Editor's note: Seeking Alpha is proud to welcome Pivotal Biotech as a new contributing analyst. You can become one too! Share your best investment idea by submitting your article for review to our editors. Get published, earn money, and unlock exclusive SA Premium access. Click here to find out more »
Hiroshi Watanabe
Summary
On April 16, 2024, shares of Aurinia Pharmaceuticals Inc. (NASDAQ:AUPH) closed at $5.00 with a valuation of ~$722 million. I have acquired a 2% position in the stock for my portfolio, which I will protect and/or augment with a couple of option plays over the next 6-9 months. Here is why: 1) The company is finally reigning in costs by "pausing" its early pipeline; 2) They are buying back up to 15% of their shares at a low cost; and 3) They continue to slowly, but methodically grow Lupkynis in the US and their ex-US partner Otsuka is at the early stages of launch in the EU, with Japan potentially coming online later this year. As a result, in less than a year, AUPH will be a single-asset, commercial biotech that should be net cash flow positive and well on its way to profitability. This should make it a more attractive acquisition target at that time, but allow it to "stand alone" as well. While my view is contrarian, I can see a potential upside of 80-115% by next January's JPM meeting.
Background: Disease State & Therapeutic Options Background
It is estimated that in the US between 200,000 and 30,000K patients live with Systemic Lupus Erythematosus (SLE), which is characterized as an autoimmune disease that attacks multiple organs in the body. Lupus Nephritis (LN) is the manifestation of this inflammation in the kidneys. It is also estimated that ~50% of SLE patients will develop LN and that the disease disproportionately affects women and people of color. AUPH has stated there are likely between 120,000 and 135,000 patients in the US now with the disease, but many remain undiagnosed and/or untreated.
Because LN is an autoimmune disease that attacks the kidneys, the goal of treatment is to protect the kidneys from long-term damage due to inflammation. Standard of care treatment had been immunosuppressive therapy typically consisting of a calcineurin inhibitor (CNI) like cyclosporin, an immunosuppressant like MMF (mycophenolate mofetil), and corticosteroids.
However, most of the drugs in the above cocktail can have toxic, long-term effects and therefore have to be monitored carefully. This in turn limits their use in LN.
Enter AUPH's Lupkynis (voclosporin). Lupkynis is considered to be a "next-gen" CNI that was basically designed to work faster, be more effective and less toxic than cyclosporin. Efficacy and safety were confirmed in its Phase 3 AURORA 1 trial and 3-year long-term safety was confirmed in its Phase 3 AURORA 2 trial. The drug is taken orally as 3 capsules BID (twice a day) and is indicated in combination with a background therapy of MMF and steroids. In addition, Lupkynis has been shown to help reduce a patient's use of MMF and steroids.
AUPH launched Lupkynis for LN on 01/22/21 right in the middle of the Covid-19 pandemic - one of the worst potential environments to launch a drug, ever. It is easy to forget now that most offices were closed for over a year and/or conducting telehealth where they could. There was no way for AUPH to effectively educate HCPs and/or patients on the new drug, especially in a disease state that is so under-diagnosed and under-treated. Therefore, it should not have been a "shocker" when initial sales were significantly lower than what many analysts projected in the first two years of launch (Evaluate Pharma had a first-year sell-side consensus at ~$240 million on Jan. 25, 2021). There was no way that AUPH, or any Big Pharma could have come close to those numbers in 2021 or 2022.
Once offices reopened, sales of Lupkynis grew. AUPH reported on February 15, 2024, that 2,066 patients were on their drug at the end of 2023 with net product revenue of ~$160 million. These are solid numbers for the true "second" year of launch. I get why some are "concerned" that the last 3 quarters of patient growth have slowed, and I also think the prior criticism of AUPH's management regarding their high-spend/focus on the early pipeline was warranted. Physician and patient disease awareness campaigns cost a lot of money as does early pipeline spend for nephrology products. Therefore, it remains logical that analysts and investors desire a sale of AUPH to Big Pharma for the next stages of growth.
However, I urge investors to keep in mind that AUPH has the money to spend (on top of the new savings from pausing its pipeline) and is now shifting its focus to the necessary commercial and marketing moves to open the LN market further. Specifically, they are focused on two basic interventions which are based on new guidelines. The first is with Rheumatologists, who see and diagnose SLE patients. The majority of these HCPs currently focus on other symptoms of SLE and do not get a urine screen for their patients - which is why LN can become such a "silent killer" (see the 2024 Corporate Presentation linked above for details). The result: LN typically gets diagnosed by a Nephrologist after injury to the kidneys has already begun. The second intervention involves getting a Rheumatologist and/or Nephrologist to actually prescribe a treatment once the diagnosis has been made. Incredibly, current estimates are that only ~30% of patients with a positive urine screen get treated.
