Compugen: A Wealth Creation Opportunity In The Making

| About: Compugen Ltd. (CGEN)
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Overview. Over the past three years, using its in-silico discovery platform for predictive drug discovery (i.e. computer models and algorithms), Compugen (NASDAQ:CGEN) has developed a hugely compelling drug Pipeline across several clinical areas with high unmet needs. Compugen's Pipeline includes more than thirty drug candidates in areas with significant interest to large Pharma including cancer immunotherapy, immunology, and its most recently announced discoveries, antibody drug conjugates (ADC).

Despite the company's recent rapid success, and albeit strong stock price performance - up 125% in the past 7 months - its small market cap ($465 million) suggests it still remains well-below the radar of most investors. We think this could change in a very meaningful way as the market comes to better appreciate the breadth and potential of Compugen's current drug Pipeline as well as that of its discovery infrastructure.

As noted, Compugen has one of the broadest early-stage drug Pipelines of any drug development company of which we are aware. And while the discoveries in any one of its areas of focus could serve as the basis for Compugen to become a very large cap biotech - our focus in this article will be limited to its cancer immunotherapy Pipeline as it is a company priority and is of urgent interest to large Pharma.

The stock market is already assigning several tens of billions of dollars of value to the leading cancer immunotherapy drugs - which are still in clinical trials - and therefore it is very likely that over the next ten years hundreds of billions of additional market capitalization could be created in the Pharma industry based on cancer immunotherapy. Against this backdrop Compugen, with one of the largest Pipelines of cancer immunotherapy discoveries under development, represents a potential staggering wealth creation opportunity for investors over the coming years.

Cancer Immunotherapy. Over the past few years cancer immunotherapy has emerged as the most exciting area in cancer research if not in all of biotech. Science Magazine recently named cancer immunotherapy its Breakthrough of the Year for 2013 (https://www.sciencemag.org/content/342/6165/1432.full). And in a recent research report Citigroup research analyst Andrew S. Baum said that cancer immunotherapy has the potential to be "the beginning of the end of cancer" and estimated that in ten years "it will likely form the backbone of cancer treatment." He further estimates that sales of cancer immunotherapy drugs could reach $35 billion per annum, an estimate that supports our contention that hundreds of billions of new market capitalization could be created around this class of drugs in the coming decade.

The science behind cancer immunotherapy, while fascinating, is well-beyond the scope of this article. We encourage readers to familiarize themselves with the ample available information about both the science behind cancer immunotherapy as well as the recent clinical data that has led observers to talk of immunotherapy as a "cure for cancer." A very brief understanding of the science is however required to fully appreciate Compugen's recent progress and long-term opportunity.

In short, cancer immunotherapy is unlike traditional cancer drugs in that it works not by targeting the cancer directly but rather by stimulating the body's own immune system to recognize the cancer as foreign and attack it. Protein receptors on the surface of T-cells have been shown to prevent the immune system from responding to the presence of cancer cells which allows the tumor to evade the immune system. However, by targeting these T-cell protein receptors with a monoclonal antibody (mAb) the T-cells are activated and trigger a normal immune response which is to attack and kill the tumor.

Over the last few years the clinical data on the lead cancer immunology drugs has confirmed the enormous potential of immunotherapy to treat ("cure") certain cancers. While researchers have found these drugs to have a high degree of efficacy in some patients - complete remission in some instances - and against certain types of cancers, in other instances they have shown to be ineffective. This has led the Pharma industry to urgently work to discover other T-cell receptors that could interfere with the body's immune system response to cancer. This has proven to be a very big challenge as the industry has been very slow do discover new targets.

With this same objective in mind Compugen utilized its predictive discovery platforms and within a period of months discovered nine previously unknown immune checkpoint targets. By comparison, the results of this six-month effort by Compugen exceeded the cumulative number of discoveries made by the Pharma industry in this area in the past half-decade. As a result Compugen has an extremely strong, yet under-appreciated, asset base in this most promising area of cancer research.

Bristol-Myers as a Long-Range Valuation Proxy. Bristol-Myers Squibb (NYSE:BMY) is unquestionably the leading company in this red hot area of drug development activity with one cancer immunotherapy drug, Yervoy (ipilimumab) having received FDA approval in 2011 and a second, nivolumab, currently in Phase III trials.

Bristol-Myers' acquired its immunotherapy assets in 2009 when it acquired Medarex for $2.4 billion. At the time, Medarex's leading drug (ipilimumab) was in Phase III clinical trials but it would still be another year before Bristol-Myers presented the crucial clinical data that showed the enormous potential of cancer immunotherapies. It is probably safe to say that had the current understanding of the potential of cancer immunotherapy been understood in 2009 Medarex would have been valued in a buyout at far in excess of $2.4 billion.

