Merck's (NYSE:MRK) acquisition of Idenix (NASDAQ:IDIX) for its hepatitis C [HCV] platform has certainly created a storm of chatter in the investment community. 12 articles have been published on Seeking Alpha alone on the merger since the $3.85B deal was reported. Not since Facebook acquired WhatsApp for $19B back in February have investors chatted so much about an acquisition. Though the Merck/Idenix deal does not reach the $19B heights that Facebook/WhatsApp did, the hepatitis C market as a whole is getting very close. Combining this deal with Gilead's (NASDAQ:GILD) $11B acquisition of Pharmasset in November 2011, and we're nearly at $15B already.
The interest isn't restricted to the size of the deals themselves. The other multibillion-dollar figure involved here is Gilead's sales figures for Sovaldi last quarter, its recently approved hepatitis C drug acquired from Pharmasset. That figure stands at $2.27B (page 23), accounting for an incredible 45% of its Q1 2014 revenue. At this rate, Gilead will break even on Pharmasset in five quarters. Understandable considering that Sovaldi sells for $84,000 per treatment regimen.
As the biotech world continues to flare HCV fever (not literally), everyone is guessing what will be the next HCV acquisition. Whoever guesses right will certainly make a lot of money. I have my thoughts on the matter, which may become apparent by the end of this piece, but nevertheless it is important to keep in mind that in acquiring a company focused on antivirals, one isn't simply getting a single product candidate, blockbuster potential though it may have. There is an entire platform behind synthesizing and manufacturing these antiviral compounds, and each company has a unique approach to doing that.
This is microengineering on a literally molecular scale, and the technology behind the antiviral is often overlooked in the bells and whistles of the product candidate itself. Arguably, the antiviral platform is even more important than the drug molecule itself, because with the platform comes the potential for many, many more successful antiviral compounds.
In most of the other pieces on the Merck/Idenix deal and speculating as to the next one, you'll find plenty of information on the specific pipeline candidates involved and their clinical data. Here, let's look a little deeper into the technological platforms behind them, starting with the two big HCV acquisitions, and comparing them with three other platforms yet to be acquired by Big Pharma.
Pharmasset's $11B began with Apath Replicon Technology
Many wonder how and why Gilead ever even had an inkling that Pharmasset was worth anywhere close to $11B in 2011, back when it had no marketable product. Its technological platform probably had a lot to do with it.
Back in 2000, Pharmasset licensed a platform for discovering HCV antivirals known as replicon technology from a private Missouri firm called Apath. The agreement was reworked several times, and finally rested on these terms: (page 18)
This agreement expires on the date of expiration of the last-to-expire U.S. patent in the licensed patent rights. The last expiration of these patents is scheduled to occur in March 2018. Apath retains no rights to the compounds we discover, and they will receive no payments or royalties for any of the compounds we discover. We are entitled to sublicense these compounds to a third party without Apath's permission or consent.
These are pretty good terms, all for a flat annual fee of $75,000 to Apath. As for the platform itself, it was ingenious. Scientists at Apath isolated and reconstructed, step by step, RNA sequences of HCV until they were able to create an RNA strand that self-replicates (the replicon) and creates HCV virus particles. They placed these into cell cultures of human liver cells (hepatocells) and tweaked the genomes of those cells as well to see what the effects on HCV replication would be. In other words, the replicon technological platform enabled Apath, and in turn Pharmasset, (and finally Gilead) to isolate genes in HCV and see what each one actually did for the virus. This, combined with how human liver cells adapted in the cell line, so they could in turn create compounds that would disrupt the most important parts of the HCV genome without hurting the human liver cells.
And there were no strings attached, no royalties to pay, just a $75,000 annual fee to pay Apath until 2018.
The platform, plus the terms, plus the preclinical data were enough for Gilead to make its $11B offer, even though its market cap at the time was only $3.62B. Gilead paid a premium of 3x market cap. Considering that Gilead's total assets were $12.7B in the quarter preceding the deal, this was quite a risk. And it paid off anyway. GILD is up 363% since.
For Idenix, Everything is Proprietary
Information about the Idenix HCV platform is a little harder to come by. Everything is proprietary, and the company is a bit paranoid that someone might steal its technology, so it doesn't say much about it in its filings. For whatever reason, this wasn't the case with Apath, which, clearly not the best at getting its money's worth ($75,000 a year and no royalties for what became a drug that sold close to over $2B in a single quarter!) didn't seem so concerned about disclosing its trade secrets. Pharmasset wasn't too concerned either, because it didn't actually own any of the patents protecting the replicon platform. In fact, Pharmasset wanted nothing to do with it and said so in its 10-K: (page 18, linked above)
We do not have the right to advise or to consult with Apath regarding the prosecution or maintenance of the licensed patent rights. We are one of several sublicensees of the licensed patents and have no rights to enforce such patents.
All we know about Idenix's platform are the few sentences in its filings (page 10) discussing small molecule fragments it has in a molecular library and the efficiency with which it picks a viable compound candidate and develops it.
Prior to acquisition, Idenix had a market cap of $1.1B on market close of June 6. Some claim that the relatively small price Merck paid for it indicates that it won't be able to compete with Sovaldi. But the premium Merck paid for Idenix relative to market value was higher than Gilead forked over for Pharmasset at 3.5x market cap.
For Achillion (NASDAQ:ACHN), It's High Tech Algorithms
Achillion is now a big name as investors speculate whether it will be the next HCV company in line to be acquired. What we can say about Achillion's platform is that it is certainly highly computerized.
