Protalix: Undervalued Growth, Plus A Possible Biotech Breakthrough

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I have followed Protalix Biotherapeutics (NYSEMKT:PLX) for some time now, as part of my never-ending search for good biotech investments. Protalix has had an extraordinary 2013, announcing two transformational developments in the past five months. The first is an agreement which secures them a rapidly growing revenue stream, with healthy profitability ensured in three years time. The second announcement was of proof of concept data from human clinical trials for a breakthrough biotechnology. This development could transform Protalix from a small, profitable, moderate-growth company into a major biotech platform company, along the lines of Isis Pharmaceuticals (ISIS) or Seattle Genetics (NASDAQ:SGEN). Despite these two major announcements, and having their first product approved by the FDA last year, PLX stock price is hovering just above a multi-year low.

Protalix's path to profitability mentioned above will have a relatively slow, predictable path over the next three years, which should provide a roughly 100% gain from current levels. The potential transformation into a biotech platform company will be more unpredictable. It might not happen at all if their breakthrough runs into problems later in development. On the other hand, a major partnership could be announced before the end of the year. Whatever path this transformation takes, if successful it would generate returns in excess of 300%, conservatively assuming they only reach half the market cap of Isis or Seattle Genetics.

Introduction

Protalix is an Israel-based biotechnology company built around their ProCellEx platform for plant cell-based production of recombinant protein drugs. Protalix has thus far focused on using this platform to develop biosimilars, or follow-on biological (FOB) drugs. The first of these, Elelyso (Taliglucerase alfa) was approved by the FDA in May, 2012, for the treatment of Gaucher disease, and is marketed by Protalix's partner, Pfizer (NYSE:PFE). Protalix developed this drug independently through the successful completion of phase III clinical trials, after which they partnered it for $60 million up-front, milestones, plus a 40% share of profits.

After recently raising $67 million from the sale of convertible bonds, Protalix has just over $100 million in cash, which is more than enough to fund them through to profitability from sales of Elelyso. Their second (wholly owned) FOB product for Fabry disease should have proof of concept data around the middle of next year, with phase III trials beginning in early 2015. Their third product is an oral formulation of Elelyso/Taliglucerase, which recently completed a phase I trial. Elelyso is an enzyme replacement therapy (NASDAQ:ERT) and active Taliglucerase enzyme was detected in patients' blood, with some patients showing clinically meaningful improvements in some symptoms. Oral delivery of biological drugs has been called the holy grail of biotechnology. This is the technology that could transform Protalix.

ProCellEx technology and products

As I have discussed, ProCellEx is Protalix's core technology for producing recombinant proteins in plant cells. This is a proprietary technology that Protalix has developed which offers several advantages over traditional mammalian cell protein expression. First of all, the bioreactors and nutrients used to grow the plant cells are simpler and cheaper than those used for mammalian cells. Secondly, the plant-produced proteins are fully functional and do not require the extra step of post-translational modification common in mammalian systems. These first two advantages significantly reduce the cost of producing proteins in plant cells, allowing ProCellEx to offer more competitive pricing or achieve higher margins. A third advantage is that some of the patents on biological drugs cover the methods of producing the protein in mammalian cells. The ProCellEx system gets around these patents and could allow earlier introduction of their biosimilar products. Finally, plant cell production is not susceptible to contamination by mammalian viruses. This is a serious problem, as Genzyme (now part of Sanofi (NYSE:SNY)) had to halt production of Cerezyme and Fabrazyme in 2009 due to viral contamination at their Allston production facility, leading to worldwide product shortages. Coincidentally, Elelyso is a biosimilar of Cerezyme and Protalix's second product, PRX-102, is a biosimilar of Fabrazyme.

Elelyso is Protalix's first product, developed for the treatment of Gaucher's disease. Gaucher's is a rare but severe disease caused by a hereditary deficiency of the enzyme glucocerebrosidase. Elelyso, along with Genzyme's Cerezyme and Shire's (NASDAQ:SHPG) VPRIV, are simply intravenous injections of this enzyme (enzyme replacement therapies, ERT). Though Gaucher's only affects roughly 10,000 patients worldwide, due to the severity of the disease and a lack of other treatment options, Gaucher ERT treatments generate roughly $1.3 billion in revenues in 2012.

