When we were first introduced to Paradigm (ASX: PAR) and began researching the company, we couldn’t understand how it was being priced relative to the information we were reviewing. We have formed the opinion that the market is largely unaware of the company and as a result, Paradigm has been significantly undervalued.
The greatest risk with investing in bio-tech is the chance of failure in clinical trial. If the company succeeds in the clinical trial however, it becomes the catalyst for a share price re-rating. It is our view that the data released from doctors treating their patients with Osteoarthritis (OA) under the Australian Therapeutics Goods Administration’s (TGA) Special Access Scheme (SAS), gives investors a very clear look through to the results of Paradigms OA phase 2b clinical trial. Based on this data we weight the probability of success in this trial at greater than 95%. “We weight the probability of success in this trial at greater than 95%”.
With this look through to the result it presents investors with a unique opportunity to buy shares in Paradigm significantly below the company’s intrinsic value. This value will be driven by a deal that is expected to follow the successful phase 2 trial results. We estimate the deal will exceed US$1b [in total deal size] for the rights to Paradigm’s OA product.
Applying a 50% discount to the estimated deal size whilst assuming zero value for Paradigms Ross River trial and other indications, increasing the issued capital by 15% and weighting the probability of success at 95% - Paradigm should currently trade on a fully diluted basis at an AUD equivalent of $4.22 per share.
Upon success of the phase 2 trial and with certainty around total deal size and approvals, we can see the company trading above $10 per share, with material upside risk should the company achieve a deal larger than US$1b or success in their other indications. SPECIAL ACCESS SCHEME (SAS)
Paradigm have repurposed the drug Pentosan Polysulfate Sodium (PPS). PPS has been around for >70 years and is currently registered in the USA and Europe to treat painful bladder syndrome via oral administration. Paradigm has repurposed injectable PPS (iPPS) into their own drug called Zilosul®, to treat Bone Marrow Edema Lesions (BMEL) associated with OA, Viral Arthritis (Ross River virus) and Heart Disease. As iPPS has a long track record of human use and safety data, Zilosul® can be accessed by Doctors treating their patients through the SAS program in Australia, or as subjects in Paradigm’s clinical trial. Doctors have now treated over 260 patients for OA under this SAS program with more applications each day (we have also referred people for treatment!). To put this in context, the phase 2 trial Paradigm are conducting for OA is treating 110 people which is currently 80% recruited.
On March 1st 2018, Paradigm released data from Doctor’s treating the first 45 patients under this SAS program. These 45 patients recorded an average 50% reduction in pain, had an 85% response rate to treatment and reported significant improvement in knee functionality. In our opinion, these results would meet the primary end points sought after in Paradigm’s ongoing Phase 2 clinical trial. “…these results would meet the primary end points sought after in Paradigm’s phase 2 clinical trial”
It is also worth noting, patients being treated in the SAS program have more severe OA than those in the clinical trial and have not responded to current standards of care/treatment. Meaning, the data when released from the trial is likely to achieve positive results consistent with the data observed in the program.
While the data set reported is limited to 45 OA sufferers, the rapid increase in the number of subjects recruited within the trial and patients in the SAS program, shows a clear demand for the product. We imagine that the significant increase in people seeking treatment, is due to the positive results of the drug. If the treatment wasn’t successful, it is unlikely Paradigm would see such a high level of interest in the drug by doctors and patients alike.
During our due diligence, we have spoken to both patients and doctors, who have confirmed the OA symptoms have subsided post treatment with Zilosul®. There have been several reported cases in the media of elite athletes taking Zilosul®, which further confirms the results being seen in the SAS program. We estimate Paradigm may have reported on nearly 200 patient’s data from the SAS cases by the release of their clinical trial results in Dec 2018. PATENTS & PROTECTION
As PPS has been around for 70 years, it is off patent. As a protection, Paradigm have registered patents over the treatment of OA with Bone Marrow Edemas (BME) using PPS. We have conducted extensive research around these protections, as a drug off patent brings potentially increased competition and risk. However, Paradigm have protected this in several ways.
