A few days old but still a good read if one has not seen it.
ArQule: The Ides Of Ibrutinib
https://seekingalpha.com/article/4255319-arqule-ides-ibrutinib
Summary
ArQule is a small cap biotech that develops small molecule kinase inhibitors. The company's lead asset, ARQ-531, is a next-generation BTK inhibitor that sets its sights on ibrutinib's commercial empire.
The company boasts a surprisingly diverse pipeline that features substantially advanced programs--partnered AND wholly owned--and is expected to initiate TWO registrational trials in 2019.
Herein, I conduct a comprehensive valuation and show that the company is a well-rounded small-cap with moderate risk and high potential returns. Risk-Adjusted PT: $9-10.
There is a tide in the affairs of men,
which taken at the flood leads to fortune.
Omitted all the voyage of their life,
Is bound in shallows and in miseries.
On such a full sea are we now afloat;
And we must take the current when it serves
Or lose our ventures. “
-- Brutus, in Julius Caesar
Friends, investors, lend me your ears.
One of Shakespeare’s seminal works, Julius Caesar, serves as a classic account of the challenges and opportunities presented by the succession of power. In this article, I hope to use this idea contained in Shakespeare’s account to explore the complex dynamics in the biopharmaceutical industry. Herein, I will make the business case for ArQule (ARQL), a company developing a next-generation inhibitor of Bruton’s Tyrosine Kinase (BTK). In my last piece, “Et tu, Bruton”, I profiled the scientific background for this technology alongside the commercial implications for this class of next-generation BTK inhibitors. The field has rapidly morphed into a $5-10 billion industry, with the development of IMBRUVICA (ibrutinib), a commercial empire which is co-governed by AbbVie (ABBV) and Johnson and Johnson (JNJ).
ArQule is one of the principal competitors emerging in this space. In this article, I will use a synthesis of popular methodologies to value ArQule.
Discounted Cash Flow (NYSE:DCF). In the analysis section for this piece, I will motivate future cash flows based on a technical and competitive assessment of the company’s lead assets, expanding beyond just the BTK program to examine the company's other small molecule inhibitors. The analysis will justify the market sizing, penetration, and timing of cash flows, and will adjust for risk using an expected return calculation.
Cash – Debt. I will adjust the DCF model to reconcile the company's balance sheet with an equity valuation.
M&A premium. I will asses an M&A premium based on an expected return resulting from the assessed probability of an acquisition in a fixed 18-month time frame. Here I will look at contemporary acquisition premiums and make the case for including an M&A premium in the company's valuation.
The final valuation will be presented as a risk-adjusted price target.
The analysis section will consist of the following:
A breakdown of scientific data, clinical results, and competitive assessments for each of ArQule’s lead programs.
A discussion of clinical and commercial milestones affecting the timing of potential future cash flows.
Market sizing based on segmentation of the relevant indications
A review of the relevant intellectual property
The meat of this article will focus on ArQule’s BTK asset, ARQ-531. The importance is reflected in the title of this piece ad the rationale is obviated by the final valuation as ARQ-531 comprises the bulk of a risk-adjusted valuation.
ANALYSIS
ARQ-531:
In my last piece, I wrote extensively about BTK, the biochemistry of covalent and non-covalent inhibitors, and the competitive ecosystem for next-generation BTK inhibitors in the clinic. As a reminder, BTK is a huge market opportunity that has attracted numerous suitors. In 2018, AbbVie and JNJ reported a combined $6.2 billion in net sales for IMBRUVICA. AbbVie further estimates peak sales for the company around $7 billion, which would place combined revenues well north of $10 billion. This huge market has attracted a number of suitors which are developing both next-generation covalent and non-covalent BTK inhibitors.
Source: Synthesis of publicly available information
Of the growing population of patients treated with ibrutinib, an estimated 27% of patients discontinue ibrutinib due to disease progression. Of these patients, around 80% test positive for a mutation called C481S, which substantially decreases the affinity of ibrutinib for BTK, effectively stunting the activity of the drug. With the sheer number of patients treated with ibrutinib, this represents a substantial patient population, even in the relapsed setting following a second-line standard of care. I have previously estimated this population in chronic lymphocytic leukemia (CLL) to comprise at least 4,000 patients, with another 4,000-5,000 potential patients in other indications. Given current pricing trends of kinase inhibitors commonly ranging from $100,000-200,000, this represents a market opportunity well over $1 billion.
