An investment in a development stage biotech is almost always a bet on a series of binary events, usually involving one compound. Investors, or more accurately speculators, will go from one make-or-break clinical trial to another make-or-break trial, then to an uncertain approval/rejection decision by the Food & Drug Administration (FDA), before the ultimate test, commercial viability, as represented by patient/physician acceptance and revenues. During this lengthy and grueling process, the company is invariably struggling under the weight of weak finances, with management continually needing to assess the best way to raise additional money. The available options are seldom good, typically requiring either the selling of large chunks of dilutive equity or borrowing money at onerous interest rates. That's not all, even assuming the company survives the testing and regulatory gauntlet, it will most likely need to secure a big partner to help market the product, an endeavor that may not be all that easy. Nevertheless, any company with the word "biotech" or "biopharmaceutical" in its name seems to have a market capitalization that approximates at least $500 million, the recent downdraft notwithstanding. As such, although inherently stressful, the biotech sector can be a potentially lucrative arena for investors.
By comparison, we think the following recommendation offers a relatively comfortable way to participate in the biotech arena. Array BioPharma Inc. (NASDAQ: ARRY) has a plethora of new-drug prospects in various stages of clinical testing. The 16-year-old company has a reasonably strong balance sheet. Moreover, most of its products are already partnered, meaning the inflow of some revenues, which alleviates the cash-burn rate, and diminished anxiety in terms of having to find a big brother to commercialize a product that may achieve FDA approval. Accordingly, the success or failure of ARRY stock won't be determined by any single high-impact binary event. In this report, we introduce the relatively unknown concern and review the myriad positives. The many prospects, meanwhile, assure a steady stream of potential stock-moving news, suggesting a long position might prove highly profitable over the long haul. As always, however, readers are advised to keep any investment in a specific special situation recommendation to a small proportion of overall risk capital.
Array BioPharma Inc.
Array BioPharma is a biopharmaceutical company focused on the discovery, development and commercialization of targeted small molecule drugs to treat patients afflicted with cancer. A little more than 16 years since its incorporation, the Boulder, Colorado-headquartered concern has evolved into a late-stage development company, with 14 drugs in various stages of clinical trials. The R&D pipeline includes seven phase 3 (or pivotal) studies that are already in progress or are planned to commence within the year. These programs include wholly-owned proprietary hematology drug, filanesib (ARRY-520) for multiple myeloma, and two partnered cancer drugs, selumetinib, partnered with AstraZeneca, and binimetinib (MEK162), partnered with Novartis.
As of June 30, 2013, the end of fiscal 2013, Array had 265 full-time employees. Two months later, however, the workforce was reduced by roughly 20% in a cost-cutting move. Founded in 1998, the company conducted an initial public offer in November 2000, listing its shares on the NASDAQ Global Market. As is the case with virtually all small biotechs, ARRY stock has been volatile through most of its history, trading at a high of $15.89 in December 2001 and hitting an all-time low of $1.68 in October 2009. As of January 31, 2014, there were 125,456,275 shares outstanding, giving the company a market capitalization of $600.9 million, at yesterday's closing price of $4.79 a share.
Array BioPharma has no product sales but the various partnership agreements do yield some revenues in the form of upfront, licensing fees, and milestone payments, which serve two very important purposes. One, they push out the need to raise additional funds, however modestly. Two, they serve as significant third-party expert validation of the company's products. In the first half of fiscal 2014, ended December 31, 2013, Array received revenues from the following: Novartis (26.5% of the total), Loxo Oncology (23.8%), AstraZeneca (17.9%), Genentech (7.9%), and Celgene (6.3%). In the comparable year-earlier period, Amgen was the most significant contributor to the top line, accounting for 32.5% of the total. The two no longer have an agreement in place, however, underscoring the sometimes ephemeral nature of biotech relationships.
Array has incurred operating losses every year since inception, including $32.1 million in the first six months of fiscal 2014, mostly due to ongoing research and development activities. As of December 31, 2013, the company had accumulated a deficit of $664.8 million, resulting in a stockholder deficit of $5.4 million. Significantly, though, the yearend (calendar 2013) balance sheet contained cash assets of $119.7 million, which, along with revenues from collaborative deals, should fund operations comfortably into fiscal 2016. The balance sheet also held net debt of $101.4 million, but that consists almost entirely of 3.0% convertible senior notes, issued last June and due in 2020. Besides being relatively cheap, the conversion terms equates to $7.05 a share, some 35% above the stock's current price of $5.20. Assuming note holders ultimately exercise their option fully, current shareholders would experience dilution of a relatively modest 15%. Looking forward, the company will undoubtedly need to access the capital markets again. A diversified product pipeline ought to help keep the terms reasonable.
