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Novabay (NYSEMKT:NBY) is developing a novel anti-microbial agent (NVC-422) that has a mechanism of action different than current antibiotics as it is derived from a very different source. The drug has shown some early efficacy signals in a number of topical indications: impetigo, viral conjunctivitis, and catheter associated urinary tract infection. Given these early signals, multiple chances to get positive data this year, and a low valuation (just about $40 million market capitalization, which is only a $27 million enterprise value), this is a nice speculative investment or, at the very least, a company that should be on investors' radars. In this report, I will focus mainly on the science behind the lead program and the data from the impetigo indication.

Bacteria and fungi have been waging chemical war against one another for millions of years. These battles have led them to develop a plethora of anti-microbial agents. The vast bulk of our antibiotics derive from the discovery and modification of these compounds. While exceptionally useful, it is also the case that multi-cellular organisms also have effective techniques for killing foreign microbes. For instance, human neutrophils kill by creating a respiratory burst that generates highly reactive oxygen species and triggers a complex process leading to the death of the microbe. While this process is intricate, it is effective and offers a unique area to draw novel anti-microbial agents.

One of the chemicals generated as a consequence of the respiratory burst is N-chlorotaurine (NCT), which has significant activity against bacteria, fungi, viruses and parasites. The problem with NCT is that it is not stable at room temperatures making it difficult to use. To address the stability issues associated with NCT, Novabay has developed a C-methylated derivative: NVC-422. Theoretically NVC-422 should have similar anti-microbial properties of NCT with the same mild adverse event profile but have a significantly increased stability profile. The anti-microbial profile was examined by Wang et al 2011, who found that NVC-422 had a robust bactericidal effect across a range of microbes (see figure 1). It is important to note that they are reporting a minimum bactericidal concentration (MBC is the concentration of drug needed to kill over 99.9% of the microbes), which is generally a higher bar than the minimum inhibitory concentration usually reported (see Levinson 2004 for a discussion of MBC and MIC). Aside from the anti-microbial activity, NVC-422 showed the increased stability the company was targeting with the new compound (figure 2 from Wang et al 2011).

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Novabay is testing NVC-422 as a topical treatment in three indications: impetigo, viral conjunctivitis, and catheter associated urinary tract infection. While the company expects to report phase II data on all three of these programs this year, this report will focus on the impetigo indication when taking a first cut at understanding the effectiveness of this compound. Novabay signed a partnership with Galderma (private dermatology company formed as a joint venture between Nestle (OTCPK:NSRGY) and L'Oreal (OTCPK:LRLCY) [OR.PA]) in March 2009 to commercialize NVC-422 with a number of dermatologic conditions that exclude onychomycosis and orphan indications. In addition, Novabay reserved the rights to co-promote in Japan and retained all rights for promotion in hospitals and health care facilities in North America. In exchange, Novabay received $50 million in possible milestones and will receive royalties on sales that start at 10% and escalate to 30%.

In general, early trial results have been encouraging. The company has published (Iovino et al 2011) the results of their phase IIa trial in impetigo. Table 3 from Iovino et al 2011 summarizes the results. In general, the clinical responses ranged from 84% at the lowest dose to 92% at the highest dose. Aside from demonstrating a clear dose response, the data compares well to current treatments. Fusidic acid, for instance, had a one week cure rate of 55% (Koning et al 2004). In addition, Dagan and Bar-David (1991) found that mupirocin ultimately cured 98% compared to only 78% erythromycin. In contrast, Eelles et al (1986) showed only an 88% cure rate for mupirocin, which is certainly good but not close to the 98% seen in the Dagan and Bar-David (1991). Placebo effects in impetigo tend to be high and quite variable, where Bangert et al (2012) found placebo cure rates ranging from 13% to 52%. In general, then, the NVC-422 clinical response rates of 84% to 92% are at least on par with the best options on the market if not slightly better.

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Of course, phase IIa data are only signals of efficacy and there are always risks and rewards associated with early data. Obviously with such high clinical cure rates, the rewards seem obvious but there are some caveats that one should watch going forward. The biggest risk for the upcoming data comes not from the treatment group underperforming but a larger than expected control group effect. Cole and Gazewood (2007: 859) note that "impetigo usually heals spontaneously within two weeks without scarring." The early data presented by Novabay was at the end of treatment (day 8) but the trial being run by Galderma has success being determined at day 15. To some extent this benefits the treatment effect as the coding of response in the phase II trial at day 8 included both clinical cures and clinical improvements, so it is not clear how many patients were actually being cured at day 8. That being said, Iovino et al (2011: 591) note that "all clinical responders at day 8 that returned for the follow up visit at day 15 were clinical successes with a SIRS score of 0 (n=103)." This means that the clinical responses seen in the phase IIs trial should be similar to the clinical success in the new trial even though the earlier trial set a lower bar. The cost of using day 15 as the endpoint is that you increase the risk of spontaneous cures in the control group. While it has been noted that placebo responses range from 15% to 52%, it is still not clear if this response could be dramatically higher with the longer time lines.

While this is certainly something to think about, there might be some mitigating issues. First, there is likely a selection effect in terms of impetigo. While it may naturally end in a couple of weeks, it is likely that those cases that seek professional help are a more significant disease expression and are less likely to see a spontaneous cure. Second, a meta-analyses of impetigo trials found that topical treatments tend to outperform placebos despite the relatively high rates of spontaneous cure. The key, it appears, is the efficacy of the treatment. Koning (2009:71), for instance, found that mupirocin outperforms placebo, which is not surprising given that it appears to be the most effective topical agent in the market. Since NVC-422 had an efficacy similar to mupirocin in its phase IIa trial (keeping in mind the lower hurdle at day 8 but transition to cures by day 15), it seems a reasonable expectation that it will similarly outperform placebo.

The Koning (2009) report is interesting in that it found that while topical treatments tend to be effective, they are not necessarily any better than one another. In other words, there is not a "best" topical treatment. Novabay, however, shows (slide 27) that serial passage against MRSA leads to growing resistance to both mupirocin and fusidic acid, which might be a differentiating factor but it is not clear what effect this would have on the market opportunity. This is especially the case when impetigo can be successfully treated with topical mupirocin for about $62 (Cole and Gazewood 2007: 864). At this point, however, it is too difficult to determine where NVC-422 would fit into the commercial landscape given that its efficacy and safety profile has not been fully developed and there is still the growing threat of resistance to current treatments. On top of that, NVC-422 is partnered with Galderma, which is an exceptionally strong partner to have in this space. It is probably better to revisit the issue of commercial potential after the phase IIb data.

Overall, Novabay has an intriguing anti-microbial agent in NVC-422. It certainly appears active in impetigo and odds favor a successful data read out unless the control group greatly outperforms. In addition, the company has two other indications with phase II data this year making an investment more than a bet on a single trial. Finally, while this article has focused on NVC-422, the company is also developing an advanced wound care business that has value in its own right. When all is said and done, Novabay offers an intriguing risk reward at these prices and at the very least should be on the radar of investors as the efficacy profile of NVC-422 is elucidated with data readouts in 2013.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Novabay: A Novel Agent Against A Common Problem