Biotechnology stocks continue to be some of the strongest performers in the markets as favorable legislation, such as the FAST and TREAT acts, have helped boost investor optimism. One of the most promising approaches in biotechnology is immunotherapy. Over hundreds of millions of years, the immune system evolved to defend humans from the non-stop attack of pathogens such as bacteria, viruses, fungi and yeast which see the human body as a luxuriant feeding ground. Deeper understanding of the functioning of the human immune system results in the development of novel therapeutic advances and NovaBay Pharmaceuticals (NBY) is a leading participant.
NovaBay technology base stems from an understanding of the action of neutrophils in the body. The first line of defense against pathogens is the barrier formed by skin and mucous tissue. When a pathogen breaches this barrier and causes an infection, the immune system springs into play and the first immune cell encountered by the pathogen is usually a white blood cell called a neutrophil. The neutrophil surrounds and ingests the pathogen and produces chemicals that kill it. Unlike antibiotics, pathogens have not been able to resist neutrophils. However, naturally-occurring neutrophils are particularly unstable with a very short shelf-life, making them unviable as a commercial product.
NovaBay's key skill was successful development of synthetic molecules that are a stable form of neutrophils. These compounds (branded as Aganocides) have a shelf-life of over two years. In total NovaBay has created over 200 different Aganocides against bacteria, viruses and fungi. The company received the patent for one of Aganocides called NVC-422 that expires in 2026. It developed the three products linked to NVC-422: a dermal gel for the skin disease impetigo, an eye drop for viral conjunctivitis and a catheter lock solution for treating urinary catheter encrustation and blockade. NovaBay also has the additional opportunity for its first product NeutroPhase: it is effectively four companies in one.
NeutroPhase received approval in the US and is the only hypochlorous acid product available to treat the estimated 6.5 million patients suffering from chronic non-healing wounds. In January 2012 Pioneer Pharma Singapore licensed rights for NeutroPhase in China for $1.3m ($312,500 upfront), on September 14 completed of $2.5m investment as part of the distribution agreement, on October 31 purchased 1,200,000 shares and on November 5 invested $1.5m in equity. Potential sales are more than $200m; discount of 10% gives $54 million of pretax profit; discount of 15% gives $36 million. Thus, the potential of NeutroPhase alone justifies the $37 million market valuation of the company.
NovaBay, however, is subject to the risks typically associated with biotech company drug development, such as unfavorable outcomes in clinical trials, success of competitors and commercial decisions by partners. In general, probability of success at phase III for immune systems is 63%. The company carries zero debt, with 28.87m shares outstanding, with a trading float of 22.37m shares. NovaBay requires more capital in 2013 and an equity offering of $10 million is expected. At the current price of $1.30 with 50% warrant coverage this offering will increase the number of shares to 46.4 million. Cash totaled $10.37m with a current burn rate of $700k per quarter. Cash is always a concern with small biotech companies, but NovaBay expects license and collaboration revenue from Galderma (see below) and Pioneer Pharma, along with their capital reserves to be sufficient to fund planned operations the next year.
Impetigo is a highly contagious bacterial skin infection common in pre-school children and adolescents. In March 2009, NovaBay partnered with Galderma (the world's largest dermatological company) to use NVC-422 against impetigo and acne. Galderma has exclusive worldwide rights and will pay royalties starting at 10% and increasing with sales to 30%. Galderma is conducting a phase IIb/III study with 350 impetigo patients and said that it sees a potential $400 million worldwide sales opportunity. Discount of 10% of royalties for NovaBay produces $118 million of pretax profit - discount of 15% gives $70 million. This can increase the stock price to $2.00.
There are three other candidates past phase II for impetigo. Ferrer's (privately-held Spanish group) second-generation antibiotic, ozenoxacin, is undergoing a Phase III study and the company is seeking a development partner for its product. Foamix develops a tetracycline antibiotic. It completed phase II with 80% and 96% cure rates after days 3 and 7 respectively.
Conjunctivitis is commonly known as red eye. In the USA there are 3.7 million cases a year. The phase II trial started in May 2012 and could be complete in mid-2013 and, if successful, NVC-422 could be approved and marketed in 2016. Using a discount rate of 10%, the net present pretax value of the royalty stream is $786 million; discount rate of 15% gives $530 million. Thus, success of this trial can drive the stock over $10 in a few years.
There are only three other candidates in development past phase I as potential competition for NVC-422 in viral conjunctivitis. Two are based on a combination of povidone-iodine (broad spectrum antiseptic) with dexamethasone (corticosteroid) - investigational study at the University of Campinas, Brazil and the privately-held US biotech Foresight Biotherapeutics. Ganciclovir ophthalmic gel, already approved and branded as Zirgan by Bausch & Lomb to treat herpetic keratitis, is also being tested as a potential therapy.
The blockage and encrustation of urinary catheters is a serious and poorly managed complication for more than 335,000 patients in the US alone. Saline, acetic and citric acids are commonly used but they should be applied 21 times per week. In contrast, NVC-422 can be administered just twice a week. NovaBay is conducting the second part of a Phase IIb study of NVC-422 that should be completed in Q3 2013. Results from the first-stage of the study showed that NVC-422 prevents catheter blockage in 80% of paired comparisons.
NovaBay will build a commercial sales force to market NVC-422 for urinary catheters in the US. The potential is second only to the viral conjunctivitis as a successful commercial organization is much more valuable than licensing.