The case for non-covalent BTKi is rooted in bioplausibility, meaning that there is a strong biological rationale for why targeting C481S mutants could work. Ibrutinib binds to the BTK protein, so if BTK changes shape slightly (i.e via the C481S mutation), ibrutinib is no longer able to inhibit BTK signaling. Simple enough, it seems, that all you need to do is design a new molecule that can affect the altered protein. Here, the reasonable investor should be cautious about the potential pitfalls of expecting a therapy that “makes sense” to work. The thesis for non-covalent BTKi is really nested in two assumptions:
Firstly, that ibrutinib relapse is caused by the development of C481S (or similar) mutation, or at least that the mutation contributes enough to patient relapse to constitute a viable target.
Secondly, that non-covalent inhibitors can achieve sufficient target coverage to inhibit BTK activity in wild-type and C481S mutated cells.
Where might these assumptions fall apart? In the clinic, we see that many relapsed patients present with C481S mutations. It is tempting to conclude that patient relapse is caused by a mutation in the BTK protein. However, this is not rigorous because it fails to consider alternative explanations for relapse mechanisms. Here, I will state several of these possibilities alongside my own commentary.
Some ibrutinib refractory patients present with PLCg2 mutations. PLCg2 is an enzyme that occurs downstream from BTK. Cell signaling pathways are intimidating, even for many scientists. When looking at a cell signaling diagram, it is easy to get lost in the maze of funny looking arrows buried in acronyms.
mage result for BTK and PLC2g signaling
Source: Targeting B-cell Receptor Signaling: Changing the Treatment Landscape of B-cell Lymphoma
To explain the concept of cell-signaling cascades, I use an analogy that comes from my experience as an amateur diesel mechanic. Starting a diesel engine requires three things: air, fuel, and compression. Compression is usually provided by a starter. In a typical diesel engine, there will be several components in the starter pathway. A battery provides the source of power, another device called a solenoid regulatescurrent flow from the battery to the motor. The solenoid is controlled in turn by a signal generated when you turn the key.
Source: https://www.carparts.com/classroom/starting.htm
Now, consider several ways in which you could jumpstart the system to bypass the normal firing process.
Firstly, you could short the solenoid, which will cause current to flow from the battery to the starter.
Alternatively, you can short the battery downstream of the solenoid, directly to the starter (at risk of giving yourself as much excitement as a 12V battery is willing to offer). Bot methodsh will kick the engine into action.
Inhibiting BTK is like cutting the wire to the solenoid. It will prevent current flow from battery to starter. BUT, a gain of function mutation occurring downstream can still short circuit the cell signaling pathway at the starter, fueling abnormal cell growth. THAT is the meat of the hypothesis regarding PLCg2 mutations in BTK signaling.
This begets the question of whether ibrutinib-resistance is caused by a mutation in BTK, PLCg2, or something else entirely. Lampson and Brown performed a meta-analysis of ibrutinib-resistant patients that were sequenced for BTK and PLCg2 mutations. They found that 72% of patients tested positive for C481S mutations, of which the majority had mutations in BTK only.
Source: Are BTK and PLCG2 mutations necessary and sufficient for ibrutinib resistance in chronic lymphocytic leukemia?
These data do not allow us to conclude that the C481S mutation causes ibrutinib-resistance. However, we can rule out PLCg2 mutations as a driver of resistance in the majority of patients.
Here we can posit a simple framework for thinking about these patients so far:
Patients with BTK mutations only we can hypothesize to experience the best outcomes in ibrutinib-resistant patients
Patients with BTK and PLC2g mutations we might predict to see a more modest treatment benefit
Patients without either mutation we might predict to have the worst outcomes.
Assuming the absolute bear case, namely, that only patients with the C481S mutation and only that mutation will respond to treatment, we can see that the total addressable market still represents well over >2,000 patients annually in CLL alone, a substantial target market in oncology.
Now, this assumes that ARQ-531 has no effect whatsoever on downstream signaling. In reality, we see some evidence that this molecule may still be able to affect PLCg2 signaling at the “starter”. ArQule has presented data suggesting that ARQ-531 may actually modulate PLCg2 signaling via alternative pathways.
Source: Investor Presentation
In the SDS-PAGE gel above we see that there was less mutated PLCg2 protein in cell lines treated with ARQ-531 compared with ibrutinib. This corresponds with a reduction in pERK, suggesting a potential source of activity distinct from BTK that could affect PLCg2 signaling.
The bottom line? Don’t write off the PLCg2-mutated patients.
Ok, if not PLCg2, what about something else entirely?