The first protection was to lock up the supply. Currently the only FDA approved supplier of PPS for human use is a German company – Bene pharmaChem (Bene). Paradigm have secured the supply of PPS from Bene for the treatment of OA, as well as their other patented indications. Should another company try to source supply via Bene it would breach this agreement. It’s worth noting that Bene are solely a manufacturer of PPS and have a commercial supply and license arrangement with Paradigm.
However, should a competitor secure supply from elsewhere they would also then need to prove they are treating OA that does not have BME. This is the core part of the patent protection for Paradigm as nearly all OA has some level of BME present. If they treat OA and it has BME, it infringes on Paradigms registered patents. This significantly reduces the size of the addressable market and it is unlikely to be pursued by a big pharma due to the patent infringement.
Paradigm also have a layer of data protection that stops other companies from accessing their trial data for a period of 5-10 years depending on the geographic location. By prohibiting access to this data, a potential competitor must then conduct their own clinical trials in order to register a generic or similar treatment using PPS.
Should a global generic manufacturer attempt to manufacture a generic PPS treatment for OA, there are several hurdles to overcome. They would first need to secure FDA approved PPS, which is not possible via Bene under the existing supply agreement with Paradigm. If they tried to manufacture PPS themselves, or source supply elsewhere, it would then need to be approved by the FDA. This process would take several years and would involve clinical trials in all three phases. After this time, they would then need approval to treat OA but without BME. Otherwise they infringe on Paradigm’s patents.
It is highly unlikely that a competitor would attempt this, given the level of difficulty required. Being first to market also has significant benefit for Paradigm as doctors become comfortable using and recommending the drug Zilosul®.
We are confident that Paradigm has taken all the necessary precautions and registered patent protections available. Therefore, should a larger competitor want to enter this market and enter quickly, they would need to enter into a deal with Paradigm. Paradigm has taken all the necessary precautions and registered patent protections available. ONCE BITTEN…
Paradigm currently has a market capitalisation of only ~$60m which appears to significantly discount the potential upside in the business. We believe that the SAS data has de-risked the potential for a clinical trial failure. However, the investment community seems largely unaware of the company, which we believe will change as more SAS patient data is released in June/July 2018 and the company begins marketing to institutional investors.
With a tight share register and no considerable institutional interest in the company, we believe the valuation will re-rate significantly over the next 6 months as the risks of failure in the clinical trial is mitigated.
One reason the investment community might be wary of Paradigm, is that, while positive results prior to a phase 2 conclusion are rare, it has hurt investors before. In June 2017 Innate Immuno Therapeutics (IIL) was unable to meet the endpoints within their phase 2 trial. However, prior to the readout of the results the company had a market cap averaging between $150m & $200m and even traded as high as a $400m as investors anticipated a positive phase 2 result.
The below chart shows the market cap of IIL on its phase 2 journey to failure. Had the phase 2 result been positive, the company would have likely traded significantly higher than $400m as the market would price in a potential multi-billion-dollar deal.
IIL Market Cap 2016 - Present
If we compare IIL’s compassionate use results to Paradigms SAS results, there are material differences. The results of IIL’s compassionate use scheme were based on a very small sample size. In January 2017 the company had treated 27 patients, yet the market cap was close to $400m. In contrast, Paradigm has released results on 45 patients and currently have over 260 TGA Approvals waiting to be treated. We anticipate that prior to Paradigm’s phase 2 results, the data from over 200 SAS cases will have been released to market.
The treatment period of IIL was over 2 years, while Paradigm is 12 weeks in total (6 weeks of injections and endpoint measurements taken 6 weeks after last injection). IIL reported that 70% of the patients had reported improvement in this 27-patient sample size. These measurements were largely based on patient self-reporting.
