A Capital-Efficient Prescription For New Drugs: Raghuram 'Ram' Selvaraju

The small biotech companies that have survived the last five years have learned to be lean, mean and efficient with shareholder capital. In this exclusive interview with The Life Sciences Report, Aegis Capital's Managing Director and Head of Equity Research Raghuram "Ram" Selvaraju discusses companies that have mitigated risk by giving new life and higher margins to products previously relegated to the dustbin of commoditized generics. He also highlights some very new and exciting developments in the realm of stem cell technologies and monoclonal antibodies that engage never-before-targeted molecules.

The Life Sciences Report: You just returned from the 28th Annual European Conference on Treatment and Research in Multiple Sclerosis in Lyon, France. Putting aside the focus on multiple sclerosis, did you get any perspective on biotech markets in general?

Raghuram Selvaraju: Right now, everyone is talking about the major cost-containment pressures at work in the healthcare industry, and in Europe in particular, where a lot of economies are in deep financial trouble. Companies are concerned about the prospects of new drug launches. Once new drugs get through the approval process, they then have to go in front of reimbursement agencies in Europe. They are looking for advantageous pricing, but nowadays companies have to be prepared for a contentious battle, which was not historically the case. That has put a damper on enthusiasm within the context of the overall sector.

There are also concerns here in the U.S. about cost-containment pressures because we have a fiscal cliff looming. If Congress can't figure out how to put the country on a sustainable fiscal path, we will see draconian, automatically imposed cuts across the board within healthcare. These cutbacks will not only impact funding for research and clinical development, but will also affect the ability of the healthcare system to pay for drugs and other diagnostic and therapeutic interventions.

The overarching concern globally is cost containment. That is going to make things difficult for the biotech sector.

TLSR: Ram, there's been a change in the regulatory environment in the U.S. Would you address that?

RS: The overall mood among healthcare-focused institutional investors, whether hedge funds, mutual funds or venture capital firms, is generally bullish, principally because of the recent demeanor of the U.S. Food and Drug Administration [FDA]. The FDA has approved a large number of drugs that have either been on its docket for a while, or that people were not expecting the agency to approve in such a timely manner. The overall positioning of the agency looks very different from the way it was in the 2005-2006 era, when we saw the Vioxx [rofecoxib] scandal and the subsequent approval and then withdrawal of Tysabri [natalizumab]. Tysabri eventually returned to the market after patients and physicians alike argued on its behalf, which illustrates how conservative the agency had become. The FDA went from being a somewhat permissive agency to extremely risk-averse. The new FDA attitude has been the principal driver of bullishness in the biotech sector recently. These days, when a drug is supposed to be approved -- when it has demonstrated strong safety and clinically meaningful efficacy in the disease area that it is designed to treat -- it has typically been approved.

TLSR: Do you think this loosened FDA stance will continue?

RS: Yes -- at least until there is another scandal. The new stance of the FDA has been driven by voices in the Obama administration and in Congress saying the agency has become too risk-averse. Complaints by industry and patient advocacy groups have not gone unnoticed. We need new drugs, especially for significant unmet medical needs.

TLSR: You follow some micro-cap companies and do serious diligence on them, which is rare. Are micro caps suitable for retail investors?

RS: I want to make it absolutely clear that I don't consider any investment in biotech to be 100% suitable for the small retail investor. The retail investor who chooses biotech should only invest highly discretionary funds in the space. The older person with only $50,000 in retirement savings shouldn't go anywhere near the biotech sector, regardless of market cap.

TLSR: Are there special risks associated with stocks in the micro-cap realm?

RS: We have been taught that drug development costs a lot of money, and that it takes several hundred million dollars -- at least -- to get a drug from concept through the clinic and into the market. The problem with this approach is that investors become inured to the fact that biotech companies are serially raising money, diluting shareholders and carrying an accumulated deficit of several hundred million dollars before getting a drug across the finish line and within sniffing distance of sustainable profitability. Personally, I think that is wrong, and I have taken great pains to point out that all drug development does not have to be prohibitively expensive.

TLSR: Ram, is there a company that meets that criterion?

