider that merely on improved sentiment, if the market assigned an EV of even a
conservative $125mm to this high potential drug portfolio (which is still on the low
side relative to the valuations of many biotech companies with early stage drugs),
the stock would trade at $3.75, nearly a triple from here but still well short of
where AXYX was recently trading. And if Phenserine proves to have a real impact on
Ab, speculation could abound that this could be a multi-billion dollar drug, and
even
if licensed out, AXYX could have a multi-billion dollar market cap in the future, so
discounting that to the present, plus adding in some value for their other drugs,
analysts might easily assign a market value in the $500mm to $1 billion range (the
$15/share area, give or take).
But putting all that aside, we also wish to point out that we will likely be out
of the stock well before it hits it highs. We’re very conservative and have a
healthy sense of what we don’t know. No matter how much good news comes out about a
potential blockbuster drug, there’s always the risk (before or after it is
approved),
that something goes wrong. So, we’ll always be adjusting our estimates of downside
and upside potential, and at some point we’ll probably sell into optimism. But
around
current levels (and probably at meaningfully higher levels as well), we think we’ve
got a compelling risk/reward ratio, and that’s why it’s our favorite stock at
present.
Disclaimer: We and our affiliates are long AXYX, and may increase or decrease our
position at any time. We have no obligation to inform anybody of any changes in our
views of AXYX.
Catalyst:
Trading at less than current net cash, yet still has big optionality in drug
portfolio. Risk-reward compelling at these prices.
Clinical trial data from Phenserine Phase IIb trial, data on reformulation process
for Phenserine, progress on development of Posiphen and BNC, etc. should highlight
much more value in the drug portfolio than currently being ascribed by the
market. |
