Ariad Pharmaceuticals Inc. (ARIA) delivered an early Christmas gift to investors on Friday morning, when the company announced that the FDA had approved revised U.S. Prescribing Information (USPI) and a Risk Evaluation and Mitigation Strategy (REMS) for its leukemia drug Iclusig (ponatinib) that allowed immediate resumption of its marketing and commercial distribution. Biotech investors might remember that ARIA shares imploded in early October, gapping down almost 70% before finally giving up about 90% of its valuation at the low of $2.15 in late-October. The implosion started after the company announced on October 9th that the FDA placed a partial clinical hold on new patient enrollment in Iclusig clinical trials due to increased incidence of vascular toxicity observed in the updated clinical data from its pivotal PACE trial in chronic myeloid leukemia (CML) patients. This was followed by even more bad news on Oct. 18th, when the FDA discontinued the CML trial, and then on Oct. 31st, when the FDA asked ARIA to temporarily suspend marketing and commercial distribution of Iclusig.
Friday's positive news and powerful rally comes on the heels of a string of recent positive news that had brought ARIA shares back from the dead and up almost 200% from the lows to trade at $6.31, just before the FDA announcement on Friday at 10:10 AM. This included news on Nov. 22nd that the Committee for Human Medicinal Products (CHMP) of the European Medicines Agency (EMA) had rendered a positive opinion on the continued availability of Iclusig in the European Union (EU) for use in patients in its authorized indications, while making specific recommendations to help minimize the risk of occlusive vascular events.
ARIA shares mounted a strong rally in the three days after the CHMP announcement, doubling on the news to an intra-day high of $5.62 before settling back into the $4 to $5 range. The conclusions reached by the CHMP confirming the positive benefit-risk assessment of Iclusig, after considering the most recent safety information, bolstered Iclusig's chances for approval not just in the EU, but many also believed improved the prospects that the FDA would lift its suspension on Iclusig in the U.S., while making recommendations similar to the CHMP and issuing a black box warning label advising on the increased risk of cardiovascular events. Soon broker Stifel upgraded shares to a Buy from Hold, on December 10th, lifting its price target to $7, citing overwhelming support from doctors at the American Society of Hematology (ASH) meeting, that were universally positive on Iclusig's benefit/risk, and saw continued demand for it as a third line agent for chronic myeloid leukemia . Stifel was also spot-on in prognosticating a resumption of commercial distribution in the U.S. in 2014 with a black box warning label indicating increased risk of cardiovascular events.
ARIA shares mounted another rally early last week, rising 63% from its $3.86 close on Monday to $6.31, just before the FDA announcement on Friday at 10:10 AM. This early week rally was triggered by news coming out of Europe that the European Medicines Agency (EMEA) put Iclusig on its meeting agenda for the week. ARIA shares made an intra-day high of $7.75 on Friday, before closing the day at $6.43. After the FDA announcement, Stifel raised their price target to $10, BMO raised their price target from $4 to $8, and equity research firm JMP Securities upgraded ARIA shares from 'Market Perform' to 'Outperform' rating.
The resumption of Iclusig's marketing and commercial distribution in the U.S. is a triumph not just for ARIA shareholders and management, and Iclusig patients, but also for patient advocacy groups and doctors in general who lobbied on the patients behalf to reopen access to the drug. Iclusig, despite its blood clotting and associated cardiovascular risks, has been responsible for the cancers of many patients to go into remission for multiple years after being resistant to other drugs. It is this lobbying by patient advocacy groups and physicians that may have played a large role in bringing it back into the marketplace. We also have to laud ARIA pharmaceuticals for resolving complex issues with the FDA within just two months after suspension of the marketing and commercial distribution of Iclusig in the U.S.
Now that ARIA shares are back from the dead, the question for shareholders is about the upside potential and downside risk of holding shares at these levels, as shares are up almost 200% from the lows of $2.15 just under two months ago.
Iclusig is an expensive drug, priced at $115,000 per year. Even before Friday's announcement, under pressure from patient advocacy groups and physicians, FDA had instituted a special program under which it allowed patients who had benefited from the drug to continue taking it. Of the 640 patients that were receiving Iclusig at the end of October 2013, 260 continued to receive it even after the suspension through emergency and single-patient investigational new drug (IND) channels, that were reviewed and approved by the FDA on a case-by-case basis, and an additional 90 patients were approved to receive Iclusig after October using these same channels.
Prior to October, in its latest SEC Form 10-K filing for 2012, ARIA indicated that its market size included 2,500 patients in the U.S., 3,800 patients in Europe, and 600 patients in Japan with CML and Ph+ALL that would become resistant or intolerant to their existing tyrosine-kinase inhibitor (TKI) therapies, including Novartis' (NVS) Gleevec & Bristol Myers Squibb's (BMY) Sprycel. However, under the more restrictive label, Iclusig may just become a drug of last resort when all the TKI options have been exhausted. Based on this revised label, ARIA expects that the target population in the U.S. drops to 1,300, and it is quite possible that this move by the FDA may be followed by other regulatory agencies, and if so, the target populations in Europe & Japan may drop to 2,000 and 300 respectively. Taken together, this makes the overall market size for Iclusig at $414 mill., assuming pricing in the U.S., EU and Japan remains in the $115,000 range. Assuming the company reaches 80% market penetration in the next four years, and 5% increase in the market size every year, that would mean total sales of $403 mill. in 2017.
