Affymax Sell-Off: Did Investors Overreact?

| About: Affymax, Inc. (AFFY)
This article is now exclusive for PRO subscribers.

On June 21, Affymax (NASDAQ:AFFY) and their partner Takeda Pharmaceutricals (OTCPK:TKPHF) announced phase 3 trial results for their investigational drug, Hematide (peginesatide), a novel peptide-based, long acting erythropoietin agonist. The trial examined the efficacy of hematide for the treatment of anemia in chronic renal failure, and met all of its primary efficacy and safety endpoints to demonstrate equivalency to recombinant erythropoietin (epoetin and darbepoetin). Normally, one would expect this to be interpreted as good news, but in the case of AFFY, it was interpreted as bad news due to the inclusion of this statement in the headline: “With Some Differences Noted in Secondary Analyses”.

Spooked investors quickly sold off AFFY stock giving it a 60% haircut from its prior trading of almost $22.50 to about $8.50 by market open. This type of market behavior is understandable, given that Hematide is Affymax’s sole clinical asset, and the failure of Hematide would leave Affymax without any clinical pipeline. Most traders expected a bounce from there as investors stop panicking and absorbed the significance of the news.

However, no technical bounce occurred, and from there, things only got worse, with AFFY constantly sliding over the next couple weeks to a low of just over $5. This trading action confused a lot of investors, and the price action and market conditions (major indices losing 7-10% last 10 trading days) only created more panic, and fueled selling and shorting.

Now, AFFY has appeared to settle out in the $5.50 range, still with an 80% haircut. Over the past 10 days I have been watching AFFY for the right entry point and in the mean time I have been able to take a careful look at the situation and determined whether or not the market has reacted appropriately. In my opinion, AFFY is an incredible buying opportunity.

First, it is important to understand the significance of Hematide and the indications it is seeking. Hematide is a novel synthetic, erythropoietin agonist peptide (small protein) which has been modified by adding polyethylene glycol (PEGylated) to make it long-lasting in the body. Erythropoietin (epoetin alfa, EPO) is a naturally occurring hormone which stimulates the production of red blood cells, and man-made erythropoietin can be administered to increase red blood cell count to treat diseases like anemia or treat the side effects of chemotherapy; both which decrease red blood cell count. There are many indications for EPO, with one of the main indications being for chronic kidney failure due to anemia.

The most well known EPO drugs are Epogen, Procrit, and Aranesp (darbepoetin) all from Amgen (NASDAQ:AMGN). They vary in indication. Epogen and Procrit require daily injections, and darbepoetin is modified to only require once-weekly injections. Hematide is different from all these drugs as it is a only a small protein a fraction of the size of the large EPO protein but retains the same stimulating function. As well, its PEGylation allows it to remain active in the body for about a month, thus only requiring once-monthly injections. Another drug, Micera from Roche (OTCQX:RHHBY), uses PEGylated whole erythropoietin to accomplish the same function and dosing as Hematide. However, Micera is only approved in the EU, and cannot be marketed in the US due to patent infringement suits filed by Amgen. This situation poises Hematide to have the long-lasting erythropoietin market in the US essentially cornered.

The US erythropoietin market is quite large: Epogen and Aranesp had combined sales of $5.2 billion last year. The chronic renal failure market alone for Aranesp was about $2.2 billion. Hematide offers direct competition to these drugs in this market. Even in the face of Epogen going generic in 2012, Hematide is a strong contender as its once-monthly administration cannot be matched by these drugs. As well, being a small synthetic peptide, rather than the whole erythropoietin protein like the other drugs, there may be less potential for less side effects due to the biological activity of EPO. It is thought that Hematide may allow for more reliable control of blood-oxygen levels and fewer safety problems seen with the other drugs. As well, given the ease of manufacturing and less frequent dosing, it is thought that Hematide may be offered as a less expensive alternative. Thus, Hematide is viewed as a means to offer considerable use, safety, sales, and potentially efficacy advantages over all existing erythropoietins.

This potential blockbuster has a lucrative partnership deal: Affymax and Takeda are collaborating on the development of Hematide and plan to co-commercialize the product once approved in the United States. They have shared costs to run the clinical trials which investigated the potential for Hematide to treat anemia associated with chronic renal failure. Affymax has already received almost $250 million in milestone and development costs from Takeda to date, including the recent $30 million milestone payment for completion of the phase III trial. Affymax will receive another milestone of $30 million upon filing the Hematide NDA and another $95 million upon FDA approval. After approval, Takeda and Affymax will share all production and marketing expenses as well as revenue. Upon approval, Hematide will be commercialized outside the United States (in the European Union and Japan) by Takeda.