In contrast, Paradigm have more data and it is both subjective and objective data pre and post the administration of the drug. Data includes MRI scans, knee function and pain scores. Paradigm’s results are outlined below, which show:
85% response rate
A 50% reduction in pain
64% improvement in knee function.
MRI scans showing BME Lesions reducing in size
Paradigm SAS Results (ASX Release)
Paradigm SAS Results (ASX Release)
While the failure of IIL is still fresh in investors’ minds, we believe it has created a buying opportunity for those who believe one doesn’t impact the other.
Given the larger sample size already released from Paradigm (and substantially stronger results), we consider the results materially surpass that of IIL. This example further cements our theory that Paradigm should trade with a market cap in excess of $300m.
Below is a chart showing the market capitalisations of both PAR and IIL. We anticipate that as the market becomes aware of Paradigm and the continued success in the SAS program, the market capitalisation will begin to re-rate, as it did for IIL during 2016.
IIL Market CAP / PAR Market Cap MARKET SIZE & REVENUES
The current treatment options for OA are very limited. Currently, the use of opioid based pain medication and anti-inflammatory drugs are the most common treatments. These, as well as stronger corticosteroids are the therapeutic options recommended to most patients. As the condition worsens, people are often then referred to have joint replacements. We believe that Paradigms Zilosul® will quickly become the market leading treatment recommendation for people with OA.
Zilosul® not only treats the pain, but also improves the knee function and treats/resolves the BME. It is truly remarkable, and given the feedback from patients, we can see this being adopted very quickly given the lack of safe and efficacious alternatives.
There are several big pharma companies trying to enter this market, as the estimated number of people suffering from OA in the US is between 20 – 30 million people per year. In Australia it is estimated to impact around 2.1 million people (ABS). It is estimated that approx 1.2m people in Australia suffer from OA.
Australia
The severity of the disease (OA) varies, however in 2016, the ABS reported there was 254,282 hospitalisations with a diagnosis of OA as the cause. Of those impacted by OA, the self-assessed health scores reported around 26% (564,000 people) with below average (fair/poor) health with OA. We have based our calculations on this group as being the most likely target market.
We estimate that Zilosul® will sell for around $3000 per treatment (6 weeks of 2 injections per week or $250 per injection). Zilosul® will also seek to become available under the pharmaceutical benefits scheme (PBS). This would see the government pay most of this treatment cost, making it far more accessible to patients. With 81,567 hip and knee replacements in 2016 (ABS), the government should look favourably on a drug that will reduce this surgical cost and help patients avoid highly addictive opioid-based pain medication.
As the safety data for PPS is well known over its long history, Doctors are likely to recommend it over other treatment options. This should result in a far higher penetration being achieved over a shorter timeframe. Our estimates are that Zilosul® should achieve a 10% market penetration of the 564,000 people who reported higher pain (or 2.4% of the overall OA market) within 2 years. This would represent ~$164m of revenue to Paradigm.
AUS OA Market
Once Zilosul® is added onto the pharmaceutical benefits scheme (PBS) we believe this will trend towards 60% of the market (327,000 patients or 15% of overall OA market). Treating this percentage of the market would bring in an estimated $982m of revenue from the Australian Market alone.
AUS OA Market
USA
When looking at other markets outside of Australia, the revenue potential is significantly larger. The US market has an estimated 30 million people suffering from OA. Using the same percentage metrics as Australia, we estimate around 7.8m people would have poor/fair levels of OA. Capturing only 10% of this market would generate over $2.3b in revenue.
US OA Market
It is likely that treatment using Zilosul® will be required every 12 months in an estimated 40% of the people being treated. This makes Zilosul® a highly attractive, recurring revenue product for big pharma. Something we believe will add significant value to any deal that will be struck for the rights to the product.
