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Small-cap biotech investing carries real risk. Startup companies tend to have only a few ideas in development, which leaves ample room for setbacks-even room for disaster. Robert "Bert" Hazlett, senior biotechnology research analyst with ROTH Capital Partners, doesn't mind taking such risks, but tempers them with a diversification strategy designed to minimize the impact of potential hiccups and blowups. In this interview with The Life Sciences Report, Hazlett expands on his strategy and mentions four companies with experienced management teams and high hopes for huge returns.

The Life Sciences Report: Bert, you have longevity in the business as a sellside analyst, and I thought it would be worthwhile to get your thoughts on how biotech investing has changed over the last 15 years.

Bert Hazlett: It's been quite a rollercoaster. For more than 15 years now, I've been considering the drug development industry broadly-both on the biotechnology side and the pharmaceutical side. From an investing perspective it seems as if it's been either feast or famine. However, at this point, I believe some of the fundamentals for the industry have changed for the better, and I am more constructive on the investment prospects for the life sciences sector than I have been in a long time.

When you step back and view it broadly, this is the first time in well over a decade that there has been a whiff of efficiency gains in the area of drug development. These gains, I believe, are due to the progression in our understanding of the biology of dysregulated cells, combined with greater regulatory acceptance of biomarkers and other tools that together are leading to enriched, more definitive trial designs. For these reasons, individual companies and their programs have the potential to progress more rapidly and more efficiently.

These developments are encouraging, some of the first positive steps we have seen toward efficiency improvements in drug development in a very long time, and we've seen positive responses in terms of the biotech and pharmaceutical indices as a result. I believe these efficiency gains will be increasingly recognized and will continue to permeate the investment climate for the next several years.

TLSR: Bert, do retail investors need to understand the science behind a therapy, or do they just need to understand the unmet need and the size of the market?

BH: I believe they need a bit of both. Retail investors need to understand that an unmet need is significant, and they need to understand the particular strategy being used by a company or therapeutic to address that unmet need. There has to be at least a basic understanding of the biology-and though it would help, that understanding doesn't necessarily need to be exhaustive.

What we have encouraged investors to do is to consider more of a portfolio approach toward investing in the biotechnology sector. In drug development, complications inevitably arise. Sometimes they can be anticipated, sometimes not. Sometimes they're small, and sometimes they're more meaningful. They can create material issues for companies, some of which are solvable and some of which are not. To mitigate the impact of a specific complication with any single program, I believe a portfolio of assets is the way to proceed in biotech investment.

TLSR: Bert, we have both institutional and retail readership at The Life Sciences Report. I want to ask one more question from the retail point of view. Have retail investors begun to get a handle on the complexities of biotech investing? Do they understand the inherent risks, especially as they look at animal models and expect those data and that efficacy to be translated to humans?

BH: I think it's important for retail investors-and all investors-to understand that increasingly complex leaps of faith and judgment are necessary for successful drug development. The process involves preclinical work, where researchers look for safety and evidence of proof of principle, but it becomes increasingly complex as research gets into humans. To some degree, you have to have faith in a management team's ability to successfully interpret, understand and apply the nuances learned from research to move a compound from preclinical models to humans, and then to successfully position the compound so it has the best opportunity to demonstrate efficacy and safety in a manner that will make it competitive in the marketplace. A retail investor needs to come to grips with the fact that biotech is a high-risk area. And I can't stress this enough-a portfolio approach is essential to diversify risk.

TLSR: Now that you have firmly established the need for a portfolio approach to biotech investing, why don't you pick a basket of stocks for our readers? Start with your favorite one.

BH: To make those leaps of faith and span the gaps in efficacy between animal models and humans, an investor should select companies led by either successful investors or management teams with particular expertise in an area. Along those lines, let me start with two names: OvaScience Inc (NASDAQ:OVAS) and Prothena Corp. PLC (NASDAQ:PRTA).

OvaScience is a company focusing on fertility, an area that has not seen a lot of innovation over the past 15-20 years. The company's management team has been able to develop opportunities on the back of very intriguing recent biological discoveries. OvaScience co-founder and CEO Michelle Dipp, a physician, is also a founder and partner at the Longwood Fund, which establishes and invests in healthcare companies. Before OvaScience, she was with Sirtris Pharmaceuticals, which was acquired by GlaxoSmithKline (NYSE:GSK) back in 2008 for $720 million [$720M]. She was also involved in the sale of the company. You have a leader at the OvaScience helm who is very seasoned in medicine, as well as in biotechnology and pharmaceutical development.

