RXi Pharmaceuticals — Update 3 November 2015

RXi Pharmaceuticals was established in 2012 as a spin-out from Galena Biopharma (incorporated in 2006) for the development of innovative therapeutics, focusing primarily on the areas of dermatology through its proprietary siRNA technology platform and immunotherapy agents. Its technology builds on the work of its scientific board chairman Dr Craig Mello, jointly awarded the Nobel Prize in 2006 for the discovery of RNA interference. The company’s lead candidate, RXI-109 is in development for dermal and retinal scarring and we anticipate multiple data readouts in these indications over the next 12 months. Earlier this year, the company licensed in immunomodulator Samcyprone, which is under development in dermatological indications. RXi began trading on NASDAQ in February 2014, following two years on the OTC market. In total, the company has raised $38m, including funds of $10.4m via a public offer in June 2015. Headquartered in Marlborough, Massachusetts, RXi has 15 employees.

We value RXi at $91m or $1.40 per share based on a risk-adjusted NPV for lead pipeline projects RXI-109 and Samcyprone and their associated costs, applying our standard 12.5% discount. We believe the potential of its pipeline is considerably underappreciated by investors in view of the current market capitalization of $29m ($0.44 per share), particularly given its estimated net cash balance at end September 2015 of $12m. Our forecasts include NPVs on forecast sales for RX-109 in dermal scarring (risk adjusted at 20%) and AMD (risk adjusted at 5%) and for Samcyprone in hard to treat common warts (risk adjusted at 20%). Additionally, we include forecasts for the US market only pointing to the potential value in opportunities for RXi’s projects globally.

RXi reported its Q215 results on 12 August; a net loss of $2.2m was recorded versus a loss of $3.2m in Q214. The company continued its tight control on costs, reporting R&D expenses of $1.4m in Q215 compared with $1.2m in Q214 and a slight dip in SG&A of $804km in Q215 versus $850km in Q214 due to lower legal costs. Earlier this year RXi restructured its capital, eliminating preferred shares through the full conversion of Series A and Series A-1 convertibles into common stock. In June it completed a share offer, raising $9.3m net proceeds ($10.4m gross) via the sale of 26 million units at $0.40, each unit comprising one common share, a 13-month right to purchase 0.5 of one share of common stock at $0.455 per share and a five-year warrant to purchase 0.5 of one share of common stock at $0.52 per share. At RXi’s share price of $0.44 we note the low price of the options and highlight the 13-month rights offer as a potential funding source of $5.9m. There is also the possibility of a share consolidation, given lack of compliance with NASDAQ’s requirements and threat of delisting as RXI’s share price is below the required $1.

RXi is vulnerable to the risks of an earlier-stage drug development company, including the possibility of unfavourable outcomes in clinical trials, regulatory changes, success of competitors and decisions by potential partners. Additionally, as RXi looks to complete mid-stage drug development trials for its treatments, particularly Phase II trials for RXI-109 in dermal scarring and Samcyprone in common warts it may need to secure financing from late 2016, contingent on funds raised through the exercise of warrants. RXi is operating in the highly innovative and ground-breaking field of RNA silencing, an area with enormous potential but also with little clinical success to date. The company’s preclinical data thus far have been positive and early work in the clinic to date has been encouraging.

RXi has been active over the past year, completing two licensing deals – the in-licensing of dermatology treatment Samcyprone and the out-licensing of its proprietary technology capabilities to MirImmune, while steadily advancing its lead compound RXI-109 in dermatological and ophthalmology indications. The company remains operationally lean, maintaining its strategic focus on opportunistic deal making, while simultaneously advancing its discovery and clinical development programs arising from its novel advanced RNAi-based technology platform.

RNAi, also known as RNA silencing, is a natural phenomenon by which cells prevent protein production by interfering with gene expression. Craig Mello, PhD, a founder of RXi Pharmaceuticals, shared the 2006 Nobel Prize in Medicine for its discovery. It is thought that the RNAi mechanism evolved as a natural cellular defence against exogenous double stranded RNA from RNA viruses.