To summarize so far, we have seen that the majority of ibrutinib refractory patients have a mutation at the C481 position and that some additional patients have a mutation in PLCg2 which could still be responsive to treatment with ARQ-531.
That leaves around 20% of ibrutinib-resistant patients that have neither a mutation in BTK nor PLC2g. From this, we know that these mutations are not necessary for ibrutinib relapse. The potential alternative explanations for ibrutinib relapse are broad. For example, ibrutinib has several immunomodulatory effects which are not fully understood, including effects on PD1/PD-L1 expression, cytokine release, and differentiation of T-helper cells.
I do not have a reasonable basis for predicting (1) how non-covalent inhibitors may recapitulate the immunomodulatory effects of ibrutinib, and (2) to what extent ibrutinib-resistance is caused by unfavorable changes in the immune environment. This is where the investor must consider the totality of the evidence for and against the role of C481S mutation status in ibrutinib resistance.
All things considered, I like where the mechanism sits.
Is a non-covalent inhibitor powerful enough to overcome mutant BTK?
Earlier, I stated two assumptions--that C481S is a driving mutation for ibrutinib relapse and that non-covalent inhibitors can achieve sufficient potency in vivo. I have since explained in detail why I think C481S comprises a viable target.
I will now briefly discuss this second assumption--why I think a non-covalent inhibitor can achieve comparable target coverage to a covalent inhibitor. For more commentary on covalent vs non-covalent inhibitors, check out the article “Et tu, Bruton?”. I will briefly review some of the key points here.
First, non-covalent inhibitors achieve pharmaceutically relevant potency of both mutant and wild-type BTK.
Source: Publicly available information
Secondly, some of the strongest known bonds in the natural world occur via non-covalent binding. Streptavidin-biotin, for example, has a dissociation constant as high as 10^-14 mol/L. A non-covalent bond is not inherently inferior to a covalent one. There are simply different physical forces at play with a non-covalent bond which usually, but not always, result in the formation of a weaker binding interaction.
Finally, we see that non-covalent inhibitors are able to achieve biochemical potency in human patients treated with ARQ-531, even in patients treated at sub-therapeutic doses, and even in patients without the C481S mutation.
Source: ASH2018 Presentation
Translating theory to patient outcomes:
Beyond the lab bench, there are a number of green lights that I have seen in ArQule’s clinical results for ARQ-531. Keep in mind that the clinical data is early and that all the caveats of small numbers apply.
With ArQule’s announcement on their 4Q earnings call that the first patient in the 65 mg cohort had achieved a partial response with 88% reduction in tumor size, most of the media and investor attention has focused on this single responder. The patient has chronic lymphocytic leukemia (CLL) and tested positive for the C481S mutation, and received prior treatment with acalabrutinib. As such, this response represents an important proof-of-concept in ArQule’s intended target market.
I will point out that this was not ArQule’s first responding patient with ARQ-531. At the American Society of Hematology (NYSE:ASH) meeting this past December, the company showed a partial response (~60% tumor reduction) in a follicular lymphoma (NYSE:FL) patient that was treated at the 45 mg dose. This result came during a meeting where multiple high profile studies in follicular lymphoma fell short.
Source: ASH2018 Presentation
Further, when we look at the waterfall plot for patients treated with ARQ-531 by dose cohort, we see an encouraging trend in the direction of disease control in patients treated at dose levels approaching a theoretical therapeutic window. Patients receiving higher doses of the drug tended to see a larger numerical decrease in their disease burden.
Source: ASH2018 Presentation
With the 45mg patients on study for <10 weeks, vs much longer treatment durations in the other patients, I would not be surprised to see some of these patients achieve responses in the future as their condition continues to improve. For context, the prior responder with FL achieved a response at 45 weeks after undergoing dose escalation. ArQule is now enrolling patients at a 75 mg QD cohort.
As a final comment on the clinical results for ARQ-531, it is noteworthy that no outcomes of atrial fibrillation have been reported so far. Per the ibrutinib label, up to 6% of patients experience atrial fibrillation, a serious side-effect that often results in ibrutinib discontinuation. Atrial fibrillation is believed to result from on-target binding to kinases in the heart. Accordingly, non-covalent BTKi may be able to overcome the on-target, off-tumor effects seen with .
“We must take the current when it serves. Or lose our ventures.”
I want to transition now from a clinical/scientific review to talk about the competitive environment in BTK. Looking at the competitive space, there are really four players developing non-covalent BTKi: ArQule, Lilly/Loxo Oncology, Sunesis, and Aptose.