Rightfully so, many analysts from firms such as Cowen and Company, Lazard Capital, Piper Jaffray, RBC Capital Markets, Robert W. Baird & Company, and Thomas Weisel Partners were bullish on AFFY with price targets over $25 (since downgraded).

All this buzz about Hematide was killed with the release of the phase III data June 21. At first glance, the clinical data news seemed great: The trial showed that Hematide was as safe and as effective as Epogen or Aranesp in four studies including over 1300 patients patients treated with Hematide compared to 1300 patients treated with epoetin and darbepoetin (Epogen or Aranesp):

The primary efficacy endpoint, the mean change in hemoglobin (Hb) from baseline, in each of the four Phase 3 studies (EMERALD 1, EMERALD 2, PEARL 1 and PEARL 2) met the statistical criteria for non-inferiority, when Hematide was compared to epoetin and darbepoetin, in correcting and/or maintaining Hb in the target range. Hematide also met the statistical criterion for non-inferiority in the combined four studies for the adjudicated cardiovascular composite safety endpoint (CSE), which was composed of death, stroke, myocardial infarction, congestive heart failure, unstable angina, and arrhythmia (hazard ratio (HR) 1.06, 90 percent confidence interval (C)I) 0.91 - 1.22). The median duration of follow-up for patients on study drug in the four trials was 1.3 years.

So what caused an 80% haircut in the stock? Something that threatened the entire Hematide franchise: The key phrase is: With Some Differences Noted in Secondary Analyses”. The result was that a minor population of non-dialysis patients with chronic renal failure showed increased cardiovascular composite safety endpoints (CSEs).

A difference in CSE events was noted, however, when a subgroup analysis was conducted in non-dialysis patients. In the PEARL trials, which evaluated correction and maintenance treatment of anemia in non-dialysis patients, the frequency of CSE events was higher in the Hematide group (21.6 percent) versus the comparator (17.1 percent) (HR 1.34, 90 percent CI 1.03 - 1.73).

Thus, in this subgroup analysis of anemia patients not yet on dialysis showed more cardiovascular side effects with Hematide, and required more transfusions, suggesting that the drug was less effective here. That fearful phrase in the title (IR really goofed in my opinion) and this small piece of data (more on this later) was enough to reduce AFFY’s market cap to $150 million, far below its cash value (more on this later).

Did investors overreact?

Before the news, Hematide was poised to corner the erythropoietin market. After the news, the whole Hematide franchise seems to be in jeopardy. Lets evaluate both sides of the story, and try to determine what the market is pricing in:

1) Argument: AFFY will not file the NDA or will run more trials first, causing delays and significant cash burn.

Response: In a phone conversation with Sylvia Wheeler, vice president of Corporate Communications for Affymax, she stated that they were still planning to file the

NDA and were going to include all data. They will consult with the FDA about some inconsistencies and confusing data pertaining to the safety profile and see if they could detect something in common with those having CSEs in the non-dialysis patients.

2) Argument: Takeda will drop the partnership.

Response: Takeda can terminate the collaboration with six months written notice or in the event of “certain specified clinical development events or failures,” according to SEC documents. However, Takeda’s “collaboration with Affymax is strong and we remain committed to continue developing Hematide,” said Josephine Zammuto, a U.S. spokeswoman for Takeda, reported here.

3) Argument: The FDA won’t give approval for Hematide.

Response: The fact is that Hematide met all its primary endpoints to the pre- determined standards agreed upon with the FDA when the trial was designed. All they have to prove is equivalent endpoints for efficacy and safety to the standard erythropoietin therapies in the combined pool of trials. The results had to fall within a hazard ratio of 1.3 using a 90% confidence interval. They accomplished that, approval seems locked in. As far as safety, Amgen's Aranesp already has a black-box warning for CSE’s; this is a known risk of this class of drugs due to the biology of erythropoietin.

The safety issues pointed out in the sub-analysis of the non-dialysis patients are technically not statistically significant. The smaller (330 Hematide treated patients) PEARL trials showed some increase in CSEs but the trial was not really powered enough to show this as statistically significant: There was no statistically significant difference in the reported HR of 1.34 within the 90% confidence interval as this encompassed a range of 1.03-1.73. The mandated hazard ratio of 1.3 was met within the confidence interval, even though there was a trend towards more CSEs.

Upon closer examination of the data, they may find that there were a few outlier patients which affected that data in these smaller PEARL trials and that the CSEs seen in these patients was due to complicating factors in their illness. This was an open label trial; although randomized both the patients and the physicans knew which treatment they were receiving. This could have introduced some bias; the patient and doctor at the trial location could have routed sicker patients to receive Hematide in the hope that it would improve over the current standard of care; or the once-monthly injection could have made sicker patients less compliant to other health issues that contributed to their CSEs. A better look at the patients case by case may reveal the cause for such biases.

