Paratek Pharmaceuticals Is A Buy For Its Broad-Spectrum Tetracycline Antibiotic

Summary

We are initiating coverage on Paratek Pharmaceuticals (NASDAQ: PRTK) with Buy rating and common share price target of $ 34.24.

Omadacycline, Paratek's next generation tetracycline antibiotic could reach peak sales of more than $ 1 billion in the U.S. and E.U.

The company could also be an acquisition target by larger players in the antibiotic space.

We are initiating coverage on Paratek Pharmaceuticals (NASDAQ: PRTK) with buy rating and common share price target of $ 34.24. The valuation of the common stock is calculated by enterprise discounted cash flow model (with risk-adjusted peak sales from omadacycline in US and EU=$ 1.2 billion in 2028) and weighted average cost of capital of 10%.

Investment highlights:

Investment highlights:

  • Price target = $ 34.24
  • Current common share price = $ 15.30
  • 52-week share price range = $ 12.05 to $ 32.64
  • Market cap = $ 271 million
  • Cash on hand (including available-for-sale securities) = $ 112.26 million
  • Cash enough to last till = second half, 2017
  • Average daily share volume = 74,044
  • Short interest = 3.1 %
  • Short interest, days to cover = 8.06

Figure 1: Paratek Pharmaceuticals, common share price chart

Investment thesis:

Paratek Pharmaceuticals is a Boston, Massachusetts based pharmaceuticals company, whose key product in the development is omadacycline, a broad spectrum aminomethylcycline (next generation tetracycline) class of antibiotic. Omadacycline has broad-spectrum activity against a wide-range of gram-positive, gram-negative, anaerobic and atypical bacteria. Omadacycline also is targeted at overcoming two major mechanisms of bacterial resistance against tetracycline: efflux pump and ribosomal protection, thus reducing the chances of bacterial resistance.

Figure 2: Omadacycline, spectrum in different bacterial infections

Omadacycline is currently in a phase 3 clinical trial in acute bacterial skin and soft tissue infections (ABSSSI) that started in June 2015. Results of this phase 3 trial are expected in mid-2016. In addition, omadacycline is also in a phase 3 clinical trial in community-acquired bacterial pneumonia (CABP). This trial started in November 2015 and results are expected in second half of 2017 (source: company corporate presentation). These 2 clinical trials are enrolling hospitalized patients with these infections, who are then treated with omadacycline for 2-3 days (depending on clinical response) and then, shifted to oral therapy for 5-7 days. A phase 1 study of omadacycline in urinary tract infections (NYSE:UTI) is expected to start in second quarter of 2016 and a phase 1 study in acute sinusitis is expected to start in second half of 2016. Omadacycline has Fast Track designation for ABSSSI, CABP and UTI in the U.S. as well as qualified infectious disease product (QIDP) designation.

Product positioning for omadacycline in ABSSSI and CABP: The following figures are taken from the company corporate presentation.

Figure 3: Product positioning for omadacycline in ABSSSI (hospitalized patient)

Figure 4: Product positioning for omadacycline in ABSSSI (community setting)

Figure 5: Product positioning for omadacycline in CABP (hospitalized patient)

Figure 6: Product positioning for omadacycline in CABP (community setting)

Paratek is, thus, positioning omadacycline as a second-line treatment in patients failing the first line treatment in ABSSSI and CABP; as well as patients at high risk of failing first line antibiotics, for example, recent hospitalization, diabetes, elderly, nursing home patients and patients with safety concerns or contraindications to macrolide/quinolone and beta-lactam antibiotics. According to the company estimate, the number of these high risk patients in the U.S. is estimated to reach about 13 million patients in 2028. Peak annual sales of successful antibiotics have exceeded $ 1 billion (levofloxacin= $ 3.4 B, Amox/Clav= $ 2.8B, and Azithromycin= $ 1.8B in 2010. Paratek owes royalties ranging in low single digits from future sales of omadacycline to Tufts University (source-10-K).

Omadacycline has several advantages over the existing antibiotics that are commonly used in the treatment of these common bacterial infections. Omadacycline has broad spectrum activity against a wide variety of bacterial pathogens, can be administered both intravenously and orally (with equivalent bioavailability), is very safe and does not have side effects like QT prolongation and musculoskeletal side effects like tendon rupture (seen with quinolones), does not have side effects seen with antibiotics like vancomycin and linezolid (used in ABSSSI), does not predispose to clostridium difficile colitis, does not interact with CYP enzymes and does not need dose adjustment in hepatic impairment. The drug is highly potent against common bacterial pathogens.

