Selvita — Services and oncology businesses to split

According to the initial details released by Selvita, the innovative oncology company will control the current R&D pipeline of small molecules and the platform technology (targeted therapeutics, cancer metabolism/immunometabolism and immunooncology platforms). The Selvita branding will be retained by the services company. Around 170 employees will be part of the innovative oncology company and the remaining 325 will join the services company. The separation is expected to be complete by end of 2019. Subject to approval by shareholders and the supervisory board, current Selvita CEO Pawel Przewiezlikowski will be CEO of the oncology company and COO Boguslaw Sieczkowski will become CEO of the contract research company (both are co-founders of Selvita). The current shareholding structure of Selvita should be maintained by both new companies. For each existing share in Selvita, the shareholders will receive one share in the innovative R&D company and one share in the services company. All Ardigen (Bioinformatics spin off) shares owned by Selvita will be allocated to the services company and all NodThera’s shares owned by Selvita will be allocated to the new R&D company.

Between 2014 and 2018 Selvita’s research Services grew by more than 30% per year to a total of PLN59m in 2018. The services company will seek to maximise its sales and profitability via organic growth and acquisition of complementary drugs discovery service providers. Of note is that the latter strategic option will become available as debt funding will be more accessible to the profitable services company.

We provided a detailed overview of Selvita’s R&D pipeline in our recent outlook report, including the two most advanced assets in clinical development, SEL24, a dual PIM/FLT3 inhibitor, and wholly owned SEL120, a selective CDK8 inhibitor. SEL24 is out-licensed to Menarini Group (and is now known as MEN1703), therefore we expect the new oncology company will focus on SEL120 and on advancing the broad preclinical pipeline. Selvita indicated that the existing pipeline of R&D projects would allow it to progress one new drug candidate into the clinic every year.

We believe such a split will be beneficial for investors as it will offer investors an investment option to match their risk/return profile. The Services segment is fast growing and profitable. As a standalone entity it will be able to diversify its capital structure, lower overall costs of capital and complement organic growth with acquisitions. The innovative R&D company will likely resemble a classic drug developer, which tends to be a high-risk but high-reward type of business. In Selvita’s case, the R&D pipeline is broad and the company has the same business goals it described in its 2017–2021 development strategy, which are to:

If these goals are met, the newsflow should be sufficient to support the share price. Therefore, both businesses appear to have enough momentum to continue as standalone entities. Data readouts could be released from both ongoing clinical trials with SEL24 and SEL120 this year, which are key catalysts for the share price as Selvita splits.

According to the Q418 update, Selvita made progress across its R&D pipeline and is on track with the plans announced in conjunction with the 2018 share issue.

The Phase I/II trial with SEL24/MEN1703 in acute myeloid leukaemia (AML) patients is progressing according to plan and now is run solely by Menarini, which should provide trial updates at scientific and medical conferences in 2019. Selvita anticipates the first clinical data could be released in 2020.

The second lead drug candidate, SEL120, is now ready to enter the Phase I trial after the FDA approved an IND application in March 2019 in patients with AML or high-risk myelodysplastic syndrome. The open-label, dose-escalation study is designed to evaluate safety, tolerability and recommended dose of SEL120. Selvita indicated that the activation of clinical centres in the US started in Q219 and administering SEL120 to the first patients could start in Q319 and, if all goes to plan, the data readout is planned for 2020. This focus on haematological malignancies is supported by the Leukemia and Lymphoma Society and Selvita has received US$1.1m in research funding in total since the collaboration was established in August 2017. However, the company believes the potential of SEL120 is much wider and could be used in various solid tumours, including in combinations with checkpoint inhibitors.

The targeted therapeutics platform also includes an ongoing project exploring the BRM/SMARCA2 target in the so-called synthetic lethality space and other projects with undisclosed epigenetic modulators. We reviewed all available preclinical data released by Selvita in our recent outlook report.

The STING agonist project is at the most advanced discovery stage in this platform. One of the key potential competitive advantages of Selvita’s compounds is that they are small molecules suitable for systemic administration, rather than several other technologies that are in a clinical stage and based on cyclic dinucleotides scaffolds that are mostly administered intratumorally. In 2018, Selvita continued optimising the compounds and aims to identify the drug candidate for late-stage preclinical development by the end of 2019.

Another project in an earlier preclinical stage focuses on regulating the T-cell dependent immune response. It involves the target HPK1 (MAP4K1), which is one of the major proteins in the signalling cascade triggered by TCR activation. Inhibition of this kinase leads to prolonged activation of T-cells and stimulates dendritic cells’ antigen presentation, which eventually leads to improved mounting of the immune response directed against the cancerous cells.