Elelyso was independently developed by Protalix all the way through the successful completion of phase III trials. After the completion of these trials, Protalix formed a partnership with Pfizer to market and distribute Elelyso. Protalix earned a $60 million upfront payment, later milestone payments of $38 million, and a 40% profit share based on worldwide sales outside of Israel, where Protalix maintained all rights. Elelyso was approved by the FDA in May 2012 and is also approved in Israel, Brazil, Chile, Mexico and Uruguay (the product is called Uplyso in Latin America). European approval of Elelyso was denied based on orphan drug exclusivity granted to Shire's VPRIV, which extends through 2020. Approvals in other territories are pending regulatory review by the relevant authorities.

Protalix's second product in development is PRX-102, a biosimilar product for Fabry disease, which is currently served by Genzyme's Fabrazyme and Shire's Replagal. Like Gaucher's, Fabry is a severe disease caused by a rare, hereditary enzyme deficiency, and both approved drugs are enzyme replacement therapies. Although the Fabry market is not as large as Gaucher, Genzyme and Shire generated roughly $900 million from their Fabry products in 2012. PRX-102 is a nearly identical product to Fabrazyme and Replagal, so there is every reason to believe the phase I/II proof-of-concept trial results will be positive when they are announced in mid-2014. Protalix expects to be able to proceed to a phase III registration trial after these results, and assuming a similar timeline to Elelyso, that trial would finish in early 2017. This timeline should have Protalix launching their second product in 2018.

Behind PRX-102, Protalix has two other exciting preclinical drugs, PRX-110 for cystic fibrosis and PRX-107 for alpha-1 antitrypsin deficiency-induced emphysema. As these are both lung conditions, these two drugs are formulated for inhalation dosing. Like Protalix's other drugs, both are ProCellEx-derived FOB drugs for rare genetic disorders. PRX-110 is a FOB of Genentech's Pulmozyme, which had $572 million in revenues in 2012. PRX-107 will compete with plasma-derived sources of alpha-1 antitrypsin, which are supply-constrained by limited plasma donors yet had a market size of roughly $600 million in 2012. Both of these products should enter clinical trials in 2014.

Path to profitability

Protalix should achieve profitability from sales of Elelyso in late 2015 or early 2016. This result was assured by the agreement they signed with the Brazilian Ministry of Health in June. Under the terms of this agreement, Brazil is obligated to purchase at least $40 million worth of Uplyso (Elelyso's Latin American name) in the first two years of the agreement, and at least $40 million per year in each subsequent year of the agreement. During the course of the agreement, Protalix will transfer its Uplyso manufacturing technologies to the Brazilian firm Fiocruz, who will package and distribute the product in Brazil. The agreement is for seven years, with an optional extension of five years, and Protalix is not obligated to complete its technology transfer until at least $280 million of purchases has been made. After technology transfer, Fiocruz will manufacture and distribute Uplyso in Brazil, paying Protalix a single digit royalty (I assume 5%). Also, as a part of this deal, Pfizer has returned all Brazilian rights to Uplyso to Protalix. In return, Protalix is obligated to pay Pfizer an undisclosed profit share which tops out at $12.5 million per year.

I will get to the profitability calculations shortly, but first I want to address the question of why Pfizer and Protalix agreed to this deal. Pfizer's profit share was 60% before, but as I show below, under this agreement it could go as low as 30%, possibly less. Protalix has agreed to give up most of the revenues of Uplyso after just 7 years, when those sales could have continued indefinitely without this agreement. Why would they agree to these terms? I was genuinely perplexed until I started digging into the numbers. The answer is that this agreement guarantees Pfizer/Protalix's product rapid penetration into the Brazilian market, allowing much higher profitability than they could have achieved otherwise. Assuming this deal completes in seven years (it is to Brazil's advantage that it complete quickly, so I assume it will) we can assume that Uplyso will generate $20 million in sales for each of the first two years and $48 million per year for the next five years. These numbers could be higher, but they can't be lower unless the term of the deal is extended, which would be to Protalix/Pfizer's advantage.

