Seattle Genetics: The Long View

Summary

• Despite 1 therapy commercialized, SGEN generates net losses.
• Label expansion and pipeline progress will eventually add revenue.
• ADC (antibody-drug conjugate) platform has attracted large-cap partners.
• Short-term, SGEN will fluctuate; long-term, it is highly like to rise significantly.

Seattle Genetics (NASDAQ:SGEN) is a biotechnology and pharmaceutical company with one commercially approved drug generating revenue. The drug has some distance to go to become a blockbuster. Meanwhile, SGEN generates net losses, $26.7 million in Q4 2014 alone. Despite that, it has a current market capitalization of $4.0 billion.

Why are investors paying such a high premium for SGEN? The bet is that the pipeline will materialize down the road in the form of revenue and profits. Seattle Genetics is exploiting a new technology platform that is helping to change the way cancers are treated.

I will start by explaining the nature of the technology platform. Then I will look at the proof-of-case therapy Adcetris. On top of that, I'll evaluate the SGEN internal pipeline, followed by molecules and indications licensed for development or co-development by partners. Finally, I will look at the cash balance and burn rate to verify that SGEN is in a good position to pursue its long-term strategy.

ADC (Antibody-Drug Conjugate)

The first 3 letters of Adcetris are ADC, and that is the name of the primary SGEN platform. ADC stands for antibody-drug conjugate. The production of antibodies designed to bind to specific molecular targets in the body, is one of the recent revolutions in modern medicine and is already a major source of profits for health sector investors. Most antibody therapies, typically monoclonal antibodies, simply attach to a cell surface to inactivate a particular antigen. But ADCs have a drug (the V in the illustration above) attached to the antibody, that is designed to enter and kill a cancer cell. If a cancer expresses a surface protein that is not expressed in healthy cells, its cells can be targeted for destruction.

Adcetris (brentuximab vedotin) was approved by the FDA in August 2011 and by the EMA for Europe in October 2012 for relapsed HL (Hodgkin lymphoma) and relapsed sALCL (systematic anaplastic large cell lymphoma). In Europe, it is also authorized for refractory HL and sALCL.

On February 2, 2015, Seattle Genetics announced it had submitted a supplemental BLA to the FDA, to expand the Adcetris label to include post-transplant HL patients who are at high risk of relapsing. This submission is based on the Phase 3 AETHERA trial data. If approved, this would be the first of what could be a series of label expansions.

Like other ADCs, Adcetris has two parts. The antibody attaches itself to CD30, a protein that is expressed on the surface of human cells, and is often over-expressed on cancer cells. In theory, Adcetris could help patients having a wide range of cancers that over-express CD30. The cancer cells are killed by the second ADC component, in this case something called MMAE or vedotin, which can be thought of as cancer poison. In short, the antibody is the guided missile and the vedotin is the warhead.

Adcetris is not perfect, but 34% of refractory HL patients in the clinical trial had complete remission, and 94% had one degree of tumor reduction. While there are a variety of reasons Adcetris could fail in some cases, the most likely one is insufficient expression of CD30 by the cancer cells, but some cells may be resistant to the vedotin component. It also has side effects, notably neuropathy. It was linked to two cases of PML (progressive multifocal leukoencephalopathy, in which the normally harmless JC virus common in human brains gets out of control) and has a black box warning about this risk.

In terms of sales, Seattle Genetics markets in the U.S. and Canada, while collaborator Takeda has rights for the rest of the world, and was marketing the drug in 50 countries at last count. Adcetris generated $46.5 million in direct revenue in the latest quarter, up 21% from year-earlier. Royalties from Takeda for Adcetris were $11.9 million, up 80% y/y. Collaborations generated an additional $4.1 million.

Internal Pipeline

Turning to the Seattle Genetics' pipeline, the first thing to notice is that Adcetris is in clinical trials in 8 additional therapeutic areas. Most of the areas are in Phase 2 or Phase 3, so if successful they should come to market in this decade. For brevity, I will note that all of them are for CD30 positive forms of the cancers listed. The disease targets are: cutaneous T-cell lymphoma; combined with chemotherapy for frontline HL; with chemo for frontline mature T-cell lymphomas; 2 combined with various agents (RCHP; Rituxan) for frontline DLBCL; non-lymphoma malignancies; and with bendamustine for second-line HL.

The R&D costs of running so many trials is one reason that, despite the success of Adcetris so far, SGEN is running well in the red. As the trials are completed, costs will come down, and if any of the indications are approved, revenue should climb, putting Adcetris and perhaps even SGEN on a profitable basis. In Q4, R&D expense was $64.0 million. The cost of goods sold for Adcetris was just $5.0 million.

The next tier of 7 ADCs, which are mostly in Phase 1, target a broad range of cancers, including DLBCL, AML (leukemia), breast cancer, renal cell carcinoma, solid tumors in general, and bladder cancer. They attach to other surface proteins than CD30. SGN-CD19A has trials in two different indications.

