KALA BIO Inc (KALA)

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Kala Pharmaceuticals: Rating Buy Ahead Of STRIDE 3 Data This Quarter
Jan. 8, 2020 4:19 AM ET|18 comments | About: Kala Pharmaceuticals, Inc. (KALA)
Bhavneesh Sharma

Vasuda Healthcare Analytics
Top biotech ideas from MD (trained at Harvard and Cornell) and MBA
(5,596 followers)
Summary
Kala Pharmaceuticals is based in the Boston area, Massachusetts, and is focused on developing topical treatments for eye diseases using its proprietary MPP (Mucus Penetrating Particles) technology.

I am bullish on STRIDE 3 Phase 3 data in dry eye disease, which is expected this quarter.

The company's stock is undervalued based on just NPV of Inveltys, its approved product.

If STRIDE 3 trial succeeds, it would open an additional large target market in dry eye disease. An estimate of its pipeline value is provided.

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Kala Pharmaceuticals (KALA) is based in the Boston area, Massachusetts, and is focused on developing topical treatments for eye diseases using its proprietary MPP (Mucus Penetrating Particles) technology. Topically administered eye medications are usually trapped by the mucus in the tear film that covers the cornea, thus limiting the drug's access to the eye tissues. The MPP technology allows the drug to penetrate the mucus in the tear film effectively, thus creating a potential for lower dose or less frequent dosing. The technology has origins in MIT Labs.

The first product candidate from the MPP technology, Inveltys (1% solution of a topical corticosteroid, loteprednol etabonate, LE) was approved by the FDA to treat pain and inflammation after eye surgery in 2018. Sales are growing 30% quarterly per the recent Q3 earnings call. Peak sales estimate for the drug is approx. $300M.

Kala's stock suffered a setback in January 2018 when KPI-121, a 0.25% QID solution of LE showed mixed results in the two Phase 3 trials required for FDA approval in treating dry eye disease. Dry eye disease is a common clinical indication and could be primarily due to dysfunction of tear glands or secondary to diseases like Sjogren's syndrome or contact lens wear, etc. The disease is thought to affect approx. 16 million people in the U.S. Current treatment includes treating the underlying cause, symptomatic treatment with artificial tears, etc. While 90% of cases are mild and don't need chronic treatment, rest 10% of patients need chronic treatments, like Allergan's (NYSE:AGN) Restasis (topical cyclosporine) or Novartis' (NYSE:NVS) Xiidra (topical inhibitor of ICAM-1 and LFA-1). In addition, many patients with mild or moderate symptoms experience occasional flare-ups of the symptoms when Restasis or Xiidra may be useful. The target market for dry eye disease is estimated to grow at approx 5% per year to $7 billion by 2025. Restasis had $1.5 billion in peak sales while peak sales estimates for Xiidra are also >$1 billion. Novartis acquired Xiidra from Takeda (NYSE:TAK) for approx. $5 billion (including an upfront payment and milestone payments), thus showing the NPV of a successful medication in treating this common condition. More than 20 treatments are under development currently for dry eye disease.

The key primary endpoint, an improvement in eye discomfort, was not achieved in the second Phase 3 trial called STRIDE 2 in Kala's dry eye disease program. The management attributed the result to a higher-than-expected placebo response in the STRIDE 2 trial. The management submitted an NDA for this indication to FDA but was issued a CRL and FDA requested another Phase 3 trial.

The management started another trial, STRIDE 3, making some changes to the inclusion/exclusion criteria to reduce the placebo response probability. Most notably, it monitored the initially screened patients who were given a placebo vehicle during the initial two week run-in period. Patients who reported an improvement in ocular discomfort (STRIDE 3 primary endpoint) were excluded from the next part of the study, the randomization part into the drug and placebo arms for two weeks (since they are showing a placebo response). This intervention and a couple of other protocol changes have improved the probability of success in STRIDE 3 trial. In the recent Q3 earnings call, the management mentioned that when it performed a retrospective analysis of the failed STRIDE 2 trial using the revisions in the protocol for STRIDE 3 trial, STRIDE 2 trial would have achieved statistical significance in ocular discomfort by a wide margin (p= 0.002).