Based on this information, my best estimate for the number of treated Gaucher's patients in Brazil is ~500. Given Uplyso's price of $150,000 per patient year, the $20 million per year represents 133 patients, or 27% of the Brazilian market and $48 million would be 64% of the market (320 patients). That level of market penetration is far greater than Protalix/Pfizer could ever have dreamt of achieving. Given that there are two entrenched products on the market in Brazil already, and a fourth product (Eliglustat, from Genzyme) on the way, they would have struggled to reach 15% market share. Even that 15% would have come fairly slowly, and required significant marketing expenses. At 15% of patients, Uplyso would generate only $11.25 million in revenue. At 80% margin that would give Pfizer a profit share of $5.5 million and Protalix $3.6 million. It is these lower levels of profits, which they would have to fight for, that Pfizer/Protalix are giving up. What they are getting in return is far higher, guaranteed, near-term profits. It's actually an excellent deal for Pfizer, Protalix, Brazil and Fiocruz, with Sanofi/Genzyme and Shire getting the raw end of the deal, as their combined Brazilian market share will drop from 100% to 36% (or lower). And just as an aside, even long-term this deal looks very good for Protalix. Assuming their back-end royalty (after Fiocruz is manufacturing Uplyso) is 5%, and assuming 90% market share (Cerezyme and VPRIV will struggle to maintain any share, as the Brazilian government will heavily favor purchases of the less expensive Brazil-manufacture and Brazil-taxed product) Protalix annual earnings from Brazil would be $3.4 million. That's roughly the same as their peak 40% profit share would have been under their prior arrangement with Pfizer.

Now I will lay out my estimates for profitability. Many of my assumptions for Brazil are laid out above, but I also assume 87% profit margins. Protalix's only expenses in Brazil should be cost of goods, 5% royalty to the agent who arranged their Brazilian agreement, and the 3% royalty to Israel's Office of the Chief Scientist (IOCS). I have deducted this 3% from margins in all territories, but their remaining $22 million of obligations to the IOCS should be paid off by 2018, so the margins go up by 3% in my final year of estimates. I also assume Pfizer and Protalix share profits 50/50 up to Pfizer's maximum of $12.5 million in Brazil. Protalix maintains all rights to Elelyso in Israel. Based on this description of the Israeli Gaucher market from 2006, I estimate the number of treating patients in Israel to be 210, increasing 4 patients per year, but each patient is only treated with half the normal dose (so only $75,000 per patient-year). Over the next five years, I estimate that Protalix will gradually reach a peak market share of 50%. This generous estimate is based on the Israeli government's incentive to encourage Elelyso use, due to its tax and royalty interests. And I assume 87% margins, less a fixed $2 million cost for marketing, etc. For the rest of the world, I assume that 50% of the $1.3 billion (2012 number) market is in play (remember, no European approval until 2020), 80% of that market is US-based, that the market grows 8% the first year and 1% slower each subsequent year until it reaches 4%, and Elelyso takes 5 years to reach a peak of 15% market share. I use an estimate of 77% profit margins before Protalix gets their 40% profit share and deduct the 15% tax withholdings on US profits. What we know about rest of world sales thus far is that the Protalix/Pfizer partnership reached profitability in Q1 2013, with Protalix profit of $400,000 in Q1 and $800,000 in Q2. The reasons I've put the peak rest-of-world market share at only 15% are the same reasons I described above for Brazil: with four total products and two of those well-established in the market, 15% seems realistic. For Protalix operating expenses, I approximate that the ~$38 million of the last two years holds steady. While some expenses might rise slightly (R&D, interest) others would need to be deducted, as they have already been counted in calculating profit margins. And I have assumed Protalix pays no tax on its profits in Israel for its first 10 profitable years, based on its "Approved Enterprise" status under Israeli investment law.

2013/14

2014/15

2015/16

2016/17

2017/18

2018/19

Revenue(Brazil)

20.0

20.0

48.0

48.0

48.0

48.0

Profit(Brazil)

8.7

8.7

29.3

29.3

29.3

30.7

Revenue(Israel)

1.6

3.5

5.9

7.3

8.5

8.6

Profit(Israel)

-0.6

1.1

3.1

4.4

5.4

5.8

Revenue(RoW)

24.6

45.1

79.6

108.7

130.4

135.6

Profit(RoW)