The central paradigm is that DNA is transcribed to messenger RNA (mRNA), which is translated into a protein. However cells produce other types of 'non-coding' RNA with different functions and one such class are the small interfering RNAs (siRNAs, 20-30 nucleotides long), which play a key role in mRNA regulation. Together with a protein of the Argonaute family, siRNA forms an RNA-induced silencing complex (RISC) and when the RISC recognizes its target mRNA (based on nucleotide matching of the siRNA), it binds and enzymatically cleaves and destroys the mRNA, thereby inhibiting the unwanted activity instructed by the mRNA, eg cell proliferation. The siRNA is intact and RISC can continue to cleave many copies of the target mRNA.

Through the delivery of synthetic siRNAs, RNAi provides a novel and potentially powerful approach to treat diseases that involve overexpression of specific proteins (eg collagen in scarring or cholesterol in hypercholesterolaemia). It may also be effective in rare genetic diseases that involve a mutation in one allele, with the other allele being normal, so reducing the mutant protein could prevent disease symptoms (eg familial amyloidosis and Huntington's disease). RNAi therapeutics can be designed against any mRNA (even for proteins not considered 'druggable') and have the advantage of blocking production of disease-causing proteins before they are made.

Large pharma companies (including Roche, Novartis and Merck) have historically found the delivery of siRNA and microRNA therapeutics challenging and have largely left the field to smaller biotech companies to develop RNAi-based therapeutics in a broad range of indications, including RXi Pharmaceuticals, Alnylam Pharmaceuticals, Arrowhead Research, Sirnaomics, Dicerna Pharmaceuticals, Silence Therapeutics, Sylentis (Zeltia), Quark Pharmaceuticals and Mirna.

RXi’s RNAi Therapeutic Platform: sd-rxRNA

The delivery of RNAi therapeutics to the right organ and cells is key. Developed in house RXi’s 'self-delivering' RNAi platform (sd-rxRNA) contains a variety of nuclease stabilizing and lipophilic chemical modifications, which the company believes has advantages over a conventional liposome-encapsulated approach. The result is RNA-antisense hybrids that combine the beneficial properties of both conventional RNAi and antisense technologies, with the aim of achieving efficient spontaneous cell uptake, potent and long-lasting intracellular activity but lower immune activation. Preclinically RXi has demonstrated efficient cellular uptake of sd-rxRNA both in vitro and in vivo, in tissues such as skin, retina, lung, spinal cord and liver, and target gene silencing in different cell types. Efforts are currently focused on local rather than systemic delivery of its compounds, including to skin, eye, lung and possibly the central nervous system. The sd-rxRNA platform will require further optimisation to overcome the tissue clearance challenges of systemic delivery.

In addition to its own in-house clinical and preclinical work, in October RXi announced encouraging results from its collaboration with Biogazelle, a firm focusing on RNA gene expression. The companies reported that specifically designed sd-rxRNAs showed robust and potent reduction of multiple long non-coding RNAs (IncRNAs) in a target-specific manner, thereby expanding the potential applications of the sd-rxRNA platform in additional diseases and disorders.

RXi is developing sd-rxRNA compounds for the treatment of scarring in the skin and eye. Its most advanced clinical candidate, RXI-109 silences the expression of connective tissue growth factor (CTGF), which plays a key role in pathways involved in fibrosis, including hypertrophic and keloid scar formation in the skin. Hypertrophic scars are abnormally raised scars that are darker than the existing skin and caused by increased cell proliferation and collagen production. Keloid scars are similar but spread beyond the original site of skin injury and may continue to grow in size for years. Both hypertrophic scars and keloids can result from common skin trauma such as acne, ear piercing, cuts and burns or vaccination. Two Phase I trials of RXI-109 in healthy volunteers have demonstrated its safety and showed a dose-dependent silencing of CTGF mRNA and protein. Approximately 100 subjects have been treated with RXI-109 by intradermal injection in all trials to date, with no major side effect or safety issues reported. Three Phase IIa trials are now underway in both hypertrophic and keloid scars:

By the end of 2015, the company expects final data for Phase IIa Study 1301 and late readouts for Study 1401. In addition to the extension to Study 1402 in severe hypertrophic scars, RXi is also planning a new keloid Phase IIa study with an extended dosing regimen. Results from these studies will inform the design of Phase IIb studies, which we assume will now start in late 2016.

Scars can have long lasting functional, cosmetic as well as psychological consequences for the patient. There are no FDA-approved therapies in the US for the treatment or prevention of scars. At the time of its 2007 deal with Renovo for Juvista (since terminated due to failure in Phase III on lack of efficacy), Shire estimated that the total US scar prevention/treatment market could be worth around $4 billion pa. In the developed world, 100 million patients acquire scars each year, largely as a result of 55 million elective operations and 25 million operations after trauma. The incidence of hypertrophic scarring following surgery varies from 40% in the general population: http://www.ncbi.nlm.nih.gov/pubmed?term=Hypertrophic%20scarring%20and%20keloids%3A%20%20pathomechanisms%20and%20current%20emerging%20treatment%20strategieshttp:// to 70% in certain Asian populations, rising to 91% following burn injury. Keloid scars are more common in darker skin, with a prevalence of less than 0.1% in the UK, rising to 16% in people of African origin. They have a strong genetic component.1 Specifically in the US there were 30.1 million surgical skin procedures in 20102 and according to the 2014 American Society of Plastic Surgeons (ASPS) report, out of 5.8m reconstructive procedures, there were 177,000 scar revision surgeries.

As suggested by Shire in 2007, the total addressable market for an FDA-approved dermal scar prevention and treatment could be as high as $4bn pa in the US. In 2014, approximately $13 billion was spent on cosmetic procedures in the US, with a mean cost per procedure of $830 (ASPS). Consumer research shows that 85% of patients would (and already do) self pay for the reduction or prevention of scarring. For example, laser skin resurfacing is commonly used to treat wrinkles, warts, scars and deep lines, with an average course costing $2,300 (ASPS, 2011).

We model peak sales for RXI-109 in dermal scarring of $1.5bn in 2027, before risk adjustments. Our forecasts assume use in 50% of scar revision surgeries, 5% of reconstructive procedures3 and 5% of breast augmentation procedures. We assume a largely self-paying market.

Standard management of hypertrophic and keloid scars includes non-invasive approaches (compression, silicone sheeting, over-the-counter creams) and invasive approaches (surgical excision, corticosteroid injection, radiotherapy, laser therapy and cryosurgery) as well as more experimental third-line therapies (intralesional 5-FU, verapamil, bleomycin, mitomycin-C, interferon alpha and topical imiquimod) – see Exhibit 3. Keloid scars are much harder to treat than hypertrophic scars and have a high recurrence rate, which can be a soon as a few weeks. Often a combination of treatments is more effective than monotherapy, for example, surgery plus steroid injection and silicone sheeting, or steroid plus 5FU. Treatment can be expensive, lengthy, and in the case of steroids and experimental drugs, have adverse side effects. Moreover, many current therapies have only been tested in small trials and efficacy data is extremely variable.

There are relatively few treatments in development for dermal scarring. RXI-109 looks to be the most advanced in development siRNA-based therapy for scarring. Pfizer's PF-06473871(EXC-001) is an antisense oligo which also targets CTGF. It completed five Phase II trials in 2012-2014, but its development now appears to have been discontinued.