Now this starts to paint a picture. If half these trials lead to FDA approvals, and then average $50 million per quarter in commercial sales, the pipeline represents 1/2 x 16 x 50 million, or $400 million additional revenues per quarter. That would be $1.6 billion per year of revenue with only a small cost of goods sold. Of course nothing is certain, even successful cancer trials take considerable time, but a multi-billion market capitalization begins to make sense.

Collaboration Pipeline

But it gets better. The ADC platform has twelve collaborators, some of them developing multiple ADCs. The twelve are: Celldex (CLDX); Genentech, which is part of Roche (OTCQX:RHHBY); Progenics (PGNX); Takeda (OTCPK:TKPYY); Agensys/Astellas; Pfizer (PFE); AbbVie (ABBV); Bayer (OTCPK:BAYRY); GlaxoSmithKline (GSK); Daiichi Sankyo (OTCPK:DSKYF). The collaboration with Oxford BioTherapeutics (private) requires SGEN to screen candidates created by Oxford, with either company able to develop the best candidates. For a list of potential indications see the Seattle Genetics ADC Collaboration table.

Most of the collaborations are currently in preclinical stage or stage 1, but 4 are already in Phase 2 and 1 has reached Phase 3: Celldex's Glembatumumab vedotin for breast cancer, aka CDX-011. Phase 2 CDX-011 data showed that while disease control in general was only slightly better than a control group that received the investigator's choice of therapy, it doubled in patients with "triple negative" cancer, nearly doubled in patients where cancers showed high GPNMB expression, and at 75% response was triple the control rate for patients who were both triple negative and high GPNMB. A phase 3 study of CDX-011 began in December 2013 and continues to enroll patients, with all subjects having triple-negative high GPNMB breast cancer having already received standard care, and compared to Xeloda (sold by Roche). Patience is key here, as enrollment is now expected to not be completed until 2016, and the full data read out will not be likely before 2017.

ADCs including CDX-011 and Adcetris are examples of highly-targeted cancer therapies. But their target molecules, GPNMB and CD30, are not rare on cancer cells. In addition to the breast cancers, Celldex reports that 85% of patients with metastatic melanoma express GPNMB. Celldex initiated a CD30 Phase 2 study in patients with advanced melanoma in December 2014.

What will the revenue streams be from the collaborations? Agreement details tend to be secretive, but follow the general industry pattern of milestone payments for getting good trial results and FDA approvals, followed by royalties if the treatment is commercialized. Milestone payments are of course lumpy; one good quarter does not imply the following will be better. Royalties are also difficult to estimate, since they depend on pricing and acceptance of the therapy by doctors and patients.

When making an analysis I (or you) can assign probabilities of eventual FDA approval for each therapy target, estimate the date that would occur, estimate a price, estimate a share of market, and thus estimate an expected dollar value in revenue per year for any given year. Feel free to perform that exercise before buying or selling SGEN. Such an approach makes guesswork seem like science. Real results vary.

I think most readers are better served by reasonable rules of thumb, as I used in my extremely rough calculation above. There are three strategies you can follow with SGEN, or other biotechnology companies either in the late development stage or early commercialization stage. You can buy in before the first FDA approval (too late for that for SGEN). You can buy in after some quarters of revenue, which gives you a better idea of longer-term revenue trends. Or you can wait until profits have risen to the point that P/E ratios are less than astronomical. That reduces risk, but of course leaves out any gain that could have been had buying at an earlier price point.

What I like about Seattle Genetics is that it has proven its ADC concept and capabilities with the commercialization of Adcetris. It has shown it has a platform that can produce a large pipeline of products that could work. What percent will actually work, we can't know, not until we have more Phase 2 results.

Biotechnology investing (as opposed to trading) takes patience. Everyone who does it eventually ends up with some company that loses value when a promising therapy fails to get FDA approval, or fails to make as much money as sell-side analysts projected at one point in time. On the other hand, it is not that unusual to buy in early and make phenomenal gains on stocks where the pipeline was (at the buying point) undervalued.

Cash and Conclusion

At the end of 2014, SGEN had $313.4 million in cash. The cash burn rate in the fourth quarter was $26.2. So cash would look adequate for about 10 quarters, and more if there are milestone payments of a significant ramp in Adcetris sales, presuming the same operating expense run rate.

I can't promise you that Seattle Genetics is going to be another Gilead (GILD) or Biogen Idec (BIIB) within a few years. I am very impressed by the pipeline. So my best guess is that whatever the fluctuations of the stock price are in the short run (2 years or less, in this case), as more Phase 3 results come in, and more FDA and international approvals, SGEN will make good on its pipeline and earlier investors will reap the greater rewards. But keep in mind that stocks like SGEN that are mainly valued based on their pipelines that usually dip whenever a product candidate fails, which is bound to happen from time to time when there are so many products in the pipeline.

Disclosure: The author is long SGEN, GILD, BIIB. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.