6.7

12.2

21.6

29.5

35.3

38.2

Elelyso profits

14.7

22.0

54.0

63.1

70.0

74.7

Protalix profits

-23.3

-16.0

16.0

25.1

32.0

36.7

Based on these estimates, Protalix should achieve profitability in early 2016, and by the end of that year have run-rate profitability of roughly $20 million. So how would you value such a company three years from now? That's a tougher question to answer, because profitability will be only one part of the company's value. Around this same time (early 2017), Protalix is likely to be announcing results of their phase III trial of PRX-102 in Fabry disease. While Fabry is a slightly smaller market than Gaucher's, the opportunity for Protalix in Fabry is significantly better, for two reasons. First, there is only one approved product for Fabry in the US, so Protalix can expect to achieve a significantly higher market share. Second, there is no orphan drug blocking a European launch of PRX-102, so it should be able to launch worldwide, unlike Elelyso. Also, any profits from PRX-102 will fall straight to Protalix bottom line, as Elelyso already covers their costs. Following behind PRX-102, Protalix also has their cystic fibrosis and alpha-1 antitrypsin deficiency drugs (PRX-110 and PRX-107, respectively). Proof of concept clinical trials for those two drugs should be complete by late 2016, and the likelihood of positive results for one or both should add additional value to the company. If it seems I'm being overly optimistic about the prospects for Protalix drug candidates, I would just point out again that these are all biosimilars with proven mechanisms and established paths through the clinic. The success rate is expected to be high. And for those concerned by the fact that Protalix profits in Brazil will drop ~90% from 2020 on, that is an issue, but also remember that Elelyso will be approved for sale in the EU that same year.

So again, how do you value this company? Here's one way to look at it. Let's say you give them a 20X multiple on the (rapidly growing) $20 million of earnings, or $400 million. Then tack on another $450 million for PRX-102, PRX-107 and PRX-110. Based on Elelyso alone, before it even entered phase III trials, Protalix was once valued at over $1 billion. Outside of the financial crisis years, the company has consistently been valued in the $400 to $600 million range (and higher) based on hopes for that one future product. Based on those numbers, I think $450 million is a fair estimate for Protalix's three other candidates, once they have more data in a few years. Finally, I would add the value of Protalix's roughly $75 million in debt-free cash at that time, assuming conversion of the recently issued notes.

With a $925 million market cap and 104 million shares outstanding after note conversion, that would give a share price of $8.89, roughly a double from current levels. Three years for a double may not be a home run exactly, but given the relatively high confidence in Protalix's path to profitability and additional drug candidates, it makes for a fairly good opportunity.

The Holy Grail

As I mentioned above, oral delivery of biological drugs has been called the holy grail of biotechnology. Patient compliance with oral drugs is much higher than with injectables. Elimination of an office visit for an intravenous infusion reduces medical costs, and patient preferences for oral drugs offer significant competitive advantages to oral drugs over injectables. Despite the considerable value that would be provided by oral biologics, the technical hurdles to their development have thus far proven impossible to overcome. The proteins that make up biological drugs are unstable in the digestive tract, and even if they could be stabilized, their size and physicochemical properties prevent their absorption from the digestive tract into the bloodstream.

Considering the above hurdles, I remain somewhat skeptical of Protalix's recent announcement that they have achieved oral delivery of PRX-112 (glucocerebrosidase) in Gaucher's patients. The announcement states that they have not only detected the enzyme in patient's blood samples, but that the enzyme is active and that some patients have shown a meaningful improvement in symptoms. It is not that I suspect that any of these statements are false; only that these results are early and lacking in details, which means they may not ultimately be good enough to develop a successful drug. In following up on this announcement, I found another company which has made similar announcements of successful oral delivery of biological drugs. The company is Emisphere (OTCPK:EMIS), and despite their reports of success and some partnerships with major pharmaceutical companies, they have thus far failed to make significant progress in developing oral biological drugs.

Having noted the reasons for skepticism, we should also consider the possibility that Protalix has just made a major breakthrough in oral biologics. Their technology is very simple actually. All of Protalix drug candidates are produced in carrot cells, but their current injectable products have the protein of interest purified out of the cell system. Their oral delivery system just takes those carrot cells intact, freeze-dries them, then resuspends the cell powder in liquid for the patient to drink. I have no doubt that such a system would be safe, and that it would protect the protein from digestion. What is less clear to me is how the protein is released from the cells and absorbed. Nevertheless, for the sake of this discussion, I will assume that the protein is released and absorbed in meaningful quantities. This presentation, from slide 49 on, shows animal data suggesting that Protalix is getting significant absorption of biologics from their cell suspensions, and that the absorbed drugs are effective in treating animal models of disease. (It includes a lot of information on their other non-oral products too.)

