e-Therapeutics — Rewards for keeping the faith

Investors have been waiting for a transaction to occur as a result of the CEO’s review, which focused on ETX’s two lead immunoncology (I/O) assets and the NDD platform. Although the recent announcement with Novo in T2D brings the validation of the NDD platform and the business development strategy, we expect further such transactions on the NDD platform and the assets available for licensing. Nevertheless, the first commercial transaction involving the NDD platform in a new disease area is something to be celebrated. In particular, the quality of the partner, Novo, in metabolic disease should give investors comfort that due diligence on ETX has been conducted by one of the world’s leading metabolic companies and found to fit its needs.

The financial terms of the transaction have not been disclosed but our expectations are that even for a partner of Novo’s size and quality, ETX would be conducting this first phase under a ‘cost-plus’ basis and the financial impact of those terms at least should be visible at ETX’s FY19 results in March 2019. In addition to this first phase, Novo has the option to license any relevant IP generated by the collaboration under commercial terms that have to be agreed by both parties. We expect ETX could be free to license the IP to other interested parties if the licensing terms are not agreed. We assume that with the Novo transaction under its belt, ETX’s options for further transactions may open up and could be followed by more NDD and product licensing deals. ETX’s position would be strengthened by further deals as it could participate in other deal structures including risk sharing or M&A in a consolidating market.

ETX’s transaction announcement may also not have been in the therapeutic area that investors were expecting bearing in mind it has two I/O assets available for licensing. However, the cumulative progress recently reported as a result of the application of the NDD platform to PD genetics and the latest validation by Novo on T2D should be a wake-up call initially for those oncology companies that have been watching for the potential of ETX’s NDD platform to discover and validate drug targets, but also for many other therapeutic areas. As we describe later in this note, those I/O assets are at a later stage than the Novo deal, so the next transactions are expected to be much more material than this first commercial deal. The delay to the licensing of the I/O assets could be due to the shifting sands in this space brought about by the high-profile failures of the checkpoint inhibitors combined with agents from Incyte and Bavarian Nordic, which may have caused licensees to conduct a higher level of diligence that takes longer.

ETX’s cash and deposits at the end of H119 were £7.6m compared to £12.4m at the end of H118 and although the financial impact of the transaction with Novo has not been disclosed, we expect the collaboration to be cash and income generative. We continue to estimate ETX’s cash runway reaches beyond 2020, subject to further licensing transactions. Our valuation includes the median value of an upfront licensing transaction, which we expect in the next year.

ETX is a UK-based drug discovery company built on a proprietary network-driven in silico drug discovery platform, which has to date been validated in 17 different discovery programmes. The company was founded in 2003 as a technology spin-out from Newcastle University and listed on AIM in 2007. The current incarnation of the platform has been in operation since 2014. Secondary offerings in 2011 and 2013 totalled £57m, which facilitated the development, strengthening and industrialisation of the network analysis platform to a ‘fully operational, highly engineered and efficient discovery engine’. In 2012 a dedicated drug discovery hub opened in Oxford to expand ETX’s drug discovery capabilities. The company has c 20 employees. The 2016 strategic/operational review focused the company on further development of the discovery platform and its six most advanced discovery assets to maximise its chances of securing commercial deals with pharma partners. In April 2017 Dr Ray Barlow joined as CEO from Amgen and carried out a separate review of the company, which further refocused its internal and business development activities.

The discovery platform and the two preclinical I/O lead candidates are, we believe, the main sources of value creation. The next licensing deal where financial terms are disclosed will be important in validating and de-risking the capabilities of the NDD platform. There is limited benchmarking for potential deal terms although there is the backdrop of intense activity in the reported transactions for preclinical I/O assets. Investment in the IP supporting its programmes should be expected to continue ahead of and through business development activities. An analysis of disclosed out-licensing deal metrics for preclinical I/O assets (Evaluate Pharma) indicates that average transaction values since 2016 were £158m (median value £57m), although the more recent acquisitions to September 2018 have been for higher values. We have therefore confined our reference transactions to earlier-stage preclinical I/O upfront payments where the average and median values (converted back to sterling at prevailing rates) are £64.9m and £43.6m, respectively. We will review our validation at ETX’s results in March 2019 when we expect the value of the Novo collaboration will be more obvious. The focus of ETX’s discovery programmes will have a bearing on potential terms; with its platform and existing I/O projects it appears to be well positioned to benefit from the technology ‘land grab’ in the I/O space.