There is a huge opportunity to improve on these two metrics. An incremental increase would yield a decent # of patients on a percentage basis (for example a 10% increase is ~200 more patients on the drug). Additional patients coming from hospitals (which AUPH had been shut out of for close to 2 years) and restarts should add volume as well. And if international sales are slow at launch, even their incremental additions, with the above, are why I am comfortable with AUPH's net product revenue projections for 2024 (see below).
Recent Stock Moves
Prior to launching Lupkynis in 2021, AUPH was considered a decent target for M&A with the stock trading at one point over $20/s. There were a couple of rumors that an acquisition was imminent, and the company even raised capital through an ATM ~$20/share through February 2022. I did not think an acquisition was likely to take place back then nor even more recently due to a variety of issues including clarity around Lupkynis' IP, the current Run Rate of the drug, and the Burn Rate of the company. Instead, I watched the stock price slowly tick down over the past two years to a value that now made more sense for me to enter.
The stock was trading close to $9/s around the JPM meeting in January. It then dipped to around $8/share shortly after most likely because there was no M&A news. The company then shared the news in their February 15, 2024, yearly update that numerous suitors had taken a look at the company and decided not to make formal offers. 11 NDAs were signed over the past year and only 1 went to due diligence. But that is all we really know publicly. Logic would say price was the issue. The stock dropped further to ~$6/share and now sits at ~$5/share with a ~$720 million valuation.
AUPH 04/16/24 Stock Chart (StockCharts.com)
I have read many "posts" and articles from investors over the past couple of years who bought the stock when it was significantly higher priced. They feel burned and are angry. For me, I am watching the CEO repurchase shares now at ~$5/share after growing sales in 2023 like he said they would (see below). Therefore, as an investor today, my suggestion is to forget the past all-time highs and at-the-market financings; forget the years of M&A rumors, and acknowledge that a potential M&A premium is now out of stock. In short - block out the noise of the past. Instead, focus on the stated moves for the future AUPH made on February 15, 2024, and the actions they plan to take in both the short and longer term to achieve them.
Discussion on Financials
Run Rate: Many analysts and armchair quarterbacks are claiming that Lupkynis sales have topped out. I disagree (per my thoughts above). AUPH projected 2023 revenues of $120-$140M and then delivered net product revenues of $159M by year-end. 2024 projected revenues are between $200-$220M. I like their chances of hitting and/or exceeding these numbers based on the updated sales and marketing focus (again, refer to the 2024 Corporate Update linked above). To follow along this year, keep watching these metrics each quarter:
- POT (Patients On Therapy): The company finished YE'23 with 2,066 POT vs. 1,525 POT in YE'22. YE'23 NPR (net product revenue) was $42.3M. YE'22 NPR was $28.3M. I think AUPH could add up to another 200 patients on the low end and 4-500 on the high end in 2024. Persistency has also increased to 55%. This too is positive.
- PSFs (Patient Starter Forms): 438 in 4Q'23 which was flat compared to the 3Q and down slightly from the first and second quarter. This is the lifeblood of new business. And it is stable. Further, the Conversion Rate remains at ~85% (and trended closer to 90% for 2Q and 3Q). We have seen POT increases with these types of numbers.
- The company also reported there is an increase in restarts and patients coming in from hospital starts. This too is a positive trend.
Burn Rate: The company announced it was "pausing" AUR200 and AUR300 on February 15, 2024, which is exactly what I wanted to hear: cost savings and focus.
- Cost Savings: AUPH estimates killing the early R&D projects should save the company $50-$55 million a year or ~$12.50-$13.75 million/quarter after a $11-$15 million write-off. I believe this is important for a company that is currently losing ~$27 million/quarter.
- Focus: AUPH can now return to being a single-product commercial biotech. They exceeded sales expectations last year and have identified commercial opportunities where they can continue to grow. There is no excuse not to execute in 2024.
Cash: AUPH had ~$350M at the end of 2023. Even with a $27M/qtr. burn rate, the company could have been fine without a raise probably for the considerable future. More countries in the EU should start to come online this year and ex-US partner Otsuka should have Japan up and running this year.