The company has suggested that any difference in efficacy in these patients wasn’t clinically relevant and that the increase in blood transfusions might have been influenced by investigator bias also. Importantly, this increase in CSE’s was not observed at all in the EMERALD trial, which had over 1000 Hematide treated patients compared to the PEARL 300 patients. This suggests that some outside factors pertaining the PEARL trial somehow added negative bias which was revealed because of the small patient population.

4) Argument: Even if the drug is able to make it to market for the dialysis condition, they will not submit an NDA for the pre-dialysis indication and thus cut their market in half. Due to safety issues, sales will be slow and so will revenue. There will have to be additional trials for this population, and AFFY will burn cash.

Response: The non-dialysis population is really only about 1/3 of the patient population, so at worst the market is cut by 30%. However, if we assume approval of the dialysis indication only, we can look at Mircera sales as historic evidence. Mircera EU sales for this indication only were about $300 million in 2009, the second year of its launch. Sales for the US should be similar or better. Since Affymax has to share half of the expense/ revenue with Takeda, $150 million seems reasonable. Analysts initially expected $1-$1.5 billion in peak sales for multiple indications a few years after launch. So it is reasonable that investors might be disappointed, but there is still significant revenue to be made even if only the dialysis indication was sought out.

The market appears to be pricing in the worst-case scenario. Under this scenario, the partnership with Takeda being dissolved, Hematide is being abandoned, and the company’s assets are being liquidated. Even if this were the case, Affymax has about $180 million in cash after the recent milestone payment. Subtracting liabilities (no long term debt), it has about $125 million in NET cash (not including non-cash assets). With 25 million shares issued, this is about $5 per share. Affymax’s cash burn will slow considerably now that the trials are complete, so it should be able to preserve most of that cash waiting for an FDA decision. As well, Affymax has another $30 million milestone payment upon submission of the FDA, giving it another $1 per share in cash in the next few months. If Hematide is approved, AFFY will also receive a $95 million milestone payment, so going into the marketing phase AFFY could have a total of $250 million in NET cash, or about $10 per share, minus its expenses during that period of time. So the current worst-case (unlikely) scenario for AFFY of liquidation for cash it is worth $ 5 per share; $6 per share upon NDA filing. This is ignoring the inherent value of entire Hematide franchise.

With all this cash, the obvious question is: Why doesn’t Takeda take advantage of the current situation and offer a buyout at a substantial premium to its current price? It would be very cost effective: Takeda would recapture much of the $250 million it has paid out to AFFY, avoid paying the additional $125 million in milestones upon FDA approval, and receive 100% of future Hematide revenues instead of 50%. What would that be worth? A quick guess would be at least $400 million, or $16 per share, a great deal for Takeda and current AFFY shareholders. At this point, I suspect AFFY shareholders who own AFFY in the $20 range would take the deal as well. I am not a big fan of buyout speculation, but AFFY lacks a “poison pill” for a takeover, and in this case this scenario seems too tempting for Takeda. Buying down here in the $5-$6 range seems like a low risk investment, with lots of upside due to a potential buyout or the more likely FDA approval of Hematide.

I see some near term catalysts to aid a recovery for AFFY:

1) reports that JP Morgan Analyst Meacham will host a conference call with CEO Arlene Morris on July 9 at 1 pm. This will be the first time Affymax will (presumably) clarify some of the clinical data. When Affymax finishes examining the data, and releases a clarification of that data, investors should react positively (considering the total failure of Hematide is priced in)

2) Investors will realize that AFFY is trading close to its cash value, and will reconsider that Hematide is a good drug with a very strong chance of FDA approval and can enter a huge revenue market.

3) The NDA filing in the next few months and $30 million milestone payment.

All of this should encourage the shorts to cover and with the right news and market conditions a short squeeze seems likely. My best guess, based on daily FINRA reports, is that about 20% of AFFY stock is currently held short.

Technically, I am starting to see a rebound in AFFY. The daily chart shows that MACD is actually turning back up, volume is dropping, accum/dist is increasing rather than dropping, ADX is reversing and the zig-zag has turned positive. Stoichastics and RSI say it is way oversold. This speaks to technical traders but be aware that shorts are watching technicals before they cover...they should be getting a clue soon. Even if this trading analysis doesn’t speak to you, as an investor you can invest in all the fundamentals about Affymax’s cash, the value of Hematide, and the unrealistic investor sentiment.

Although the fair value of AFFY is hard to determine given the situation, it is obviously much higher than the market is currently pricing it.

Disclosure: Author holds a long position in AFFY