Deep dive into the pharma/biotech industry, part 2

Walk-through of why Bluebird Bio ($BLUE) is an attractive investment idea

In part 1 (link: https://valuechaininvesting.substack.com/p/deep-dive-into-the-pharmabiotech), we went through the business model for pharmaceutical and biotech companies and an attractive area of interest for these companies, gene therapy. In this part, we’ll cover the major companies with leading gene therapy platforms and focus on attractive investment ideas in this industry.

The front-runner gene therapy platform companies are detailed below. Notice that I’m staying away from big pharma companies where gene therapy is a small part of the overall product portfolio as it’s unlikely to move the needle as much in these larger companies. Big pharma companies in my opinion are decent bonds to have in an investment portfolio but finding alpha there is tough unless the market corrects and these bonds offer better downside protection than other holdings and/or the sentiment on big pharma is overly negative due to regulatory pressure and the sentiment eventually mean reverts. I don’t see the big pharma bucket as a compelling opportunity here, so I’ll focus on the mid-cap space instead.

As you can see, there’s a wide spread in valuation of companies with $BLUE being the cheapest on future revenues and $CRSP being the most expensive. If, like me, you’re wondering why, then stay tuned. One thing you’ll note from above is that the number of approved drugs and number of current late-stage or phase 3 clinical trials don’t correlate much with valuation. For instance, Alnylam, which has the most FDA-approved drugs and the most phase 3 clinical trials and so should be the least risky platform bet only has a middle-of-the pack valuation. $ALNY’s valuation is similar to that of $MRNA, which does not have any approved drugs but clearly, is well capable of making safe and efficacious treatments like the covid-19 vaccine that is approved on an emergency-use basis currently.

$CRSP has the most expensive valuation, which reflects the large versatility of this platform to not just insert synthetic genetic code but to also edit existing genetic code. The company is currently engaged in human clinical trials with its platform and has good preliminary data, but there are no current phase 3 trials. One risk to note for the CRISPR-Cas9 platform is that if the targeting mechanism is not specific enough to the genetic sequences of interest, then there could be permanent edits of other genetic sequences. With this in mind, $CRSP is the most expensive and highest risk genetic platform, and even though it has the most upside potential, the risk/reward does not seem skewed in our favour.

Bluebird bio ($BLUE) is a compelling investment in genetic therapies

To me, $BLUE represents the most attractive genetic platform opportunity. Why are we getting the gift of a promising gene therapy platform at such a low valuation? Because of perceived risk with the safety of the genetic platform in the form of unexpected adverse reactions in clinical trials involving lentiviruses. For instance, two separate patients were diagnosed with blood cancer after treatment with lentiviral-tagged therapies from clinical trials. As a result of this disclosure, the FDA put a hold on ongoing clinical trials involving lentiviruses until the adverse events were further investigated. The immediate instinct is to draw parallels to the 1990s when a patient dosed with an adenovirus-tagged therapy died from a large immune response and regulators turned up the ratchet on gene therapy trials. But, this framing is unfair for $BLUE, which has made a lot of progress in establishing a good safety and efficacy record for lentiviral-tagged therapies as part of developing its platform upon this specific vector. For instance, across several clinical trials, they have dosed ~100 patients with lentivirus-tagged therapies and reported no serious adverse reactions that they deemed related to the drug treatment.

Part of the fear is that lentiviruses have been linked to cancer because of their ability to stimulate cancerous pathways or to inactivate cancer-protective pathways in infected cells (https://www.ncbi.nlm.nih.gov/pmc/articles/PMC5152689/). Indeed, in early clinical trials involving retroviruses that are similar to lentiviruses, 5 out 20 patients developed cancer (25% rate of infection). However, lentiviruses have been modified over subsequent generations to minimize the cancer-causing potential of lentiviruses and the most recent data from $BLUE indicates a ~2% rate of infection. Now this is still ~10x higher than what you’d expect in a non-lentivirus exposed control population, but 10x lower than initial clinical trials. The bottom-line is that there are side-effects with all treatments and this is also the case with lentivirus-tagged therapies from $BLUE, but considerable progress has been made in improving the safety profile of this therapeutic class and keep in mind that these therapies offer cures for life-threatening genetic conditions like sickle cell disease and beta-thalassemia. While these diseases can be treated with lifetime blood transfusions, the life expectancy of these individuals is still significantly shorter than average due to the disease. As such, genetic treatments like the ones proposed by $BLUE should be welcome news for patients affected by these genetic conditions.