- AUPH is due to receive net tiered royalties of 12-20% from EU sales and 10-18% from Japan. Japan has the larger potential opportunity market and AUPH is due to earn a $10M milestone for Japanese approval, likely to occur later this year (see Slide 25 of the Corporate Presentation linked above for more details).
Couple the significant decrease in R&D spend and the US market's slow growth with the potential incremental increase from ex-US sales…and AUPH should very well be cash flow positive by the end of the year. Profitability should then follow.
Share Repurchase: In addition to the termination of activities on the early pipeline, AUPH announced in its 02/15/24 press release their intention to repurchase up to $150M of their shares. Prior to the announcement, the stock was trading at ~$8/s. The stock then dropped to ~$6/s. As a Canadian company, AUPH was allowed to repurchase up to 5% of their shares/yr (which they stated could be ~7.23M shares). AUPH began the repurchase program on 02/21/24 (at a price at least $2/s less than the prior week's close) and applied for "Exemptive Relief" to purchase up to 15% of their shares (~another 14.69M shares), the maximum amount allowed.
On February 29, 2024, relief was granted. At the time of the repurchase commencement, there were at least 145.76 million shares outstanding trading at ~$5/share. This means that AUPH has the potential to repurchase ~22 million shares at a 25-37% discount to the closing price prior to the February 15, 2024, announcement, translating into a potential savings of up to ~$10-$25 million of the $150 million they allocated. Even if AUPH adds 2-3 million more shares in ESOP/performance rewards, that might put the share count at ~125 million by the end of the year (not fully diluted).
Valuation
Back-of-the-envelope Math: Below are 2 simplified valuations, one low and one high, that give a potential target price range over the next 6-9 months. I have left off a discount rate, which would obviously lower the potential gains from an acquisition of the company due to the short duration of a potential 6-9m investment- feel free to use your own if you like.
On the low end: If AUPH hits on the low end of their FY'24 net product revenue (NPR) of $200M, and we give it a modest take-out multiple of 5x, that takes you to ~$1 billion valuation. Throw in year-end cash of ~$130 million {$350 million - $150 million share repurchase, -$55 million burn rate (-$13.125 million midpoint from above calculation x 4 quarters), -~$15 million write-off} and that brings you to ~$1.13 billion valuation. If there are ~125 million shares at that point, that would bring the value of the stock to ~$9/share for ~80% potential upside to the closing price on April 16, 2024.
On the high end: If AUPH hits the high end of their FY'24 NPR of $220 million, and we give it a slightly higher take-out multiple of 5.5x, that takes you to ~$1.21 billion valuation. Throw in year-end cash of ~$145 million (similar to above, but with the company now saving $15 million on the stock repurchased at a lower price) and that takes you to ~$1.355 billion valuation. With ~125 million shares, that would put a year-end price for AUPH closer to ~$10.84/share and a potential upside of ~116%+ from the close on April 16, 2024.
Risks
The greatest risk to AUPH in many investors' minds appears to be around Patent questions. Only a professional, biotech patent attorney can provide true guidance on this subject, and I am not one of those. But here are a few things we do know:
- Lupkynis was granted a Method of Use (MOU) patent #991 on 04/11/23 that goes to 2037. Issued by USPTO, "…this patent further refines the method of using Lupkynis in combination with (MMF) and corticosteroids using eGFR as a method of pharmacodynamically dosing the product in patients with lupus nephritis". It also supplements the #'036 patent listed in the Orange Book that had an already FDA-approved product label out to 2037.
- A Composition of Matter (COM) patent expired in October 2022 and a New Chemical Entity patent expires on January 22, 2026.
What does this mean? If a generic maker wants to file an ANDA for Lupkynis, theoretically they can file anytime to "certify" (challenge) against the NCE patent in accordance with the Hatch-Waxman Act of 1984. There are 4 types of certifications that the ANDA filer can file against. In simplest terms, the FDA prefers option #4 (a paragraph 4 certification) which claims the filer believes the innovator's patents in the Orange Book are not relevant or invalid. For the first-filer, the FDA will then grant them 180 days of exclusivity from the termination of the patent(s) in question should their challenge prevail.
The problem for the first-filer is that the act of filing a paragraph 4 certification is an act of patent infringement…which has been purposefully built into the Act. Basically, the innovator is forced to start litigation against the filer, and the filer counter-sues to have the patent(s) listed in the Orange Book tossed out. Without getting into too many more specifics here, this process can take many years to resolve, but there are protections for the innovator built into the ACT, including the triggering of a 30-month stay from the date of the last COM/NCE end.