Source: Company 10K statements
Based on common-sense analysis, the currents of competition heavily favor ArQule. Consider the following points:
Patient Accrual Rules Clinical Progress
There is extensive competition for relapsed CLL patients. There are many treatments approved and under development for CLL; between radiation, surgery, chemotherapy, ibrutinib, venetoclax, rituximab, and immunotherapy, patients and physicians have options. With soon-to-be four non-covalent BTK inhibitors in ongoing clinical trials, patient accrual to these trials will be more challenging than ever. After demonstrating evidence of single-agent activity in monotherapy, I would expect ArQule to garner a substantial edge in recruiting patients that are looking at trying a non-covalent BTKi.
Cash is King
Both Aptose and Sunesis are in a cash crunch. Both have a limited runway and are suffering from depressed share prices. Tight budgets and a dilutive equity offering will distract from their ability to advance clinical trials. By contrast, ArQule has $100 mn in the bank, with near-term milestone payments from a separate program on the table. While Lilly has the fattest coffers of the cohort by far, it is unclear whether Lilly will choose to prioritize the development of LOXO-305 following their acquisition of Loxo Oncology.
The Early Bird
Despite being the first in clinic (excluding Genentech, who discontinued their BTKi program in oncology), Sunesis has struggled to dose escalate Vecabrutinib to a therapeutic dose. A dose-limiting event in their second cohort mandated an extension of that cohort. ArQule now leads the pack with increasing enrollment at therapeutic doses. LOXO-305 entered the clinic late and Aptose has yet to dose their first patient, although they submitted their IND for CG-806 in February.
Beyond BTK: A look at ArQule’s other platforms
While the investor should be drawn to ArQule for the BTK program, there are several quite compelling opportunities that should convince you to stay. Here, I will take a look at the company's lead programs in oncology and rare disease.
Derazantinib:
Derazantinib is a small molecule inhibitor of the family of fibroblast-growth factor receptors (FGFR). The drug is technically classified as a multi-kinase inhibitor because it maintains activity against several other kinases. In early 2018, ARQL outlicensed Derazantinib to Basilea in the US, Europe, and Japan, and to Sinovant Sciences, Ltd in China, Hong Kong, Macau, and Taiwan. The terms from these agreements provide ArQule with:
$13 million in upfront payments
Up to $326 million in regulatory/commercial milestones from Basilea, plus royalties ranging from high single-digit to mid-teens
Up to $82 million in regulatory/commercial milestones from Sinovant, plus royalties in the low double-digits.
The partners are pursuing approval in an initial target market of intrahepatic cholangiocarcinoma (ICCA), a rare form of cancer in the liver. The American Cancer Society estimates that 8,000 patients are diagnosed with iCCA each year. Treatment options are poor for these patients. Only 15% of newly-diagnosed patients are estimated to be operable. Treatment options are limited for patients with non-resectable tumors. They receive either receive chemotherapy or are referred to a clinical trial or to receive supportive care. Lamarca et. al estimate a response rate of 8% in patients receiving treatment with chemotherapy.
Therefore, this indication begets:
A large number of patients in the second-line without viable treatment options, and
A short step to a first line therapy
ArQule previously reported results for Derzantinib at the 2017 ASCO meeting from a Phase 1/2 trial of Derazantinib in patients with second-line iCCA. In the population harboring FGFR mutations, 21% of patients treated achieved a partial response, with an 83% disease control rate.
Based on these data, ArQule launched a registrational trial in 4Q17 that is now being run by Basilea. This is a single arm, open label trial in patients with FGFR2 fusions with at least one prior systemic therapy. The poor outcomes and lack of options in iCCA present a (relatively) quick and easy path to market.
In January, Basilea announced interim analysis from the registrational trial that essentially replicated the previously reported Phase 1/2 results in the first 29 patients treated.
Source: rQuleA Publication
Miransertib/ARQ-751:
Miransertib (ARQ-092) and ARQ-751 are both pan-AKT inhibitors that inhibit the AKT isoforms 1,2, and 3. Miransertib and ARQ-751 differ slightly in the way that they affect the AKT protein. AKT is a protein kinase that comprises part of the PI3K/AKT/mTOR pathway. Abnormal activation of AKT has been implicated in oncology as well as a class of rare diseases such as overgrowth syndrome. I will separate my discussion on each of these programs.
