Why Inovio Surged 26% On August 9

| About: Inovio Pharmaceuticals, (INO)
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Summary

AstraZeneca/MedImmune bought rights to INO-3112.

Milestone payments could total $700 million.

Inovio keeps and will develop VGX-3100 for HPV-induced pre-cancers.

Inovio (NYSEMKT:INO) is a development-stage biotechnology company specializing in DNA vaccines. DNA vaccines can generate immunity to infections or even cancers, but do so by putting DNA in cells. The cells then generate the antigens that the immune system uses to identify and destroy pathogens.

On Monday, August 10, Inovio's stock price surged 26.2% to $8.19 per share on a volume of 16.8 million shares. That left Inovio with a market capitalization of $588 million, still a small cap, and still 37% off its 52-week high of $13.04.

While Inovio announced its second quarter results on Monday, as a development-stage company its revenue is minor and comes from collaborations and grants. It was the announcement that MedImmune, a subsidiary of AstraZeneca (NYSE:AZN), might pay up to $700 million in milestone payments to license INO-3112 that set the stock on fire.

INO-3112 is a combination of Inovio's VGX-3100 with INO-9012. Inovio has been studying it in Phase I trials for HPV (human papillomavirus) induced cancers of the neck, head and thorax. When the Phase I studies are completed, MedImmune plans to use it in combination with drugs from its own pipeline, probably in the CPM (checkpoint modulator) class.

Inovio will retain the rights to continue to develop VGX-3100 for HPV induced pre-cancers. Inovio has solid Phase 2 results for VGX-3100, but there had been concerns about the need to raise cash for the Phase 3 trial, which is now estimated to have a cost tag of $80 million. Given the milestone payments from MedImmune and cash raised through a stock sale May, Inovio now has plenty of cash to carry out the trial and the continuing development of the rest of its pipeline.

CEO Joseph Kim talked about combination of Inovio's DNA vaccines and CPMs from MedImmune and other companies as packing a one-two punch against cancers. In the case of INO-3112, Inovio claims strong generation of killer T cells that attack the HPV. In the VGX-3100 trials that resulted in clearing or decreasing HPV in the patients and, in many cases, a reversal of cancers and pre-cancers to earlier stages. CPMs have been shown to have therapeutic value (and billions in sales) themselves; they prevent cancer cells from masking themselves from the immune system. Hopefully cancer cells by the CPMs will be attacked by an army of T cells, wiping out the cancer.

However, Inovio believes VGX-3100 showed results that also warrant a single-agent Phase 3 trial and, if results stay on trend, FDA approval for commercialization. Early-stage cancers (or pre-cancers) appear to be treatable with just VGX-3100. Inovio will develop VGX-3100 with its own funds, and keep ownership, for now. The MedImmune combination therapy would target more advanced HPV-induced cancers.

The MedImmune deal includes the development of one or two DNA-based vaccines against other cancer targets to be selected by MedImmune.

In addition to the milestone payments, if the therapy (or therapies) makes (make) it to commercial sales, Inovio will receive a royalty, which will be tiered and could exceed 10%.

Capitalization

At the end of Q2, Inovio had cash and equivalents of $154.6 million with no debt. That does not include the upfront payment for the new collaboration with AZN of $27.5 million.

This should be adequate to fund Inovio's research through 2018. Because AZN, other partners, and grants from the government are funding much of Inovio's research, the cash burn rate per quarter should remain fairly low. It was just $8.5 million in Q2. The burn rate would increase when the Phase 3 trial of VGX-3100 starts in 2016.

Valuation

Valuing development-stage companies is a difficult art with much room for differences of opinions. There are many variables that affect the long-term value of such companies. If a drug candidate is believed by investors to be likely to be approved, and then fails in a trial, a company's value can crash. Conversely, there have been many instances of companies whose therapies were heavily discounted by the larger brokerage houses, but then soared when they obtained good Phase 3 results, FDA approval, and commercial success.

To me it looks like the AZN deal has confirmed that Inovio is headed towards a much higher market cap category. However, the risks are still considerable. The Phase 3 trial of VGX-3100 will not start until 2016, and the detailed data from the Phase 2 trial will not be published until later in 2015. It may take years for AZN to conduct its own trials of INO-3112, and the combination of CPMs with cancer vaccines, while reasonable, may not work out in the complicated world of the human body.

Balanced against those risks are the breadth of the Inovio pipeline. Inovio is working with Roche on a hepatitis B vaccine. It is leading a consortium funded by DARPA to test Inovio's Ebola vaccine. It has many more pre-clinical or early-clinical candidates.

In addition there is the entire field of dMAbs, where Inovio recently announced the preclinical success of a therapy for Dengue Fever. See my Inovio's dMAb Technology: A Medical Revolution Worth Investing In for background.

In effect AZN just agreed to pay Inovio $700 million for INO-3112 and two unknown DNA therapies, if the planned combination therapies work. Plus royalties.

My guess is that Inovio's DNA vaccine platform can keep generated vaccine candidates, and improving them, until there is a success. I believe both INO-3112 and VGX-3100 have high likelihoods of success.

Specifically, I would assign a 90% chance of eventual FDA approval to VGX-3100. Since it is a cancer cure for a percentage of patients, I would hazard that it would be priced higher than ordinary vaccines. Given today's market, $5,000 per patient would seem a workable number, given that effective treatment would avoid the need for surgery. The number of patents with new HPV induced pre-cancers each year in the U.S. is well over 250,000 [See Epidemiology of Human Papillomavirus Infections]. If 100,000 chose Inovio's treatment each year, that would generate $500 million in annual revenues. If operating margins were even 20%, that would represent $100 million in operating profit per year. That would support a market cap of $2 billion. If it were a sure thing. But since it is at least a 2018 event before revenue even begins to ramp, and things can go wrong along the way, a heavy discounting of the optimistic scenario is warranted for those buying the stock today.

So I would, at this point, set a target of a $1 billion market capitalization. I am a long-term investor, and think in the long run, with multiple commercialized therapies, Inovio could become a much bigger player, if it is not acquired by some company that realizes how valuable the DNA vaccine and dMAb platforms are.

At $1 billion market capitalization, Inovio would have a price of $13.93 per share, presuming the share count stays at 71.8 million. Again, that is just a target, not a prediction. It depends on what other investors think of the future value of Inovio.

Disclosure: I am/we are long INO.

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.