Disclosure: I am short ALNY.

Business relationship disclosure: My research firm provides research services to clients and manages funds for compensation, and I therefore benefit to the extent shares in ALNY decline.

Since we wrote our first article on Alnylam (ALNY), the stock has risen 30%, making what was previously merely an overvalued stock now reach nosebleed levels. The main event that has transpired since that time was a secondary offering by JP Morgan and the company’s presentation at the JP Morgan Healthcare conference from January 7 to 11. Neither event seemed material to us, and the recent rise in the stock price seems unwarranted from a fundamental perspective.

Secondary Equity Raise

On January 16, the company raised $174 million in a secondary offering. Given that the company had $228m of cash as of September 30, it does not appear that the company needed the additional capital for any near-term reasons. According to its prospectus, the use of proceeds were the company’s ALN-TTR02, ALN-TTRsc, ALN-AT3, and ALN-AS1 programs, which are the same programs that ALNY had been budgeting for prior to the capital raise.

Rather, we believe that Alnylam was simply taking advantage of an unusually strong biotech market to raise capital before the market re-rated the company’s valuation to a more reasonable level.

We have reviewed recent equity research reports published over the past month, and have not seen any additional data or commentary that warrants the sharp rise in the share price this month. The company’s lead underwriter for the secondary offering is JP Morgan, and they issued short research reports on January 6 and January 9, mainly a preview and post-presentation commentary for the company’s investor presentation at the JP Morgan Healthcare conference two weeks ago. We saw little in the research updates that indicated any particular progress in the company’s pipeline. As previously discussed, ALNY currently has no drugs in Phase III trial, and has a far weaker pipeline than Isis Pharmaceuticals (ISIS), the other pure-play RNAi player, and yet trades at a comparable valuation. ALNY has a market capitalization of $1.3bn, compared to $1.4bn for ISIS.

We continue to believe that ALNY and ISIS will see their valuations diverge as investors begin to better differentiate between the drug portfolios of the two companies.

JP Morgan Healthcare Conference

Alnylam presented at the JP Morgan healthcare conference earlier this month and a transcript is available here. In reviewing the transcript, we find little to suggest that Alnylam has a pipeline worth $1.3bn. Most of its drugs remain predominantly in Phase I trials, and we’ve noted key problems with the trial data provided thus far for its ALN-TTR02 candidate. According to the transcript, the company doesn’t project a start date for a Phase III clinical study of the drug in FAP patients until the end of 2013 at the earliest, and that’s contingent on promising results in the current Phase II clinical study. Those Phase II results are due in the middle of this year.

Furthermore, Alnylam’s ALN-TTR02 candidate is only one of three clinical programs for the rare genetic disorder caused by a dysfunction of the transthyretin (TTR) protein, called Familial transthyretin amyloidosis (FAP) / TTR-mediated amyloidosis (ATTR), as discussed by Chimera Research. And Alynylam’s candidate is the furthest behind. Pfizer’s (PFE) Vyndaqel therapy is currently approved in Europe, and is undergoing a more in-depth Phase III trial to respond to an FDA complete response letter. In second place is Isis Pharmaceuticals’ ISIS-TRRx, which is partnered with GlaxoSmithKline (GSK). Isis and Glaxo have announced a Phase II/III study that was set to begin enrollment by the end of last year.

Alnylam, in contrast, does not have a partner, and its trial is only studying the drug once every four weeks for two cycles (2 doses), thus limiting the amount of data that will be available to determine the safety and efficacy of the drug.

Finally, FAP’s market size is limited — the dysfunction affects only roughly 5,000 to 10,000 patients worldwide. Given that the earliest ALNY’s drug could come to market is likely 2017 onwards, and that it trails both Pfizer and Isis in progress thus far, we find the company’s current market capitalization as wildly over-optimistic about ALN-TTR02′s prospects.

Alnylam’s other Phase II trial, in ALN-RSV01, reported disappointing results last year and has been placed on the backburner. The RSV program was barely mentioned in the JP Morgan conference presentation. The rest of Alnylam’s drug candidates are in Phase I.

Yet the company trades at a $1.3 billion market capitalization. We don’t think this makes sense. We recognize that biotech stocks routinely garner several hundred millions of dollars of market capitalization despite drug candidates being in only Phase I or Phase II trials and having long shot odds of ever receiving FDA approval. Yet for a company with this sort of uninspiring drug portfolio to garner a $1.3 billion market cap is highly unusual.

Alnylam seems to be caught up with the broad-based biotech and market rally this month. The S&P Biotech index (XBI US EQUITY on Bloomberg) is up 9% in January, and it makes sense that Alnylam’s 30% rally since the start of the year is several multiples of that given its smallcap and speculative nature. That said, the stock’s rise does not seem to be supported by the fundamentals. As well, the stock has witnessed no insider buying in almost a year, with the last insider purchase occurring in February of last year. In fact, insiders have been selling since that time, disposing of more than 1.6 million shares in the open market. In particular, the global pharmaceutical company Novartis (NVS), which acquired 13% of ALNY several years ago as part of a collaboration agreement, dumped 1.55m shares at $19.42 in September. If the smart money is selling, we question who is buying at prices 30% higher.

Disclosure: I am long ASTX.

Business relationship disclosure: My research firm provides research services to clients and manages funds for compensation, and I therefore benefit to the extent shares in ASTX rise.

We believe that Astex Pharmaceuticals’ (ASTX) shares represent an excellent buying opportunity. Despite positive recent developments at Astex, the company has seemingly gotten lost in the shuffle, with shares slumping sharply – more than 35 percent – during the fall biotech correction. Since then, Astex has rebounded nicely. However, given that the company has reported significant positive developments in the interim, we would not be surprised to see the share price catch up with the excellent news flow, taking Astex to a new 52-week high above $3.50/share.

And, unlike almost all other small biotech firms, there is limited downside should Astex’s upcoming catalysts not play out. The company is profitable, cash flow positive, and has a tremendous amount of cash on the balance sheet, $130 million, that ensures the company can maintain its R&D budget for years to come.

Given that Astex’s market cap is less than $300 million, investors can purchase a company with an excellent existing property – Dacogen, and a strong developmental pipeline including four Phase II and one Phase I drug, all entirely owned by Astex, along with various discovery and development agreements with a variety of large pharmaceutical companies for an enterprise value of only $155M. On paper, Astex looks like an obvious bargain. But we needed to dig deeper through the bear case to see if there was something we were missing before we got too comfortable with Astex.

Dacogen’s Patent Cliff: Not So Steep

Just as the United States’ fiscal cliff served as a distraction that needlessly galvanized investor panic over what ended up being a minor event, Astex’s so-called patent cliff has been a focal point that has driven unfounded investor concern. At the moment, Astex’s primary driver of value creation is Dacogen, a drug that treats a variety of blood-related cancers generally termed Myelodysplastic Syndromes (MDS). In 2006, the FDA gave Dacogen approval for treatment of all types of MDS. Partnered with Eisai (ESALF.PK) (for the North American market) and Johnson & Johnson (JNJ) subsidiary Janssen Pharmaceutica (all other markets), the drug has been a commercial success. It is currently approved in more than 30 countries, and Astex enjoys a generous 20% royalty rate on worldwide sales. Dacogen generated royalty revenue of $60 million in 2011, and appears to be set to rise to nearly $70 million for full-year 2012.

Astex’s primary source of revenue, Dacogen, currently has Orphan Drug exclusivity. Unfortunately for Astex, this is set to expire in May 2013, though it may be extended to November 2013. After this, Dacogen will be vulnerable to competition from potential generic entrants. A lot of investors have looked at this and have written off Dacogen almost entirely. Once exclusivity expires, it seems, a lot of people anticipate that Dacogen revenues will almost immediately slump to zero. This is the only reasonable way to arrive at such a low present business valuation for Astex, given the company’s strong balance sheet and pipeline. As long as the company can remain profitable and cash-flow positive with Dacogen while financing a robust series of clinical trials, it should only be a matter of time until some of the pipeline candidates begin to bear fruit.

Our take is that Dacogen will not experience a sudden plunge in sales at the end of 2013, but rather a much more measured decline; the market’s fears are substantially overblown. Taking a look at the MDS market, we find that there are two significant players, Dacogen, and Celgene’s (CELG) Vidaza. Vidaza has roughly 60% market share, while Dacogen takes the other 40%. This balance has held steadily for a number of years. Therefore, Vidaza is a good point of comparison from which we can extrapolate future Dacogen sales trends.