Oncology
The PI3K/AKT/mTOR pathway has been a popular candidate for pharmaceutical development. PI3K pathway signaling is a common motif in many forms of cancer. You may recall seeing this pathway from our earlier cell signaling diagram of BCR signaling where PI3K signaling occurs in parallel to BTK. Just like PLCg2 occurs downstream from BTK, mTOR and AKT occur downstream from PI3K.
mage result for BTK and PLC2g signaling
There are currently three PI3K inhibitors that have been approved by the FDA: idelalisib, copanlisib, and duvelisib.
Source: FDA labeling, corporate 10K
Frankly, these inhibitors have been marginal drugs so far, both clinically and commercially. Four years after approval, Gilead’s Zydelig (idelalisib) did just over $100 million in annualized sales in 2018. Commercial PI3K inhibitors received approval based on surrogate endpoints of progression-free survival (NYSE:PFS) or overall response rate (ORR). I have yet to see a really compelling survival curve for a PI3K inhibitor. Given the harsh side-effects of PI3K inhibitors, like fatal diarrhea and colitis, which have resulted in black box warnings from the FDA, pathway drugs need to make a stronger case for clinical benefit to prompt commercial adoption. This is tough in indications like CLL or non-Hodgkin’s Lymphoma, where survival headlines have been dominated by numerous highly effective drugs in the relapsed setting, like ibrutinib, venetoclax, and now CAR-T therapy.
Despite the development challenges facing the PI3K pathway, the number of product candidates under development are almost too numerous to count.
Source: Chemical data from PKIDB database
At this point, the PI3K pipeline is a virtual kinase lottery, with a high degree of homogeneity among investigative compounds. Each compound has a slightly differentiated set of characteristics. Some are larger (molecular weight), some are smaller. Some target one isoform over another. Some have a higher solubility in a cell’s fatty membrane (called lipophilicity or LogP)—the list goes on. In the above figure, I have chosen to highlight the diversity of these characteristics.
Interestingly, TG Therapeutics (TGTX) edged their name back into the conversation at AACR19 the other week with data from their PI3K inhibitor, umbralisib, in non-Hodgkin’s Lymphoma (NHL). The company reported a 19% complete response rate in patients with a type of NHL called marginal zone lymphoma. (see: AACR: TG Therapeutics' umbralisib shrinks tumors in 52% of lymphoma patients). Umbralisib is a bit of a black sheep as far as small molecule drugs go. Lipiniski’s rule of five measures the “drugginess” for a compound based on a set of molecular properties affecting pharmacokinetics. Umbralisib breaks 2 of these 5 rules and has a LogP that is higher than any other kinase under development. However, it is yet to be seen how umbralisib will stack up against the other commercially-approved inhibitors.
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In contrast to PI3K, targeting signaling downstream maybe has the potential to edge out the benefit/toxicity profile of PI3K inhibitors. AKT mutations specifically occur in about 3-5% of all cancers. Inhibitors targeting these mutations have been hit and miss in the clinic. Roche/Genentech (RHHYB) have produced several rounds of interesting data from ipatasertib, a small molecule AKT inhibitor targeting the AKT 1,2, and 3 isoforms. Ipatasertib was developed by Array Pharma, who has a successful track record developing and out-licensing kinase inhibitors. At AACR19, Roche highlighted data from a Phase 1b study showing a 73% response rate in advanced triple negative breast cancer (TNBC) patients treated in combination with Tecentriq. This comes in the wake of the FDA’s decision to grant Tecentriq accelerated approval in TNBC in combination with paclitaxel.
Ipatasertib is also undergoing a pivotal Phase 3 trial in TNBC in combination with paclitaxel. In the randomized, placebo-controlled phase 2 trial, LOTUS, ipatasertib + paclitaxel showed improved overall survival of 23.1 months vs 18.4 months in the placebo arm.
Where most of the PI3K under development, along with ipatasertib, are ATP-competitive drugs, both ARQ-092 and ARQ-751 are allosteric inhibitors, so-called because they bind to and inhibit AKT by affecting a part of the protein other than its “active site”. ArQule has a handful of single-agent partial responses to show in solid tumor patients treated with ARQ-092 or ARQ-751. These include breast cancer and endometrial cancer—patients with advanced disease that are highly refractory (~8 prior lines of therapy). Because of the advanced stage of these diseases, any activity should not be discounted. BUT, I have a hard time generating much excitement over a 5% clinical response rate.
My expectations for ArQule’s AKT program in oncology are modest. The clinical data has thus far been underwhelming, and the company is facing substantial competition from big pharma with deep pockets and more advanced products. ARQ 092/751 in oncology is a free chip at the roulette table—it has the potential to evolve into a much more valuable asset, although I wouldn’t stake a position on it. The company is wise to keep a seat at the table in oncology while prioritizing the AKT program development in overgrowth syndrome.