Figure 7: Potency of omadacycline against common ABSSSI causing bacterial pathogens

Figure 7: Potency of omadacycline against common CABP causing bacterial pathogens

Results of phase 2 trial of omadacycline in complicated SSSI (cSSSI):source:10-K:

In the phase 2 trial comparing omadacycline to linezolid in cSSSI, there was higher clinical response rate (98%) vs. 93.2% in the linezolid arm in clinically evaluable patients (those who completed the therapy as per protocol). These patients were first treated with intravenous form of the antibiotics, followed by oral form for as needed. Two-third of patient suffered from major abcesses.

Figure 8: Results of phase 2 trial of omadacycline compared with linezolid in cSSSI

Paratek terminated an ongoing phase 3 trial early due to FDA's decision to change the primary end-point of skin infection trials as >20% reduction in lesion size 48-72 hours after therapy. A post hoc analysis of some patients in the phase 2 trial (who were evaluable for the revised ECR end-point) showed comparable efficacy between omadacycline and linezolid.

Figure 10: Post-hoc analysis of phase 2 trial of omadacycline vs. linezolid in ABSSSI

There were no serious adverse events considered to be caused by omadacycline in this phase 2 study. Treatment-emergent adverse events were seen in 41.4% of omadacycline-treated patients (21.6% as potentially treatment related), compared to 50.9% of linezolid-treated patients (30.6% as potentially treatment related). Gastrointestinal adverse events were comprable in the two groups. Details of treatment-emergent adverse events is given in figure 11.

Figure 11: Phase 2 study of omadacycline in ABSSSI: comparison of treatment-emergent adverse events vs. linezolid

Sarecycline: Sarecycline is a novel tetracycline for topical use in acne and rosacea. Paratek has licensed the commercialization rights for Sarecycline to Allergan (NYSE: AGN) in the U.S. but has retained the ex-U.S. rights. Sarecycline is currently in a phase 3 study in acne. Peak sales of sarecycline are expected to be about $ 250 - 300 million as per Allergan estimates. Paratek will receive tiered royalties ranging from mid-single to low-double percentage of annual sarecycline sales.

Figure 12: Paratek Pharmaceuticals, product development pipeline

Near-term catalysts:

- Omadacycline, phase 3 data in ABSSSI: mid-2016.

- Omadacycline, phase 3 data in CABP: second half, 2017.

- Sarecycline, phase 3 data in acne: second half, 2016.

Intellectual property:

Paratek owns various patents related to omadacycline till 2023 and 5 year additional marketing exclusivity due to QIDP designation. Various patents related to sarecycline extend till 2031 (from 10-K).

Management:

Founder, Dr. Walter Gilbert: Dr. Gilbert was awarded the Nobel Prize in Chemistry for discovering a method for DNA sequencing. He also co-founded Biogen and Myriad Genetics.

CEO and Chairman of Baord, Michael Bigham: Former VP and CFO at Gilead; more than 25 years of senior leadership experience in biopharma industry; MBA from Stanford University.

President and CMO, Evan Loh: Former VP at Wyeth where he oversaw development of Tygacil; MD from Harvard Medical School.

CFO, Douglas Pagan: Former VP finance at Acceleron Pharma; former at Biogen and Bristol Myers Squibb; MBA from Columbia Business School.

Competition (from 10-K):

ABSSSI:

The competition to omadacycline in ABSSSI includes existing antibiotics like Vancomycin, Linezolid, Daptomycin, Dalbavancin, Tedizolid, Oritavancin, Quinapristin/Dalfopristin, Tigecycline, Telavancin, Ceftaroline and generic trimethoprim-sulfamethoxazole. In addition, various new antibiotics are in development in ABSSSI, for example, Delafloxacin and Radezolid (Melinta Therapeutics), CG-400549 (Cystal Genomics), GSK 2140944 (Glaxo Smithkline), Nemonoxacin (Taigen Biotechnology), Avarofloxacin (Allergan) and Brilacidin (Cellceutix).