Notably, Vidaza went off patent back in May 2011. Despite being off patent for a year and a half, there is still no generic version of Vidaza on the market, nor has any generic been approved to come to market. Since patent expiry, Vidaza sales have, contrary to expectations, continued to surge, rising 32% in 2011, and Vidaza sales have continued to grow at a double digit clip into 2012. Given that Vidaza is a very successful drug that produced more than $700 million in FY ’11 revenue for Celgene, and that it controls the larger share of the MDS market, it would seem like Vidaza would be a great candidate for a generic drug maker to target. And yet, 18 months later, there is still no generic alternative for Vidaza. We think it is far too pessimistic to assume that Dacogen will immediately face generic competition once it loses exclusivity since Vidaza has avoided genericization for so long – particularly since Vidaza has greater market share than Dacogen. Rather than seeing Dacogen sales go off a cliff in November 2013, we anticipate that a much longer tail, perhaps reaching well into 2015, will develop for Dacogen’s sales.

Furthermore, in a development thus far largely ignored by the market, Dacogen received a major boost in the intellectual property department recently. In September, Astex announced that its partner, Janssen-Cilag, had received approval from the EU to market Dacogen for acute myeloid leukemia (AML). Dacogen has been used off-label for this indication previously, and now it has become the first drug to be approved and labeled specifically for AML. Astex earned a $5 million milestone from the approval, and will now have a 10-year window of exclusivity for Dacogen for treating AML in Europe. We’d also point out that one additional competitor in the AML field, Campath, was recently pulled from the market. Though Campath was not labeled for AML, it did have some off-label usage for that indication which may now migrate to Dacogen.

While Astex was reticent to give too specific an estimation of how quickly sales will ramp up for Dacogen in Europe during a recent conference call, all signs point to it making a meaningful impact. Management did guide next year’s Dacogen royalty revenues to $60 million, a small decline from this year’s near $70 million run rate. We’d note, however, that management has a history of guiding low and then raising guidance gradually through the year. Given the new revenue stream coming online in Europe, and the continued success of Vidaza more than a year since it has gone off patent, we anticipate Dacogen sales will surprise expectations to the upside. And in the worst case scenario, where the bears are right and Dacogen sales plummet in the United States next year, the new approval in Europe should ensure that Dacogen continues to generate a meaningful revenue stream to Astex for years to come.

Looking Beyond Dacogen

While Dacogen sales are likely to remain firm longer than anticipated, Astex’s pipeline also offers great promise. The present-day Astex was formed in July 2011, when a company named Supergen bought out Astex, a privately-held UK firm. Supergen had its Dacogen franchise, but little else in the pipeline, and as such was cash rich and drug prospect poor. To fix that imbalance, they acquired Astex, which had a wide range of development programs, and the combined company has been able to accelerate its research efforts.

In our view, the most exciting of the development programs is SGI-110. SGI-110 is a follow-on drug to Dacogen. The highlight thus far of the SGI-110 program has been the change in delivery method, from IV to subcutaneously. This change has led the drug to be longer acting. SGI-110 has shown up to 400% longer half-life than Dacogen. Interim results, announced in April, of Astex’s Phase I/II trial showed multiple AML patients with complete responses.

The full results of that trial were presented December 10th at the American Society of Hematology (ASH) annual meeting. The results were excellent for shareholders, and Astex shares have risen steadily since December 10th. With many people concerned about patent expiry for Dacogen, investors seem to be missing the fact that with SGI-110, Astex has already developed its Dacogen follow-on that will likely be able to fully replace Dacogen and even gain market share. We were particularly pleased to find that SGI-110 showed efficacy for AML in patients who had already been treated with other hypomethylating agents on the market (such as Dacogen and Vidaza). Currently many AML patients are treated with off-label Dacogen and Vidaza prescriptions, but if SGI-110 can become the first drug to be approved and labeled for AML in North America, it should be able to take significant market share from Vidaza, and prevent the treatment of AML from becoming generacized when a Vidaza or Dacogen generic finally reaches the market.

Since SGI-110′s trial results demonstrated encouraging efficacy, we would not be surprised to see news of a partnership for the drug. In the longer run, if SGI-110 can merely continue taking the 40% market share that Dacogen gets currently, Astex would have another highly successful drug on its hands. A study published December 24th adds even more potential for the Dacogen franchise. The study found that treating a relapsed stage 4 patient with neuroblastoma with Decitabine (Dacogen) was followed by complete remission. Quoting from the study abstract, we find that “This is the first report combining demethylating chemotherapy to enhance tumor antigen expression followed by a cancer antigen vaccine.”

What this means in practical terms is that Dacogen/SGI-110 has now, for the first time, demonstrated potential to be used in combination with antigen vaccines to treat bone marrow cancer, breast cancer, and so on. This would, clearly, open a huge new market for Astex and potentially rerate shares to a far higher valuation than if Dacogen/SGI-110 is used only in direct treatment of MDS and AML.

And in addition to SGI-110, Astex’s 2013 will offer investors plenty of opportunities; there are numerous other programs to look forward to. For example, AT13387, which is an oral HSP90 inhibitor used to fight gastrointestinal tumors. In 2009, Astex received a 5 year grant from the prestigious US National Cancer Institute to develop AT13387. While there is not enough data to make a judgment on how AT13387 will perform in the clinic, we are optimistic given the NCI’s involvement.

As you can see from the above graphic, Astex has a lot going on. There is far more to the story than just Dacogen, with the company having four wholly owned Phase II oncology drugs. In addition, the company has a whole roster of partnered programs, with a wide variety of quality collaborators, including Novartis (NVS), AstraZeneca (AZN), and Glaxo SmithKline (GSK).

SGI-110 To Offer Great Upside, While Cash Shelters Astex From Negative Surprises

We are confident that Astex will perform strongly, because unlike most baby biotech companies, Astex has lots of cash, no debt, does not frequently dilute its shareholders, and is profitable and cash flow positive. Astex has $1.39/share in cash that should serve to insulate the company’s shares from too much downside during market turbulence. And the company has many opportunities to generate shareholder value in coming months.

The SGI-110 data gives every sign of showing that Astex has a blockbuster follow-on drug to Dacogen in the making. A successful Dacogen replacement would likely be worth more than Astex’s entire current market cap. And even if that were to not pan out, the company has a variety of Phase II programs in oncology and other fields; it is hard to predict which of these will bear fruit, but with so many balls in the air, there is a good chance that one or several of the ongoing studies will yield positive results. Finally, the market has badly misread the sales curve Dacogen will follow over the coming couple of years. As the market prices in a much slower decline in sales than analysts anticipate, we expect Astex to be revalued sharply higher. With Astex, there are many ways an investor could win, and even if they all fail to work out, downside is limited thanks to the solid balance sheet.

Disclosure: I am short ALNY.

Business relationship disclosure: My research firm provides research services to clients and manages funds for compensation, and I therefore benefit to the extent shares in ALNY decline.

In our previous articles, available here and here, we discuss why we believe Alnylam Pharmaceuticals, Inc. (ALNY) is overvalued. The company’s pipeline is too thin to justify the current stock’s high valuation, and analysts’ optimism is greatly misplaced with respect to the company’s drug ALN-TTR02.

In this article, we provide a comparison between ALNY and Isis Pharmaceuticals, Inc. (ISIS), another leader in the RNA interference biotech sector. ALNY and ISIS are both players in the RNAi space, and although we think that both stocks exhibit a high degree of risk, we don’t think it makes sense that they trade at comparable valuations. We believe that ISIS has a stronger pipeline, a higher quality patent portfolio, and superior partnership relationships with big pharma. Yet ISIS trades at $1bn market capitalization / $900m enterprise value, while ALNY trades at a similar $970m market capitalization / $750m enterprise value.

We don’t think that makes sense. On numerous fronts, ISIS appears to us as the far more attractive option, and we believe that the difference in valuation should be more significant between the two. In this article, we will summarize several of our reasons.

Phase III Trial Candidates

As discussed in our previous article, ALNY has no drugs currently in Phase III trial (see 10K and most recent 10Q). After ALN-RSV01 provided disappointing results in its Phase IIb trial in May, ALNY was left with ALN-TTR02 as its most promising drug candidate. As we’ve discussed, we believe that the Phase I trial that triggered the stock’s dramatic rise in July targeted an insufficiently meaningful endpoint, TTR serum knockdown, rather than endpoints that represent meaningful improvement for patient quality of life, such as the Neurologic Impairment Score-Lower Limb (NISLL) score or change from baseline in the total Quality of Life score (Norfolk QOL-DN). Similarly, the company’s Phase II trial design indicates that the company will not attempt to correlate TTR serum knockdown with clinical results. The Phase II trials are too small to generate statistically significant results with respect to ALN-TTR02′s clinical response.