Overgrowth syndrome:
Proteus syndrome and PROS are both ultra-rare diseases caused by overactive mutations in the PI3K pathway. PROS (standing for "PI3K related overgrowth syndrome") represents a set of diseases resulting from gain of function mutations in the PI3K gene. Similarly, Proteus Syndrome (NASDAQ:PS) is caused by a somatic mutation in the AKT1 oncogene. Miransertib, as we have already seen, acts on AKT. PROS and Proteus Syndrome are a nasty pair of diseases. Surgery is the standard of care for both and there are no approved systemic therapies available for patients with overgrowth syndrome. Miransertib would be the first approved pharmacotherapeutic option in these patient populations.
Early results with miransertib have been compelling in PROS patients. ArQule measured responses to treatment using Lansky Performance Status, a measure of the functional status of a patient.
Source: Lansky Performance Status
6/8 patients treated with miransertib saw an improvement in Lansky PS, while 2/8 saw no deterioration. Using this metric, 20 points corresponds to the difference between a patient under critical care with moderate to severe restriction, and patient able to self-care, walk, and play.
Source: ASHG annual meeting presentation
Both PROS and Proteus Syndrome are very rare. In the US and EU, ArQule estimates there are potential 300-600 patients with PS and 3-6,000 with PROS. In my opinion, these numbers are overly optimistic. Li, Chang, and Akgumus estimate PROS at an incidence at <1 in 1,000,000 births. This estimate would yield a total market of closer to 300 patients in the US.
However, drug approvals have a history of increasing the prevalence of rare disease diagnosis. This comes with increased physician awareness and education, in part due to the availability of a novel systemic therapy, and also in part due to the effects of pharmaceutical marketing. ArQule has even quantified this effect in a review of rare disease launches, shown below.
Source: ArQule Presentation
While the market size is small, it is reasonable to predict some growth in the total addressable market due to increased awareness surrounding overgrowth syndrome and potential treatment options. My revenue forecasts for overgrowth syndrome are tempered, with annual patient treatment numbers in the double digits. There is a scenario where ArQule could exceed even the bull case I have forecast, by growing the total market sizing and achieving significant penetration in the rare disease community.
Pricing is a sore issue with rare diseases. ArQule has laid the foundation for a pricing model by observing the inverse relationship between price and prevalence. The smaller the market, the higher a price that is necessary to support a return to investors.
Source: ArQule Presentation
Based on the number of patients I expect they will be able to treat, I suspect that a price north of a million dollars per year is on the table.
Miransertib in rare disease indications is likely to attract a different type of partner, compared with an oncology program. I wouldn’t be surprised to see ArQule seek a partnership with a rare disease juggernaut like Alexion as an alternative to issuing dilutive equity offering in the next year. The company's core competencies are in kinase development, not rare diseases, making this candidate an excellent outlicensing opportunity.
The rare disease program also carries with it the potential to receive a priority review voucher from the FDA. In an article last year, I reviewed methodologies for valuing this type of program ("The Science of a Biotech Valuation"). The review vouchers comprise a bizarre program. On one hand, they incentivize drug development in rare and pediatric diseases. On the other, there is no requirement that they be applied to the program for which they were awarded. Further, they can be sold on the open market to another party. Historically, the review vouchers have fetched prices as high as $350 million.
One intriguing proposition if awarded would be for ArQule to apply priority review to a potential accelerated approval for ARQ-531, thus pre-empting competition to capture market share in CLL. The large market size and potential cash flow could support the underlying financial decision-making process in such a case.
Overall, I find the rare disease program attractive for a couple reasons:
Miransertib meets a significant unmet medical need in a patient population that could evolve into a substantial market.
There is a reasonable probability to generate near-term cash flow through execution of a licensing agreement or through the potential sale of a priority review voucher.
The program provides important diversification for the company's pipeline.
Overview of Intellectual Property Portfolio:
ArQule has a well-defined patent portfolio. In contrast to biologics, pharmaceutical patents tend to be more cut and dry. ArQule has issued patents for composition and matter for each of their assets, with patent expiry ranging from 2030-2039. The key patent for ARQ-531 expires at the end of the year in 2035, leaving the company with 13+ years of potential market exclusivity form a prospective 2020-2021 approval.
