By Ivan Deryugin
Since our last report on Achillion Pharmaceuticals (ACHN) in November, shares have turned up a muted performance, losing around 7%. Through February, shares rose steadily, climbing from just below $8 in November to above $10. However, beginning in late February, shares of Achillion began to sell off, falling below $7.40 as a secondary offering and a flare-up of concerns relating to Achillion's market position have put pressure on the stock. Many investors are under the assumption that through sofosbuvir, Gilead Sciences (GILD) will dominate the entire HCV market, leaving Achillion, Idenix (IDIX), and other HCV players behind. However, while Gilead is likely to claim a large portion of the global HCV market, the market is spacious enough for other players to carve out niches. And through a compelling portfolio of wholly-owned compounds, Achillion is doing just that. With a market capitalization of around $600 million (versus Gilead's $75 billion), Achillion's hurdle for success in the market (based on potential sales of its HCV drugs) is smaller than that of Gilead, AbbVie (ABBV), or Bristol-Myers (BMY), all of which are developing HCV compounds. And with a solid balance sheet and clinical pipeline, Achillion has what it needs to move out from under sofosbuvir's shadow.
Financial Review: Raising Discretionary Capital
In late February, in conjunction with its Q4 2012 earnings releases, Achillion elected to commence a secondary offering to bolster its balance sheet. It's important to note that this offering was not done under duress. Achillion ended 2012 with $77.418 million in cash & investments (and debt of $697,000), meaning that based on its 2012 burn rate of $46.534 million, Achillion had well over a year of operating cash remaining. However, Achillion elected to take advantage of market conditions to strengthen its balance sheet. The offering of 16,894,410 shares of stock, at $8.40 per share, closed on February 27, and raised a total of $133.5 million in the process. Importantly, the offering, which priced on February 21, came in at a discount of just 1.2% to Achillion's prior close. When the proceeds of this offering are taken into account alongside Achillion's present cash and expected quarterly burn rate for Q1 2013 of $11.6335 million (the company's average quarterly burn rate for 2012), Achillion's pro forma net cash balance currently stands at $198.5875 million, enough to fund operations for more than 4 years, based on the company's 2012 cash burn. Even assuming a 25% increase in operating cash burn (Achillion's compound annual growth in operating cash burn over the last 3 years), Achillion would still have enough cash & investments on its balance sheet to fund operations for nearly three-and-a-half years. Part of the pressure on Achillion's share price since then may be due in part to the sheer size of the offering: Achillion sold nearly 17 million shares in the offering, and with just under 80 million shares outstanding as of February 11, this offering expanded Achillion's share count by over 21%. The pricing, however, of Achillion's secondary was favorable, and with over $200 million in cash & investments on its balance sheet, Achillion isn't likely to return to the capital markets for some time, given that it has ample capital to fund its operations for several years.
Reviewing the Pipeline: Several Catalysts to Come in 2013
For Achillion, 2013 is set to be an active year in terms of moving its HCV programs through development. In late 2012/early 2013, Achillion conducted a "reframing" of its HCV program, and now breaks down its HCV development efforts into 3 different "cases":
- The Base Case: Achillion's base case is a combination regimen of ACH-3102, the company's NS5A inhibitor, and sovaprevir (formerly ACH-1625), Achillion's NS3 protease inhibitor, with or without ribavirin. This regimen is designed to target genotype I HCV patients, as well as other HCV patient subgroups.
- The Upside Case: Achillion's upside case is a regimen consisting solely of ACH-3102 and ribavirin, designed for the treatment of genotype Ib patients, as well as other patient subgroups. Genotype Ib is the prevalent form of HCV in Europe and Japan, and is also found in markets such as China and Brazil (in the United States, genotype Ia is the most common form of HCV, with 60% of HCV cases in the U.S. consisting of genotype Ia infections).
- The Value-Added Case: Achillion's value-added case, designed to treat genotypes 1-6, as well as special HCV cases, actually consists of 3 different regimens. The 1st consists of sovaprevir, ACH-3102, and DAAs (direct acting anti-virals). The 2nd consists of ACH-2684 (Achillion's next-generation NS3 protease inhibitor) with ACH-3182 and DAAs. The 3rd regimen consists solely of ACH-3182 and DAA's.