RXi is also developing RXI-109 for retinal scars (intraocular use) and corneal scars (topical use). In wet age-related macular degeneration (wet AMD) abnormal blood vessels grow subretinally (neovascularisation) and leak fluid and blood. RXI-109 may reduce the subretinal scarring seen in wet AMD and reduce the rate of vision loss. In animal models, a single intravitreal dose of RXI-109 reduced levels of CTGF protein at day seven in a dose-dependent manner. The Investigational New Drug (IND) was passed by the FDA in August 2015 and RXi aims to start a dose-escalating Phase I/II trial to evaluate RXI-109 in patients with advanced wet AMD (already treated with anti-VEGF medications) in Q4 2015 – study 1501.

AMD is a leading cause of vision loss in the over 65s and represents a significant market opportunity. According to US NIH National Eye Institute estimates, there are 200,000 new cases a year and over two million Americans had AMD in 2010; a figure expected to rise to five million by 2050. There is no cure, but vision loss may be slowed by treatments which reduce neovascularisation such as the anti-angiogenic VEGF-inhibitors (Lucentis, Macugen, EYLEA and off-label use of Avastin), and photodynamic or laser therapy. While anti-VEGF treatment normally stabilizes or can improve vision, scar formation after treatment has been identified as one of the main causes of the loss of visual acuity.4 The value of the wet AMD treatment market was estimated at $4bn in 2011 and could reach over $8bn by 2016, according to Nature Reviews Drug Discovery 2012, due to an ageing population and as additive and complementary treatments become available. In 2014, the two leading treatments for AMD (VEGF inhibitors Eylea and Lucentis) each registered $1.7bn in sales and both are on track to achieve more than $2.0bn in sales in 2015. We currently model potential sales reaching $1.3bn for RXI-109 in AMD in 2030 assuming 25% market penetration.

It is envisaged that RXI-109 will potentially be used in combination with existing VEGF inhibitors, in order to target both VEGF and CTGF to down regulate both the angiogenesis and fibrosis pathways. In addition to RXI-109, several other RNAi approaches are being taken in this area, the most advanced being Quark Pharmaceuticals/Pfizer's PF-655 which is an siRNA against a proprietary target protein that inhibits mTOR. In Phase II, PF-655 in combination with Lucentis was better at improving visual acuity than Lucentis alone. In addition to RNAi drugs in development there is also significant competition from other approaches for wet AMD. Drugs under development include including an anti-PDGF (platelet derived growth factor) under development by Ophthotech in Phase III, which in combination with a VEGF-inhibitor, looks to disrupt the formation of new blood vessels. Top-line data for Ophthotech’s treatment is expected in 2016.

In February 2015, augmenting its portfolio of treatments in therapeutic dermatology, RXi licensed in global rights for the topical gel, Samcyprone from Hapten Pharmaceuticals for an upfront payment of $100,000 and 200,000 shares of RXi common stock. Hapten will also be eligible for milestones and escalating mid-single digit royalty payments based on commercial objectives and product sales. RXi is currently conducting a Phase II program for Samcyprone in viral warts, while we understand that trials are ongoing by independent investigators in alopecia areata (baldness) and in cutaneous metastases of malignant melanoma, where Samcyprone recently received orphan drug status. Other potential indications for Samcyprone include actinic keratosis, basal-cell carcinoma, squamous-cell carcinoma and cutaneous metastasis of non-melanoma cancers. Samcyprone is a proprietary gel-like formulation of the topical DPCP (immunomodulator diphenylcyclopropenone), with a potential improved safety profile through its lower concentrated dosing and more consistent easier delivery. DPCP is not FDA approved and must be formulated in acetone by a pharmacist, based on directions from an individual dermatologist and therefore there is no standardized usage. It works through the initiation of a T-cell response by altering the expression of multiple genes and miRNAs in the immune response. A small molecule, DPCP has been used by dermatology centers for more than 30 years, primarily as a stimulant for the regrowth of hair in patients with alopecia areata. In one retrospective study with 54 patients with alopecia areata (alopecia areata is an autoimmune disease in which hair loss occurs in some or all areas of the body), terminal hair growth was labelled ‘excellent’ at 76%-100% in 40.7% of patients, ‘good’ at 51%-75% in 14.8%, ‘moderate’ at 26%-50% in 14.8% of patients and mild (<25%) in 29.6% of patients.5 Recent data published in peer reviewed journals also show DPCP efficacy in certain skin diseases, ie alopecia areata, warts and cutaneous metastases of malignant melanoma. There is currently one patent and three outstanding patent applications for Samcyprone covering the compositions and methods of use in warts, HPV, skin infections, skin cancer and immunocompromised patients, expiring between 2019 and 2031.