$BLUE presented their findings of further investigation into the blood cancer diagnoses from lentivirus in their clinical trials which indicated that the lentivirus-tagged treatments were not the likely cause of blood cancer. The FDA agreed and has since then lifted the hold on clinical trials, allowing $BLUE to resume their investigations on these treatments. However, the cloud of uncertainty still hangs over the company and neither the stock price nor the valuation has recovered to levels before they reported these adverse events.

But wait, there’s more…

What we have not discussed so far is that $BLUE also has a successful cell therapy platform based on CAR-T technology. Simplistically, this involves taking immune cells from a patient, re-engineering the immune cells to target a specific tumour type, and then infusing the re-engineered immune cells back into the patient. CAR-T is currently used as a last-resort but is shown to be very effective with a ~60% reduction in risk of death versus control groups. There are now 4 FDA approved CAR-T therapies for different types of cancer by Gilead, Novartis, Bristol Myers Squibb, and $BLUE in partnership with Bristol Myers Squibb. Abecma was the CAR-T treatment by $BLUE that was approved by the FDA earlier this yr in February and $BLUE has several clinical trials for expanding CAR-T treatment in other types of cancer. Abecma is estimated to generate peak revenues of ~$1bn with ~1/2 of this (ie., $500m) going to $BLUE. CAR-T therapies will be spun-off as a separate entity called 2seventy bio expected to occur in Jan 2022.

What is this part of $BLUE’s business worth? Recall that Gilead paid $12bn to acquire Kite Therapeutics for its CAR-T platform; in hindsight, while the science behind CAR-T has exceeded initial expectations, the economics have fallen short as the companies have taken a long time to get CAR-T capable facilities up and running and to get buy-in from payers. While it is likely that Gilead overpaid for Kite, if for the sake of argument, we applied the same price/peak revenues multiple as what Gilead paid for Kite (~4x), then $BLUE’s CAR-T franchise should be worth $2bn. In contrast, $BLUE’s entire market cap currently is just $1.8bn and this includes both the lentiviral-tagged therapies and CAR-T therapies.

What’s $BLUE worth?

If $BLUE is able to remove the cloud of uncertainty surrounding lentiviral therapies by getting FDA approval for one of the ones it is currently conducting clinical trials on then it is likely to trade at a similar future multiple to that of $ALNY and $MRNA that is ~5x higher than what $BLUE currently trades at (ie., ~$125/share). However, if they fail to get FDA approval then it is likely that the intellectual property behind lentiviral therapies is still worth something and they should have a multiple floor based on the value ascribed to their CAR-T franchise which has 1 FDA-approved therapy in place and more in the pipeline. If you put a 5x EV/revenue multiple just based on expected 2023 sales from their CAR-T franchise alone then the company is worth ~1/10 of its current value (ie, ~$2.5/share). Based on the current share price of $25/share, the market is only assuming a 20% probability of $125/share and 80% of $2.5/share. In my mind, this is pretty warped given the potential benefits of lentiviral-tagged therapies. Note also that while lentiviruses were once thought to be associated with causing cancer, there is no indication that newer generation versions of lentiviruses cause cancer.

Hence, this is an example of an investment idea where the odds are skewed in the investor’s favour. Even if you assign only a 50% probability that a lentivirus-tagged therapeutic is approved (treatments in phase 3 clinical trials are found to have a 60% likelihood of approval), then $BLUE is worth 2.5x what it currently trades at.