Achillion is moving each of these regimens through the clinical development process, and in 2013, the company will release several sets of clinical data for its HCV development program.
Achillion will release SVR4 (Sustained Virologic Response at 4 weeks) data for genotype Ib CC patients taking ACH-3102 with ribavirin this month (the company's "upside case"). ACH-3102 is an NS5A inhibitor that has shown itself to be far more effective at preventing resistance than previous generation inhibitors, and it has been granted Fast Track status by the FDA. Baseline amino acid variants within the NS5A protein confer resistance to these inhibitors, and many patients see a quick emergence of resistant variants of HCV when they begin treatment. ACH-3102, however, has been altered by Achillion to retain its efficacy against such strains of HCV, and in clinical data, it has shown itself to be effective, with a decent safety profile. In January, Achillion reported interim data for ACH-3102, and announced that enrollment in its Phase IIa trial of ACH-3102 has been completed. The primary endpoint of Achillion's Phase IIa trial is safety, as well as SVR12. Secondary endpoints include RVR (Rapid Virologic Response) & ETR (End of Treatment Response). The clinical data showed that ACH-3102 was well tolerated in the 8 patients for whom data was available, with no serious adverse events or treatment discontinuations reported. Within that trial, 100% of patients that completed treatment (n=3) achieved SVR4, and those 3 patients also all achieved ETR. Importantly, no patients in the trial showed viral breakthrough, which helps underscore the high barriers to resistance that ACH-3102 has, which will likely be a key selling point for the drug if and when it secures FDA approval. RVR was seen in 6 out of 8 patients (75%), and is defined as 25 IU/mL at week 4. Two of the patients in this trial, however, did not achieve undetectable levels of HCV RNA, which, on the surface, is cause for concern. These 2 patients (defined as Subject E and Subject F) had clinical virologies far different than those of the other patients that Achillion has produced data for. Data for Subject E showed that this patient experienced a 3-log reduction in baseline HCV RNA after week 1 of the trial, but that the improvements in HCV RNA tapered off after that. Further research revealed that Subject E has, at a minimum, 3 linked viral mutations, which is highly unusual within HCV cases. It is these linked mutations that can lead to viral breakthroughs, and Achillion's CSO has noted that the probability of a patient having this level of mutations is highly unlikely. Subject F had even more mutations. An analysis done by Achillion revealed that this subject had 6 mutations that help confer resistance to NS5A inhibitors, and the company has been unable to rule out the possibility that Subject F had prior exposure to other NS5A inhibitors. But, Subject F still saw decreases in HCV RNA while taking ACH-3102, and this supports Achillion's notion that ACH-3102 has high barriers to resistance. Achillion will be releasing updated SVR4 data this month, and SVR12 data is set to be released in the 2nd half of 2013, providing investors with another opportunity to see the efficacy and safety profile of ACH-3102.
Sovaprevir, also known as ACH-1625, is Achillion's NS3 protease inhibitor, and forms the core of Achillion's "base case," which combines sovaprevir with ACH-3102, with or without ribavirin. Sovaprevir features once-daily dosing, requires no boosting, and has a low probability of drug-drug interactions. The drug has shown high potency (IC50 ~ 1nM), and has acceptable barriers to resistance, albeit not at the levels of ACH-3102. In Phase IIa trials, sovaprevir was well tolerated, with no patients discontinuing treatment due to sovaprevir at any of the 3 dosage levels (200 mg, 400 mg, and 800 mg). From an efficacy perspective, sovaprevir's efficacy, as measured by SVR12, differed depending on the dosing levels. 80% of patients in the 200 mg dose arm showed SVR12, 77% showed SVR12 in the 400 mg dose arm, and 85% showed SVR12 in the 800 mg arm. Achillion will be initiating Phase II trials that combine sovaprevir with ACH-3102 in genotype I patients during Q2 2013. Achillion will utilize staggered dosing for ACH-3102, with patients receiving a 150 mg dose on day 1 of the study, followed by 50 mg "maintenance" doses. The rationale behind such a move stems from viral kinetic models Achillion created utilizing Phase I data for ACH-3102 and sovaprevir, which have led the company to believe that this dosing strategy will lead to high viral clearance in test subjects. In addition, CSO Milind Deshpande has stated that if Subject F were in this particular clinical trial, the addition of sovaprevir could have a meaningful impact on their HCV RNA. As for the use of ribavirin, Achillion plans to conduct the first stages of this trial with ribavirin, and then make a decision as to whether or not to drop it, contingent upon what kind of sustained viral responses it sees in patients on ribavirin. The study will be conducted initially in the United States, leading to a high level of genotype Ia patients, and will focus on RVR and SVR4 as its virologic endpoints. Incremental data regarding this trial could be available in the 2nd half of 2013.