According to RXi, the total addressable market in the three indications for which DPCP is currently being used (warts, melanoma and alopecia areata) is approximately $1bn, with warts the greatest potential market at an estimated $500m. Warts are benign tumours caused by infection with human papilloma viruses and can be mucosal or cutaneous. Cutaneous warts are common, particularly among the young. Various studies have shown that up to 33% of children and young people have cutaneous warts and 3%-5% in adults. In children and teenagers warts disappear within a year, but while there is little research, are typically of longer duration in adults with recovery affected by immune system strength. This spontaneous resolution can take years, and in the interim warts can grow and spread causing pain and distress due to appearance. A number of treatments have been used for cutaneous warts, but evidence of efficacy remains poor. Imiquimod is the most commonly-used medication for cutaneous warts, despite its lack of approval in this indication (it is currently indicated for basal cell carcinoma, actinic keratosis and genital warts in adults) and prior to becoming generic in 2011 achieved sales of $350m in 2010. There are no controlled trials for imiquimod in cutaneous warts, but there is some evidence of efficacy in various case studies.

RXi is finalizing its protocol for a Phase II trial in warts, targeted for initiation by year-end. Primary endpoint of the study is clearance of Samcyprone-treated warts versus untreated warts over a 12-week treatment period. The company expects this first study to be relatively easy to recruit, enabling a safety database to support investigator sponsored trials in added indications. Our model includes peak sales for Samcyprone of $177m in 2027 in hard to treat warts only at 50% penetration.

Given DCPC’s ability to alter the expression of miRNAs in immune responses, RXi anticipates studies with Samcyprone could enable the discovery of drug targets to treat skin and systemic-related immune disorders, resulting in the development of more potent/selective compounds.

In recent quarters, RXi has completed work showing dose-dependent knock down in mRNA and protein levels in compounds targeting the collagenase and tyrosinase enzymes, additionally supported by in vitro studies in cell cultures and skin equivalents. RXi has reported strong interest in these compounds from third parties in both the therapeutic and consumer skin care areas. Applications in the cosmetics field have the potential to progress relatively quickly. In October, RXi announced the selection of two compounds for cosmetic product development based on its sd-rxRNA platform. RXI-231, targeting tyrosinase, showed a visible reduction of pigmentation in melanocytes in a human epidermis tissues culture, displaying 100 fold potency over well-known skin lightening agent kojic acid. RXI-185, targeting collagenase matrix metalloproteinase-1 (MMP-1), has been selected for its potential in skin improvement. RXi looks to be well positioned in this area as CEO Geert Cauwenbergh has considerable experience, having worked for Johnson & Johnson in charge of developing the skin care franchise for the beauty and cosmetic consumer.

In March of 2014, RXi out-licensed RXi’s sd-rxRNA technology to MirImmune for ex-vivo use in developing cell-based cancer immunotherapies. The agreement allows MirImmune access to RXi’s sd-rxRNA and rxRNAori patent families for ex-vivo modification of cells for the treatment of cancer in return for an annual licensing fee, milestone payment, sublicensing income, single-digit royalties, as well as the right to acquire a double-digit stake in MirImmune’s equity. We believe the agreement signifies a validation of RXi’s technology platform, opening doors for future licensing agreements. RXi seeks similar arrangements with prospective partners also reporting ongoing discussions with potential strategic partners to partake in more comprehensive deals entailing equity investments.

