Biopharma investors tend to dread the so-called Complete Response Letter, or CRL from the FDA. And the reason is obvious enough, i.e., rejection. Yet, CRLs can create tremendous bargains in the sector, given that most clinical stage biopharmas literally implode after receiving one.
Investors would be wise to look past the carnage created by CRLs and instead look at the potential buying opportunities they leave in their wake. Arena Pharmaceuticals (ARNA) and MannKind (MNKD) are two prime examples of how investors can rake in stunning gains by locating biopharmas with drug applications that need work to achieve approval, but are not totally dead.
In this article, I discuss the asymmetric risk to reward ratio created by Dynavax's (DVAX) CRL for its hepatitis B vaccine candidate, Heplisav. In my view, Dynavax is going to at least triple over the next two years, and could be go much higher than that if the drug is approved. The best part about investing now is that the stock offers two ways to win with limited risk, which I discuss further below.
Dynavax Technologies Corporation is a clinical-stage biopharma that develops novel products to prevent and treat infectious and inflammatory diseases and cancer. The company's lead clinical candidate is Heplisav, a hepatitis B vaccine that was rejected by the FDA earlier this year due to insufficient data to evaluate the drug's safety profile. Additionally, Dynavax has other early stage clinical candidates such as an autoimmune program partnered with GlaxoSmithKline (GSK), an asthma program partnered with AstraZeneca AB (AZN), a cancer immunotherapy program, among others. Nonetheless, Heplisav is far and away the value driver for Dynavax in the near term. As such, the remainder of this article will focus on Heplisav's value proposition for investors.
One of the most important issues to understand is that the FDA does have a favorable view of the Heplisav's efficacy, voting 13 to 1 in favor of the efficacy of the vaccine. The agency issued a CRL because the Advisory Committee disagreed over whether there was enough data to properly evaluate the safety of the vaccine. Specifically, the committee voted 8 to 5, with one abstention, that the data was insufficient to support the vaccine's safety profile. That said, it's important to note that they didn't say the vaccine was unsafe, rather that more data was needed to properly assess the safety profile. That is a key distinction.
To remedy this outstanding issue, Dynavax announced last month that they have finalized a new trial design that will explicitly look at the vaccine's safety profile in a large study, and patients are expected to begin enrollment early next year. In short, the drug works but the FDA wants to make sure safety is not an issue.
If you're not aware, this situation is relatively unique in the biopharma world. Recent estimates suggest that over 60% of Phase III trials fail to show efficacy or superiority over other approved therapies. In effect, this general clinical risk is already off the table for Dynavax investors, and this is why I think Dynavax stands an excellent chance to produce stellar long-term gains.
Keeping with this theme, investors unfamiliar with this sector should note that it's extremely rare to find a company with an advanced clinical candidate whose market cap is south of $400 million. This situation is temporary in my opinion, and the stock is beginning to be move to a more normal market cap per sector averages, now that the expected round of public financing has been completed. And indeed, since Dynavax completed its latest financing (see below), shares of DVAX have already moved 25% higher. This is only the beginning of a marked move higher in my opinion, and a number of hedge funds apparently share my outlook.
Hepatitis B and Hepislav's Value Proposition
Hepatitis B is a viral infection that inflames the liver, increasing the risk of contracting cirrhosis and liver cancer. Infections can be either acute or chronic, with the vast majority of cases resolving spontaneously. No cure currently exists and chronic cases tend to be treated via a host of anti-viral meds. Even so, a handful of vaccines are commercially available including GlaxoSmithKline's Engerix-B and Twinrix, as well as Merck's Recombivax-HB. The global annual sales for the current host of Hep B vaccines are estimated at around $700 million.
In terms Heplisav's value proposition, think of it this way. If Dynavax can capture just 10% of this $700 million market as it currently stands, the company's market cap should, at a minimum, nearly triple from current levels ($240 million). Simply put, if we apply a conservative forward P/E of 10 under this scenario, this would yield a market cap of $700 million. It's important to note, however, that the sector average is currently 55. So this is indeed a highly conservative estimate. Prior to Heplisav's rejection, the market appeared to agree with this estimate as Dynavax's market cap hovered around $600-700 million in the year leading up to the drug's regulatory review. As such, I believe a $700 million market is a reasonable target going forward.