ACH-2684 forms a crucial part of Achillion's "value added" case, however, with only Phase Ib proof-of-concept trials complete, focus has not yet shifted to this clinical program. Unlike Achillion's other 2 programs, the company has expressed interest in partnering with other companies in conducting clinical trials of ACH-2684 in combination with other HCV assets. In Phase Ib trials, ACH-2684 was well tolerated, and saw decent efficacy in both genotype I and genotype III patients. At the 400 mg dosing level (twice daily), genotype III patients saw HCV viral load drops of as much as 2.03 log10, and genotype I patients (at once-daily dosing) saw mean reductions of 3.73 log10. In addition, Achillion has tested ACH-2684 in cirrhotic patients, and at the 400 mg dosing level (once daily), these patients saw mean HCV viral reductions of 3.67 log10. While Achillion is currently focused on ACH-3102 and sovaprevir, investors should not forget ACH-2684, and we believe that as 2013 progresses, Achillion will provide more color on this particular clinical asset.
Defining Achillion's Niche
To compete against sofosbuvir, Achillion (as well as other HCV-focused companies) cannot simply go head to head with what has become Gilead's most important asset. They must frame their HCV assets as providing something different. And when it comes to ACH-3102 and sovaprevir, Achillion has defined its niche quite well. ACH-3102 has a long half-life, and features biphasic elimination within a patient's system. The first phase lasts between 25 and 30 hours, and the second (terminal) elimination phase lasts about 250 hours. ACH-3102's long half-life is due to the fact that while 90% of the drug is eliminated within 48 hours, the remaining 10% is eliminated far slower. Achillion has argued that ACH-3102 can offer meaningful advantages in treating HCV patients co-infected with HIV, as well as cirrhotic patients. Around 10% of the total HCV patient population is co-infected with HIV, and the company has expressed interest in conducting clinical trials of ACH-3102 with ribavirin or ACH-3102 & sovaprevir & ribavirin exclusively in these patient populations. Achillion is also planning on conducting trials of ACH-3102 in other genotypes (specifically genotypes II, III, and IV), with the goal of starting these studies before the end of 2013. In addition, Achillion CSO Milind Deshpande spoke at length on the company's Q4 2012 conference call about another potential market opportunity: transplant patients. Several of ACH-3102's qualities create potential for its use in this market. Aside from the compounds high level of resistance and its long half-life, the uptake mechanism of ACH-3102 has the potential to be useful in treating transplant patients. The uptake of ACH-3102 into the liver does not require any transport mechanisms, and parasite models involving ACH-3102 have shown that its uptake occurs passively, not actively. We believe that through the course of 2013, Achillion will provide more color on its potential niche HCV markets, and that as more clarity on such markets materializes, confidence in Achillion's market position will improve.