RS: IntelGenx Corp. (OTCQB:IGXT) is a company in my coverage universe that has an accumulated deficit of only $17.5 million [$17.5M], a market cap of less than $36M and an enterprise value of about $30M. But the company has managed to get FDA approval for a drug without help from an external party, whether a partner or otherwise. The drug is Forfivo [bupropion], a higher-dose, extended-release version of Wellbutrin for major depressive disorder. It is being launched by IntelGenx's sales partner Edgemont Pharmaceuticals LLC.

IntelGenx has proven a drug can be taken through development and to the market successfully without spending a massive amount of money. This drug may represent only a niche opportunity, and I'm not suggesting that it is a blockbuster. But the company has succeeded where much larger companies have failed to get anything approved. There are many illustrations of the hypothesis that drug development can be done in a cost-effective, capital-efficient way. Telling investors that all drug development is expensive is disingenuous and wrong.

TLSR: Aside from capital efficiency, what else do you look for using this type of investment thesis?

RS: I look for management teams with substantial ownership stakes in their own companies. I don't like it when CEOs pay themselves massive salaries and don't own a single share of stock -- that's a disaster waiting to happen. IntelGenx was founded by its president and CEO, Horst Zerbe, who still owns 23% of the company. He founded IntelGenx as a formulation expertise-focused company, and now it has three core platform technologies that enhance drug delivery, enable development of novel formulations and improve the dosing convenience of existing drugs. Notice I said existing drugs. This company is not engaged in pie-in-the-sky, de novo drug development on a novel, invalidated target. It is improving existing agents that have indisputable safety and efficacy profiles.

The company has a plethora of clinical-stage candidates, all of which are amenable to approval via the FDA's 505[b][2] regulatory pathway, which is a hybrid of the abbreviated new drug application, used by generics companies, and the new drug application [NDA], used by branded pharmaceutical companies. The 505[b][2] route has distinct advantages because companies get the same exclusivities given to de novo development via NDA, but have the added advantage of working in a domain wherein chances of approval are much higher.

In my opinion, IntelGenx's model represents not only a cost-effective approach to drug development, but a risk-mitigated approach as well. Saying you are going to dilute him/her to the smallest extent possible is a responsible message to take to the shareholder. Horst Zerbe can say that because he is a shareholder in his own company.

TLSR: In addition to IntelGenx's Forfivo, the company has a pipeline of products for insomnia, migraine, erectile dysfunction and neuropathic pain management, among others. Is your $3 target price driven solely by Forfivo, or do you have these other products factored into your model?

RS: I attempt to ascribe a risk-mitigated net present value to all components of a company's clinical-stage pipeline. My valuation methodology takes account of IntelGenx's other drug candidates, but I ascribe a $1/share amount to the company's lead product candidate, Forfivo, by itself.

TLSR: Is there another example you would like to talk about?

RS: Following in the capital-efficiency vein, Israel-based BioLineRx Ltd. (BLRX) is an interesting company. It has a good pedigree; the company was co-founded by Teva Pharmaceutical Industries Ltd. (TEVA) and has been an incubator project. BioLineRx has done some cost-effective, cost-contained, capital-efficient drug development. Since its inception roughly nine years ago, it has raised about $120M. It has burned through about $90M or so while building a pipeline of seven clinical-stage candidates and more than 20 preclinical candidates, all of which are optimized. The company trades at an enterprise value of less than $30M, but its pipeline is commensurate with that of a company 10 or 15 times its size.

TLSR: Are you applying the concept that some micro-cap stocks are not necessarily the great risk that consensus opinion seems to indicate with regard to BioLineRx?

RS: Yes. We see a massive amount of value in BioLineRx, available at a disproportionately low price. Not to mention that the company has two drug candidates in phase 3 development, with results from both pivotal programs due over the course of next year. The company does not lack near- and mid-term value-driving catalysts. It's quite the opposite.

I am particularly impressed that BioLineRx has managed to develop multiple drug candidates in different disease indications simultaneously in an organized manner, without burning a lot of money in the process. A case in point: The company recently reported that it completed preclinical development for a hepatitis C [HCV] candidate. That alone should be sufficient motivation for investors to significantly bid up the price of the stock, because HCV is a hot disease indication right now. We have seen a rash of high-priced acquisitions, deals and partnerships in this domain, and I expect that to continue. With HCV, companies can start throwing off efficacy data almost as soon as they are in clinic or start dosing patients -- data that the market can take to the bank.