The biotech concern began the new calendar year with four drugs in clinical studies, which consists of three phases, following which, assuming each achieves the desired results, the sponsor would submit an application to the FDA requesting approval for commercial introduction. The most advanced is ARRY-520, a KSP inhibitor for the treatment of multiple myeloma. Data from two trials, a phase 2 and a phase 1b trial, are likely later this year, leading possibly to the initiation of a pivotal late-stage, or phase 3, study in the back half of 2014. Two other drugs, ARRY-797 (for treating osteoarthritis) and ARRY-502 (asthma), have successfully completed phase 2 studies and Array is seeking an appropriate partner that has the wherewithal to both undertake the expensive and lengthy final phase of development and ultimately guide the products to market. The final proprietary drug in clinical development is ARRY-614, a p38/Tie2 dual inhibitor that's being tested in a phase 1 trial for possible use in the treatment of myelodysplastic syndromes.
An Extensive Portfolio of Partnered Prospects
Array BioPharma has 10 ongoing partner-funded clinical programs, including two that are in pivotal late-stage trials, five that are in phase 2 studies, and three that are still at the earliest stage of clinical development. MEK162 represents one of the two most advanced prospects, being studied by Array and partner Novartis International Pharmaceutical in multiple phase 3 trials for the MEK inhibitor's efficacy in treating NRAS-mutant melanoma and ovarian cancer. The second top prospect is Selumetinib, also a MEK inhibitor, which partner AstraZeneca, PLC has initiated in pivotal trials in both thyroid cancer and non-small cell lung cancer. Deeper in the R&D pipeline are Danoprevir, a hepatitis C virus protease inhibitor that's being developed by InterMune, now owned by Roche Holdings; ARRY-543, being developed by ASLAN Pharmaceuticals for gastric cancer; GDC-0068, and AKT inhibitor for cancer, being developed by Genentech, Inc.; LY2606368 a Chk-1 inhibitor for cancer that's being developed by Ely Lilly; and VTX-2337, which is being developed by VentiRx, also for cancer. Biotech giant Genentech is also the partner for two products in phase 1 trials, while Oncothyreon is partnered for the final early-stage prospect, ARRY-380, a HER2 inhibitor for breast cancer.
Milestone Payments and Royalties
Array has received a total of $623.5 million in research funding and in up-front and milestone payments from its partnerships and collaborations since inception, including $154 million in initial payments from strategic agreements with Amgen, Celgene, Genentech, Novartis and Oncothyreon that were entered into over the last four years. The existing partnered programs have the potential to deliver a total of approximately $2.5 billion in additional milestone payments if the partners achieve the agreed upon drug discovery, development and commercialization objectives. Significantly, too, Array stands to earn royalties on any resulting product sales or share in the proceeds from licensing or commercialization from the partnered programs. The MEK inhibitor program with Novartis, for example, could yield as much as $408 million in additional aggregate milestone payments, along with double-digit royalties on worldwide sales of any approved drugs; there are 19 ongoing or planned clinical trials of MEK162. The selumetinib partnership program with AstraZeneca, meantime, offers some $75 million in potential milestone payments and royalties on product sales. Also noteworthy is the "drug discovery and development option and license agreement" that was signed with Celgene Corporation last July. The deal resulted in an up-front payment of $11 million and could produce milestone payments of as much as $376 million, plus royalties on drug sales. This collaboration pertains to the development of Array-invented medicines targeting a novel inflammation pathway.
Array lost $62 million, $0.57 a share in fiscal 2013, after losing $24 million in fiscal 2012. Moreover, the development stage biotech will probably lose $0.60 to $0.70 a share both this fiscal year and next. Indeed, red ink is likely to flow for the foreseeable future, which means a return trip to the capital markets is entirely likely before the bottom line makes its initial foray into positive territory. Clearly, there are a lot of moving parts and myriad uncertainties. The latter certainly includes low earnings visibility, another characteristic of small biotechnology companies. On the flip side, however, is an impressive drug discovery program that has generated an extraordinary number of potential new drugs. Also impressive is management's success in securing partners for so most of its prospects, both at the clinical and preclinical stages of development. It's important to note, too, that many of the prospects target markets that offer enormous revenue and earnings potential.
Investors in small biotech stocks typically look for one or two binary, high-impact events on which to set their sights. The dynamics are a little different with this particular opportunity, however. Array's large number of products, several of which are in multiple trials for various indications, means stockholders can expect a steady stream of news throughout the year. All in all, we think ARRY shares represent a relatively attractive way to gain exposure to the lucrative but highly volatile and risky biotechnology sector.
Disclosure: I am long ARRY. 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.