OvaScience is relying on the recent emergence of biology that shows mature females have egg-producing cells, which the company calls EggPCs. These EggPCs are the source of OvaScience's new technologies, which are designed to enhance procedures like in vitro fertilization [IVF].

TLSR: I know the company has two programs. Would you talk about them and the value proposition?

BH: OvaScience's first program, AUGMENT, is based on supplementing unfertilized eggs with additional energy in the form of mitochondria from EggPCs, which can increase the success rate of IVF. The therapy is designed to improve IVF by injecting mitochondria from EggPCs into a mature oocyte, along with sperm. If successful, this would be a very important development in the world of fertility. The company could launch AUGMENT as early as H2/14, on the heels of a study that is currently underway. AUGMENT has the ability to be a material addition to the IVF process.

The company has a second technology, called OvaTure, which takes EggPCs and actually matures them into fertilizable eggs. This is groundbreaking technology that could actually change or replace IVF. That said, OvaTure is at an earlier stage and is a higher risk technology. Right now, the AUGMENT product alone makes OvaScience very attractive. We have an $18 price target. We like OvaScience a lot.

TLSR: Are any hormones used in the AUGMENT process to stimulate production of these EggPCs?

BH: The typical IVF process includes ovarian hyperstimulation, producing a larger number of eggs using a hormone injection. The small ovarian tissue biopsy taken to harvest the EggPC material with AUGMENT occurs prior to the IVF procedure, so no hormones are used beyond what is required for regular IVF.

TLSR: The regulatory pathway for the AUGMENT program is the U.S. Food and Drug Administration's [FDA's] 361 HCT/P pathway, which is for minimally manipulated tissues and cells. Is there any chance the FDA could step in and say it will regulate this technology and require trials under a premarket approval [PMA], or the less stringent 510[k] pathway?

BH: The 361 HCT/P deals with specific tissues and minimal alteration of those particular tissues. Our view is that AUGMENT is eligible for 361 HCT/P because it is using the mitochondria from a patient's own cells, though there is a risk that the FDA could ask the company to do more work than its current single study. The company has communicated with FDA about its plans for AUGMENT, and at this point has not been asked to do more.

TLSR: Investors are obviously interested in share price catalysts. As we move into and through H2/13, the company is scheduled to expand its study. Could this be a catalyst to move the shares in a positive direction?

BH: The upcoming study expansion is important, and one of the reasons the company raised money recently. I believe that increased awareness that OvaScience is moving aggressively into certain international jurisdictions should be a catalyst for investors. Particularly in Europe, where there is a much higher rate of IVF procedures, there has been good receptiveness to OvaScience and AUGMENT.

TLSR: What is the business model of OvaScience? How will the company realize revenue from the AUGMENT program when it's marketed? What is its product?

BH: The separated mitochondria isolated from the EggPCs are the company's product. OvaScience has not disclosed a ton of information about its process because it considers that a trade secret.

TLSR: When the product is returned to the clinician, the procedure then becomes a regular IVF procedure. Is that right?

BH: When the mitochondrial product is returned to the clinician, the intra-cytoplasmic sperm injection occurs, as does the supplemental injection of the mitochondria into the egg. AUGMENT largely fits right into the regular IVF regimen.

TLSR: I'm sure most payers will not be covering this service. Fertility has traditionally been a cash business. How much will this cost the patient?

BH: We believe that pricing would be about the same as that of acquiring a donor egg, which is roughly $15,000 [$15K] per procedure. OvaScience's view is that it should be able to price its technology along those lines because individuals would likely prefer to successfully use their own eggs.

TLSR: Are additional doses able to be preserved until the next ovulation cycle? Will multiple doses of mitochondrial material be sent back to the obstetrician/gynecologist?

BH: Both the cells and the mitochondria can be preserved. OvaScience has done cryo [freezing] tests on the mitochondria, and they appear active after freezing. There is the potential for multiple doses to be created, but we are not certain how that will be handled by the company.

TLSR: AUGMENT is the lead program for OvaScience. It's in the clinic, in a trial of up to 40 patients who have failed 2-5 IVF cycles. The program will utilize the 361 HCT/P pathway, so basically, the company does not need FDA approval. On the other hand, the preclinical OvaTure program, which is designed to create mature fertilizable eggs from the patient's EggPCs, will require an investigational new drug [IND] process and ultimately a new biologic license application [BLA] must be filed. Why the difference?