ISIS, on the other hand, completed Phase III trials for Kynamro and submitted the drug for approval to the FDA (see 10K and most recent 10Q). Kynamro is designed for patients with severe forms of familial hypercholesterolemia, or FH, at high cardiovascular risk, who cannot reduce their low-density lipoprotein cholesterol, or LDL-C, sufficiently with currently available lipid-lowering therapies. ISIS has partnered with Genzyme, who licensed the drug in 2008 and paid a $175 million licensing fee, made a $150 million equity investment in ISIS, and has paid ISIS several milestone payments. Granted, the drug’s future looks questionable, given that it was rejected by European regulators earlier this month and received a mixed 9-6 vote from the FDA advisory committee in October.

Nevertheless, at least ISIS has a drug that has completed a Phase III trial and been submitted to the FDA. In its entire history, Alnylam has yet to undertake a Phase III trial. The closest was ALN-RSV01, for the treatment of respiratory syncytial virus, or RSV, infection. But after its Phase IIB study missed the primary endpoint of reduced BOS in an “intent-to-treat” (ITTc) analysis of confirmed RSV infected patients, the drug is no longer a focal point for the firm. Today, ALNY’s most promising drug is ALN-TTR02, which only launched its Phase II trial in June. As previously discussed, we didn’t find the ALN-TTR02 Phase I data to be very significant and are uninspired by its Phase II trial design.

Additionally, ISIS has multiple other discoveries that have progressed further than ALNY’s. OGX-011, which ISIS and OncoGenex (OGXI) jointly discovered and which is now licensed to Teva Pharmaceutical Industries Ltd. (TEVA), is currently undergoing two Phase III trials, with another one on the way.

We should also mention that ISIS’s drug Vitravene was approved in 1998, though it is no longer commercially viable. And alicaforsen is an antisense drug that ISIS licensed to Atlantic Pharmaceuticals that targets intercellular adhesion molecule 1, or ICAM-1, which is over-expressed in inflammatory disorders including ulcerative colitis and pouchitis. The FDA and European Medicines Agency, or EMA, have since granted alicaforsen Orphan Drug Designation for the treatment of pouchitis in the United States and Europe, respectively. While there are limited revenue opportunities from these drugs for Isis, they are worth mentioning when comparing Isis’s ability to design drugs that can ultimately be commercially viable, as compared to Alnylam.

Pipeline Comparison

Beyond simply Phase III candidates, we can more broadly compare the two companies’ pipelines. ISIS’s pipeline is available here. Alnylam’s pipeline is available here. The contrast is stark.

ISIS lists 26 drugs in its pipeline. ALNY lists only 10 (see page 7 of the 10K for additional disclosure on the individual drugs, as opposed to a summary of the program). Below is a table that compares the trial stages of ISIS’s drugs as compared to ALNY’s.

While both ALNY and ISIS have 5 drugs at the pre-clinical stage, Isis has 2 approved drugs, 2 drugs in Phase III and 11 drugs in Phase II. In contrast, Alnylam only has 2 drugs in Phase II. One of those is ALN-RSV01, whose disappointing results earlier this year has rendered it to the backburner, and the other is ALN-TTR02, which features, as we’ve discussed, a Phase I trial that targeted a less-than-meaningful endpoint and a Phase II trial construction that fails to inspire us.

Furthermore, as Chimera Research Group wrote earlier this week, Alnylam’s solution for Familial amyloid polyneuropathy (FAP), or TTR-mediated amyloidosis (ATTR), has fallen behind both Pfizer and Isis in terms of progress. Pfizer’s Vyndaqel has already been approved in Europe, and is facing further Phase III trials in the US at the FDA’s request. ISIS has partnered with GlaxoSmithKline (GSK) for its TTR drug ISIS-TTRRx, and announced last week that it received orphan drug status and was granted fast track designation by the FDA. The registration-directed Phase II/III clinical study on ISIS-TTRRx is expected to start this month.

In contrast, ALNY has yet to find a partner to help develop its TTR program here in the United States. In October, the company granted Genzyme an exclusive license in Japan and the Asia-Pacific region to develop and commercialize RNAi therapeutics targeting TTR, but this does not equate to a big pharma partner that will help ALNY design its Phase II / III trials for FDA approval in the United States.

As such, ALNY has fallen behind ISIS in its only Phase II drug that remains promising. In contrast, ISIS has not only pulled ahead with respect to its TTR therapy, but has 10 other Phase II drugs and 2 Phase III drugs in its pipeline.

Partnership Comparison

Another way to compare Alnylam to Isis is to examine the number of reputable big pharma companies that each has been able to attract as partners for its development programs, as well as compare the economics that partners have given in exchange for licensing rights. An analysis of partnerships is particularly helpful for Alnylam and Isis because both companies view themselves as specialists in RNAi technology, in terms of patents and knowhow, and should therefore theoretically rely on their RNAi expertise to develop early-stage solutions that they would then monetize through big pharmas. Larger pharmaceutical companies have the requisite expertise of conducting more complex later stage trials, overseeing the FDA approval process and commercializing the final product.

As in other areas, the partnership profile of ALNY looks particularly thin when compared to that of ISIS. In ALNY’s 2011 10K, the company describes its product pipeline on pages 6 to 12. Let’s go through each of Alnylam’s development programs, with a focus on the company’s big pharma partners. Below is a chart summarizing ALNY’s partners for its current U.S. programs.

As we can see, Alnylam’s list of big pharma partnerships for current development programs is sparse. For ALN-RSV, ALNY partnered with Cubist Pharmaceuticals Inc., a $2.7bn market cap pharma. As we discussed, ALN-RSV reported disappointing Phase IIb results earlier this year, and does not currently have a promising future. In its agreement with ALNY, Cubist paid an upfront cash payment of $20m in 2009 and has yet to pay any additional milestones. ALNY’s only other partnership in its current development pipeline involves Medtronic, more a medical device maker than a pharma drug specialist.

That’s it for ALNY. Although the company had inked deals with firms like Roche and Novartis in the past, as explained in a previous article, these firms gave up on ALNY long ago and are nowhere to be found with respect to Alnylam’s current pipeline of drug candidates.

In contrast, ISIS’s numerous partnerships with big pharma indicate that its patents and pipeline have been better vetted by large pharmaceutical companies that are looking to identify viable future drugs. ISIS’s drug discovery programs are provided on pages 4 to 17 of their 2011 10K. Additionally, a quick look at this page demonstrates that for its current drug pipeline, ISIS has partnered with large firms including Genzyme, Biogen (BIIB), GlaxoSmithKline (GLAXF.PK), Teva (TEVA), Pfizer (PFE), and numerous others.

For instance, on Kynamro, Genzyme partnered with Isis to take the drug through Phase III trials and submit it for FDA and CHMP approval. Earlier in this article, we discussed how Genzyme paid a $175 million licensing fee, made a $150 million equity investment in Isis, and has paid Isis several milestone payments.

For its two cancer drugs, LY2181308 and ISIS-EIF4E, ISIS has teamed up with Eli Lilly and Company (LLY). Eli Lilly is responsible for the development of LY2181308, for which ISIS can receive milestone payments of up to $25 million.

With respect to ISIS’s rare disease franchise, ISIS entered into a preferred partner alliance with Biogen Idec that allows Biogen an option to develop and commercialize ISIS-SMNRx for spinal muscular atrophy. Genzyme has right of first negotiation for the company’s muscular dystrophy drug ISIS-SODIRx and GlaxoSmithKline is ISIS’s partner for its TTR drug ISIS-TTRRx and liver disease drug ISIS-AAT.

As previously discussed, ISIS’s OGX-011 drug has been licensed to Teva and the drug is currently undergoing Phase III trials.

The more extensive partnership relationships of Isis is yet another sign that Isis has a more promising future than Alnylam.

Other Metrics

As a final note, Isis also outshines Alnylam on certain superficial metrics.

ISIS has 1,500 patents worldwide, writing in its most recent 10K that “as of February 13, 2012, [ISIS] owned or exclusively licensed approximately 1,500 issued patents worldwide.” ALNY, on the other hand, lists 700 patents, writing in its most recent 10K that “[ALNY's] intellectual property estate for RNAi therapeutics includes over 1,800 active cases and over 700 granted or issued patents, of which over 300 are issued or granted in the United States, the EU, including by the European Patent Office, or EPO, and Japan.”

When it comes to research and development spending, ISIS has outspent ALNY over virtually any historical period that one would look at. Below is a comparison of the two companies’ research and development expenses over the past few years, as well as over the past 3, 5 and 10 fiscal years.