ARIA operating expenses are currently about $80 mill. per quarter or $320 mill. annually, including almost equal parts R&D and SG&A expenses. Assuming that SG&A expenses fall by a third, as ARIA plans to pare down half its staff, and that R&D expenses drop by 20%, it would mean annual operating income of $168 million. Assuming a nominal 35% for taxes, we arrive at annual net income of $109 mill. or about 59 cents per share based on current 186 mill. shares. ARIA has cash reserves of $290 mill., and just $10 mill. in debt, and it burns through about $55 mill. per quarter. That burn rate is bound to drop with the reduction in operating expenses to the $55-$60 mill. range, which will last them until about mid to end-2015, when the company may need to raise more cash diluting existing shareholders. Given ARIA's low share price, assuming 20% dilution, ARIA could earn 49 cents per share in FY 2017. At current prices, it trades at 13 times possible earnings in FY 2017, four years out, which is steep, as if you assume a required return of 25% to account for biotech risk, and give it a multiple of 25 in FY 2017, it would put its current fair value at $5, below where the stock traded at the end-of-day on Friday.
Making more optimistic assumptions, however, for example, Iclusig does not get a more restrictive label in EU & Japan, so their total addressable patient population remains at 3,800 and 600, and assuming the same drug price at $115,000 per year per patient, we get a market size of $656 mill., and total sales of $637 mill. in 2017. Making similar assumptions about operating expenses and taxes, we arrive at net income of $262 mill. or $1.41 per share, which assuming 20% dilution, a 25 multiple to earnings in FY 2017 and a required return of 25% would give us a current fair value based on those assumptions of $12, almost twice the end-of-day close price on Friday of $6.43.
Combining these two, it seems that at current prices, the market is assigning a 20% probability that Iclusig still gets to address the overall 4,400 patients in the EU & Japan, instead of the reduced 2,300 patient population, in case those regulatory agencies take a cue from the FDA. Your decision on whether ARIA is a good investment at these levels will depend on what probability you assign to that outcome. We believe that a 20% probability seems reasonable, and consider ARIA shares fairly valued at current levels, and would not buy them here, until there is more positive news that comes out. This could include, for example, the outside possibility that Iclusig could still get to address the entire 2,500 patient population in the U.S., based on further clinical trials that tests Iclusig at lower doses, provided the lower dosage has similar efficacy and is safer at those levels. Also, it is conceivable that in such a case, clinical testing and approval could extend to a number of other cancer indications, including other leukemia, lung, gastrointestinal and thyroid cancers. This would lead to peak sales of Iclusig to well over $1 billion, warranting a market valuation back in the $3 bill. to $5 bill. range, but that seems very unlikely for now.
Guru Fund Managers Were Bearish on ARIA Prior To October's Fall
ARIA shares have been under heavy distribution by guru fund managers for each of the last five quarters in a row. From a peak of 9.77 mill. shares held by guru fund managers at the end of 2Q/2012, guru fund managers dumped 0.73 mill. shares, 3.80 mill. shares, 0.58 mill. shares, 4.20 mill. shares & 0.14 mill. shares in 3Q/2012, 4Q/2012, 1Q/2013, 2Q/2013 & 3Q/2013 respectively, ending with only 0.33 mill. shares at the end of the latest 3Q/2013. This is significant as in just over one year, guru fund managers dumped more than 96.6% of their holdings in the stock. Also, in the latest 3Q/2013, just prior to the catastrophic fall in October, three guru fund managers sold the stock and none bought it, and in the prior 2Q/2013, it was sold by eight guru fund managers while none bought it.
The top guru fund seller during the latest 3Q/2013 was legendary billionaire investor Ken Griffin's Chicago-based hedge fund Citadel Advisers (click on the link for latest quarter summarized 13-F's), that sold 95,268 shares. Prior to that, the largest sellers were billionaire Stephen Cohen's hedge fund SAC Capital that sold 6.82 mill. shares over the previous four quarters, Andreas Halvorsen's hedge fund Viking Global Investors that sold 1.93 mill. shares in the prior three quarters, and Daniel Loeb's event-driven hedge fund Third Point LLC, that sold 2.10 mill. shares in the prior four quarters.
The vote of guru fund managers on their lack of confidence in ARIA's outlook stands in sharp contrast to that of mainstream Wall St. analysts, with 18 out of 22 ranking its shares at Buy/ Strong Buy prior to October's catastrophic news, with price targets of $24-$29. This included none other than mighty Goldman that put a $21 target on ARIA just last month, including upgrades also by Maxim Group, Summer Street, Oppenheimer, and Chardan Capital Markets, among others.
For anyone invested in the markets, however, it is common knowledge that biotech crashes like we saw on ARIA in October are all too common. An interest of ours is using the buying & selling data of leading fund managers, as reported in their latest quarterly 13-F and daily SC 13D/G SEC filings, as an additional data-point to inform us on the probability of event outcomes, both positive and negative, and not just for biotech clinical trials, but for all stocks in the overall market. Our findings have revealed a strong correlation between leading fund manager activity and the price direction for a stock over subsequent quarters, the most notable of which is the net selling we saw in Apple shares in the quarters preceding the decline. So, for investors that look for confirmation of their thesis from guru fund managers, their massive exit from the stock in each of the prior five quarters could have provided a clue as to what value these leading fund managers may have assigned to this biotech company's pipeline.