BH: With AUGMENT, OvaScience is taking a mature fertilizable egg and adding to its level of mitochondria. With OvaTure, it is taking the EggPCs themselves and maturing them in a bed of ovarian tissue to become fertilizable oocytes. This program is still in early stages, and in our view there are materially more regulatory hurdles to be completed. Because of that, it is higher risk. But it is being viewed by investors-and by me-as a potential replacement for IVF rather than a cooperative technology.

TLSR: You said you wanted to talk about Prothena. Go ahead.

BH: Like OvaScience, Prothena has a seasoned management team that includes experts in drug development who came from Elan Corp. (NYSE:ELN). The Prothena team played a material role in the development of anti-abeta [amyloid beta protein] antibodies for Alzheimer's disease and of the anti-cell adhesion antibody Tysabri [natalizumab] being used in treatment of multiple sclerosis [MS]. The team at Prothena has significant expertise in the areas of protein misfolding and cell adhesion, which are the focus of the company's primary development efforts. We think the company represents a high-risk/high-reward opportunity for investors, given management's expertise and the opportunities within its pipeline.

TLSR: I'm looking at the development pipeline, and the disease indications are all tough ones. The lead compound NEOD001, an antibody, for AL and AA amyloidosis, is in Phase I, and there are preclinical programs for PRX002 for Parkinson's disease and PRX003 for inflammatory diseases and metastatic cancer. None of the Prothena programs are palliative-they are all proposed as disease-modifying agents. If any one of these programs can be developed to maturity, your target price of $16 is very low.

BH: We agree. If any one of these programs progresses materially, our current target price will turn out to be very low. We incorporate healthy discounts in all of these programs because, as you correctly point out, these are disease-modifying opportunities for very significant, very devastating conditions that are also very high risk.

Our view is that Prothena has good shots on goal for all of these indications. That doesn't guarantee success by any stretch of the imagination, but the Prothena team has developed antibodies that have shown activity in other challenging settings. We believe this team understands protein misfolding extremely well, and can develop therapeutics with the potential to be quite meaningful.

Regarding the lead program, NEOD001 for amyloidosis, some investors may say it's very early. We are interested because, in this initial study, the antibody is being examined in patients with amyloidosis, rather than in healthy volunteers, so we may get a meaningful signal of efficacy even at this early stage. The antibody is designed to clear the misfolded protein deposits in these patients, and because of that, we could see some benefits in organ performance. If the therapy shows even modest benefit organ or disease burden, we believe that could trigger the potential for its rapid development.

TLSR: Are you saying that a Phase III program might not be necessary in this situation?

BH: Absolutely. Amyloidosis is a disastrous situation for patients. With a meaningful signal in this initial study, if this antibody behaves in humans as it has in preclinical models, you could envision a scenario where you have very rapid development of the molecule. A meaningful Phase II study might be enough. Having that potential, with signals that can be gleaned from early-stage data-perhaps as early as the beginning of next year-puts Prothena in a different class than an ordinary biotech company with a Phase I program.

TLSR: When will we hear about the Phase I program, since it could be so important?

BH: We hope to have early data on NEOD001 in the beginning of next year, and the potential to move into Phase II could occur as early as H1/14.

Prothena's other programs are worth considering as well. PRX002 for Parkinson's disease is an antibody that targets misfolded alpha synuclein, which appears to be a bad actor in neuronal death in Parkinson's. That target is gaining a lot of attention in the field, and Prothena may enlist a partner to move the program along rapidly, which we believe would be a positive catalyst for its shares.

PRX003, for inflammatory diseases and metastatic cancer, targets the melanoma cell adhesion molecule [MCAM]-right up the alley for this team, which developed Tysabri for MS. MCAM is an extremely interesting target, as it is involved with tumor angiogenesis and is a recognized marker of cancer metastasis, so the company has several directions to consider with its development. Though it is very early, the more I consider this product's potential, the more I am intrigued, and I believe the company feels the same way.

TLSR: Let's move to another idea, please. What else did you want to talk about?

BH: Endocyte Inc. (NASDAQ:ECYT) is a very interesting company that is evaluating the use of prognostic tools to identify patients who have the potential to respond better to its oncology therapy. It is using overexpression of the folate receptor, which is expressed on tumor cells but not on most healthy cells, as a biomarker. Between 80-90% of ovarian and lung cancers express the receptor. Endocyte has developed a folic acid vehicle linked to a cytotoxic warhead that targets the folate receptor. The folic acid/cytotoxic conjugate binds to and is internalized by the folate receptor through endocytosis, and becomes very damaging to the particular tumor cells. Ovarian tumors show the greatest folate receptor expression, and that setting is the initial indication for both the diagnostic and therapeutic.