TLSR: Shares of BioLineRx are up 39% in the past four weeks, yet it only has a $57M market cap.

RS: Exactly. By the end of Q3/12, it is probably looking at $25-26M in cash. We are talking about an under-$30M enterprise value, which seems paltry in light of what is going on at this company.

TLSR: Can you mention another company that you like?

RS: Ampio Pharmaceuticals Inc (AMPE) is also focused on the 505[b][2] pathway. The company is interesting principally because it looks at repurposing approved drugs for new disease indications. This is a more sophisticated model than IntelGenx's, which is focused on reformulation but not changing the purpose of the drug. And as I said before, the 505[b][2] application advantage is that the route to market is significantly abbreviated, and the cost associated with clinical development is significantly lower.

TLSR: Was there one more company you wanted to mention?

RS: The last company that I would highlight is Synergy Pharmaceuticals Inc. (SGYP). The company is in a single phase 3 trial with a drug candidate very closely related to Ironwood Pharmaceuticals Inc.'s (IRWD) recently approved drug, linaclotide, which is going to be launched in December under the trade name Linzess. Linzess went through four phase 3 trials in chronic constipation and irritable bowel syndrome, and met 66 primary and secondary endpoints with statistical significance.

Linzess is based on an endogenous human hormone, but it is not an exact replica of that hormone. Instead, it is a peptide that was identified in a bacterial endotoxin that is known to perform some of the same functions as the endogenous human hormone, which stimulates fluid secretion into the intestine. Obviously, if there is more fluid in the intestine, there is greater gastric motility, and therefore issues associated with chronic constipation and irritable bowel syndrome can potentially be resolved. Synergy has a direct copy of the endogenous human hormone, plecanatide [formerly SP-304]. If the mechanism has been validated by Ironwood's drug, and Ironwood's drug causes some diarrhea as a side effect because the bacterial endotoxin overstimulates the receptor and oversecretes fluid into the intestine, Synergy's drug candidate is not only more risk-mitigated, but also could demonstrate comparable efficacy without the problem of diarrhea.

TLSR: How much could Synergy Pharmaceuticals be worth?

RS: Ironwood is worth roughly $1.4B, but it only owns about 40% of Linzess, whereas Synergy owns 100% of plecanatide. Using Ironwood's current market cap of about $3B as a proxy, we think Synergy's $300M market valuation represents an unwarranted discrepancy.

TLSR: Ram, I've enjoyed this. Thank you.

RS: I've enjoyed it very much.

This interview was conducted by George S. Mack of The Life Sciences Report and can be read in its entirety at http://www.thelifesciencesreport.com/pub/na/14673 or on our instablog.

Raghuram "Ram" Selvaraju's professional career started at the Geneva-based biotech firm Serono in 2000, where he discovered the first novel protein candidate developed entirely within the company. He subsequently became the youngest recipient of the company's Inventorship Award for Exceptional Innovation and Creativity. Selvaraju started in the securities industry with Rodman & Renshaw as a biotechnology equity research analyst. He was the top-ranked biotech analyst in The Wall Street Journal's "Best on the Street" survey (2006) and went on to become head of healthcare equity research at Hapoalim Securities, the New York-based broker/dealer subsidiary of Bank Hapoalim B. M., Israel's largest financial services group. While at Hapoalim, Selvaraju was regularly featured in The Wall Street Journal, Barron's, BioWorld Today, and Reuters/AP. He was also a regular guest on the Bloomberg TV program "Taking Stock," appeared with Bloomberg TV's on-air correspondents Betty Liu and Gigi Stone, and was a guest on CNBC's "Street Signs with Herb Greenberg."

DISCLOSURE:
1) George S. Mack of The Life Sciences Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Life Sciences Report: None. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Ram Selvaraju: I personally and/or members of my immediate household own shares of the following companies mentioned in this interview: None. I personally and/or members of my immediate household am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.
4) Aegis Capital Corp. has received compensation for investment banking services from the following firms within the past 12 months: Ampio Pharmaceuticals, Synergy Pharmaceuticals. Aegis may seek to obtain compensation for investment banking services from any or all of the companies mentioned over the course of the next three months. The firm does not own 1% or more of the outstanding shares of any of the companies mentioned.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.