Takeover Prospects: Setting Aside the Mania
As Gilead took control of Pharmasset, and Bristol-Myers took control of Inhibitex, speculation intensified that Idenix and Achillion were imminent takeover targets. This speculation pushed Achillion's share price to well above $12 in early 2012, and the deflation of said speculation helped contribute to Achillion's fall to below $6 by August 2012. On the surface, Achillion seems a tempting target. With its recent equity offering, the company has enough cash to fund operations for several years. And even more importantly, its HCV assets are un-partnered, meaning that any potential acquirer would retain full economic rights to ACH-3102, sovaprevir, and ACH-2684. And Achillion executives have gone on record in saying that they are open to the idea of a takeover, with CEO Michael Kisbauch stating in November 2011 that Achillion was in "advanced discussions" with potential partners or acquirers. A variety of companies have been named as potential suitors for Achillion, including Gilead, Vertex, Bristol-Myers, Merck (MRK), Roche (OTCQX:RHHBY) and AbbVie . However, the HCV market of today is quite different than that of late 2011 and early 2012, and several of these suitors may not be as driven to acquire Achillion as they could have been during that time period.
- Vertex: Despite launching the new wave of HCV medications with Incivek, the drug has been overshadowed relatively quickly by sofosbuvir. Vertex has shifted focus towards its cystic fibrosis (CF) franchise, and although the company is still developing next-generation HCV drugs (the company inked a collaboration agreement with Bristol-Myers for VX-135 on April 5), it is clear that Vertex is prioritizing the expansion of its CF franchise. And although the company's financial position is solid (with over $900 million in net cash & investments), we believe it would be difficult for Vertex to maintain its existing levels of R&D and take on the development of Achillion's HCV drugs without compromising its financial position.
- Bristol-Myers: Only 8 months after its takeover of Inhibitex, Bristol-Myers was forced to write off $1.8 billion of the $2.5 billion takeover due to adverse kidney and heart toxicity, effectively wiping away nearly $2 billion of shareholder value in a single deal. The company's board of directors is likely to have a much higher bar for future HCV deals (and perhaps all deals) after the failure of Inhibitex's lead clinical program, thereby diminishing the odds of an Achillion takeover, for the level of scrutiny that Bristol-Myers may have relating to Achillion could potentially only be satisfied after Achillion reports a slate of positive clinical data, thereby making the price tag of any deal more difficult to digest. This should not be seen as a strike against Achillion. Rather, it is a reflection of the possibility of increased conservatism on the part of Bristol-Myers. Having lost nearly $2 billion on one HCV deal, the company may be skeptical about conducting any additional HCV deals.
- Gilead: Analysts have argued that a Gilead takeover of Achillion would be a defensive move, and allow the company to fortify its market position in HCV. The combination of sofosbuvir, ACH-3102, sovaprevir, and ACH-2684 could be a powerful portfolio that would further cement Gilead's status as the market leader in HCV. However, Gilead's financials (both its balance sheet and its stated financial goals) diminish the odds of such a deal, at least in the near-term. Gilead ended 2012 with $2.58 billion in cash & investments, and with Achillion's market capitalization currently under $600 million, a takeover would seem palatable, even when a decent premium is factored in. However, the takeover of Pharmasset saddled Gilead with over $6 billion in new debt (the company ended 2012 with over $8 billion in debt) and the company has turned its focus towards deleveraging, with a stated goal of reaching a debt level of 1.5x EBITDA by mid-2013. Gilead has already slowed its buybacks dramatically to accommodate this goal (less than $700 million of stock was repurchased in 2012, down from $2.3 billion in 2011 and over $4 billion in 2010), and a takeover of Achillion would likely derail Gilead's deleveraging goals.
Achillion's standalone prospects are bright, and it is on those standalone prospects that the bullish thesis for the company is based. The HCV market of 2013 is different than what it was in late 2011 and early 2012, and we do not recommend that investors buy shares of Achillion based solely on a belief that the company will be acquired. While a takeover is not outside the realm of possibility, market conditions are no longer as conducive to such an outcome as they were in 2011 & 2012.
The HCV market is more than just sofosbuvir, and Achillion Pharmaceuticals has the potential to play meaningful role in its global expansion. The company has a solid and unpartnered pipeline with several catalysts in 2013, and a strengthened balance sheet with enough cash to fund operations for several years (based on current burn rates). Investors that have not yet invested in Achillion have been presented with an attractive entry point, and existing investors have been offered a chance to increase their stakes at attractive prices.
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