TLSR: How is the prognostic/diagnostic used?

BH: Etarfolatide is a radiolabeled isotope combined with folic acid that binds to the folate receptor, which functions as an imaging agent used to identify folate receptor-positive tumors or sites.

TLSR: The tumor is illuminated, so to speak, with the imaging agent, and that is the indication for the use of the proposed product vintafolide [EC145], which is now in Phase III for platinum-resistant ovarian cancer? Is that right?

BH: Exactly. The diagnostic agent etarfolatide [EC20] is given, the scan is performed, and the question is how positive the response is. It is a relatively simple procedure. And the first indication for the therapeutic vintafolide is the platinum-resistant ovarian setting, as you mentioned. I believe it has a good chance for conditional approval for that setting in the EU later this year, based on its Phase II data. Importantly, that approval would also validate other folate receptor-based programs in the company's pipeline.

TLSR: Is the company selecting out the high expressers?

BH: That is exactly what's happening. About 40% of patients are high expressers of folate receptor in refractory ovarian cancer, and the goal is to identify them. However, the diagnostic also screens out those who do not have folate receptor-expressing tumors, those that are not good candidates for vintafolide. So the procedure basically screens out 60% of patients. We think that this approach will appeal to entities like the European Medicines Agency [EMA], and various governments that are going to consider paying for treatment in Europe. We think payers in the U.S. will respond to this as well.

TLSR: What's the next catalyst for Endocyte?

BH: Etarfolatide [the imaging agent] and vintafolide [the therapeutic agent] are now being examined by the European authorities. The combined application for both the diagnostic and therapeutic was filed with the EMA last October, and the agency will make a decision in the next several months as to whether or not it is going to approve this product conditionally. Data readouts for a Phase IIb study in non-small cell lung cancer and a Phase III study in ovarian cancer are also expected during the first half of 2014.

TLSR: In April 2012, Endocyte partnered vintafolide with Merck & Co. Inc. (NYSE:MRK), which now has an exclusive license to develop, manufacture and commercialize the product. However, Endocyte is responsible for conducting the Phase III PROCEED study and the Phase IIb TARGET trial for non-small cell lung cancer [NSCLC].

BH: The deal is interesting from both parties' perspectives. Endocyte got a large chunk of money up front-$120M. The trial design and protocol were largely underway for the Phase III ovarian study in the U.S., so Endocyte is managing that study, with Merck funding a portion of it. Beyond that, Merck is funding all of the lung cancer work and the other studies, even when Endocyte is conducting the trial. There are also potential milestones worth another $880M to Endocyte, plus the U.S. profit share, plus an international double-digit royalty.

Interestingly, Endocyte has retained full economics to the etarfolatide diagnostic, which could help with development down the road of more potent therapeutics with folic acid as the targeting agent. All in, we think the partnership is a very good deal for Endocyte.

TLSR: Bert, thank you for the time today. I enjoyed it all very much.

BH: Thank you.

This interview was conducted by George S. Mack of The Life Sciences Report.

Robert [Bert] Hazlett, a biopharmaceuticals senior research analyst, joined ROTH Capital Partners in 2012. Hazlett has more than 15 years of equity research experience covering the biopharmaceuticals sector. Prior to joining ROTH, Hazlett was a managing director and senior analyst at BMO Capital Markets, covering both the large capitalization and emerging pharmaceuticals sectors. Before BMO, he covered similar sectors as a managing director at SunTrust Robinson Humphrey, as a vice president at Robertson Stephens, and also held analyst positions in healthcare research at Lehman Brothers and UBS Securities. Hazlett received his master's degree in business administration [finance] in 1996 from Columbia University and a bachelor's degree in economics in 1987 from Yale University.

DISCLOSURE:

1) George S. Mack conducted this interview for The Life Sciences Report and provides services to The Life Sciences Report as an independent contractor. He or his family own shares of the following companies mentioned in this interview: None.

2) The following companies mentioned in the interview are sponsors of The Life Sciences Report: None. Merck & Co. Inc. is not affiliated with Streetwise Reports. Streetwise Reports does not accept stock in exchange for its services or as sponsorship payment.

3) Bert Hazlett: I or my family own shares of the following companies mentioned in this interview: None. I personally am or my family is paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: OvaScience Inc. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.

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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. I have no business relationship with any company whose stock is mentioned in this article.

Source: Meet High Risk And High Reward, Biotech's Profit Partners: Bert Hazlett