A 10% market share is also likely a highly conservative estimate as well. Heplisav has already been shown to have superior efficacy and longer-lasting immunity compared to Engerix-B. As such, Heplisav could very well become the vaccine of choice, capturing the bulk of the Hep B market, if approved. Even as a secondary player in the Hep B market, however, Heplisav offers early investors a tremendous value proposition because Dynavax's market cap is so depressed following the FDA's CRL, and their recent public offering. I personally think this situation will soon be corrected with a major move to the upside in coming weeks.
Heplisav's Future Prospects
Clinical and Regulatory Summary Paraphrased from Dynavax's recent 10-Q
Dynavax recently finalized the design of a new Phase III study for Heplisav intended to provide a sufficiently-sized safety database for the FDA to complete its review of the Biologics License Application ("BLA"). The trial will be observer-blinded, randomized, active-controlled, multicenter trial of the safety and immunogenicity of Heplisav compared with Engerix-B in adults 18 to 70 years of age. Total enrollment for the study will be 8,000 patients, with 5,500 Heplisav subjects and 2,500 Engerix-B subjects, stratified by age and diabetes diagnosis.
The primary objectives of the study will be: (1) to evaluate the overall safety of Heplisav with respect to clinically significant adverse events and (2) to demonstrate the noninferiority of the peak seroprotection rate induced by Heplisav versus Engerix-B in subjects with type 2 diabetes mellitus. All Heplisav subjects will be evaluated for safety for one year following the second dose and all potential autoimmune events will be adjudicated by a Safety Evaluation and Adjudication Committee. Immunogenicity assessments will be conducted in a subset of subjects, including those with type 2 diabetes. The study is expected to conclude in Q4 2015, with a possible approval in late 2016. Dynavax estimates the cost of the study to range from $50-55 million.
In Europe, Heplisav's Marketing Authorization Application is currently under review by the European Medicines Agency's (EMA). Dynavax is currently preparing its response to the 120-Day Questions and expect to submit the response before the end of 2013. Based on the current schedule, the company and investors alike are expecting a possible approval as early as Q4 2014.
Per the company's Q3 earnings report, Dynavax had $76.5 million in cash and cash equivalents as of September 30, 2013. However, Dynavax raised an additional $125 million through a public offering on October 30th, 2013 (see hyperlink above). With a cash burn rate of approximately $5.8 million per month, I estimate Dynavax to have about $190 million in cash and cash equivalents remaining. When Dynavax launches the Phase III trial for Heplisav early next year, the burn rate should increase to over $8 million per month (all else being equal). As such, the company's current cash position would keep them afloat until midway through 2015. However, I would expect another secondary well before this time, and CEO Eddie Gray basically stated as much on the company's recent conference call. My guess is that the timing of another secondary will depend largely on the strength of the stock price, with the company delaying another public offering for as long as it remains feasible to do so. No one likes to raise money at such depressed share prices, especially when management holds a decent portion of the float.
Because of recent regulatory and financing events, shares of DVAX have dropped precipitously from their former highs. Even so, the path to approval is now clear and financing-at least in the short-term, has been secured. Consequently, hedge funds and insiders have started buying the stock hand over fist, pushing DVAX 25% higher in recent weeks. My belief is that this is the beginning of a sustained bull run on Dynavax, in large part, because the stock offers investors two ways to win. Specifically, the company is severely undervalued compared to its peers at similar developmental stages. As such, investors could use DVAX as a pure momentum trade as the market cap appreciates closer to sector norms. Given that almost no negative catalysts are on the short-term horizon, DVAX offers a nice upside with almost no risk when viewed in this light. For investors looking for a possible triple, there is good reason to believe that Heplisav will eventually be approved, but the investing timeline under this scenario should be viewed as a minimum of three years. Nonetheless, the average annualized gains could easily exceed 100%. Indeed, that is probably why hedge funds have taken such a deep and abiding interest in shares of Dynavax following the recent public offering. Overall, Dynavax is starting to make a bull run now that the regulatory and financial risks have been spelled out.