First, there is the Achillion Automated Chemistry Platform, software that automates some of the steps in synthesizing small molecules, basically the building blocks of any of these antivirals. From there is the Compound Acquisition and Repository Tracking, which streamlines and categorizes the building blocks into different chemical groups. Then data mining software takes these categorized building blocks and cross references them with known biological activity by category. With this information, Achillion can start piecing together the building blocks like a jigsaw puzzle. Then, the Competitive Intelligence and Data Mining system sifts through publicly available information about preclinical and clinical activities around the world and any that may overlap with the compounds Achillion pursues at this stage. Achillion's software continues to follow the development process step by step, including organizing preclinical results to spot candidates.
Judging by Achillion's 163% jump on the news of the Idenix/Merck deal, many seem convinced that Achillion is next in line. Achillion's current market cap as of June 19th is $782M. Though it of course won't necessarily happen, a similar multiple would put a potential deal at $2.35B.
Springbank and its Small Molecule Nucleic Acid Hybrids Platform
Springbank is an HCV-focused private firm, though making plans for an IPO according to its latest investor conference call.
Springbank's platform for synthesizing antivirals is called Small Molecule Nucleic Acid Hybrids. [SMNH] In each SMNH, 2 to 6 nucleotides (the building blocks of DNA and RNA) are linked to create a tiny chain of nucleic acids that can code for amino acid sequences. Each one of the SMNHs can be used to create another block in an antiviral, and the blocks can be fitted together for what Springbank calls "rational drug design." For example, some nucleotide sequences code for hydrophobic molecules, some hydrophilic, and depending on what the company wants on the molecule, it can code and build it according to specified needs using these SMNHs. They can also be used to create enzymes to bind to certain proteins, for example proteins in HCV.
Cocrystal (OTCQB:COCP) has X-Ray Crystallography, A Nobel Laureate, and Connections
One HCV company overlooked by the 12 SA articles already published on the Idenix/Merck deal is Cocrystal. Cocrystal's platform is based on x-ray crystallography. In one sentence, x-ray crystallography arranges large molecules in a repeating crystal lattice called a cocrsytal and then shoots x-rays at the cocrystal to take an atomic scale picture of the molecule. This picture is then used to map the molecule atom by atom and see how other molecules will fit into a weak spot in the molecule and attack it.
It should be clear how Cocrystal can use this system to synthesize antivirals. It finds highly conserved genes throughout all the genotypes of a given virus (in the case of HCV there are four main ones), maps that gene in an x-ray crystallograph atom by atom, and then synthesizes a molecule that will inhibit that gene.
This would seem like pie-in-the-sky science fiction, if not for the fact that heading the research team is Dr. Roger Kornberg, Nobel laureate in chemistry in 2006 for his work on x-ray crystallography of RNA polymerase, a transcription gene used by many viruses. Cocrystal is going after two genes in HCV: hepatitis C RNA dependent RNA polymerase, and RNA helicase, two genes the company sees as the biggest weak points in all genotypes of HCV.
Cocrystal is focusing on pursuing antivirals for three diseases. Besides HCV, it is also focusing on influenza and HRV, or human rhinovirus, AKA the common cold. Of these three, HCV is the most advanced, with preclinical testing nearly completed and the company planning to file an investigational new drug application in December (page 13), following which Phase 1 trials will begin. At that point we will find out the effectiveness of Cocrystal's research.
The influenza IND is planned for December 2015, and HRV only for December 2016. This is either because there is a lot more money and urgency in HCV, or because there are a lot less genotypes of HCV than there are of the flu or the cold. There are 99 known genotypes of HRV, and only 4 of HCV. It takes a lot more time to take and analyze x-ray crystallographs of 99 viruses than it does 4.
Cocrystal also has connections going for it as well. Followers of TEVA (NYSE:TEVA) Chairman and Opko Health (NASDAQ:OPK) investor Dr. Phillip Frost should be familiar with Cocrystal as the new incarnation of the corporate shell of BioZone, which was acquired by MusclePharm (OTCQB:MSLP) in January, which Frost is also invested in. Frost is behind the scenes here, so there is already a direct connection to Big Pharma in Teva. In fact, Teva funded Cocrystal's research back in 2011 to the tune of $7.5M (10-Q page 11)
Let's not forget as well that prior to being acquired by Gilead, Pharmasset had a relationship with the company through Emory University. (See 10-K linked above, page 18) Personal connections are doubtless important in big $11B deals, and will probably be a large factor in the next acquisition.
A Word on Risk
Unlike Achillion, Pharmasset, or Idenix, the risks involved in Cocrystal include the stock being a microcap. Investors need to especially watch out for cash burn rate and dilution. It is hard to establish an accurate cash burn rate because there has only been one quarter of operation, but be that as it may, Cocrystal spent $1.5M with $10M in current liquid assets. At this point, that gives it enough cash for about a year, but this may change as again there is only one quarter with which one can establish these numbers.
Assuming the numbers stay stable though, dilution is a strong possibility, but financing affecting the share price negatively is less likely because Frost will likely look after his investment and fund Cocrystal through private placements. Therefore, whether you believe there is significant downside risk in Cocrystal depends on whether and to what degree you believe Frost believes in and will stick up for his investment.
That said, even without an acquisition, the valuations of HCV-focused companies with positive preclinical and early clinical data as discussed here imply that if even Phase 1 starting in December shows promise, Cocrystal's current valuation of $40M will have to be readjusted much higher.
So who is the next HCV company to be acquired? Hard to say, but don't think it's all and only about preclinical and clinical data for a single pipeline candidate. The technological platform, as well as personal connections high up in the chain are crucial to these multibillion-dollar deals. If one really wants to make the best guess, look for all three: The data, the platform, and the connections.
Disclosure: The author is long COCP. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.
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