We like to write about a wide range of ideas in the financial markets, even if such ideas may be well beyond the high end of our own risk spectrum. Our writings on the smaller, high-growth (and riskier) ideas in healthcare/biotech, for example, remain an attempt to draw attention to some of the fantastic innovation helping to reshape treatment paradigms. Let’s follow up on some of the high-risk companies in the healthcare/biotech arena that we previously highlighted.
By Alexander J. Poulos
Loxo Oncology Scores a Major Partnership
Image shown: Loxo is bouncing off of support levels following its “gap higher” earlier this year. This looks bullish. Chart as of December 10.
In July of this year, we provided a detailed overview of the stunning advances at Loxo Oncology (LOXO) in a piece titled “Loxo Oncology Presents Compelling Data on Its TRK Inhibitors,” A brief overview of the science behind the TRK inhibitors: A defective TRK gene can fuse with another otherwise healthy gene resulting in abnormal growth that may provide the necessary impetus to spark the growth of a tumor. The abnormal TRK fusion gene is witnessed in a broad swath of solid tumors, hence the theory of targeting the TRK gene mutation as a way of combating solid tumors.
Loxo data was the runaway smash of June’s ASCO conference, but Loxo remains an early stage company that continues to consume cash as it funds additional clinical trials for its promising compound Larotrectinib. The equity ran up into the $90 range post our article as speculators wagered that Loxo Oncology would become a prime target for an acquisition from Big Pharma.
The share-price has subsequently sold off in what we view as an overreaction as Loxo cemented a deal with Bayer (BAYRY), a German multinational with extensive expertise in life sciences and chemicals. We reviewed the terms of the agreement and found them very acceptable as Loxo will receive a $400 million upfront payment along with an even split of development costs. In essence, the $400 million should be viewed as a reimbursement of the costs incurred thus far in addition to providing seed money to guide Loxo through the next round of development and ultimate commercialization.
Loxo is entitled to additional regulatory milestones of $450 million and a further $200 million in milestone payments upon regulatory approval and the first commercial sale in specific major markets. Bayer with its extensive network of contacts in its home markets in Europe will assume the regulatory and commercialization duties while paying Loxo a double-digit tiered royalty. We find this as a desirable outcome as Loxo does not have the means, nor expertise to build out a sales force for Europe. Loxo will evenly split the commercialization costs in the US with Bayer. We interpret this part of the agreement as a clear signal that Loxo has ambitions to grow the company instead of looking for a quick exit.
We think the deal is a necessary first step in what appears to be a bright future ahead for Loxo Oncology. The transaction with Bayer should pave the way for Loxo to bring Larotrectinib to market with a firm plan in place to market and support the growth of the product.
Clovis Oncology Disappoints Investors
Shares of Clovis Oncology (CLVS) have recently come under heavy selling pressure as initial sales results of Rubraca have disappointed investors. Rubraca reported sales of $16.8 million for the recently-concluded quarter, which did not provide a spark to catalyze a run higher for the equity. We feel the sell-off at Clovis is symptomatic of the broader overall selling in the biotech market as many speculators have fled.
Image shown: Clovis’ stock has “closed the gap higher” from earlier this year. Chart as of December 10.
As of the end of the third quarter of 2017, Clovis had $628 million of cash and marketable securities on hand which should prove to be an ample amount to fund label expansion for Rubraca further. Unlike Loxo, Clovis is utilizing a go-it-alone strategy as it attempts to build from scratch a sale force to market and support the launch of Rubraca. Our challenge with this stratagem is the sudden shift in focus. Clovis’ primary strength is in drug development an entirely different animal from sales and marketing. We believe it is a very ambitious goal to attempt to fund R&D while diverting additional resources to market Rubraca.
Naturally, speculators have seized on this info that Clovis is receptive to a potential acquisition since a co-development deal is not in place. Using the equity reaction to the Loxo deal discussed above as a template, a specific deal premium was built into the share price of Loxo as speculators concluded an acquisition was imminent. When a co-development deal materialized, it acted as a catalyst for an equity sell-off. We feel a similar phenomenon is in place at Clovis even though an agreement is apparently not in place.
For those who wish to speculate in the oncology space, it is essential to keep in mind the indication for the primary clinical compound. In the case of Rubraca, it is the only molecule that is being developed by Clovis, which adds an extra layer of risk to the name. Rubraca has thus far been granted approval to treat those affected with advanced ovarian cancer with a BRCA mutation that failed two or more rounds fo chemotherapy. Clovis is in the midst of funding additional trials to expand the prescribing label into prostate cancer and for maintenance therapy in ovarian cancer, which if successful, will expand the overall patient pool.
We will continue to monitor events as they unfold at Clovis. We feel the go-it-alone strategy at this time is the correct move. If Rubraca continues to expand its prescribing label the value of the company as an acquisition target may continue to grow, provided valuations and financing hold up in this frothy marketplace. Conversely, the opposite is also true. If Rubraca fails to post impressive data in ongoing clinical trials the value of the company would significantly diminish, even if the marketplace remains overheated.
Nevro Shocks Investors
Shares of medical-device maker Nevro (NVRO) came under intense selling pressure post the release of its earnings report on November 6th. Nevro reported sales of $82.3 million versus $60.9 million for the equivalent period in 2016. The results denote a year-over-year revenue growth rate of ~35%, which is outstanding.
The equity sold off as the company offered sales guidance for the fourth quarter which failed to inspire confidence. Nevro expects sales for all of 2017 to fall within the range of $315-$320 million in 2017 versus a previously-disclosed range of $310-$320 million. The failure to raise revenue guidance, in our view, has served as the primary catalyst for the recent leg down in the share price.
Image shown: Nevro appears to be breaking through support levels, a bearish sign. Chart as of December 10.
We are not surprised with the inherent volatility in the share price of Nevro, however. We find exaggerated moves in high-growth entities in the biotech/med-device space as par for the course (as risk and uncertainty runs high). Though we’re very much cognizant of pricing action, we are more concerned with the underlying molecule/treatment. In the case of Nevro, for example, the Senza neurostimulator continues to grow its share of the overall market.
We feel that perhaps an overlooked portion of the recently released earnings report may be the increase in gross margins; we generally view the rise in margins as evidence of the potential for profitability to expand further through economies of scale if Nevro can continue to drive top-end sales. Gross margins for the third quarter equaled 70% versus 69% in the previously completed quarter, a nice move high considering the pace of growth.
Nevro is not a profitable company as it continues to invest in further studies of its product suite to gain additional indications, so there remains tremendous risk, of couse. However, Nevro remains firmly entrenched in its initial growth trajectory as it is building out its sales force to market and support its Senza products which remains a costly endeavor. As we have seen in the above mentioned Clovis example the go-it-alone strategy is expensive but potentially very lucrative if the product can capture significant market share, thus catapulting the company into the pantheon of a well-entrenched industry stalwart. We will continue to monitor events as they unfold at Nevro, and we will post a timely update when warranted.
<This article discusses information regading very risks biotech equities. Investing in any stock is associated with risk of capital loss, but especially so with biotechs.>