Sage Therapeutics: Sell-Off Play

| About: Sage Therapeutics (SAGE)

Summary

We are initiating coverage on common stock of Sage therapeutics with Buy rating and long-term price target of $76.24.

Our future forecasted revenue shows that the main value drivers for Sage therapeutics will be SAGE-217 in various chronic neurological indications.

Phase 2 results of SAGE-547 in postpartum depression and phase 3 results of same product candidate in supra-refractory status epilepticus might provide near-term upward boost to the stock price.

Sage therapeutics (NASDAQ: SAGE) is an emerging biopharmaceutical company focused on developing neurosteroids in various central nervous system (CNS) indications. We are initiating coverage on common stock of Sage therapeutics with Buy rating and long-term price target of $76.24.

Investment highlights:

- Stock price target (fair value): $76.24

- Current stock price: $28.54

- 52-week stock price range: $26.28 to $77.48

- Market cap: $915M

- Average daily share volume: 522,162

- Cash/cash equivalents: $299.68M

- Cash enough to last till: beginning of 2018

- Debt: nil

- Short interest: 9.8%

-Short interest, days to cover: 5.47

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Figure 1: Sage therapeutics, stock price chart (source: Bloomberg.com)

Investment thesis:

We have previously published a research report on Marinus Pharmaceuticals (NASDAQ: MRNS), in which we described the role of naturally occurring neurosteroid hormones on various receptors in the brain. The various neurosteroids molecules being developed by Sage therapeutics modulate the extrasynaptic GABAA receptors as well, rather than just synaptic GABAA receptors (blocked by benzodiapines like diazepam). Modulation of extrasynaptic GABAA receptors may be useful in mood disorders, refractory seizures, orphan epilepsy syndromes, and various neuropsychiatric disorders.

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Figure 2: Sage therapeutics, product developmental pipeline

SAGE-547 in supra-refractory status epilepticus (SRSE):

SAGE-547 is an intravenous form of allopregnanolone, a naturally occurring neurosteroid that is being developed in supra-refractory status epilepticus. SRSE is defined as the acute seizure episode that does not respond to multiple agents like benzodiazepines, barbiturates etc. usually used in these episodes. These patients are usually treated with general anesthetic agents like propofol and are placed on mechanical ventilation. Their brain waves are measured using an electroencephalogram (EEG) while multiple combinations of anti-seizure medications are tried. About 15% of acute seizure episodes may develop into SRSE.

Administration of benzodiazepines can lead to down-regulation of synaptic GABAA receptors leading to resistance to these agents. Modulation of extrasynaptic GABAA receptors may help to overcome this resistance, thus providing the rationale for using neurosteroids in refractory acute seizures. In addition, inflammation is believed to play a role in refractory seizures and by reducing inflammation in the brain, neurosteroids may provide additional benefit in refractory seizures.

Indeed, SAGE-547 administration has proved its merit in phase 2 clinical studies. Patients treated with SAGE-547 IV for 5 days had 73% overall response rate in SRSE (as measured by weaning the patients off the general anesthetic agent). In another open label phase 2 clinical trial, SAGE-547 was administered IV for six days in SRSE. 82% of these patients were weaned off general anesthetic agents without the need to restart general anesthesia in 24 hours. This is also the primary endpoint for the ongoing phase 3 clinical trial of SAGE-547 in SRSE, and these results give us confidence that this phase 3 trial will succeed. Results of this phase 3 trial are expected in the second quarter of 2016.

SAGE-217

SAGE-217 is a next generation, orally administered, once-daily neurosteroid that is being developed in several clinical indications. Postpartum depression (PPD) is a common clinical condition that may affect 10-15% of women. No specific therapies have been approved just for PPD. Rapid decline in allopregnanolone-related hormones in the brain has been seen in PPD and therefore, treatment with neurosteroids might be beneficial in this condition. SAGE-547 has shown clinical efficacy in PPD and based on its encouraging results, SAGE-217 is being developed in treatment of PPD.

Essential tremor (ET) is another common movement disorder. About 1.5 million people in the U.S. may have moderate to severe symptoms of ET. SAGE-547 has also shown clinical efficacy in this disorder and based on its clinical results, SAGE-217 is also being developed in this clinical indication.

Childhood orphan epilepsies like PCDH19 mutation, Dravet's syndrome, epilepsy associated with Fragile X syndrome (FXS), Rett's syndrome and Lennox-Gastaut's syndrome are a major cause of morbidity. SAGE-217 is also being developed in the maintenance treatment of these childhood orphan epilepsies.

Apart from the clinical indications mentioned above, Sage therapeutics also plans to develop its neurosteroid pipeline in various mental and neuropsychiatric disorders like sleep disturbances, mood disorders, anxiety disorders, and movement disorders. These clinical conditions are quite common and might add significant revenue in future.

