Updating My Thesis On Aquinox After The Equity Raise

Summary

Aquinox started patient dosing in AQX-1125’s phase 3 trial earlier this month.

The changed primary endpoint and longer time on therapy increase the probability of success of the phase 3 trial.

Baker Bros participation in the secondary offering is a good sign.

Updating my thesis after the equity raise.

Aquinox's (NASDAQ:AQXP) share price has been all over the place since I initiated coverage in January 2016. The stock fell together with the sector earlier this year and rose together with it over the last few months and has effectively doubled since it was added to the Growth Stock Forum's Long-Term Growth Portfolio. This article sheds more light on recent events and provides an update to valuation considering the increased share count after the latest equity raise.

Latest developments are bullish for Aquinox

Before delving into recent developments, some background is in order (see my January PRO article for a detailed view):

  • AQX-1125 ('1125 for convenience) is the company's only candidate, which is being developed to treat Bladder Pain Syndrome/Interstitial Cystitis, or BPS/IC.
  • Elmiron is the only approved treatment with efficacy similar to placebo.
  • '1125 barely missed the primary endpoint in phase 2 trials (p=0.061) but achieved several secondary endpoints, including maximum daily pain which will be the primary endpoint of the phase 3 trial. The primary endpoint change and the fact that the phase 3 trial will be twice as long (separation from placebo was observed as time passed and '1125 might have reached the phase 2 primary endpoint if the trial lasted longer), which I believe increases the chances of success in the phase 3 trial.
  • Elmiron sales in 2014 were $279 million, the addressable market is large and underdiagnosed. '1125's potentially better efficacy and better compliance could make the product much more attractive than Elmiron and the product could eventually reach $500 million to $1 billion in annual sales (Aquinox is actually targeting $1 billion plus in peak sales).

With these things in mind, let's review the latest developments.

In early September, the company started patient dosing in '1125's phase 3 trial. The primary endpoint is the maximum daily bladder pain score at twelve weeks (compared to six weeks in the phase 2 trial) and secondary endpoints will include urinary symptoms, including frequency and nighttime awakenings and measures of quality of life. The trial will include an open-label extension of up to 40 weeks and the company expects to announce top-line data in Q4 2017. This should be the most important event for Aquinox shareholders over the next few years as the results should substantially de-risk the pipeline and potentially unlock significant shareholder value.

The company decided to take advantage of the 100% rise in the share price to raise the much-needed capital. The company raised $75.4 million in gross proceeds last week by selling 6.15 million shares at $12.25 (including the 800,000 over-allotment option). The company had $99 million in cash and equivalents at the end of Q2 and the capital raise should raise that balance to around $170 million, which should be sufficient for the company to finish the phase 3 trials of '1125.

And while the equity raise dilutes the shareholder base, I think that the timing was great and that the price was fair. It is also worth noting that Baker Brospurchased 2.77 million shares or slightly more than half of the shares offered (before the over-allotment option was exercised). Baker Bros owns 45.1% of outstanding shares, and Aquinox is now a top-10 position for the famous biotech hedge fund (8th adjusted for the increased number of shares and considering the share price appreciation, compared to the 15th place at the end of Q2 2016), which is surprising considering the company's size (the fully diluted market cap is just over $350 million). I believe that the size of the stake is very indicative of their overall bullishness on Aquinox.

Updating the valuation on the increased share count

I have updated my model on Aquinox to reflect the increased share count. The conservative price target is now $16.50 while the mid-range price target is $27. The probability of approval is now 60% and should go to 90% on positive phase 3 trial results in Q4 2017 which (along with the passage of time) should drive the conservative and mid-range PT to $29 and $47 respectively. My new price target on Aquinox is $27, based on the mid-range of the model below.

Low estimate Mid-range High estimate
AQX-1125 peak sales 500 750 1000
Net income 150 243.75 350
Multiple 15 15 15
Probability of approval 60% 60% 60%
Future value 1350 2193.75 3150
Diluted shares outstanding 24.7 24.7 24.7
Future EPS 6.07 9.87 14.17
Discount factor 0.305 0.305 0.305
Present value 411.53 668.74 960.24
Price target 16.66 27.07 38.88
Click to enlarge

Source: author's estimates and calculations

The lack of significant competition and the fact that Elmiron was able to rack up almost $300 million in annual sales with an efficacy profile very similar to placebo makes my confidence level in the above-mentioned peak sales estimates higher than usual and the company itself stated that it is targeting $1 billion plus in U.S. peak sales. Aquinox holds the worldwide rights for '1125 and the ROW sales and profits represent a free call option for long-term shareholders. A ROW partnership agreement could further solidify the company's financial position in the following years (due to the upfront payment) but I doubt we will see an announcement anytime soon (certainly not before the phase 3 data in Q4 2017).

Conclusion

I remain a long-term bull on Aquinox. The company has strengthened its balance sheet last week and the Baker Bros hedge fund bought 2.8 million shares and holds a 45.1% stake in the company. I have increased my conviction rating from 4 to 5 despite the stock being up 100% since it was added to the Long-Term Growth Portfolio. The '1125 phase 3 results in Q4 2017 are the most significant catalyst for Aquinox and they could substantially de-risk this story. On the negative side, failure in phase 3 trials would destroy much of the shareholder value and the stock is likely to fall to $4 or $5, which would be the remaining cash balance per share at the end of Q4 2017.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in AQXP over the next 72 hours.

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 reflects the author's personal opinion and should not be regarded as a buy or sell recommendation or investment advice in any way.