Source: Google patents
Program Timelines and Milestones:
The company sits on a number of key catalysts coming up in the remainder of this year. At the annual meeting of the European Hematology Association (EHA) in June, the company will release updated data for ARQ-531 and by the second half of this year, they expect to initiate registrational trials for ARQ-531 and miransertib in overgrowth syndrome.
Source: Synthesis of publically available information
Rationale for an M&A Premium
“Remember March, the Ides of March did not Julius bleed for Justice’s Sake”
In my last comprehensive valuation of Loxo Oncology, I declined to use an M+A premium. I did not see an acquisition as a probability at the price levels at the time of the writing. Generally, I think investors are easily drawn into thinking their investments are high probability acquisition targets. In reality, considering there are some 200+ publicly traded biotech and pharmaceutical companies with market capitalization of greater than $400 million, vs 5-10 historical acquisitions in this same cohort, an acquisition is relatively unlikely in absolute terms. Under an assumption of equal weight, there stands a raw probability of 2.5-5% that any given company is acquired. In this article, I will break with my own views on valuing M&A, and discuss why I believe ArQule deserves an acquisition premium.
As AbbVie prepares to undergo significant operational changes with the decline of the Humira franchise, the company will look to solidify their long-term position in heme-onc.
To drive home this point, I will highlight a case study of Novartis’ Gleevec (imatinib) franchise. Imatinib is one of the most effective cancer drugs ever developed. The drug targets the Bcr-Abl tyrosine kinase, in patients that have chronic myelogenous leukemia (CML) with a genetic alteration called Philadelphia chromosome. For many patients with CML, imatinib has turned their disease into a chronic, manageable condition. Accordingly, Gleevec has earned its place as one of the top-selling drugs of all time. Faced with the pending patent cliff for Gleevec, Novartis developed a more potent Bcr-Abl inhibitor, called nilotinib (Tasigna). In 2018, Tasigna achieved just shy of $1.8 billion in net sales for Novartis, mitigating the effects of Gleevec’s vacated sales and protecting market share in CML.
In 2018, AbbVie and Johnson and Johnson reported over $6 billion in combined global sales revenue for ibrutinib. AbbVie forecasts that this number will soon grow to $7 billion. Between venetoclax and ibrutinib, chronic lymphocytic leukemia has become a central feature of AbbVie’s business strategy. At the American Society of Hematology annual meeting in December 2018, the company reported strong results for ibrutinib in combination with rituximab vs FCR in a randomized clinical trial in younger patients with CLL. This now leaves AbbVie with a foothold in every single arm of a treatment algorithm for newly diagnosed multiple myeloma.
https://pbs.twimg.com/media/DsdQWN4X4AEKnLz.jpg
Source: Chronic Lymphocytic Leukemia Treatment Algorithm 2018
There are a few reasons that this provides a powerful business case for AbbVie:
The American Cancer Society estimates that roughly 21,000 patients are diagnosed in the United States with CLL each year.
The prognosis for CLL patients treated with ibrutinib is generally favorable to other more aggressive blood cancers such as acute lymphoblastic leukemia (NYSE:ALL) or non-Hodgkin’s Lymphoma (NHL), meaning that patients remain on treatment for a long time (O, Brien et al report an average treatment duration of 39 months in a 2018 study
AbbVie overwhelmingly controls the market share for first- and second-line CLL.
Many ABBV bulls point to hematology as the new core of the company in a post-Humira era. So how does this come back to ARQL?
Ibrutinib comes off-patent in 2026, leaving the franchise open to competition. For competitors, ARQ-531 could be a gateway into CLL. For AbbVie or JnJ, a next-generation product could keep generic erosion at bay. By contrast, ARQ-531 is patent-protected into 2035.
At worst, ARQ-531 is an ok drug in post-ibrutinib patients with C481S+ relapsed disease. I have previously established that this is a large market in its own right and that the drug could go on to do $500mn-$1bn plus in annualized sales in the relapsed setting alone. Pharma loves small molecule kinase inhibitors—they are well established, cheap to make, and easy to market.
At best, ARQ-531 has a shot at earlier lines of therapy. Reduced cardiotoxicity, or an incremental benefit in efficacy, would give AbbVie (or another suitor for that matter) a fresh product to champion in CLL. Throw in a rare disease program and a product candidate in oncology and ARQL starts to look real attractive as an industry target.
