Buy Ophthotech, Get Cash And Zimura For Free

| About: Ophthotech Corporation (OPHT)

Summary

OPHT is an unloved, micro-cap stock trading at more than 20% below its net operating cash, with a restructured burn rate which prevents significant further loss of capital.

Zimura, a drug for Dry AMD currently in a pivotal Phase 2/3 trial, is clinically de-risked and a high potential upside option.

Heads, I win; tails, I don't lose much.

This is a very simple investment thesis, which I think is a deep value play with excellent upside potential. The outcome is binary, so it is a "Heads, I win; tails, I don't lose much" bet. Let me know what you think about the risk-reward profile in the comments section.

Summary of the Opportunity

Ophthotech's (NASDAQ:OPHT) lead drug candidate, Fovista, failed pivotal trials for the treatment of Wet AMD in December 2016, and the stock has since declined by more than 90%. Stupid money thought that the Phase 2 trials would be repeated in Phase 3, and bet on the stock at an extremely high valuation that didn't protect them on the downside in case they were wrong. It turns out they were wrong, and a number of big investors with large positions flocked for the exists and took a heavy loss. I am a buyer of these sellers.

The company subsequently underwent a corporate restructuring in which ~80% of its staff was cut, and all but one remaining Fovista trial was scrapped, which will result in a lowered cash burn rate. At present, I calculate ~$4.35/share of net cash - and my calculation includes severance payments from the restructuring and 1Q17 cash burn (see math below). Most importantly, the company has a clinically de-risked pipeline asset, Zimura, in a Phase 2/3 trial for Dry AMD.

Given the lowered burn rate with the shelving of Fovista, an investor can now buy the company at more than 20% below its net cash value and get the Zimura interim trial analysis outcome within the next 18 months (likely earlier) as a free option! If the Zimura results are negative (as the market is more than pricing in) the 20%+ margin of safety should prevent much permanent loss of capital from the current stock price.

And if the results are positive, the upside can be tremendous. With the stock currently trading at ~$3.40/share, I believe this is a highly asymmetric bet with limited downside (ie. a free binary option on Zimura which was shown to be safe and have a dose-dependent clinical response, while the company trades at over 20% below its net cash available for operations).

Why the Downside is Limited

In the most recent 10-K, the company had $289MM in cash and equivalents and $59.2MM in real liabilities (accrued R&D, accounts payable/accrued expenses). In addition, they assume $14.4MM for restructuring charges (severance and leases), and I assume a $60MM 1Q17 cash burn rate because they are finishing off the final Fovista with Avastin/Eylea trial.

(289MM-59.2MM-14.4MM-60MM)/(35.7MM shares outstanding) = $4.35/share net operating cash available.

Note: Liabilities on balance sheet also include non-refundable $125MM payments from Novo for future Fovista royalties, and $200MM upfront payment from Novartis for Fovista partnership. My understanding is that the company's obligation for these payments has been fulfilled by taking Fovista through clinical trials, and thus these should not be considered true liabilities at present.

After the Fovista trial with Avastin/Eylea is finished (some time in 1H17), I calculate a new cash burn rate of ~$6.5MM/quarter, which includes expenses for the ongoing Zimura clinical trial.

Why There is Significant Upside Potential

Zimura, a Complement Factor 5 Inhibitor, is currently in a Phase 2/3 trial for treatment of Geographic Atrophy (a form of Dry AMD with no approved treatments, which is a precursor to Wet AMD and a large market in its own right). Zimura has shown to be well-tolerated and with preliminary clinical efficacy signals in Phase 1/2a trials in both Dry and Wet AMD (see data under "Zimura" section here). While other complement inhibitors for AMD have failed or are in development, I think Zimura is somewhat de-risked. From the above link:

We have completed a small, multicenter, uncontrolled, open label Phase 1/2a clinical trial evaluating the safety and tolerability of Zimura administered as a monotherapy to patients with GA. We did not observe any evidence of drug related adverse events in this clinical trial. We observed a relative trend in this clinical trial, favoring the higher of the two dose groups, with respect to the reduction in the mean growth of the GA lesion area, as measured by an independent reading center, at 24 weeks. When a reduced dosing schedule was implemented during the subsequent 24 weeks, weeks 24 through 48, this relative trend in reduced growth in GA lesion area was no longer evident. We believe this apparent reduction of growth in GA lesion area size when Zimura was dosed with greater frequency compared to less frequent dosing in the same group of patients, may suggest a possible drug effect. Data from third party clinical trials of drug candidates targeting the complement pathways have been conflicting. However, there was a suggestion in one trial of the potential to reduce growth of GA lesions in a pronounced fashion where specific biomarkers were present.

Because there is nothing approved for the treatment of Dry AMD, the Phase 2/3 trial is going up against a sham injection, so if a drug effect is indeed occurring (as the above statement suggests), it may show statistical superiority over placebo, making Zimura a high-potential asset to bet on at an irrationally cheap valuation.

The catalyst would be an interim analysis of the Zimura Phase 2/3 trial which should occur some time between 2H2017 and 2H2018. That means there are realistically at most 18 months remaining before this expected binary outcome (if not fewer), and based on the new expected cash burn rate that would cost ~$40MM.

The Phase 2/3 trial is enrolling 300 patients, and we can estimate the cost of the trial at approximately $15MM ($50,000/patient). Most of this cost is accounted for in the new burn rate, but let's be conservative and assume it will be an additional $55MM until we have an interim analysis outcome on Zimura.

The current market cap for OPHT is ~$121MM, and my calculation of net operating cash available as of 2Q17 is ~$155MM. In my mind, this means that even if Zimura turns out to be a dud (since you never know) you stand to lose very little in terms of net cash value of the company after 18 months.

Risks

Zimura turns out to be a dud and management continues to burn cash over the coming years and pay themselves high salaries without any regard to maximizing shareholder value.

Opportunities

A couple of 5%+ holders have emerged after the Fovista failure. We need an activist who will seek a reverse merger or liquidation if the Zimura trial turns out to be negative, so that shareholder value can be preserved in a worst-case scenario.

Disclosure: I am/we are long OPHT.

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.

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