Bellus Health: Coughing Its Way To Being Swallowed By Big Pharma

Summary

• Bellus Health's lead drug, BLU-5937, is potentially a best-in-class P2X3 antagonist for chronic cough.
• Merck purchased Afferent Pharma for their P2X3 antagonist for $500M up front, and $750M in milestones.
• The major side effect of Merck’s drug, Gefapixant (or MK-7264) is the loss of taste sensation in over 70% of patients at the effective dose in a Phase 2 study.
• BLU-5937 has a 1,000 higher selectivity for cough receptor (P2X3) versus the taste receptor (P2X2/3), which should avoid the class side effect.

Bellus Health (OTCPK:BLUSF) is a Canadian biotech trading on the TSX under the ticker, BLU, and the US OTC under the ticker BLUSF. BLUSF is developing a treatment for chronic cough, BLU-5937, that has the potential to be best-in-class – with the only other drug in the class being developed by Merck, Gefapixant (or MK-7264). Merck has set the start date of the Phase 3, 720 patient study for March 2018, and has therefore obtained FDA consent for the end-point and power required for approval. Merck purchased the compound prior to the completion of a Phase 2 study (rare timing) for $1.25 billion in biobucks. Biobucks is slang for deals that have milestone components – this deal had $500 million up-front and up to $750 million in additional milestone payments. Given the clear big pharma demand, paved regulatory path to market and the potential mechanistic advantage; I believe that this Company is a hidden gem among the vast swath of microcap biotech companies.

Strategic Transformation

In early 2016, the Company was developing KIACTA™, a treatment for Amyloid A amyloidosis. The Phase III study met a milestone in January 2016 when the study achieved 120 patient events linked to the deterioration of kidney function. At the end of the first quarter 2016, they highlighted the following:

• Completion of the KIACTA™ Phase 3 Confirmatory Study for the treatment of AA amyloidosis in January 2016; top-line results expected in Q2 2016;
• Issued 7.3 million common shares on January 1, 2016 to settle convertible notes, as scheduled, further simplifying the Company’s capital structure;
• Concluded the quarter with cash, cash equivalents and short-term investments totaling $9.0 million.

The Phase III study did not reach its end-point. On 6/6/2016, BLUSF (OTC Markets) closed at $2.03. Following the announcement, the stock closed at $0.29, going as low as $0.19 in the pursuing weeks.

Late in 2016, the Company identified a P2X3 antagonist inside the NEOMED Institute, which was previously an Astra Zeneca research facility. Early in 2017, they completed the world-wide licensing agreement for the P2X3 antagonist, BLU-5937, as well as cleaned up the Company’s capitalization table to remove all of the convertible securities from the balance sheet.

After a year of rounding out the pre-clinical and intellectual property work on BLU-5937, the Company concluded the year with a C$ 20 million financing at C$0.38 (or approximately US$0.30).

The Company is starting 2018 with over C$20 million in the bank, a potential best-in-class drug ready for development, a paved regulatory pathway and a $1.25 billion exit comparable post Phase II; and is selling for a stock price equal to the last investment round which valued the company at approximately C$46 million, or US$36 million.

Chronic Cough

Chronic cough is a cough that lasts over 8 weeks in adults or over 4 weeks in children, according to Mayo Clinic. In some cases, it is merely annoying, in others, it may be cause for loss of sleep, lightheadedness, or even vomiting. There are multiple causes, so doctors need to work through a pathway of tests to diagnose the cause for a particular patient. Those potential causes include post-nasal drip, reflux, infections, taking an ACE inhibitor, chronic bronchitis, or asthma. There are multiple treatment options, depending on the diagnosis. In the event a doctor is not able to target treatment at the source of the cough, then the patient is really out of options. There are no FDA approved therapies for chronic cough, and symptom relief is likely not possible from over the counter cough suppressants because the patient failed that treatment before going to the doctor.

Best in Class

Assuming that the Merck drug is the standard by which all others in the class will be measured given its late stage of development, BLU-5937 needs to either win on efficacy, win on safety, or win on side-effect profile.

Based on pre-clinical data, both the BLUSF and Merck drugs have a dose-dependent suppression of cough counts in a standard Guinea Pig model. Assuming that plays out in man as well, then they will likely tie on efficacy. In addition to comparing the two compounds, this data also provides additional support to the receptor target.

Figure 1: Guinea Pig Cough Response Study (Control vs. BLU-5937 and MK-7264)

Merck’s drug as already been patients and has been proven safe. Following the Company’s submission for regulatory approval to perform the first in man study, one would assume BLU-5937 would likely be safe as well, as it would have been deemed safe in two classes of animals (usually rodent and canine). There is always a risk that BLU-5937 will find some novel pathway of risk once it is dosed in humans, however the odds are low. It may be old data, but in a past lifetime I performed and analysis that showed 90% of compounds passed the Phase I safety study, which only suggests the model of using rats and dogs as our toxicity screeners prior to dosing humans continues to be useful for drug development. Therefore, assuming BLU-5937 is approved to initiate a human study, then the odds are high that the compound checks the box on safety, and the compounds will therefore tie on safety.

The key to this contest is in the side effect profile, which the Company has highlighted in their presentations and backed up with data in animals. The key receptor involved with the suppression of the cough response in the larynx, trachea and bronchus, the P2X3 receptor, has a closely related receptor on the taste buds, the P2X2/3 receptor, as shown in Figure 2. BLU-5937 has an IC50 for the cough receptor at concentrations in the low nanomolar range and an IC50 for the taste receptor in the mid micromolar range; while MK-7264 has an IC50 for the cough receptor at concentrations in the mid nanomolar range and an IC50 for the taste receptor in the high nanomolar range (Source: Company presentation). This difference allows the Company a wider dose range for cough suppression prior to blocking the receptor involved with taste. In an animal model where rats were given water and water with quinine, rats on the Merck drug chose quinine about 30% of the time, as shown in Figure 3.

Figure 2: P2X3 receptor versus P2X2/3 receptor

Figure 3: Rat taste test between BLU-5937 and MK-7264

Taste was highlighted as a non-insignificant side effect of Merck’s Phase 2 study. At the highest dose (50 b.i.d.), Gefapixant reduced Awake Cough Frequency (coughs/hour) by 37 percent. The high dose was the only dose to reach statistical significance versus placebo. The lower two doses both reduced cough by 22 percent, which suggests with a larger trial, those two doses would be statistically significant as well.

At the highest dose, 47% of patients reported Dysgeusia (an alteration in taste) and 24% reported Hypogeusia (reduced ability to taste). Those were the major side-effects, suggesting that targeting this receptor class is probably safe. Gefapixant therefore has a dose limiting side effect of taste, if the patients care about taste. Given that BLU-5937 has a 1,000 more selectivity to the airway receptor versus the taste receptor in models, BLU-5937 should have a higher dosing window before the taste side-effect becomes apparent.

Therefore, of the three opportunities to win the class, BLU-5937 could succeed by having the better taste side-effect profile, and potentially win in a substantial way that could make someone ask some questions of the smart people at Merck. Good for BLUSF investors.

Investment Thesis for Bellus

If you believe that Merck understands the market potential for a chronic cough suppressant and the potential for a P2X3 antagonist to provide a viable therapy for the indications, then one could reasonably assign a value of any company with a better drug at something north of $1.25 billion biobucks. If one then believes the Company’s data on receptor activation, the FDA’s ability to screen for unsafe compounds through the IND review process, and the Company’s data on the lower potential for a side effect profile, then the Company should be worth something north of $1.25 billion biobucks after they complete a dose ranging Phase 2 study with 250 patients, and match Merck’s efficacy and safety profile.

Assuming the Company takes 3 years to complete their Phase 1 and Phase 2 clinical studies, then their valuation should be north of $1.25 billion by the end of 2020 (my assumption on the clinical timeline based on the Company’s guidance of a 2019 Phase 2 trial initiation). Even assigning a ridiculously high cost of capital of 50% in a standard quarterly cash flow model, I calculate the current NPV of the Company @ $250 million (~US$2.20 stock price). Assigning my usual risk metrics by phase of clinical trial (75% Probability of Success (“PoS”) @ IND, 90% PoS @ Phase 1 and 50% PoS @ Phase 2) with a more standard 20% cost of capital, I calculate the weighted average current NPV of the Company @ $180 million (~US$1.45 stock price). These valuations do not include the approximately 16 cents per share in cash sitting on the balance sheet right now.

Since they do not need funding anytime soon, the only way to buy into the Company at this point is through open market, either through the TSX or the OTC. The stock trades about 100,000 shares a day on the TSX and about 20,000 shares a day on the OTC. As the Company marches through its clinical program, the value should substantially rise, as this in an execution play without the overhang of an impending financing like many other biotechs. Insiders own 30% of the Company and institutions own 35%.

After passing the IND approval risk hurdle expected in Q2 2018, I calculate the weighted average current NPV of the Company to jump to $345 million (~US$2.70 stock price). A similar doubling of value is modeled to occur after the successful completion of the Phase 1, expected in late 2018 or early 2019.

Major Risks

Financing Risk: Given the balance sheet, and the clear regulatory pathway (which translates into reasonable cost projections), the risk of further dilution any time soon is low. At $25,000 per patient, the Company’s clinical trial costs should not exceed $8 million over the next three years. Their quarterly operating expenses appear to be around $1.1 million, not including external clinical trial expenses. That math suggests they have the cash to see the Phase 2 data near the end of 2020. They will be able to hit three significant value-enhancing milestones before they need more capital. If they run the program slower than projected, then the risk goes up, but they should at least be fund through two milestones and most of the dosing of the Phase 2, regardless of pace.

Tree in the Forest: This a Canadian company has coverage from two Canadian banks (Bloom Burton and Mackie Research), but no US coverage. Visibility is low on this side of the border. According to their press release on their last financing, Bloom Burton Securities Inc. facilitated the transaction. I have been investing in small cap biotechs for many years, but am US focused and had not heard of either firm. I know that the CEO is working hard to gain visibility.

Nepotism Question: The CEO appears to be making the circuit and presenting well, but he does not come from the traditional US biotech path of either hailing from a big pharma, or a traditional venture-backed company. This is his first time in the CEO chair and his father, who is the Chairman of the Company, may have had a roll in that decision. The CEO’s previous roles at Picchio Pharma, Inc. also seem linked to his father, who appears to own and run Picchio Pharma, Inc. It is highly like that the CEO does not fall far from the proverbial apple tree, which appears quite successful, but it always raises a question when father and son are linked inside of a public company. I do not feel this is a substantial risk given the time the CEO has spent in the pharma world and the credibility of the rest of the board (Franklin Berger is a notable GREAT in the biotech space).

Conclusion

This is the cleanest investment story I have seen in a very long time. There is a big pharma validated target, a massive exit deal comparable for a therapy that only had partial phase 2 data at the time of purchase, a clear potential for better target product profile than the most recent exit deal, and an off-the-radar company who has the capital in the bank to complete the program to the point of take-out (if not done before Phase 2 data). This one will take 2-3 years to play out, but the upside potential is 30X if the biobuck deal is anywhere close to being on par with the previous deal.

Editor's Note: This article covers one or more microcap stocks. Please be aware of the risks associated with these stocks.

Analyst’s Disclosure: I am/we are long BLUSF. 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.