Consider, since Bristol-Myers acquired Medarex five years ago the potential of cancer immunotherapies has become far better appreciated. This is reflected in the market value of Bristol-Myers which has increased by approximately $54 billion over this time to $89 billion; a pretty good IRR on a $2.4 billion acquisition. While it is admittedly difficult to discern exactly how much of the increase in BMY's market value reflects the company's cancer immunotherapy potential, it is worth noting that during the 2010-2013 period Bristol's revenues and earnings have been largely stagnant. This means that the entire increase in BMY market cap is due to an expanding valuation multiple and suggests that enthusiasm for the company's drug Pipeline has been the impetus for the stock's rise. And nothing in the Bristol-Myer drug Pipeline is more high profile than its cancer immunotherapy assets.

To be clear, we're not suggesting the current implied value of Bristol-Myers' cancer immunotherapy assets is an appropriate valuation comp for Compugen today since Bristol-Myer's lead cancer immunotherapy drug candidate is more mature than Compugen's. However, the $2.4 billion 2009 deal price for Medarex is instructive when you consider that it is about five times Compugen's current $465 million market value. As well, the market's implied value of these assets today as reflected in BMY's market cap (~$54 billion) should also prove instructive when you consider how Compugen may be revalued in the coming years as the potential of its Pipeline is developed and discussed.

Compugen's Profile is Rising. Compugen is a company we have been following at Domino Analytics since our inception in 2008. What originally piqued our interest in the company was its in-silico predictive drug discovery platform which had at that point been under development for about a decade. This platform promised an ability to discover drug candidates using proprietary computer models and algorithms rather than rely on the traditional wet lab, trial and error approach. If Compugen's approach worked it would be a radically disruptive technology, a far more economical and efficient manner of discovering drug candidates at a time when large Pharma's Pipelines were dwindling and their R&D costs were soaring. At the time, with CGEN's market cap measure only in the low-tens of millions, skepticism as to whether they could pull this off was clearly high.

The company identified immunology and oncology as the first clinical areas it would focus its discovery platform and efforts on and within six months, having spent less than $1 million, Compugen reported a significant number of discoveries. These discoveries, having been made in-silico, have since advanced through pre-clinical development being validated in both in-vitro and in-vivo studies. As mentioned above, the discoveries Compugen made during this initial discovery run were nine novel immune checkpoints for which the company is now in the process of developing monoclonal antibody therapies against. What is worth emphasizing at this point is that Compugen's approach to drug discovery via its in-silico platforms has been absolutely validated as evidenced by a $540 million licensing agreement it struck with Bayer last August covering two cancer immunotherapy drug candidates.

As noted, while Compugen shares have more than doubled since its licensing deal with Bayer it still trades at a sub-$500 million market cap which suggests it remains largely unknown to the investing public. Despite having what is probably one of the broadest portfolios of cancer immunotherapy assets in the industry and having already inked one licensing deal the company still has no formal Wall Street research coverage and little institutional sponsorship. Despite this, we believe the company's profile could increase substantially this year as:

  1. The company has stated that it expects to enter into at least one additional cancer immunotherapy licensing agreement with a large Pharma company this year.
  2. Management indicated that it expects to receive pre-clinical milestone payments ($30 million) from Bayer this year.
  3. The company has announced plans to accelerate the development of its cancer immunotherapy Pipeline which includes a move into larger facilities in South San Francisco.
  4. The company is going to provide additional information and clarity on its plans to advance at least one of its cancer immunotherapy discoveries into clinical trials on its own.

Conclusion. While drug development is always a risky proposition, recent clinical data strongly suggests that cancer immunotherapy will become the backbone in cancer treatment over the coming decade. In the process this new class of drugs will generate tens of billions of revenue and hundreds of billions of market cap appreciation for the leading companies in the field. Compugen's strong Pipeline of cancer immunotherapy assets positions it extremely well to participate in this dynamic.

Given the breadth of Compugen's drug Pipeline - over thirty drug candidates across cancer immunotherapy, immunology, and antibody drug conjugates (ADC) - the company's risk profile is far lower than a traditional biotech whose fortunes may hinge on the success of one or only a few discoveries. As well, unlike a typical biotech, Compugen has enormous asset value outside of its drug Pipeline in the form of its proprietary discovery infrastructure which it has used to feed its Pipeline. Its discovery infrastructure together with its Pipeline - which as we highlighted includes discoveries in several areas of urgent interest to large Pharma - makes Compugen an ideal acquisition candidate.

Compugen's sub-$500 million market cap provides little downside risk, and relative to an upside opportunity that can be realistically measured in the tens of billions of dollars we believe the stock offers a uniquely compelling and highly asymmetrical risk-reward set-up.

Disclosure: I am long CGEN. 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.