In this platform Selvita has its own projects and a longstanding collaboration with Merck (compounds undisclosed). Of the internally run projects, the most advanced are focused on the adenosine pathway, more specifically on the modulation of the production of adenosine by tumour cells (CD39/CD73 enzymes) and its effects on immune cells (A2A/B receptors).

Selvita is focusing on best-in-class dual A2A/A2B receptor antagonists and expects to nominate the drug candidate for IND-enabling studies in 2019. Compounds are differentiated versus competitors and showed excellent anti-tumour efficacy in combination with immuno- and chemotherapies in preclinical studies. Entering the Phase I clinical trial is planned in 2020. Another project in this platform involves SHMT2 inhibitors in early discovery stages of preclinical development.

In June 2018 Selvita’s spin-out, NodThera, announced a £28m fundraise from a consortium of investors co-led by Sofinnova Partners and 5AM Ventures. Selvita’s last reported ownership of NodThera is 14% on a fully diluted basis. NodThera was created around Selvita’s NLRP3 inflammasome inhibitor technology with first-in-class compounds. Inflammasomes have been identified as the molecular mechanism behind the activation cascade of interleukin (IL)-1. IL-1 is a family of pro-inflammatory cytokines that have been widely implicated in pain, inflammation and autoimmune conditions and more recently in cancer.

We note that inflammasome inhibitors continue to draw the pharma industry’s attention. The most recent example is the deal announced on 1 April 2019 by Novartis and IFM Tre. Novartis paid $310m upfront and up to $1.265bn in potential milestones to acquire IFM Tre. Novartis gained access to a portfolio of two preclinical and one clinical NLPR3 antagonist for an array of chronic inflammatory disorders including atherosclerosis and non-alcoholic steatohepatitis. IFM Tre was a spin out from IFM Therapeutics, which sold STING and NLRP3 assets targeting oncological indications to Bristol-Myers Squibb in August 2017 for $300m upfront and potential milestones of up to $1.01bn. IFM Therapeutics was seeded with just $2m in October 2015, so a combined upfront of $610m and potential milestones $2.28bn in less than five years represent a very attractive reward.

Selvita’s reported total 2018 revenues of PLN110.1m (4% y-o-y) were largely in line with our expectations. The total top-line y-o-y growth was achieved despite strong Q117, when a large income of PLN20.3m was recognised after the company out-licensed SEL24 to Menarini Group. Selvita reports in three business segments: Services, Innovation (income from SEL24 was included in this segment) and Bioinformatics.

Selvita’s 2018 net income was also affected by Selvita’s spin out NodThera raising new funds from a consortium. Selvita changed the accounting of NodThera’s shares from the equity method to fair value and booked PLN16.6m in profit.

We have made some revisions to our revenue estimates in each segment. Overall 2018 revenues slightly surpassed our expectations. As usual, Selvita released its first 2019 order backlog:

The Services segment again appears to be poised for substantial growth in 2019, as does Bioinformatics. Subsidies should also increase as Selvita advances its R&D pipeline. Contracted revenues for the Innovations segment could decrease this year, but as we describe above, the value in this segment is created via R&D and actual revenues can fluctuate substantially. Operating loss of PLN13.6m was slightly better than our expected PLN16.3m. Total operating expenses were PLN123.7m compared to our expected PLN121.0m. Exhibit 2 summarises our estimate changes post Q418 results. Selvita reported cash of PLN125m at end-Q418 (PLN114m as of 22 March 2019) and PLN4.1m in debt.

Our valuation of Selvita is slightly higher at PLN1.34bn or PLN83.9/share versus PLN1.24bn or PLN77.6/share previously. The revision of the operating estimates and rolling the model forward had a small positive effect on the rNPV values of the R&D projects and the DCF. We maintain our valuation approach and assumptions discussed in detail in our last outlook report. We use risk-adjusted NPV models with a discount rate of 12.5% for Selvita’s R&D projects at various stages. Separately, we use DCF-based calculations with a discount rate of 10% to value the core drug discovery services business and research collaborations.

We have made one substantial update to our rNPV calculation by replacing the SHMT2 inhibitor project with STING. While both projects are active, we see the STING agonist making rapid progress towards clinical development. According to the latest update, Selvita aims to identify the drug candidate in this project for late-stage preclinical development by the end of 2019. We use the following assumptions for this project: