This article was selected to be shared with PRO subscribers, who also got 7 days' exclusive access to Elle Investments’ original Top Idea on ObsEva (NASDAQ:OBSV). Elle Investments is a small family office that manages its portfolio using a “quantamental” approach. Find out more about PRO here.
Seeking Alpha: Can you briefly summarize your bullish thesis for readers who may not have seen it yet?
Elle Investments: ObsEva is a microcap biotech company focused on the women’s reproductive health market. After hitting $18.00/share in September 2018, it began a slow and gradual decline over the next year or so. This decline was not due to any specific data readouts, so we attribute it to a combination of growing investor concern over the dwindling cash situation as well as steady advancement from competitors. Then, on November 7, 2019, shares saw a sharp 65% drop when a failed nolasiban Phase 3 trial for IVF was announced. Shortly thereafter on December 9, positive linzagolix Phase 3 PRIMROSE 2 results for uterine fibroids (“UF) were announced but the stock did not go up (and still has not).
We think all of these items have contributed to the mispricing. The company has made it a corporate objective to enter into a partnership for linzagolix commercialization, so the lack of funds to launch on their own does not concern us. Also, we assign no value to nolasiban and our valuation is completely supported by linzagolix alone, so the recent 65% drop, in our view, only served to make the shares more attractive. Lastly, we think the PRIMROSE 2 data clearly showed that linzagolix is at least as efficacious (and potentially best-in-class) as AbbVie’s (NYSE:ABBV) Orilissa and Myovant Sciences’ (NYSE:MYOV) relugolix. On top of that, OBSV could differentiate itself with its low dose option for UF that does not require add-back therapy (“ABT”), given the large number of women that prefer to avoid taking hormonal supplements due to the side effects.
We acknowledge that bone mineral density (“BMD”) loss continues to be a serious side effect to watch out for with this class of drugs in general (gonadotropin-releasing hormone (“GnRH”) receptor antagonist), but linzagolix thus far remains comparable to Orilissa and relugolix and also above the -3% threshold that the FDA has mentioned when debating the approval of competitors.
If the efficacy and safety data hold up in the upcoming readout (2Q20) for the second Phase 3 trial for UF (PRIMROSE 1), then we think that at a minimum, linzagolix will see decent commercial sales of at least $300M+ in just the US and EU combined. The stock has been overly-punished, and the fully diluted market cap of about $150M makes this very undervalued.
Along with the upcoming PRIMROSE 1 data readout this quarter, both the PRIMROSE 1 and PRIMROSE 2 extension studies could serve as a catalyst, along with a partnership announcement. Our PT is $13.39/share, offering 349% upside. We think OBSV is a Buy.
Seeking Alpha: What do you think is the more likely financing type (equity, debt, partnership)? Which of these is the most and least preferred option and why?
Elle Investments: We think (and are hoping for) a partnership announcement. Marketing a new pharmaceutical drug can get very expensive very quickly, and we are well aware that OBSV is up against a giant in ABBV and a much larger company in MYOV. Many tiny biotechs make the mistake of trying to commercialize on their own rather than partnering, and shareholders suffer as a result. But during some of the recent discussions with analysts, management made comments acknowledging that their specialty is the research side, and so we take this as a good sign that they realize selling linzagolix on their own would be an uphill battle.
For our model, we factored in the future financing costs that would be incurred should they borrow the almost $200M (at 20%) that they would need to both pay development and regulatory milestones to Kissei Pharma and build the sales force from scratch. But this was just to show how undervalued the stock really was, even adding an extra $40M or so in interest expense to their income statement. We really do hope they find a partner instead of raising the money by borrowing or selling shares.
Seeking Alpha: To follow up, would you recommend a long position before or after it secures financing? What (if anything) would investors be missing who say “I’ll invest after it secures financing as there is less risk then”?
Elle Investments: This is always the issue with pre-commercialization stage biotechs - when the seemingly endless stream of dilution via stock offerings will end.
The problem with trying to time an investment based on what you think will be the last round of dilutive financing is that you might miss a lot of upside in the process. A partnership announcement that includes a sizable upfront payment with a high royalty rate can make a stock jump 50%. An investor might also miss the run-up that occurs in the share price as a major catalyst is approaching. And ironically, if dilutive financing does occur but the discount to market price for new investors is very small, then the stock can also go up a lot, as it shows that there is strong demand to buy shares.
Also, with a company like OBSV that has a small market cap, a buy-out could very easily occur, though we find it difficult to speculate on the odds of buy-outs in general.
So, there you have it, the usual trade-off between potential upside and risk/volatility. We like the reward/risk profile for OBSV in general but every investor should price in the risk and size the investment in relation to his complete portfolio. Finally, all investment decisions should be dynamic (at least in spirit) and can be adjusted over time. For OBSV, we feel that it belongs with a minimum size position in most investor portfolios right now; one can always add later if the stock price and risk profile, together, warrant it.
Seeking Alpha: While you note that “caution should always be taken when comparing data across trials,” can you discuss how data from other trials in general, and specific to this thesis, can inform your investment decision-making process? What best practices are there for analyzing such data and attempting to make comparisons?
Elle Investments: Biotech investing would be so much easier for investors if all trials involved head-to-head comparisons between competing drugs. Unfortunately, this is not always the case, and we are forced to compare data across placebo-controlled trials. Because of the inconsistency in results that might arise when patient demographics, dosing procedures and duration, primary and secondary endpoints, etc., are not consistent across trials, investors should always take these cross-trial comparisons with a grain of salt.
One method that can be used is to adjust for the efficacy for the placebo response, which OBSV does in their slides for both the primary endpoint and a very important secondary endpoint (amenorrhea response rate). Even making this adjustment, the results for linzagolix fare very well relative to the other two drugs.
The other component to focus on is safety relative to the competition. Rather than trying to rank the drugs based on, for example, headaches (7% for linzagolix vs. 11% and 9% for relugolix), we think it’s more meaningful to simply conclude whether the drug has an acceptable tolerability profile given the benefit it’s providing, and whether it falls in the general tolerability profile range relative to the others. We feel that linzagolix does this for both the mild side effects such as headaches as well as the more serious side effect of BMD loss.
For what it’s worth, the high dose (with ABT) of linzagolix had an efficacy response rate of over 90% in the PRIMROSE 2 trial. In absolute terms, this is better than what Orilissa and relugolix have demonstrated. But even putting the response rate from competitors aside, a response rate of over 90% is pretty good, and we can feel very confident concluding that linzagolix did something for a high percentage of women that received treatment. Because of this, capturing at least a 10% market share (in both the UF and endometriosis markets) seems like a very reasonable assumption, even without the head-to-head data we would need to definitively say which drug is the best. And in this case, the market cap has fallen so much that even with this very conservative market share assumption (not to mention conservative estimates for pricing and the respective patient pools for UF and endometriosis), the upside is substantial.
Thanks to Elle Investments for the interview.
This article was written by
Disclosure: I am/we are long OBSV. 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: The Elle Investments portfolio is managed utilizing a “quantamental” approach where each position, while based on Fundamental Analysis, is sized as part of a larger quantitative portfolio. The commentary presented here is for research purposes only and is not to be taken as investment advice. Readers are expected to perform their own due diligence and/or hire an investment professional prior to entering/exiting positions. Published research ideas are related to the specific market price and publicly available information at the time of research submission/publication. Elle Investments will enter/exit positions without notice.