Incyte (NASDAQ:INCY) is a commercial stage, large cap biotechnology company with two commercial drugs and a broad development pipeline. Agenus (NASDAQ:AGEN) is a small cap biotechnology company which has licensed out a commercial vaccine component, has a broad pipeline and several larger development partners. On February 14 Incyte announced it had amended its prior collaboration agreement with Agenus.
Incyte will invest $60 million as equity at a price of $6 per share. Before the announcement, Agenus had closed at $4.12, so the offer is at a 45% premium over that. However, Agenus had a 52-week high of $7.49 on October 5, 2016, so the investment is at well below the 52-week high.
Incyte already had agreements with Agenus for developing 4 of its cancer checkpoint modulators, named after their targets: TIM-3, LAG-3, GITR, and OX40. The TIM-3 and LAG-3 therapies were already royalty plus milestone agreements for Agenus, with Incyte having exclusive global clinical development and commercialization responsibilities.
The GITR and OX40 programs had been co-funded programs with profit sharing agreements. They also will become Incyte's responsibility to fund and develop, with Agenus receiving milestones (if reached) and 15% royalties if the drugs are ever sold commercially.
Agenus received a $20 million milestone payment as part of the change, though apparently that is an acceleration of a milestone set under the prior agreement. For all four programs, milestones could reach a total of $510 million.
So, why did Agenus not go to $6 a share and hang there, rather than jumping to $4.78 and then backing off?
Development stage biotechnology companies are notoriously hard to value, and there has been rotation out of the sector since about mid-2015. In addition, many of the biggest players in the stock market have rules forbidding their investment in stocks trading for under $10. For more cautious investors, there is no guarantee that any of the four cancer therapies will ever reach commercialization. Thus the $580 million in milestones are hypothetical, as are future royalties.
I think the argument is strong that Agenus is undervalued at $6 per share, and Incyte's investment confirms that view. Incyte has a large cash balance, about $800 million, and good cash flow from its cancer drug Jakafi, but management is careful with cash. They have a very broad pipeline of their own that they can invest their cash in, so I don't think they would invest in Agenus unless they think that is likely to provide a good return to their shareholders.
Agenus ended Q3 with $95 million in cash, and was running through the cash at about $25 million per quarter to fund its own development efforts. It will no longer have to pay to develop GITR and OX40 (now INCAGN1876 and INCAGN1949), slowing the cash burn. And another $80 million should more than double the cash Agenus had exiting 2016. At the Q4 analyst conference, management had stated they were looking for non-dilutive funding.
Agenus already cashed in on its potential future revenues from QS-21, a component of GlaxoSmithKline's shingles vaccine. Its other programs are mostly preclinical or in Phase 1, so there is a long road to commercialization. The exception is Prophage for glioblastoma, a brain cancer, which completed a Phase 2 trial with passable, but not outstanding, results. Given the number of failures of clinical therapies for glioblastoma, it may never go into Phase 3, or will be combined with a checkpoint inhibitor. Although Agenus management has said it has been talking to potential collaboration partners, that has been going on for some time.
So why fund Agenus? It has 7 known checkpoint antibodies in development (including the 4 licensed by Incyte), and says it has multiple undisclosed candidates. It has a platform for evaluating new checkpoint targets and developing candidates that target them. From this platform it would take only one success story to pay for the whole program.
Consider that (as I write) the market capitalization for Agenus is $371 million. What would normally support a $371 million market cap? Using my rule-of-thumb P/E ratio of 20, earnings would need to be $19 million per year. Or just $5 million per quarter.
Even given the cost of drug development, and the tendency of pharmaceutical companies to re-invest cash flow in more R&D for more new products, $5 million per quarter is a very attainable target. A successful cancer checkpoint modulator could generate hundreds of millions in revenue per year.
At its Q4 2016 analyst conference today Incyte reported that its cancer therapy, Jakafi, generated $853 million in revenue in 2016 and expects it to generate over $1 billion in revenue in 2017.
Unlike CEOs and boards of directors in some other industries, biotechnology CEOs need to think long-term. They must spend money on R&D now, to make money later, often 5 to 10 years later.
Incyte was already spending money to develop drugs generated by Agenus checkpoint antibody development platform. Now has invested equity in the company and its platform. They don't care much if the Agenus stock price goes up or down today, this week, or even this year. They are betting on what will happen three to five to ten to twenty years from now.
That is how I invest: looking for companies undervalued now, if you know where they are likely to be in 3 to 5 years. In pharmaceutical companies, that means evaluating pipeline values.
Agenus closed on February 14, 2017 at $4.40, up just 6.8% for the day.
Disclosure: I am/we are long AGEN, INCY.
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: I have owned Agenus stock since October 2013 and Incyte since November 2016.