The competition to omadacycline in CABP includes existing antibiotics like Azithromycin, Clarithromycin, Levofloxacin, Moxifloxacin, Tigecycline, Linezolid, Ceftriaxone and Ceftaroline. In addition, various new antibiotics are in development in CABP, for example, Solithromycin (Cempra), Delafloxacin and Radezolid (Melinta), GSK-2140944 (Glaxo Smithkline), Lefamulin (Nabriva), Nemanoxacin (Taigen), and Avarofloxacin (Allergan).

Valuation:

We modeled peak risk-adjusted revenue from omadacycline (drug launch=2019) in ABSSSI and CABP in the U.S. and E.U.= $ 840 million at 10% market penetration and $ 1.2 billion at 15% market penetration in 2028 (after adjusting royalties payable to Tufts) (20% probability of success, mean for successful phase 2 drug as per Milken Institute statistics). Peak annual sale from sarecycline in acne were forecasted as about $ 267 million in 2031 (for Allergan) and Paratek's revenue was modeled as tiered royalties on annual sales (range= 5% to 12%). R&D expenses were adjusted and capitalized. Net operating profit after tax (NOPAT) was forecasted as 17.5% of annual revenue, R&D as 17.6% of annual revenue, which is the average for pharmaceutical firms as per NYU-Stern data. We forecasted reinvestment rate of 60% for Paratek after 2019 (after omadacycline launch in the U.S. and E.U.).

To calculate the weighted average cost of capital (OTC:WACC), we used a target debt/capital ratio of 11.5% which is the mean for pharmaceuticals (NYU-Stern data) and cost of equity =8.58% which is close to the mean for the sector (8.37%). We modeled the WACC=9.34% (link to model). In the DCF model, we used a minimum discount rate of 10% from 2017-2031 (range 10% to 15%).

Enterprise value of future operating cash flows, USD $ 539,874,812
Non-operating assets, as of 3/31/16, total, USD 123,495,000
1. Cash/cash equiv. 44,143,000
2. Available for sale securities 68,120,000
3. Restricted cash 2,629,000
4. Accounts receivable 488,000
5. Prepaid and other assets 3,925,000
6. Other long-term restricted cash 1,011,000
7. Fixed assets, net 823,000
8. Other long-term assets 276,000
9. Goodwill 829,000
10. Intangible assets 1,251,000
Liabilities, as of 3/31/16, total, USD 58,783,000
1. Accounts payable and other accrued expenses 10,369,000
2. Accrued contract research 13,233,000
3. Current portion, Intermezzo reserve 2,385,000
4. Long-term debt 19,595,000
5. Contingent obligations 1,105,000
6. Other liabilities 3,669,000
7. Fair value of stock options 8,427,000
Estimated fair value of equity , USD 604586812
Outstanding common shares as of 3/31/16 17,658,160
Fair value per common share $ 34.24

Table 1: Calculating fair value of the common stock for Paratek Pharmaceuticals. The enterprise value for future operating cash flows was calculated using the enterprise DCF model which can be downloaded here.

We calculated the fair value for the common share as $ 34.24 after adjusting all non-operating assets and outstanding claims and liabilities. This share price was modeled under peak annual sales for omadacycline=$1.2 billion in 2028 (risk-adjusted) and WACC/discount rate=10%. The DCF model can be accessed here. The range in the fair value of common share price under different peak market penetration/peak annual sales and different discount rates is given in the table below.

Peak market share, US +EU WACC

Fair

value/share

15% (peak sales $ 1.2B) 10% $34.24
15% (peak sales $ 1.2B) 12% $26.50
15% (peak sales $ 1.2B) 15% $18.82
10% (peak sales $ 840M) 10% $23.10
10% (peak sales $ 840M) 12% $17.93
10% (peak sales $ 840M) 15% $12.83

Table 2: Paratek Pharmaceuticals, fair value/common share under different scenarios.

In conclusion, we are adding common share of Paratek Pharmaceuticals to our model portfolio at an average price of $ 15.30 as of 5/26/2016 with price target of $ 34.24. The firm could also be an acquisition target in the future.

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Supporting Documents

  1. DCF_model_Paratek.xlsx
  2. WACC_model_Paratek.xlsx

Disclosure: I am/we are long PRTK.

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.

Additional disclosure: This article represents my own opinion and is not an investment advice or solicitation to buy or sell any security. Investors should do their own research and consult their financial adviser before making any investment.

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