For AUPH and Lupkynis, that puts concrete patent protection at a minimum to mid-2028 (January 2026 plus 30 months)…another 4 years from now. But that is when the 2 MOU patents Lupkynis has listed in the Orange Book will still apply…protecting Lupkynis through 2037. It is reasonable to assume that AUPH will settle with a first-filer to allow a generic prior to December '37. It is unreasonable to ascribe minimal-to-no value to these 2 MOU patents. Why? Because these MOU patents are in the Lupkynis' label. If a generic filer wants to instruct patients on how to effectively use their generic Lupkynis in LN, they are going to have to pay to use these patents and/or wait for them to expire. This is how the "game" is played (if one wants to view some relevant and recent examples, look at AbbVie, Amgen, and Jazz - they are expert defenders).
Whenever a generic challenge comes in for Lupkynis, AUPH will sue and start a several-year process of delays (an action CEO Peter Greenleaf confirmed on a recent call with TD Cowen on March 05, 2024). This should yield several more years of exclusivity for Lupkynis.
FDA's Orange Book filings for Lupkynis (FDA.gov)
Other potential risks
I may be early, and the stock may drop further in the short term (falling-knife syndrome), but I am comfortable entering ~ today's $722M value and would add to my position if the stock were to drop another 10% on no news.
If POTs start to drop and/or PSFs have 2 quarters under 400, it will raise a red flag.
There will be a fed flag as well if there are delays in EU and/or Japan commercialization (which doesn't appear likely).
Competition today: Benlysta
GSK already had a competitor in the space, Benlysta (belimumab). Benlysta is a monoclonal antibody (mAb) approved for both SLE and LN, with the latter indication coming about a year before Lupkynis was approved. Sales of Benlysta in 4Q'23 were ~$488 million and ~$1.69 billion in 2023 (from p.6 of GSK's Full-year and Fourth Quarter 2023 report on 01/31/24; GSK does not provide a breakdown for SLE vs. LN patients).
The drug is administered either as a monthly IV infusion or a weekly subcutaneous injection. It has a different mechanism of action/target and based on the efficacy and safety data in its label, Benlysta does not work better or faster than Lupkynis (Please note that direct comparisons from clinical trials and/or labels are difficult to make due to different patient populations and endpoints/metrics used in the studies. Only a direct head-to-head study could officially determine superiority in the FDA's eyes). So, same LN disease indication, but potentially different patients, different costs, and different AEs, etc. There is a place for both drugs to treat LN, but in my opinion, Lupkynis will eventually surpass Benlysta in LN-specific sales due to efficacy, safety, and ease of use.
Competition in the future: Cell therapies and additional mAbs.
CAR-Ts for Lupus? Sure, eventually, and only for the most severe patients. Yes, 30+ CAR-T companies are or will be pivoting from cancer to autoimmune diseases, but CAR-Ts are expensive, labor intensive, and as of now, require toxic preconditioning. Only the worst of the worst SLE/LN patients will get this type of treatment, and it will take more than a couple of years to get this option to patients should it continue to show strong results in the early clinic. There may be promise in NK cells as well (natural killer), but they too are a long way off from potential commercialization. There are a handful of mAbs making progress in the clinic targeting CD20, BAFF, and/or APRIL that have demonstrated progress in SLE and/or potentially LN. They too have a way to go before potential commercialization and most are IV or subcutaneous injections. If they are eventually successful, I would think they are a greater threat to Benlysta than Lupkynis.
Conclusion
By year-end 2024, AUPH should be a single-product commercial biotech that is cash flow positive and slowly growing in the US, EU, and potentially Japan. Single-product companies are one of the most attractive acquisition targets in the industry. Ones that are generating free cash flow are even more so. AUPH should be able to navigate patent challenges over the next several years, giving it commercial exclusivity for potentially 10+ years, and there does not appear to be an oral competitor on the horizon for quite some time. Further, the company has $560 million in non-operating loss tax credits that should definitely appeal to certain potential acquirers.
For these reasons, it is my opinion that AUPH's stock price will rise between 80% and 115% from its current levels and re-emerge by year-end as a "bolt-on" asset for one of the dozens of biopharmas actively hunting for a $1-$2 billion acquisition.
I will update any trading changes after I make them and if or when my investment thesis changes.
