There are really only two reliable catalysts for biotech stocks - reporting clinical data and announcing equity offerings - and the latter one is seldom a positive for the stock. With ArQule (ARQL) looking to increase its sharecount by more than 11% (including the shoe), Tuesday's 12% decline on another red day in the market doesn't seem so out of line. Even with the pullback though, it's not blatantly clear to me that this is a must-own biotech.
Queuing Up For Tivantinib Data
Far and away the most valuable asset for ArQule is its Phase III drug tivantinib - a c-Met receptor tyrosine kinase inhibitor. C-Met is a popular target these days, with companies including Roche (OTC:RHHBY), AVEO (AVEO), Amgen (AMGN), Bristol-Myers (BMY), and Exelixis (EXEL) all developing drugs with this target in mind.
Right now, ArQule has two Phase III studies ongoing in non-small cell lung cancer (NSCLC) and Phase II studies in liver cancer [hepatocellular carcinoma (HCC)], colon cancer, and gastric cancer. The drug is partnered with Daiichi-Sankyo in a deal that splits clinical development costs and grants ArQule double-digit royalties.
Investors are within six to nine months of seeing substantial incremental data on this drug. There will be an interim analysis of the Phase III MARQEE study within a couple of months (mid-2012), but likely only a slim chance of an early halt for efficacy. Closer still are full Phase II data from the company's HCC trial (at ASCO), while top-line Phase II results from colorectal cancer should come later in 2012, along with a Phase III study initiation in HCC.
Whenever Data Needs Explanation, Be Careful
What concerns me about tivantinib in NSCLC is the results of the earlier Phase II study. Technically, this trial was a failure, as the drug failed to show statistically significant progression free survival improvement in the intent-to-treat population. That's a bad sign, as Phase II oncology trial results are almost always better than Phase III, and these Phase II results would very likely not have led to FDA approval.
But that's not the whole of the story. Sub-group analysis showed better results, and the company designed its MARQEE study to target those patients with non-squamous histology (a population type that showed better responsiveness in the Phase II study). With this different design, there is a considerably better chance that tivantinib will show enough efficacy to garner approval in some significant NSCLC patient sub-types.
That said, I'm still cautious. It's hard to say exactly how much Phase II results were impacted by patient selection issues, and the if the adjusted Phase II data shows the typical deterioration seen in the transition from Phase II to Phase III, I'm not sure it's going to be strong enough to support a sizable revenue target for the drug.
Multiple Shots On Goal
Tivantinib is not a one-target drug, though. We're all still waiting to see the full details from the Phase II results in HCC, but the reported hazard ratio information (0.64) and the news that it met the primary endpoint for PFS improvement is encouraging. This also lends a little more confidence to the NSCLC program; it's not uncommon for cancer drugs to work in one indication and not another (just ask Roche), but this backs up the idea that the drug does have meaningful anti-cancer activity.
Unfortunately, the value of the HCC indication is questionable. This is not a common cancer and many patients do respond well to Onyx Pharmaceuticals' (ONXX) Nexavar. All in all, a second-line label could open up about $150 million to $200 million in potential revenue - which would lead to an interesting commercialization decision for Daiichi-Sankyo (OTC:DSKYF) were the drug to get approved in second-line HCC but not NSCLC.
Other indications like colorectal cancer and gastric cancer are more like call options at this point. Strong efficacy in CRC could be worth a lot and would represent a surprise (and meaningful upside for the stock) relative to current expectations. In contrast, the market potential for gastric cancer is not all that interesting.
Competition Could Be A Data-Sensitive Issue
Non-small cell lung cancer is hardly an overlooked indication. AstraZeneca's (AZN) Iressa has reached blockbuster status on its NSCLC label, while Roche's Tarceva and Lilly's (LLY) Erbitux also generate sales here.
It's also a reasonably popular development target. Roche is developing MetMAb with an eye toward NSCLC, as are AVEO (AV299) and Amgen (AMG-102). In addition to these drugs (that have a similar target mechanism of action), other biotechs like Celldex (CLDX), Cyclacel (CYCC), and GTX (GTXI) are all looking at potential NSCLC indications for some of their experimental compounds.
Competition is only a limited threat at this point, as so many of these competitors are in the lab and the vast majority will fail to make it to market. That said, this is another one of those cases were data will play a major role. Roche's Phase II data from MetMAb was no better than tivantinib (and was worse in some respects), and strong efficacy numbers in identifiable patient subsets could create lucrative semi-protected markets.
Considering The Value
As I said before, I'm concerned about the Phase II data package on tivantinib and that prompts me towards a little more caution on ArQule stock. Not only am I looking for a relatively smaller amount of revenue from the NSCLC and HCC indications ($1 billion in total), but I'm assigning a higher-than-normal discount rate and a slightly lower implied multiple due to the structure of the Daiichi partnership. All in all, with the new shares factored in, I see fair value on ArQule shares of about $8 - more or less where the stock now sits after sell-off.
Bulls will likely fume at such low numbers, so here are a few other scenarios to consider. If tivantinib produces $1.3 billion in revenue and merits a slightly better (lower) discount rate and better multiple, the fair value nearly doubles to $15.75, while an extremely optimistic tivantinib target ($2 billion) pushes the fair value over $25. Please note that I'm well aware of ArQule's relative deep early-stage pipeline (with four additional drugs in the queue) - I simply do not believe in assigning value to drugs that haven't even delivered Phase II data other than in exceptional circumstances.
The Bottom Line
ArQule's a small oncology biotech with a potentially lucrative platform technology in kinase inhibitors. At this point, though, I'm just not confident about the data seen to date If tivantinib pans out and at least one more of the early-stage compounds shows strong early data (particularly '621, '736, or '087), I would expect ArQule to go into play as a buyout candidate for drug companies looking to acquire a broad technology platform in oncology.
Additional strong data on tivantinib (either in HCC or CRC) would make me feel a lot better about the program and the stock, and I realize that I risk sacrificing a lot of upside by waiting for that data instead of buying today and hoping for the data. That said, with my admittedly conservative views today, this stock is not a priority for me.