Conclusion

Yet despite ISIS’s clear competitive advantages over ALNY, whether measured in terms of Phase III drugs, its overall pipeline, or its partnership relationships, the two companies trade at comparable valuations. ISIS and ALNY have nearly the same market capitalization, and ISIS’s enterprise value is only 20% higher.

We think this is nonsensical. In no way are we championing ISIS as a long investment, given that Kynamro faces a strong possibility of a Complete Response Letter from the FDA in early 2013, and that commercially viable RNAi therapies remain elusive. As we discussed in a previous article, RNAi therapies continue to face safety-related obstacles in their quest to get regulatory approval. Most recently, Europe’s Committee for Medicinal Products for Human Use issued a negative opinion against Kynamro, using firm language questioning the drug’s safety profile:

“However, the CHMP was concerned about the medicine’s safety. The Committee noted that a high proportion of patients stopped taking the medicine within two years, even in the restricted group of patients with homozygous familial hypercholesterolaemia, mainly due to side effects such as flu-like symptoms, injections site reactions and liver toxicity. This was considered important because Kynamro is intended for long-term treatment in order to maintain the cholesterol-lowering effect. The CHMP was also concerned by liver test results in patients taking Kynamro showing a build-up of fat in the liver and increased enzyme levels, and was not convinced that the company had proposed sufficient measures to prevent the risk of irreversible liver damage. Moreover, the Committee was concerned that a greater proportion of patients taking Kynamro experienced serious cardiovascular events (problems with the heart and blood vessels) than patients taking placebo. This prevented the CHMP from concluding that Kynamro’s intended cardiovascular benefit, in terms of reducing cholesterol levels, outweighed its cardiovascular risk.”

As such, ISIS seems to us to be a highly speculative stock. But while ISIS’s current valuation may be merely speculative, the valuation of ALNY is wholly unreasonable. ALNY should be trading at a far more significant discount to ISIS. More generally, Alnylam’s current product pipeline does not come close to justifying the company’s current $1bn market capitalization.

Disclosure: I am short ALNY.

Business relationship disclosure: My research firm provides research services to clients and manages funds for compensation, and I therefore benefit to the extent shares in ALNY decline.

As we documented in our first article about Alnylam (ALNY), the company’s pipeline is significantly weaker than many people, in particular the institutional analysts, seem to think. We doubt that we are alone in that assessment, since both the actions of the company’s management and insider shareholders would seem to indicate a significant lack of confidence in the company’s direction.

First, why just a year after announcing a concrete plan to bring five drugs into advanced clinical development, did ALNY fire a large number of researchers, laying off 30% of its workforce? Keep in mind that Alnylam will have more than $200 million in cash at the end of this year, so, unlike many other biotech companies, Alnylam does not face the prospect of a cash crunch at any point in the near future.

What possible motivation would the company have for so greatly decreasing the pace of its R&D and slowing its pipeline development if it believes its RNAi therapies have a good probability of succeeding? It doesn’t add up that the company talks about the great promise its pipeline holds while at the same time it lets go swaths of employees and continues to advance its drugs at such a languid pace. One seemingly failed program, RSV, and one, TTR, that has only been tested in a couple of small Phase I trials is not a lot of progress to show for the last five years of Alnylam’s existence.

TTR: Analysts’ Optimism Greatly Misplaced

Oddly enough, if you read through JP Morgan’s (JPM) bullish initiation report on Alnylam, you find that its analyst ascribes a 65% chance of Alnylam’s TTR drug getting approved based on the Phase I data. The analyst further concludes that Alnylam could be projecting revenue generation from the TTR drug in 2016. This 65% chance of approval figure is patently absurd. We’d point out that BioMedTracker has noted that historical data indicates that final approval for drugs graduating from Phase I ends up at less than 10%. We’d also remind JP Morgan’s analyst that Alnylam showed very solid and encouraging Phase I results in healthy patients for its RSV program, but that program now appears unlikely to even enter a Phase III trial, let alone garner FDA approval.

We also were genuinely surprised to find JP Morgan’s analyst assigning a mere 15% discount rate to the TTR compound. This is a questionably low figure for a Phase I (or even Phase II) compound, and this figure should be much closer to 25%. Given that much can go wrong between now and potential FDA approval years down the road, the errant 15% figure accounts for much less risk than is appropriate.

To add to that, we’d also note that JP Morgan seems to have missed a key issue that would normally cause analysts to have greater concerns and apply larger discount rates to early stage drugs. With respect to Alnylam, a competitor has a more advanced drug in development for TTR. In this case, Isis (ISIS), in combination with its partner GlaxoSmithKline (GSK), has a drug for TTR that is also entering Phase II. Isis is initiating its Phase II/III study this year, after it successfully cleared Phase I.

In stark contrast to Alnylam’s extremely small Phase II study with only a handful of research sites and less than two dozen patients, Isis is conducting a large and robust study that is specifically seeking to evaluate the effects of Isis’ drug “on neurological dysfunction and on quality-of-life in patients with amyloid polyneuropathy.” In other words, Isis is actively searching for meaningful clinical data and is seemingly on the fast track to try to get their TTR drug toward FDA approval.

While it is unclear whether or not the FDA will approve KYNAMRO, Isis’s most advanced drug prospect, (the FDA will decide next year), Isis has been able to demonstrate that its delivery platform is capable of producing clinically effective drugs in patients, a step that Alnylam is still struggling with. At this point, it seems that Isis has to be the favorite in the race to produce a successful TTR drug that will get to market first.

As we’ve demonstrated previously, Alnylam’s pipeline is very dependent on TTR working out effectively. Alnylam has slashed its efforts in focusing on other drug candidates to, as it put it in a press release earlier this year, align “its resources to focus on what it believes to be the company’s highest value opportunities with accelerated clinical development plans.” There is a very real chance that Alnylam will be beaten by Isis in the race to market for its TTR drug; even if Alnylam’s drug candidate turns out to be effective and earns FDA approval, that doesn’t ensure the company will ever generate significant revenues from the TTR drug.

Partnerships

We have doubts about the company’s recent partnerships. While any sort of partnership is probably better than none at all, the recent partnership with Genzyme for TTR seems less than promising. Alnylam received $22.5M from Genzyme for the Asian rights to the TTR product, plus future potential payments and royalties should the drug reach the market. The cash is nice, but this is quite a small deal should the drug actually work out. Again, for a company with so much cash in the bank, what is the rush to limit upside on the company’s pipeline? Or is the cashing out via a partnership a sign that the pipeline holds much less promise than management has been leading investors to believe?

For investors unfamiliar with Alnylam’s history, the $22.5M partnership with Genzyme and/or the development deal with Monsanto might seem like significant corporate milestones. However, one must remember that back in 2007, Roche (RHHBY.OB) paid Alnylam $331 million up front, and potentially more than a billion in future milestone payments to participate in Alnylam’s development pipeline. Three years later, Roche gave up, and dumped RNAi technology, taking a complete loss on its $331 million investment. Roche wasn’t the only company to get burned with a large Alynylam partnership. Novartis (NVS) also spent an exorbitant sum of money to partner with Alnylam in 2005. This partnership would be terminated years later without providing much value to Novartis.

Not surprisingly, since then Alnylam’s partnerships have shrunk in both scope and in monetary value. While the Genzyme partnership is beneficial to the company, it is far less encouraging than the previous Roche and Novartis agreements. With Alnylam’s seeming failure in RSV, potential partners are likely to be much more wary about giving Alnylam large upfront payments until the company can demonstrate statistically significant results in the clinic.

Turning our attention back to Isis’ competing TTR drug, it is important to note that Isis has received a far more meaty partnership for that TTR drug from its partner, GlaxoSmithKline. According to a recent Isis press release, Isis has already received $10 million in milestone payments for its TTR drug. Furthermore, Isis will receive a $2.5 million upfront payment and is eligible to receive another $7.5 million for the initiation of the Phase II/III study. Isis will also be eligible to earn another $50 million in pre-licensing milestone payments to support the Phase II/III study.

In sum, Isis will likely have earned more than $70 million in payments from its partner by the time its more ambitious study is completed. Meanwhile Alnylam only received $22.5 million from Genzyme, and its study will produce far less statistically significant data than Isis’s. All signs point to Isis being the favorite in the race to produce a successful TTR drug.

Valuation: $840 Million in Market Cap Seems Awfully Generous

At $16/share, Alnylam has an $840 million market cap. As we’ve demonstrated, Alnylam’s pipeline is narrow and is in an extremely early stage of clinical development. Its leading candidate, the TTR drug, faces a strong competitor. Even if the company’s RNAi approach pans out in the long run – by no means a sure bet – that would still seem like a fairly aggressive valuation for a company that is unlikely to have much of a shot of getting FDA approval for any of its drugs until 2016 at the very earliest.