Putting the Pieces Together and Diving into a Valuation
As a reminder, I value each of ArQule’s lead programs based on the present value of future cash flow from that program. For each present value calculation, I use a discount rate of 10%. I account for uncertainty in each of these programs using scenario analysis. First, I calculate the present value of net revenue generated under three scenarios: bear, base, and bull cases. For each case, I state the key assumptions for the corresponding DCF model. Next, I generate a probability weight based on the technical and regulatory probability of success for that scenario. Finally, I calculate the expected value for that program using the associated probability weight.
You will notice that for each program the bear case is that the drug fails. Further, I have modeled a high probability that each drug is not approved.Biotech investing is RISKY and to assume otherwise is to ignore the reality of drug development. A strong investment makes sense of the potential risk by using an expected value calculation that takes into account a high probability of failure.
Scenario Analysis for Future Cash Flows
I have included a sample of the DCF statement used to generate cash flows for ARQ-531 and Derazantinib programs under base cases below. I have chosen not to include a terminal value calculation, despite the fact that ArQule’s patent portfolio exceeds the highlighted 10-year cash flow horizon. Due to the fast pace of innovation in biotech, I do not feel comfortable forecasting cash flows past 10 years. Each cash flow horizon is based on market sizes, market penetration, drug prices, royalties, and other revenues as discussed in the preceding analysis. Any other assumptions are commented as appropriate
Sample DCF Analysis
Next, I estimate the present value of operating and income expenses based on:
The company’s current financial operations
Pro forma expenses derived from the scenario analysis
Projected expenses are used to calculate the net present value (NYSE:NPV) of the combined programs. Cash + equivalents (less debt) are added back to reconcile enterprise value with an equity valuation.
Reconciling Cash Flow Analysis to a Price Target
Finally, I assess an M&A premium based on a 20% probability that the company is acquired within 18 months at a 70% premium to the equity valuation. This is based on a review of biotech M&A for the past two years.
Companies developing small molecule inhibitors have received beefy acquisition premiums. Even Loxo, who carried a hefty valuation into 2019, landed a 67% premium over their 30-day SMA.
Select Acquisition Premiums for Companies Developing Small Molecule Inhibitors
Source: SEC Schedule 14D/9
Acquisition Premiums, other Biotechs
Source: SEC Schedule 14D/9
After assessing an M&A premium, the resulting price target of $9.34 reflects a 68% premium to the company’s current share price of $5.56.
The breakdown of this price target is shown below. As promised, ARQ-531 presents the primary value driver for ArQule.
Et tu, ArQule?
ArQule is subject to the formidable gamut of risks that are standard in the biotechnology sector. These include the following:
Failure to receive full or partial regulatory approval for their product candidates, including ARQ-531.
Failure to successfully commercialize an approved product.
Failure to fund continued business development, research and development.
All things considered, I like how ArQule is positioned to navigate the biotech minefield.
Risk Mitigation
Failure to receive regulatory approval Multiple, independent franchises in oncology and rare disease minimize the downside from a worst-case scenario involving ARQ-531. Further, risk-adjusted cash flow analysis accounts for a HIGH probability of failure, standard to drug development.
Failure to successfully commercialize an approved product Protein kinase inhibitors are one of the most easily commercialized classes of drug in oncology. Market sizing for post-ibrutinib relapsed markets supports a commercially viable population for ARQ-531. Further, ArQule is positioned as first-to-market in CLL which may allow them to edge out their competitors.
Failure to finance operations ArQule has $100 million in the bank which should be sufficient to fund operations for the near future. Near-term milestones for derazantinib and a potential license for miransertib in rare disease provide non-dilutive sources of revenue.
My Takeaways:
ArQule has a long and heretofore unremarkable history of developing small molecule kinase drugs. With ARQ-531, I think they finally may have found a winner. The company is well-positioned to advance the product into the clinic ahead of their competition.
ARQ-531 is technically and competitively positioned as the strongest next-generation BTKi in post-ibrutinib patients, making it an attractive champion for ABBV/JNJ and competitors in hematology/oncology.
Near term opportunities for growth (derazantinib milestone payments, business development for miransertib in overgrowth syndrome) provide a runway for key catalysts in 2H19, including Ph1/2b data for ARQ-531 and miransertib, as well as the initiation of registrational trials in oncology and overgrowth syndrome.
A conservative fundamental valuation (10% discount rate, no terminal value calculation, and ~50% chances of COMPLETE failure for each candidate) still supports ARQL as being materially undervalued. This is consistent with a common-sense macro perspective of ArQule's ~$600mn market cap.
Despite the company's strong runup to start this year, I am happy to continue holding shares of this company below $10, prior to outcomes from any of the company's milestones in 2019.
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