Following the new CEO’s 2017 review, the number of active projects was reduced from 6 to the two higher-value commercially relevant I/O programmes, as well as business development based on the innovative functionality of the NDD platform itself. ETX’s operating loss reduced by over 58% to £6.8m to the year ending 31 January 2018 and H1 interims continued this prudence with an operating loss of £2.8m and a cash outflow of £2.0m. The cash balance at the end of H119 was £7.6m (£12.4m, H118).

The next significant transaction that ETX announces could dictate the company’s valuation. With two I/O assets and the platform capabilities available for business development transactions, just one of these significant transactions is likely to change investors’ views on the company.

ETX offers public market investors a unique opportunity to gain exposure to a cutting-edge in silico drug discovery platform that has already attracted significant investment, enabling it to be fully operational since 2014. This platform has generated new chemical entities (NCEs) in several different disease areas and, under a new CEO, after the Novo transaction is on the cusp of commercial validation that generates sustainable sales and income.

ETX’s approach combines data mining (of both public and proprietary sources), big data network analysis, machine learning and artificial intelligence (AI). The platform needs highly skilled employees to analyse and interpret biomedical data to generate novel insights, intellectual property and NCEs for potential commercialisation. This network-driven drug discovery approach encompasses the complexity of biological systems, which is often not a consideration in traditional single-target drug discovery. This does not mean that ETX’s NDD aims to identify a combination of leads that act together to inhibit a specific pathology, but rather that NDD will see through and connect the cross-talk, receptor affinities and redundancy in pathways so a single molecule can inhibit the specific pathology.

Unlike ETX, other companies focused on the application of AI techniques to drug discovery are mainly private and many come from a software-engineering approach to solve ‘problems’, rather than having biology at the centre of the technological process. ETX also explicitly considers the curation, processing and analysis of data. This enables it to uncover new insights into biology and novel mechanisms of action, which is outside the capabilities of companies that are more concerned with pattern recognition in aggregated data.

ETX now has four assets:

The NDD platform deals are likely to be discovery research collaborations that in many ways validate the platform and demonstrate that partners are unable to find the capability elsewhere. An NDD platform deal is likely to be subordinated by the licensing of at least one of the self-funded NDD-derived programmes, although this will depend on the size of the partner and the magnitude of the financial aspects of the transaction.

The amino acid tryptophan is involved in many pathways that include regulating immune tolerance. The increased cellular turnover in the active portion of tumours seems to lead to tryptophan depletion and the accumulation of the metabolite kynurenine. Together, this combined metabolite imbalance has been purported to contribute to the ability of a tumour to evade the immune system. As such, tryptophan catabolism appears to tailor-made for an NDD approach whereby a single active molecule could prevent the accumulation of kynurenine and depletion of tryptophan by effects on more than one pathway and could enhance the activity of another checkpoint inhibitor in the treatment of solid tumours. ETX has optimised lead molecule inhibitors of tryptophan catabolism and are completing the additional work aimed at generating the biological data that would enable a differentiated profile to be built before the leads are made available for out-licensing.

One of the downsides of an active and adaptive immune system is that sometimes it can overreact and attack normal healthy tissues, resulting in diseases such as multiple sclerosis and systemic lupus erythematosus. This illustrates the ‘goldilocks’ nature of the immune system because the converse – where immunosuppression by tumours down-regulates the cell-mediated immunity that would ideally attack and eliminate tumours, to ignore them instead – is a multi-pathway effect. Thus, ETX’s immune checkpoint modulator pathway in lead optimisation is another potential enhancer of the checkpoint inhibitor anticancer drugs that are already on the market.

The output for a preclinical discovery platform is transactional and investors have been waiting for the validating transactions, which have started to occur. On its way to the first transaction on T2D with Novo, ETX already has a recent transactional track record in the two AI collaborations with Intellegens and Biorelate, which aim to enhance the NDD platform. The recent collaboration with C4X Discovery may be the kind of thing investors expect because it is a joint research collaboration to identify novel targets in PD. While these transactions demonstrate that ETX can sign deals, as far as many investors are concerned the proof will be in further NDD platform utilisation by other big pharma or biotech partners, or an out-licensing of one or both of the NDD-derived self-funded programmes, which would result in sustainable revenue and income. These bigger deals will take more time to execute. The transaction with Novo in T2D adds to the evidence from the PD platform that the NDD platform can take genetic information and add value that leads to potentially new therapeutic interventions.