What does this mean for Protalix if they have achieved oral delivery of useful levels of Taliglucerase/Elelyso? Well, obviously that gives them another product in the Gaucher's market, which could allow them to significantly increase their profits from Taliglucerase. While that would be valuable, the really transformational potential comes from all of the other orally delivered biologics this technology would enable. In the presentation linked above, you can see early evidence of Protalix's bigger plans in their data on PRX-106, an orally delivered formulation of an Enbrel biosimilar. They show that orally delivered PRX-106 is effective in animal models of immune-mediated hepatitis and colitis. This could mean that Protalix is considering developing their oral Enbrel biosimilar on their own, but Amgen's recent US patent covering Enbrel until 2028 makes that a less attractive opportunity. Protalix could still develop the molecule for use outside the US, but a better option might be to partner with Amgen to develop oral Enbrel for world-wide use. In the US, oral Enbrel would gain a significant competitive advantage against Humira and other injectable anti-inflammatory biologics. Outside of the US, Pfizer owns the rights to Enbrel, but those (non-oral Enbrel) patents expire soon. Amgen would own the newly-patented oral Enbrel worldwide. The value to Amgen would be enormous; Enbrel sells roughly $8 billion per year.

I imagine Protalix forming a partnership with Amgen something along the lines of the deals that Isis and Seattle Genetics do with their partners. A small up-front payment ($5-10 million) with perhaps $100 million in milestone payments, and a 5-10% royalty on sales, with Amgen paying all development costs. These numbers are lower than Isis/SGEN get because Protalix is not enabling truly novel products, rather they are creating competitively advantaged, patent-extended biosimilar drugs. Nevertheless, a 5% royalty on an $8 billion dollar drug would yield $400 million in annual profits for Protalix. Based on the data Protalix has already generated on PRX-106, I would anticipate that this drug could begin clinical trials late next year.

After an oral Enbrel deal with Amgen, Protalix could start working on partnerships for numerous other multi-billion dollar biologic drugs. The top 10 biologic drugs each sold between $2.4 and $9.3 billion in 2012. Protalix could possibly partner with Roche for Rituxan ($7 B), Herceptin ($6.2 B) and/or Avastin ($6 B), Biogen for Avonex ($2.9 B), Amgen again for Neulasta ($4.1 B) or possibly AbbVie for Humira ($9.3 B). And this is only considering the older, well-established biologics. Oral delivery would create value for any biologic, at any stage of development. And because the costs to Protalix for creating these drugs for their partners would be very low, they could enter several such partnerships per year. Again, witness the success of this model for Isis and Seattle Genetics.

Now we have to ask what Protalix would be worth as a biotech platform company such as I have described. In a few years, they would have PRX-106 and two other partnered drugs in clinical trials (in addition to their own drugs, PRX-102, 107 & 110) with perhaps 2-5 others in various stages of pre-clinical research. They won't have developed an Isis or Seattle Genetics-size pipeline by that time, but their pipeline would be quite broad, and they will have improved their finances with the payments and milestones that accompany these developments. Just to get a very crude estimate of what Protalix might be worth at that time I'll take the average market cap of Isis and Seattle Genetics and cut it in half. That would give Protalix a market cap of $2.25 billion and a share price of $21.63/share. That would be a 380% gain from current levels.

At this point I just want to remind readers that all of these prospects based on oral delivery of biologics are quite speculative. The "Path to profitability" scenario is reasonably likely to give all of the up side we will ever see in Protalix (i.e., ~100% gains). However, given our relatively high confidence in the path to profitability scenario, our down side is limited. I can take a reasonably large position in Protalix because of the safety (and gains) provided by the path to profitability. Then if the oral delivery platform comes to fruition, it just happens that I own a lot of free options on that company.

Conclusion

Protalix has a clear path to profitability based on Elelyso/Uplyso sales over the next three years or so. In that same time frame, they are likely to advance 2-3 additional follow on biologic drugs through successful proof of concept clinical trials. Based on these results, the company has a very good chance of delivering roughly 100% gains by late 2016. At the same time, the company's recently announced evidence for oral delivery of biological drugs offers the possibility of transformational growth (roughly estimated at 380% returns). It is this combination of high-probability moderate gains and lower-probability explosive growth that makes Protalix such a compelling investment opportunity.

Disclosure: I am long PLX, ISIS. 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.