By way of comparison, Sirtex (SRX) an Australian listed bio-tech, currently has revenues of ~$230m and a market capitalisation of $1.6b. Paradigm’s gross margin is likely to be similar to Sirtex, yet the revenue and addressable market for OA are significantly larger.
Sirtex Financials
BIG PHARMA
Upon success of Paradigms clinical trial (which we believe based on the data has been de-risked substantially), Paradigm will likely look to sign a deal with a big pharma company. We anticipate a deal to be signed after lodging for Provisional Approval in Australia and Fast-Track (Breakthrough) approval in the US with the FDA.
Should these approvals be granted, Paradigm will be able to sell Zilosul® without a full phase 3 clinical trial in its traditional form. As the opioid crisis in the US continues to deteriorate, we believe Paradigm are well placed to be granted this approval. If so, Paradigm will be able to reach commercial sales significantly quicker & it would also add significant value to any deal Paradigm strikes with a big pharma company. “…Paradigm could sell Zilosul® without a full phase 3 clinical trial”.
Big Pharma are very interested in finding a drug to treat OA as there are currently limited options for people suffering with the condition. One of the major drugs under clinical trial is a Nerve Growth Factor (NGF) inhibitor. These NGF drugs look to block the pain associated from OA and to date have had billions spent on their development.
Teva and Regeneron’s collaboration on an NGF drug (Fasinumab) was recently put on clinical hold by the FDA after safety concerns of the drug persisted. This deal was valued up to US$2.6b.
Tanezumab is another NGF drug currently in a Phase 3 clinical trial by Pfizer. Again, not without safety concerns; particularly rapid joint destruction in patients treated with the drug. Considering the bad press around these NGF inhibitors, we believe Zilosul® would take preference with both patients and doctors over drugs that inhibit NGF. Zilosul® also treats the cause of the pain, where the NGF simply blocks the pain.
For a company like Regeneron, entering into a deal with Paradigm is potentially very appealing given their US$2.6b NGF OA product has been halted by the FDA.
The value of a potential deal with a big pharma like Regeneron will depend heavily on the phase 2 results and the ongoing SAS patient data. There are also several other factors that will impact the size of the deal, however we estimate the total deal size Paradigm could achieve will be between US$1b to $2b for the US rights. For global rights, this deal may comfortably exceed this figure given the size of the market. Paradigm would also likely be paid royalties somewhere between 10-20% on net sales of Zilosul® for the term of the agreement. DEAL VALUATIONS
Executing a deal with a big pharma is nothing new for the Board and Management of Paradigm. Paul Rennie (CEO) and Graeme Kaufman (Non-Executive Chairman) have both come from top level ASX listed companies and have executed one of the largest biotech transactions in Australia in recent times - the US$2b transaction between Cephalon and Mesoblast in 2010.
Paul Rennie was the inaugural COO at Mesoblast and was solely responsible for the in-licensing of the dental pulp stem cells from the US National Institute of Health. The dental pulp stem cells were key to the CNS component of the Cephalon licensing transaction with Mesoblast in 2010, worth up to US$2B and including the US$220m direct equity investment in MSB.
Chairman Graeme Kaufman is renowned in the Australian biotechnology industry where he has held various top level executive roles at Mesoblast until 2013 (and was likewise heavily involved in the Cephalon transaction). He was instrumental in the privatisation and ASX listing of CSL, including the negotiation of key contracts with stakeholders prior to listing and served as its Chief Financial Officer for over 20 years. Another notable transaction that Mr Kaufman was also involved in whilst at CSL is the licensing for the cervical cancer vaccine GARDASIL®, a vaccine that has saved countless lives and in 2016 generated global sales of over US$2.6 billion (for Merck).
We are confident that the team can execute a deal in excess of US$1b for Paradigm upon successful results in the upcoming phase 2 clinical trial for OA. As indicated from the MSB/Cephalon deal, the market will typically re-rate the company to account for future cash flows as part of any deal.