RXi is subject to the risks associated with earlier-stage drug development companies, including the possibility of unfavourable outcomes in clinical trials, regulatory changes, success of competitors and commercial decisions by potential partners. Additionally, as RXi looks to complete mid-stage drug development for its treatments, particularly Phase II trials for RX-109 in dermal scarring and Samcyprone in warts, it will need to secure additional financing from late 2016. Required funding will be contingent on the future conversion of outstanding warrants. RXi is operating within the highly innovative and ground-breaking field of RNA silencing, an area with enormous potential but also with limited clinical success to date. The opportunity in this area provides significant upside on success of projects progressing through clinical programs; however, the novel approach brings additional risk. As stated, RXi’s technology platform combines the beneficial properties of both conventional RNAi and antisense technologies, with the aim of achieving potent and long-lasting intracellular activity but lower immune activation. Preclinical data so far has been positive. Early work in the clinic to date has been encouraging. Lastly, in the case of Samcyprone there remains risk related to the three outstanding patent applications.

We value RXi at $91m or $1.40 per share on an rNPV basis or $1.17 per diluted share, when considering a potential exercise of 13 million shares issued at a strike price of $0.455 in connection with the company’s recent share offer. We believe the potential of its pipeline is underappreciated by investors pointing to the company’s current market capitalization of $29m ($0.44 per share) and bearing in mind its estimated net cash balance at end September 2015 of $12m. We model risk-adjusted cash flow for RX-109 in its targeted indications of dermal scarring and AMD through its expected patent life to 3031 and for Samcyprone in its lead indication for the treatment of warts with market exclusivity also running to 3031, including discounted future operational cash flows including expected R&D and general and administrative expenses attached to each clinical treatment in development. We include aggregate estimated risk adjusted and discounted milestones from potential partners for the licensing in of RX-109 in dermal scarring ($11m) and AMD and for Samcyprone ($5m) in viral warts risk. Our forecasts also include royalty and milestone payments as per RXi’s agreement with Hapten for Samcyprone.

RXi looks to be adequately capitalized with Q315 cash on hand estimated at $12m, which should fund the company into the latter part of 2016. As guided by management, RXi’s current operating cash outflow will likely be maintained at ~$2.0m per quarter throughout next year. Earlier this year the company restructured its capital, eliminating preferred shares through the full conversion of all Series A and Series A-1 convertibles into common stock. In June, the company also completed a successful share offer, raising $9.3m net proceeds ($10.4m gross) via the sale of 26 million units at $0.40 with each unit comprising one common share, a 13-month right to purchase 0.5 of one share of common stock at $0.455 per share and a five-year warrant to purchase 0.5 of one share of common stock at $0.52 per share. At RXi’s share price of $0.44 we note the low price of the option and consider the 13-month right a viable financing option which could bring funds of up to $5.9 million if exercised. Additionally, RXi has a $10.7m outstanding equity line available through the Lincoln Park Capital Fund, which becomes accessible following the expiration of the 13-month purchase rights. Our forecasts include $10m in illustrative long-term debt in our model in each of 2016 and 2017, ie a $20m near-term funding requirement, mainly to cover expected R&D costs. However amounts remain heavily dependent on the ongoing trial requirements of clinical programs and RXi’s ability to license out its later-stage projects in a timely fashion to partners on reasonably attractive terms. RXi published second quarter 2015 results on 12 August. The net loss for the quarter was $2.2m compared with the $3.2m loss in Q214. R&D of $1.4m in Q215 compared with $1.2m in Q214 as the company continued a rigorous control on costs, while focusing efforts on its three ongoing clinical trials, and particularly 1402 in dermal scarring. RXi maintains its lean corporate structure. Excluding non-cash based compensation, SG&A expenses were $0.6m in line with the $0.6m reported in Q214.