Competition: The main competitor to Sage therapeutics' neurosteroid pipeline is Marinus Pharmaceuticals. We have recently published a research report on Marinus Pharmaceuticals on Seeking Alpha which can be accessed here. Marinus Pharmaceuticals' ganaxolone failed in a pivotal clinical trial in adult focal seizures, but the company is pursuing other indications like PCDH19 epilepsy and treatment of status epilepticus. It is also testing ganaxolone in behavioral disturbances seen in FXS (not just in epilepsy associated with FXS).

Near-term catalysts:

- - Results of phase 2 clinical trial of SAGE-547 in PPD are expected in July 2016.

- - Results of phase 3 clinical trial of SAGE-547 in SRSE are expected in second quarter of 2016.

Intellectual property: Various patents related to SAGE-547 and SAGE-217 extend till 2036.

Management: The executive team consists of members with many years of experience in CNS drug development.

CEO, Jeff Jonas, MD: He has over 20 years of experience in pharmaceutical and healthcare industry; former President of Regenerative Medicine Division and Senior V.P., R&D at Shire PLC; former Executive V.P., ISIS pharmaceuticals; former Chief Medical Officer at Forest Laboratories. Before that he founded AVAX technologies and SCEPTOR Industries.

Chief Medical Officer, Steve Kanes, MD, PhD: Former practicing psychiatrist; served as the Executive Director/ Therapeutic Area Clinical Director for the inflammation, neuroscience and respiratory GMED division of AstraZeneca (NYSE:AZN).

Chief Scientific Officer, Al Robichaud, PhD: Former V.P. of Chemistry and Pharmacokinetic Sciences at Lundbeck USA; former, Senior Director and Head of Neuroscience Discovery Chemistry Department at Wyeth Research.

Senior V.P, Research, Jim Doherty, PhD: He has over 14 years of experience in neuroscience drug discovery and development; former Director and Head of Neuroscience for CNS and pain innovative medicine at AstraZeneca.

Link to details of the management team and the Board of Directors.

Valuation of common stock:

We used the enterprise DCF method (risk-adjusted NPV) to calculate the fair value of equity for the company. We used the following inputs to model future forecasted revenue (total risk-adjusted revenue = $6.5B in 2036 at patent expiry).

1. SAGE-547 in SRSE: peak risk-adjusted forecasted revenue= $338M in 2036 at patent expiry (after adjusting royalties payable to Cydex).

Inputs: Price per treated case=$20,000; annual incidence in U.S. and Europe=80,000; Probability of success=55%; peak market penetration=80%.

2. SAGE-217 in postpartum depression: peak risk-adjusted forecasted revenue= $186M in 2036.

Inputs: Price per treated case=$10,000; annual incidence in U.S. and Europe=310,000; Probability of success=30%; peak market penetration=20%.

3. SAGE-217 in essential tremor: peak risk-adjusted forecasted revenue= $5.76B in 2036.

Inputs: Annual price per treated case=$20,000; annual incidence in U.S. and Europe (moderate to severe symptoms)= 4.8M; Probability of success=30%; peak market penetration=20%.

4. SAGE-217 in childhood orphan epilepsies (PCDH19 mutation, Lennox-Gestaut syndrome, Dravet's syndrome, epilepsy in FXS, Rett's syndrome): peak risk-adjusted forecasted revenue= $115M in 2036.

Inputs: Annual Price per treated case=$20,000; annual incidence in U.S. and Europe= 96,000; Probability of success=30%; peak market penetration=20%.

5. SAGE-689 in refractory status epilepticus: peak risk-adjusted forecasted revenue= $136M in 2036.

Inputs: Price per treated case=$5,000; annual incidence in U.S. and Europe= 455,000; Probability of success=30%; peak market penetration=20%.

R&D expenses were capitalized as investment. McKinsey's NOPLAT method was used to estimate terminal value (3% annual decline after patent expiry in 2036). While forecasting future free cash flow, average ratios like revenue/EBIT, revenue/R&D, revenue/depreciation and amortization etc. were taken from the average sector data for pharmaceuticals collected by Professor Damodaran at NYU-Stern. We used cost of capital=12% for first 10 years and then decreased to 10% in line with mature pharmaceuticals. Operating loss carry-forwards were risk-adjusted at 30% probability and fair value of outstanding employee stock options was used as liability in calculating the fair value for the firm equity. Undiluted share count was used to calculate the fair value per common share.

Using these inputs, we calculated the fair value for the common stock of Sage therapeutics= $76.24. The enterprise DCF model can be downloaded here.

Risks in the investment: Various neurosteroid product candidates mentioned above might fail to succeed in clinical trials, side effects might limit their use, regulatory agencies might not approve them and healthcare insurers might not reimburse them.

In conclusion, we are initiating long position in the common share of Sage therapeutics in our model portfolio as of 6/26/16 at an average price of $28.54 and common share price target of $76.24. The company has near-term catalysts mentioned above that might provide a boost to the stock price.

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Disclosure: I am/we are long SAGE.

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.

Additional disclosure: This article represents my own opinion and is not a substitute for professional investment advice. It does not represent solicitation to buy or sell any security. Investors should do their own research and consult their financial adviser before making any investment.

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