Some other signals support a near-term bullish view for the company's stock and its drug development efforts. Major institutional investors like RA Capital ($17M stake) and Orbimed ($13M stake) have invested in the company before IPO and continue to hold the stock despite its beaten-down condition after CRL in dry eye disease and mixed STRIDE results. Last week, the management was granted stock options equivalent to approx 1 million of common stock (including 365K stock options for the CEO, which will vest if the stock price is >$3.84). The stock was up this week on high volume, suggesting investor interest in the stock. The management is quite experienced. CEO Mark Iwicki was CEO at Civitas (acquired by Acorda Therapeutics (NASDAQ:ACOR)) and ex-CEO at Sunovion Pharmaceuticals (acquired by a Japanese Pharma). He also was Business Unit Head for several therapeutic areas like CVS, Diabetes, etc., at Novartis. Other members of the management team have impressive bios as well, including CMO Brazzell who was Global Head and SVP of R&D at Novartis eye division, and CSO Chen who worked in vaccine delivery and development at AstraZeneca (NYSE:AZN) and Merck (NYSE:MRK).

The company is expected to have $72M in cash reserves in 2019 end at the current operating burn rate. Long-term debt was $71M at Q3 end. From the target market point of view, I used 10% of patients of total U.S. patient population as input (who are expected to have chronic symptoms or frequent flares needing KPI-121 or 1.6M). The input price was $5K/year, equivalent to Restasis and Xiidra. Using these inputs, the estimated target U.S. revenue opportunity is $8 billion/year. Even if KPI-121 captures just 10% of the market, peak sales could reach $800M/year in the U.S. 6 years after the launch in 2020. Using peak sales multiple of 4 for enterprise value (average for pharma companies), probability adjustment by 65% (average for drugs in phase 3) and discounting by 15% rate, I estimate risk-adjusted NPV for KPI-121 as $900M. The company's current market cap is just $167M. In addition, I did not include Inveltys which is estimated to have a peak of $300M in sales. Using these assumptions, if STRIDE 3 trial succeeds, the company's stock could have a >5x upside potential in a few years. Even if STRIDE 3 trial fails and Inveltys is the company's sole marketed product, the company's fair value based on just Inveltys (assuming $300M peak sales in 2025) is estimated as $750M, which is much higher than the current market cap. The company's stock thus appears a bargain at its current level. The STRIDE 3 data is expected in Q1 and April options are implying +/- 60% move in the stock price (range $7.75 to $2/share).

A bear case for the investment would include high debt (resulting in a negative liquidation value by net-net formula), the possibility of placebo response in STRIDE 3 trial despite protocol modifications, no buying by prominent institutions or direct common stock purchases by the management and insiders when the stock was beaten down in 2019, possibility of side effects like cataracts, glaucoma, etc. on long-term use of KPI 121 (side effects associated with steroids), though the drug is mostly intended for use for short duration only for rapid relief in flares or in severe cases where the benefits outweigh the risks, increasing competitive landscape in dry eye disease where drugs with novel mechanisms of action (Aldeyra Therapeutics (NASDAQ:ALDX)) could limit KPI-121 market share, delay in STRIDE 3 data release from year-end 2019 to Q1 2020 (explained by the management as slow enrollment, though it could be due to the stricter inclusion/exclusion protocol explained above), etc.

In conclusion, I am rating the stock a Buy (after assessing the Bull and Bear cases) and plan to start a long position over the next 72 hours. The first price target is $7.50/share.

(KALA product pipeline)

Risks in the investment include the bear case mentioned above, high placebo response resulting in STRIDE 3 trial failure which could crash the stock to $2/share, the possibility of a capital raise before the STRIDE 3 data (appears less likely though given the current cash position). Investing in biotechnology companies and playing binary catalysts like data releases may not be suitable for all investors and it is possible to lose the entire capital invested. A small allocation and diversification across at least 25-30 investments are suggested.
https://seekingalpha.com/article/4315703-kala-pharmaceuticals-rating-buy-ahead-of-stride-3-data-this-quarter