The management team’s strategy doesn’t seem to make much sense, and recent headcount reductions significantly threaten the company’s ability to execute its touted 5×15 initiative. With meaningful clinical results from actual sick patients at the earliest more than a year away, it’s hard to envision a scenario where Alnylam can maintain such a large valuation over the coming quarters.

The last potentially bullish catalyst for Alnylam, the spin-off of its micro RNAi subsidiary Regulus (RGLS), turned out to be “an outright disaster“. Alnylam attempted to spin off Regulus at a price of $11/share. The IPO failed to generate any market interest, and ended up pricing at a mere $4/share, a 61% discount from the intended IPO price. The Regulus spinoff was supposed to help Alnylam “derisk” to some degree by giving the company more financial flexibility and also serve as another demonstration of the market’s faith in Alnylam’s RNAi drug development technology. Instead, the IPO failed to raise anything close to the expected proceeds and served as a stark reminder of the market’s continuing doubts over the long-term viability of the RNAi field, and Alnylam’s research in particular.

Finally, Alnylam’s sum-of-the-parts valuation has been significantly reduced by the loss of $65 million in cash (and another $10 million in likely milestone payments) in the patent settlement with Tekmira (TKMR). Now Alnylam faces a future where its best drug candidate, its TTR program, appears to be rapidly falling behind in development in comparison with Isis’ competitor program, and it has to compete while having lost a significant amount of its cash and intellectual property base. Alnylam has performed a lot of interesting science, and its IP is certainly of interest. But its market capitalization of $840 million paints far too rosy a picture of ALNY’s actual prospects of developing a revenue-producing drug.

All together, we see substantial downside in ALNY shares.

Disclosure: I am short ALNY, BTX.

Business relationship disclosure: My research firm provides research services to clients and manages funds for compensation, and I therefore benefit to the extent shares in ALNY and BTX decline.

Alnylam Pharmaceuticals (ALNY) offers one of the most compelling short selling opportunities we have seen this year. The company has a nearly billion dollar market cap despite having no FDA-approved drugs, no Phase III candidates, and no significant recurring revenue streams. In addition, the company has suffered several significant setbacks, most notably when the company’s most developed pipeline candidate failed to meet expectations, along with the Tekmira (TKMR) patent litigation settlement.

Now, the company is, at best, four years away from getting any drugs to market, and as we show in this report, there is significant doubt as to whether its RNAi pipeline will end up producing anything of value whatsoever, even in the distant future. Furthermore, as we will detail in Part II of this report, the patent litigation settlement Alnylam reached with Tekmira represents another blow to Alnylam, as it loses a quarter of its cash reserve, along with future milestone payments and significant loss of valuable intellectual property in the RNAi space.

Alnylam’s Growing Valuation Gap

The market had been pricing Alnylam shares roughly correctly, more or less, up until May of this year. At that point, the market’s perceptions diverged widely from Alnylam’s true valuation. This was caused by two factors. The first of these was that Alnylam’s most promising drug candidate, ALN-RSV01, failed in its Phase IIb trial, missing its primary endpoint. Oddly enough, Alnylam shares barely slipped on the day that Alnylam released its preliminary disappointing findings in May. The market also barely reacted when the company reported equally disappointing final results in September.

This is a critical mistake on the part of the market. ALN-RSV01 represented Alnylam’s only relatively advanced drug prospect. Besides losing the prospect of nearer-term FDA approval and revenue, ALN-RSV01′s failure serves as a stark reminder that Alnylam has still failed to prove that any part of its platform actually is effective in treating ailing patients. This is an important thing to note, as Alnylam has made lots of promotional hay out of its Phase I trials, where it is able to show strong results when treating healthy patients with its drug candidates.

This brings us to the second error that has led Alnylam’s shares to become grossly overvalued. Despite the market ignoring negative news from Alnylam when it ran a trial treating actual sick patients, the market showed great enthusiasm for nearly meaningless Phase I results. In this case, the stock popped 60 percent in a single day, rising from $12.50 to more than $19 per share following the release of results from the company’s ALN-TTR02 Phase I results. In our view, nearly all of this 60 percent pop was unwarranted and will be erased in the near future.

Alnylam’s Seemingly Misleading Approach To Drug Development

We have serious concerns about the way Alnylam’s management has decided to proceed in developing its RNAi platform. These concerns include the development of ALN-TTR02, a drug for a rare genetic disorder Transthyetin Amyloidosis (frequently called ATTR or FAP). The results for Alnylam’s recent Phase I ALN-TTR02 trial caused the stock to soar 60% in a single day. However the trial results are of questionable utility due to the fact that, by all accounts, it seems that Alnylam targeted an incorrect primary endpoint, TTR serum knockdown, for the trial. TTR serum refers to specific undesirable proteins in the patient’s blood and TTR serum “knockdown” refers to a decrease in the concentration of those proteins.

ATTR is caused by the body incorrectly depositing proteins, either in the wrong location or in excessive quantities. This can lead to a variety of maladies. Alnylam’s logic behind targeting TTR serum knockdown is that if the body produces fewer incorrect proteins, diseases can be slowed or even reversed. However, Alnylam’s trial was in healthy patients, and it does not necessarily follow that successful TTR serum knockdown in a healthy volunteer can be replicated in a sick patient. Nor is it a given that reducing TTR serum will successfully slow progression of the disease.

There is one drug, Pfizer’s (PFE) Vyndaqel, which is further along in development, to treat FAP – in fact, Vyndaqel is approved in Europe, but the FDA has asked for a new trial before approval. Vyndaqel’s original Phase III trial did not target TTR knockdown as its endpoint, which makes sense since TTR knockdown in and of itself does not make a sick patient healthier. Instead, Vyndaqel’s co-primary endpoints were its responses to treatment as indicated by the Neurologic Impairment Score-Lower Limb (NISLL) score and change from baseline in the total Quality of Life score (Norfolk QOL-DN). These endpoints represent meaningful improvement for patients’ quality of life, rather than merely success in lowering a statistical metric. Simply knocking down TTR serum is not proof of drug efficacy and will not suffice to obtain FDA approval.

Similarly, the company’s Phase II trial design indicates that the company will not attempt to correlate TTR serum knockdown with clinical results. The Phase II trials are too small to generate statistically significant results in regard to ALN-TTR02′s clinical response. It appears there will only be four clinical sites for the trial. Given the extreme rarity of the disease in the general population and the limited number of clinical sites, it seems as though Alnylam has little chance of obtaining much useful data from this trial. Alnylam seems to be doing the bare minimum necessary to attempt to get this drug to Phase III and/or generate partnerships.

Why Alnylam May Not Be Targeting Near-Term Clinical Results

There are several potential reasons why Alnylam seems more focused on a metric of questionable utility, TTR serum knockdown, rather than on clinical results. For one, it is important to remember that RNAi is still an unproven technology. The RNAi/antisense phenomenon was first discussed in scientific publications in 1998 and the two scientists who discovered it were awarded a Nobel Prize in 2006. Despite that, there are still no FDA-approved drugs using RNAi technology. Alnylam likes to tout itself as a leader in RNAi technology, but that is a dubious distinction, as RNAi thus far in its more than decade-long history has produced little that can actually be commercialized.

We previously profiled a number of stem cell stocks, ACTC.OB, BTX, GERN, OSIR, and STEM, in an article that reminded investors that stem cell therapy remains an emerging technology that has been burning early investors because the science is still at too embryonic of a stage for viable commercial drug development. The RNAi technology segment is not too dissimilar.

While antisense molecules (i.e. RNA) have successfully proven that they can reduce and downregulate specific proteins, no company has as of now been able to use that ability to create a drug that has been both effective and safe enough to earn FDA approval. Because of the inability to convert protein knockdown into effective safe drugs, the RNAi field remains wholly unproven. We have significant doubts about the entire field of RNAi therapeutics given the lack of any successful drugs thus far.

The closest anyone has come to success with RNAi is Isis Pharmaceuticals (ISIS) which has a drug that has gone through Phase III but has, as of yet, failed to gain FDA approval. Isis’s drug, Kynamro is an antisense therapeutic that targets RNA to lower high cholesterol. It successfully met all its endpoints in its Phase III trial, but the FDA advisory committee vote was mixed and the FDA has not yet decided whether or not to approve the drug.

The Kynamro situation highlights the significant safety concerns associated with RNAi therapies. In one extension study in Phase III where Isis treated 141 patients, 62 of the enrollees – nearly half – discontinued treatment due to adverse effects! Only 40 patients (28%) agreed to continue with an additional two years of treatment. Kynamro causes significant issue with liver toxicity and fat buildup in the liver, along with injection site rashes.