As a result of the Cephalon deal, MSB appreciated from a low of 67c in 2009, to over $9.93 in 2011, taking its market capitalisation to over $2.8b over this 2-year period.
MSB 2009-2011 Share Price & Market Cap MANAGEMENT OWNERSHIP
Management also have a significant amount of capital invested in Paradigm. Mr Rennie has invested over $2.5m in the business and owns 17.9% of the shares on issue. The other members of the board and management own 5.9%, taking the total management ownership to 23.8% of the issued capital. Management focus on limiting overheads and spending outside of R&D, and we believe this strong level of ownership aligns management with shareholders in achieving the best deals for Paradigm going forward.
Insider Transactions & Management on Market Purchases VALUATION METRICS
Currently Paradigm has ~130m shares on issue (fully diluted). We believe this will increase to a maximum of 150m shares before commercialisation. It’s likely any further costs, should a phase 3 trial be required, will be paid as part of a deal struck with a big pharma partner.
Based on the SAS data that has been released and will continue to be released, we believe Paradigm should trade with a market valuation that reflects this increased high probability of success in their phase 2 clinical trial.
Our expectation is that Paradigm will achieve a deal on their OA product for the rights in US/EU/Japan. The size of this deal is conservatively estimated at US$1b in total size. We then estimate the Australian market would potentially achieve a valuation based on future cash flows at an estimated valuation of US$300m.
Applying a conservative probability valuation, we have discounted this valuation of US$1.3b (AUD$1.73b) by 50% to account for unforeseen risks. This gives a risk weighted valuation upon success of the Phase 2 trial at an estimated A$866m.
If the result of a positive Phase 2 trial is a risked valuation of $866m, then the market is currently pricing (including future dilution) a ~9% probability of success in the Phase 2 trial.
Probability Weighted Valuation
Based on the SAS data that has been released and will continue to be released from Paradigm, we believe the probability weighting towards success should be increased significantly. We are getting the answers to the exam before it’s finished. We are getting the answers before the exam.
Taking this into consideration and assigning a 90% probability to a successful phase 2 trial, the valuation based on the above scenarios accommodates a share price of $5.20.
Probability Weighted Valuation
Even on our most conservative estimates, it is difficult to see how Paradigm trades below an A$300m market capitalisation (~$2 per share) given the size of the OA market, how quickly Zilosul® could be commercialised and the quality of the data they have released through the SAS program.
We anticipate that when the next SAS data is released (likely end of June, early July 2018) Paradigm should have treated around 90 patients. Should the data continue to show the positive results seen to date, the stock will likely re-rate towards a valuation that represents the discounted deal size valuation.
When these deals are eventually announced (likely during 2019) the discounted to valuation will be significantly reduced as a clear pathway to commercialisation and revenues will be evident, driving the valuation substantially higher. CONCLUSION
Paradigm presents a unique opportunity wherein the results that are usually so closely guarded around a clinical trial, are accessible to the market in a different form (SAS). At a market cap of ~$60m, Paradigm has been priced for failure, when we believe the exact opposite will be achieved.
With a strong likelihood of being fast-tracked and receiving provisional approval by the FDA and TGA respectively, Zilosul® is potentially 18 months away from commercial sales. There is a huge demand for this drug given the lack of alternative treatments available and with so much safety data, we believe the demand will likely exceed expectations. Within 5 years, Zilosul® may be the first point of call for patients suffering from OA.
Our view is that the market has significantly undervalued Paradigm. As more SAS data is released and we see successful results of phase 2, (which we believe it will be) the company should have a representative share price of >$4. The size of the deal Paradigm will sign then becomes the next potential re-rating catalyst.
However, it is our view that over the next 5 years assuming all results are successful, and deals completed, Paradigm may achieve a share price in excess of $20 per share.
Paradigm may well be the next Sirtex (2009: $1.50 to 2015: $40 a 2566% increase) or Mesoblast (2009: 70c to 2011 $9.93 or 1318%).
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