While the most advanced assets available for licensing from ETX’s platform are in the I/O therapy area and ETX’s recent announcement demonstrated progress in PD, the breadth or disease-aware nature of the NDD platform has now been demonstrated by the transaction with Novo in T2D.

T2D is a disease characterised by a decreasing sensitivity to insulin, which regulates the blood sugar. The majority of the diabetes market is T2D and is expected to grow at a CAGR of 7.6% to exceed 350 million patients by 2030.1 Obesity is a known risk factor for T2D and the rate of growth of T2D patients is driven by rising obesity levels and diagnoses of metabolic syndrome, which usually precedes a T2D diagnosis. Once diagnosed, patients are counselled on diet and exercise but most progress to first-line oral antidiabetic therapy such as metformin to bring their blood glucose levels under control. Very few patients remain in glycaemic control on first-line therapy and most eventually escalate to subcutaneous injections of a glucagon-like peptide (GLP-1) agonist, insulin, or both. Even with many different classes of anti-diabetic medications, long-term glycaemic control amongst T2D patients is not common and the clinical need remains high.

Novo is a leader in metabolic disease and has now recognised that ETX’s NDD platform is one of the few ways it can potentially address this difficult problem. Even with the best insulin analogues and GLP-1 agonists, the high level of mortality and morbidity (including amputations) that comprise the unmet need have clearly spurred Novo to explore other mechanisms that are likely only to be revealed by a network biology approach such as ETX’s NDD platform.

ETX’s sources of value creation its discovery platform and self-funded NDD-derived assets available for out-licensing. In addition, the recent developments in PD have suggested that ETX’s NDD platform can be used to add value to genomics data. We have tried to simplify our valuation by separating the platform and the assets available for out-licensing. Despite the significant historic and continuing investment in the development of the discovery platform, its valuation will mostly be tied to the number and scale of transactions generated. As most of these are still to come, we have taken the value of this platform to be the current market capitalisation (c £18m), although we recognise this is a significant discount the total £61.4m investment raised at, and since, the IPO to generate these capabilities. In our notes earlier this year, we used Lerner’s venture capital method as our preclinical valuation approach, but this can have very wide and subjective ranges depending on the exit (terminal) valuation, the discount rate and the time to exit. To represent the future transactional value component of ETX, we have taken a comparative-transaction approach.

The terms for the first significant licensing deal that ETX signs will be an important validating and de-risking event. However, there are few reliable benchmarks for potential deal terms, although there is the backdrop of the recent intense activity in the transactions for preclinical I/O assets. An analysis of the disclosed out-licensing deal metrics for preclinical I/O assets (from Evaluate Pharma) indicates the average transaction values since 2016 were £158m (with a median value £57m, which limits the influence of any outliers). Two of the three most recent preclinical I/O transactions between August and September 2018 have been above and below this value, adding further utility to the median value; only the €210m total value of the third transaction, the acquisition of ViraTherapeutics by Boehringer Ingelheim, was disclosed, so it has not been used. We have therefore confined our reference transactions to only earlier preclinical I/O up-front payments where the average and median values (converted back to sterling at prevailing rates) are £64.7m and £43.6m, respectively. For the early-stage deals expected to derive from the ETX NDD platform, the recent developments in PD and the transaction with Novo in T2D do not imply less emphasis on I/O. Instead, they add to the evidence that a network-biology approach could also be applicable to I/O and possibly other areas such as fibrosis.

We have added the value of a single median preclinical transaction (representing a future transaction) to ETX’s market capitalisation (representing the platform value) to result in a valuation of £63.5m or 24p per share, which is unchanged from previously.

At ETX’s FY18 results, the effects of the most recent strategic review on reducing the company’s cash outflows were evident and expected to continue. ETX’s operating loss was reduced by over 58% to £6.8m to the year ending 31 January 2018, so the continued reduction in H119 operating loss to £2.8m (versus £3.7m H118) was not a surprise.

The reduced number of programmes had enabled underlying cash burn to be reduced in H218; that continued focus enabled a further reduction in y-o-y cash burn to £3.4m in H119 from H118’s £4.6m. Based on the narrative in the interim results announcement, we have continued to taper the operational cash burn and forecast combined FY19 R&D and administrative costs to c £5.0m compared to c £6.0m previously.

ETX has no debt. Cash and deposits at the end of H119 were £7.6m compared to £12.4m at the end of H118. We expect this cash runway to last until at least 2020 without further reducing the investment in the two lead assets.