We find it extremely interesting, and troubling, that Alnylam continues to focus only on protein knockdown instead of focusing on safety and clinical results. It is already widely established that antisense molecules can knockdown specific proteins. Alnylam’s Phase I results for TTR-02 are in no way groundbreaking. What remains to be seen is whether protein knockdown can be converted into a safe and effective drug – and with TTR-02, Alnylam does not appear to be even attempting to prove that at this point.

Safety Concerns

Given the significant problems with Isis’s Kynamro that have blocked it from getting FDA approval, we highlight the lack of concern Alnylam investors have had over reaching a similar outcome. Alnylam and Isis are using an extremely similar technology and method of action to target different indications. Isis’s and Alnylam’s approaches to drug development are closely related (so closely, in fact, that they launched a separate RNA biotech company, Regulus Therapeutics (RGLS), together in a joint venture). We can’t help but suspect that both companies will face similar safety issues as they continue to develop RNAi drugs.

Our concerns are magnified when we take into account the fact that Alnylam seems intent on running Phase I trials that consist of a single dose of the development drug. Again, this shows a strong preference toward trying to generate protein knockdown – a dubious metric – rather than truly testing the drugs for clinical efficacy or safety. Would Alnylam’s drugs create similar adverse effects to those that have derailed Isis’s Kynamro? We simply don’t know, in part because Alnylam is so keen on doing single dose trials. By doing single dose trials, Alnylam minimizes the risk of adverse side effects that would result from a longer trial. Given Kynamro’s struggles, we understand Alnylam’s hesitancy to run longer trials, but it strikes us as a bad omen for Alnylam’s pipeline development in the longer run.

We’ve Been Down This Road Before

It is instructive to review how Alnylam handled the development of its previous lead candidate, ALN-RSV01, which attempts to target the Respiratory syncytial virus (RSV) that causes more than 300,000 hospitalizations a year. In early 2008, investors were excited after Alnylam announced results of an RSV study that seemed to show significant efficacy for the drug.

The company, as Seeking Alpha contributor Fredric Cohen M.D. reported, ran a trial in which they purposely infected healthy volunteers with RSV viral particles, quarantined them for twelve days, and then tested to see how much viral load the treated volunteers drug had as compared with the placebo group. Note that the company did not find a pattern of less symptoms from RSV in either group, but rather they set (and achieved) endpoints of having fewer viral infections and less viral load in the treated patients.

From this initial apparent success, it would be more than four years before the company’s trials in humans progressed far enough to make it apparent that the drug doesn’t seem to reach its endpoints in actual clinical situations with patients who naturally became sick rather than being purposely infected. Just as Alnylam has done presently with its TTR-02 program, where it achieves an endpoint of dubious utility in healthy patients, Alnylam pulled this very same maneuver off in 2008 with RSV.

If Alnylam follows the same course as it did previously, it may be many years before investors discover whether TTR has any statistically significant effect in actual ATTR patients rather than the healthy patients it has tested so far. Given that Alnylam’s current Phase II trial of TTR-02 involves only a couple dozen patients and is not designed to measure clinical efficacy of the drug, investors will be waiting for years before they get to see any meaningful data.

Alnylam’s (Narrow) Pipeline

Since Alnylam has an extremely thin pipeline, it is hard to understand why investors have assigned the company such a large valuation. The company’s only program within a couple years of potentially heading for FDA approval, the RSV program, appears to have floundered and may never even see a Phase III trial after its poor results in Phase II earlier this year.

Meanwhile the TTR program has only demonstrated results in healthy patients, and the demonstrated results thus far have only been for a non-meaningful endpoint that will not help the company achieve FDA approval. Alnylam has, after years and years of effort, still failed to prove that its RNAi approach has any statistically significant clinical benefit in human patients. None whatsoever. And other companies, particularly ISIS, while getting closer to the mark, have still been unable to create any RNAi products that are effective that also have an acceptable safety profile. RNAi as a field has a whole lot to prove, and Alnylam lags even its RNAi competitors as it has not been able to demonstrate statistically significant efficacy in non-healthy patients, let alone efficacy and safety together.

The rest of Alnylam’s much-hyped 5×15 pipeline, which was supposed to bring five RNAi therapeutic programs to “advanced clinical development” by 2015 appears to be floundering. The company announced its 5×15 initiative in January 2011. It has now been almost two years, and only the TTR program has successfully left Phase I. The Hypercholesterolemia program is in Phase I, and the other three 5×15 programs are still in development and have yet to even enter Phase I. Furthermore, the Hypercholesterolemia program appears to be dead in the water, as it has no partner, and both Amgen (AMGN) and Sanofi (SNY) in partnership with Regeneron (REGN) have drug candidates much further into clinical development than Alnylam’s.

Here is the company’s pipeline, according to its website.

This is what the market has assigned $700 million of enterprise value. For that $700 million, you get a struggling RSV program, a partnered liver cancer program that has a small trial in China upcoming (i.e. don’t expect anything significant from it anytime soon), the TTR program, a stalled out Hypercholesterolemia program, and three other programs still in development that are little more than a gleam in the eye of management at this point.

Alnylam’s decision to lay off 33 percent of its workforce in January of this year (just barely a year after the previous 30 percent headcount reduction) makes one wonder exactly what business model Alnylam’s management is aiming for. From last year’s excitement over five drugs heading for advanced clinical development, we are down to two seemingly viable candidates.

And as we’ll thoroughly explain in our next article, Alnylam just spent an entire year’s worth of normal cash burn in one fell swoop to resolve the Tekmira patent litigation, and it has lost a significant chunk of its intellectual property. Alnylam’s prospects are fading, and as it loses ground to rivals such as ISIS and Tekmira in the still unproven field of RNAi technology, it is hard to imagine that Alnylam’s near billion dollar valuation can be sustained. Shares could fall sharply in coming weeks as investors come to grips with Alnylam’s darkening prospects.

Disclosure: I am short ONCY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Investors apparently have not quite understood what was said recently in Oncolytics Biotech’s (ONCY) update on their Phase III trial of Reolysin (REO 018). The implications for the head and neck cancer program and how this will affect their company going forward are quite negative, and yet the market has only mildly punished Oncolytics for the greatly disappointing update. Once the market realizes the implications of REO 018′s delay, considerable downside should be expected in Oncolytics’ shares.

What happened with the interim analysis?

Last week, Oncolytics notified investors that it had conducted an analysis of the blinded combined clinical data for all 80 patients enrolled in the first stage of the study. However, they go to great lengths to disguise the fact that the study was a failure.

At the time of the analysis, 23 patients of the 80 had not yet progressed but were included for the purposes of analysis. The median evolving progression free survival (PFS) of the 80 patients, which comprises the combined control and test groups, was greater than expected, as was the best response rate. On further examination, it was observed that patients for whom only metastatic disease was being measured by clinicians, were responding differently to treatment than patients who had local regional head and neck disease.

When biotech companies have positive data, they directly come out and say it. Oncolytics decided to dance around the analysis and give no comparative numbers, trying in our opinion to conceal the statistical shortcomings of the data. The company used an all too common excuse for failed trials: the control arm performed better than expected. With such a high median evolving PFS between the two groups and Oncolytics’ surprise at this, it seems abundantly clear that the current study design was unlikely to achieve statistical significance. If Oncolytics had spent more resources on running a randomized trial before REO 018, they might have designed the trial differently.

After Reolysin passed the initial safety hurdle, Oncolytics began enrolling patients into what was supposed to be the Phase III portion of the study, while they conducted the interim PFS analysis. This is no longer the case. The additional 80 patients that were supposed to be enrolled in the second stage of the original study will now be a part of what amounts to a large Phase II study stratified “between patients with local recurrent disease, with or without metastases, and patients with distal metastases.” Head and neck cancers are heterogeneous by nature, so this should have been foreseen as a potential issue. It is really grasping at straws to suggest that this was an unexpected development, and investors should be skeptical of the management team’s ability to design trials following this blunder.

What’s next for REO 018

REO 018 unequivocally failed to meet its objectives that would have led into a pivotal Phase III study. Originally, REO 018 was planned to be a registrational study supportive of a Biologics License Application (BLA) that it would submit to the FDA in order to commercialize Reolysin. However, a careful examination of the press release reveals that this study will no longer be used for that. Specifically, they say that:

Oncolytics intends to treat this expanded first stage of the REO 018 clinical trial as a separate supportive study to a planned registration study that will be similar to, and take the place of, the original second stage of the REO 018 clinical trial. Enrollment in the first stage of the study is complete and no additional patients will be enrolled pending approval of a planned registration study. (emphasis added)

Essentially, the company will wait for the 160 patient dataset to mature and analyze that data to help inform them for a separate Phase III trial of unknown size. Data from this initial group of 160 patients will likely be available sometime in the first quarter of next year. This analysis carries a similar risk of not achieving statistical significance.

During the conference call, executives at the company tried to suggest that they might still be able to file for approval in 2014. This seems implausible for several reasons. First, this is entirely too dependent on the successful outcome of two studies, not one. Oncolytics needs the current 160 patient trial to be indicative of future success in a new Phase III study. Second, there is risk that this future Phase III trial won’t work out either. This revised path to approval is fraught with obstacles.

Even under the most optimistic scenario (positive data in the current 160 patients in Q1/Q2-2013), they likely wouldn’t be able to begin enrolling patients in a new Phase III study until the second half of 2013. We believe they would be unable to recruit patients quickly enough to have a mature dataset in time to file a BLA in 2014. Oncolytics would likely need 9-12 months to enroll the right number of patients and an extra 6-9 months to allow patient data to mature. The earliest investors will see a BLA for Reolysin would be in 2015, and there is a good chance that even this projection is much too optimistic. Given this new delay, there is a whole lot of cash burn and share dilution on deck before Reolysin could approach FDA approval.

Early lung cancer data

Friday, in a conveniently-timed separate development, Oncolytics announced their single-arm Phase I study had met the primary endpoint in patients with squamous cell carcinoma of the lung (SCCLC). They noted that five of 15 patients (33%) showed partial response (PR) (four confirmed, one unconfirmed), and an additional eight patients with stable disease (SD). Their disease control rate (complete response (CR) + PR + SD)) was 87%. Given the extremely small sampling of patients, it is hard to get excited about these data. Objective response rate (ORR) is a highly variable and subjective endpoint based on investigator assessment. Oncolytics’ data look inline with current treatment standards.

Celgene’s Phase III trial comparing Abraxane (nab-Paclitaxel) plus carboplatin versus standard paclitaxel plus Carboplatin, revealed objective response rates of 41% versus 24% in patients with SCCLC. 24% is the relevant number for comparison with Oncolytics. Remember, Oncolytics said they saw four confirmed and one unconfirmed partial responses. If you drop the unconfirmed response, their ORR was 26.66%. They barely met the endpoint for moving into the second stage of enrollment, which required four or more partial responses or better. This data does little to add significant value at this point in time. In addition, it is yet another single arm study; as investors have learned already, in the past, favorable single arm studies have not portended great things for Oncolytics’ clinical pipeline.

Conclusion

We view Oncolytics’ decision to push forward in head and neck cancer as an unwise investment and replete with unnecessary risk for investors. Oncolytics likely has less than $33 million on hand. Oncolytics claims to have cash through next year, but it would be wise to raise cash at some point before the 160 patient efficacy analysis, since failure there would certainly jeopardize Oncolytic’s remaining ability to raise any cash whatsoever.

In any case, it is hard to see why investors are still paying $2.45 a share for Oncolytics’ shares – nearly what it was prior to the disappointing data release. Following the failure of the REO 018 trial, it seems clear that Reolysin remains a long way from reaching commercialization, if ever, and Oncolytics has nothing else in the pipeline to support its share price should the Reolysin platform fail completely. The REO 018 setback virtually ensures that more dilution is upcoming to fund the new trials. It’s hard to justify the $200 million market cap at this point, and we expect investors will substantially discount Oncolytics’ shares in the near future to reflect the increasingly perilous road Reolysin faces to toward FDA approval.

Additional disclosures: Read our disclaimer.

In our opinion, investors are assigning an overly inflated valuation to an unproven Phase II drug with an unusual mechanism of action on a substantially incomplete subset of data.

The market’s reaction to Bavi’s trial data release in May has certainly been bizarre. For more than a month after news of the Bavi study was released, the stock traded flat, as the market correctly concluded that the data was incomplete and inconclusive, and that there are still numerous hurdles Peregrine must overcome simply to get to a Phase III trial, let alone getting FDA approval. This is often the case for unproven companies with novel treatments for cancer.

Yet beginning in the end of June, the market apparently decided to propel Peregrine’s market capitalization from a reasonable $50 million to $300 million over the subsequent two and half months – a lofty valuation for a company with a phase II cancer drug. As longtime market participants know, for every small cancer-focused biotech company that actually succeeds, there are numerous others that end up in complete failure, when their interesting idea just doesn’t pan out.

In this article, we will explain why we are highly skeptical that PPHM will maintain its current valuation much longer.

Bavi: It’s Time for Reality to Set In

While the most recent Bavi data gives its proponents some hope, let’s not forget that it follows March data that seemed to indicate the drug was a complete bust. For historical context, Peregrine has been working with Bavi for nearly 9 years now; it filed its trademark for Tarvacin (which has since been renamed Bavituximab) back in November 2003. Since then, it has been a long and winding road for Bavi, with briefs spurts of enthusiasm quickly giving way to long periods of discouragement. With the company running trials for Bavi for many different types of cancer, Peregrine frequently has had opportunities to promote small bits of positive information that may often turn out to be no more than statistical anomalies.

This is an important consideration when thinking about the ongoing Phase II Bavi trial for Second-Line Non-Small Cell Lung Cancer (“NSCLC”). Back in December of last year, investors were treated topreliminary data from a Phase II study of Bavi in front-line NSCLC patients. The study was open-label. Peregrine informed investors that Bavi had shown a 50% improvement in overall tumor response rate versus the control group. While this is not a key FDA endpoint for an NSCLC drug trial, it certainly seemed to be a piece of good news. However, the data was not statistically significant – in fact, there can be a fairly wide range of tumor response rates just due to chance factors, and Peregrine’s study used numerous international patients from a variety of countries and examined too small a number of patients.  As a result, the data simply wasn’t conclusive despite the seemingly positive headline.

In March, hopes with respect to the trial were crushed, and Peregrine shares collapsed, losing nearly half their value in a few weeks following updated results from the Bavi study showing that the overall response rate for Bavi was only 25%, nearly identical to the control group’s 23% response rate. Results weren’t much better for mortality; Bavi delayed tumor progression or death by 6.7 months, a mere 0.3 month gain in comparison with the control group. It seemed like the drug was a bust. Peregrine’s shares sunk to less than 50 cents, and the company was all but left for dead.

Of particular note was a key difference between the preliminary December reading and the March results. First, the March results were based on independent central review, which meant that the statistics were reviewed via a more independent analysis than the December results, which presumably were based on a preliminary viewing by the investigators actually running the trial. The FDA and prospective partners will always place more reliance on independent central review, particularly in open label trials where doctors and patients know which patients are receiving the control therapy and which are receiving the drug being tested. In the case of Peregrine’s front-line NSCLC trial, independent central review in March 2012 yielded materially different results than the preliminary reading issued in December 2011.

Naturally, we assume that the May 2012 announcement for the second-line NSCLC trial was again not based on independent central review, since if it was, Peregrine would have likely eagerly disclosed it in its May press release. As well, we’ll explain below that in the same way that the December headline figures were not statistically significant, the May 2012 data that was released to much fanfare is also unlikely to be statistically significant.

More to the point, we have concerns about the incompleteness of the May data – other than a few headline-grabbing figures, there is little scientific meat to analyze at this point. It is nearly impossible to judge whether or not the May results are finally a genuine breakthrough, or whether Peregrine is simply taking advantage of another fortuitous statistical anomaly.

Problems with the May data abound. No hazard ratios (HRS) or p-values were released. Without a discussion of p-values or HRs, investors cannot conclude whether the May results are statistically significant. Rather, the conspicuous lack of mention of p-values or HRs indicates that the trial likely did not reach statistical significance with respect to Overall Response Rate (ORR) and Progression-Free Survival (PFS).

Management has also hinted at potentially meaningful results regarding median overall survival (OS) for the second-line NSCLC trial. On that topic, given the small size of the trial’s sample and the nature of NSCLC survival curves, as well as the fact that HRs and p-values were conspicuously not disclosed, we find it quite unlikely that the median overall survival (OS) will ultimately be statistically significant. Furthermore, we would also point out that overall survival was not the primary endpoint of the trial. This is all yet further illustration that Bavi is still only in phase II trials, and still has a long road ahead of it.

We would next add that the study was unblinded in May 2012. This has implications on ultimate findings regarding the median overall survival. Simply put, measuring OS after unblinding introduces potential bias.

As well, we have yet to see a comparison of results between the U.S.-based patients and the international patients who were included in the May results. A listing of locations for the second-line NSCLC trial is available here, and the testing locations include India, Russia, Ukraine and the country of Georgia. Are OS results consistent across all geographic regions? The inclusion of these international patients adds additional complexity to the data.

There are even more basic questions and assumptions that have not been clarified. For instance, were baseline factors such as performance status and EGFR status, which refers to a cell receptor whose overexpression has been linked to numerous cancers including lung cancer, balanced between all three treatment arms? Variances in these statuses would be yet another potential cause of bias that could render Bavi’s preliminary results statistically insignificant.

Various analyst attempts to dig deeper into the data have been rebuffed with the claim that the data needs to mature but that it is “trending” in the right direction (for example, see management’s comments in their most recent conference call). We’d remind readers that the data was trending well for frontline NSCLC back in December, and then suddenly the “trending” stopped in March and Peregrine shares lost half their value. It is difficult to understand how the data can go from poor in March to “as compelling Phase II data as I’ve ever seen”, according to Peregrine’s Head of Regulatory Affairs, in such a short span of time.

As we said in the beginning of this article, we would note that the market’s initial reaction to the May 21^st results were muted. In the chart below, we can see that Peregrine’s shares wallowed for a month following the release of the May data.

Our interpretation? We believe that when the May results were released, investors who had long followed Peregrine essentially shrugged them off.  These investors had learned to wait for more conclusive results when it came to Peregrine management’s claims before, rather than drawing unfounded conclusions from preliminary data. In short, regardless of the quality of Peregrine’s drug program, we think that longtime investors readily recognize that Peregrine’s public pronouncements have been less than forthright in the past, to put it diplomatically.

Then suddenly in late June, the stock began to rally and soon went parabolic without any significant new developments. The trading action speaks more to some combination of bullish newsletter articles, investment banking chatter, and then a short squeeze to top it all off, rather than any great market faith in Bavi. Why is this stock worth $3/share now when it was still worth a mere 50 cents weeks after the release of the “exceptional” data?

If investors are buying into the Bavi story on news released in May, keep in mind that investors who have been following Peregrine for years had the opportunity to buy all the Peregrine shares they wanted under 50 cents and passed on the opportunity. Furthermore, not only were longtime Peregrine investors not buying shares, but management was issuing new shares at [approximately 50 cents] during May.

Suspicious Dilution: If Results Were So Promising, Why Was Management Selling Shares at 54 Cents?

One of the more revealing disclosures in the recent annual report was the fact that the company was selling its own shares at approximately 54 cents during the same period that the supposedly “exceptional” May data was being made public.

As disclosed in the company’s 10K:

“Subsequent to April 30, 2012 and through June 30, 2012, we sold 2,752,691 shares of common stock at market prices under the December 2010 AMI Agreement for aggregate gross proceeds of $1,496,000.”

Peregrine has various At Market Sales Issuance Agreements, which allow the company to raise money continuously at current market prices. In other words, PPHM can issue and sell shares periodically on the secondary market without disclosing the share sales until after the fact. Based on its 10K disclosure, Peregrine was issuing these shares during the May and June time frame at less than a fifth of where PPHM stock is currently trading at.

Despite having access to the supposedly great May results which have been a catalyst for the stock, Peregrine’s management team was concurrently unloading millions of shares of stock onto the market at depressed prices. What did management know that investors buying the stock at $3 per share are not understanding? We would guess that management – which was flooding the market with shares when they traded at all-time lows – has a better sense of what the company is worth than third-tier investment banks such as Roth Capital or various internet articles that have stoked the flames of speculation about Peregrine’s stock recently.

When management says one thing and does something else, it is always prudent to be skeptical. And given how the data from this particular drug went from supposedly great (but not statistically significant) in December ’11 to a bust in March ’12 and now back to “exceptional”, according to CEO Steve King, we are less than impressed by his verbal characterizations, and more interested in his actions.

If investors buy Peregrine at $3/share, they better know something that management and long-time Peregrine investors do not. In our opinion, the share sales and the initial month of flat trading speak are far more revealing than the recent flurry of buying by momentum and day traders looking for a quick trade. Compared with its peers, it is baffling to try to figure out why the market has assigned Peregrine a $300 million market cap.

Further Dilution is on the Horizon

Peregrine supporters have suggested that it is a statement of great confidence in Bavi’s prospects that the company will be able to raise a substantial amount of capital from a convertible bond instead of more equity raising. We find this line of reasoning to make no sense at all. Peregrine has a real asset – its contract manufacturing facility organized under the Avid Biosciences moniker – that generates real revenues and even some EBITDA. It is not surprising that a bank would be willing to lend against such an asset. There is no reason to think this loan suggests anything unusually promising about Bavi’s drug pipeline prospects. It is simply an acknowledgment that unlike many small biotechs, Peregrine has a real recurring revenue asset to borrow against. The CFO partly ascribed its ability to take out convertible debt to its ownership of the Avid Biosciences asset, saying in the most recent earnings call:

“…our next immediate focus is to secure a less-dilutive debt-financing vehicle similar to a term loan. Recognizing the growing value in the Avid asset, and the strong clinical data in second-line lung cancer, we are pursuing a non-convertible-type loan in the range of $20 million to $30 million.”

Raising capital by debt instead of equity may be a little less dilutive for shareholders in the short run, although the convertible could very well be packaged with warrants issued to the lenders. While a convertible offering is better than, say, selling shares at 50 cents a pop as management was doing one quarter ago, it is not any reason to be bullish. Debt is still debt at the end of the day, and with Peregrine still so far from bringing a product to market, any encumbrance to the company’s balance sheet should be viewed negatively.

And contrary to a recent bullish article’s suggestion, Peregrine will still need to issue equity – a lot more of it – to get Bavi through Phase III and into production and marketing, should it be so lucky to get FDA approval. Peregrine has only six months of cash at current burn rates, and the suggested convertible debt offering only buys it a couple more quarters worth of time. Given that Peregrine has taken nine years to get Bavi toward the end of Phase II, it is quite the assumption to think Peregrine will be able to get its drug through the rest of the FDA approval process in an expedited fashion. This company will need a lot more cash in coming years.

In his Wedbush conference presentation last week, CEO Steve King made a stunning statement. He said (at the 24 minute mark) that:

“We’ve not been raising money through the capital markets in any way, we are not currently planning on going out for or have we been actively involved in any other fund raising activities.”

We’re not sure if Mr. King misspoke, was attempting to mislead, or whether he simply has a very poor memory. Peregrine’s latest 10-K filing shows that Peregrine has been raising tons of money through the capital markets by issuing millions upon millions of new Peregrine shares, in contrast to the CEO’s statement. Peregrine’s most recent 10-K states:

“Historically, we have funded a significant portion of our operations through the issuance of equity. During fiscal year 2012, we raised $34,330,000 in gross proceeds (Note 7). Subsequent to April 30, 2012 and through June 30, 2012 we raised an additional $1,496,000 in gross proceeds under an At Market Issuance Agreement (Note 7). As of June 30, 2012, additional shares of our common stock for aggregate gross proceeds of up to $185,886,000 may be available under our current effective shelf registration statements on Form S-3.”

A simple glance at the company’s number of shares outstanding shows that Peregrine’s survival has depended on raising capital by issuing equity.

Clearly, Peregrine has become increasingly reliant on equity offerings to fund its business, and in our opinion, that’s unlikely to change anytime soon, regardless of what CEO King may have said in passing at the Wedbush conference.

Bavi and Peregrine: Unproven and Overvalued

Peregrine has been working on Bavi for nine years and still has not even reached Phase III. It has been working on Cotara for an even longer period of time, and Cotara has now been put on the back burner after Peregrine stoked shareholders’ hopes for years with press releases about Cotara’s Phase II trials. Normally drugs that are actually game-changing treatments reveal their amazing capabilities in a shorter period of time, particularly for diseases that have median survival periods of only a few months. If either Cotara or Bavi were revolutionary treatments, it seems unlikely that they would have needed nearly a decade to prove themselves. And if Bavi were really an amazing treatment for a variety of cancers, we would think that another pharma company would have recognized that by now and already partnered with Peregrine.

Instead, we appear to be seeing the same pattern that played out only six months ago. Peregrine rode a positive but thin sample of Bavi data to boost investor enthusiasm in December. When more complete data from the study came out, shares tanked. Now we again have a limited optimistic sampling of data from the same Bavi study and investors have bid the company’s shares to the heavens. There are ample reasons to suspect this will end the same way it did in March, with Peregrine shares experiencing a rapid decline once the market takes a more realistic view of the May data release.

Additional disclosure: Read our disclaimer.