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Why One Drug Flop Tanked Incyte's Stock

Shannon Jones, The Motley Fool

Biotech is not for the faint of heart. About 90% of drugs and therapies tested fail to make it to market. Even drugs with promising phase 2 data are up against huge odds of failure -- as Incyte (NASDAQ: INCY) shareholders were reminded of all too well today.

In this week's episode of Industry Focus: Healthcare, host Michael Douglass and Motley Fool contributor Shannon Jones look at what went wrong with Incyte's Epacadostat, where the company can go from here, and what this unfortunately means for the immuno-oncology sector on the whole. Then, in more pleasant news, the hosts dive into Novartis' (NYSE: NVS) newest acquisition of gene therapy company AveXis. Find out what this means for Novartis, why Biogen (NASDAQ: BIIB) might be getting the stink eye from their investors right about now, whether or not Novartis overpaid to tuck this company under their belt, and more.

A full transcript follows the video.

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This video was recorded on April 11, 2018. 

Michael Douglass: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Wednesday, April 11th -- as Shannon will point out to you, my birthday -- and we've got a roundup of two big news stories: a Phase III flop with major implications across biotech, and a big buyout. This is Michael Douglass, your intrepid Financials and past Healthcare host, filling in for Kristine Harjes, who is taking a well-deserved vacation. We just decided to change everything up for this episode, because Todd Campbell is not calling in, either. Instead, I'm joined in the studio by healthcare analyst, Shannon Jones, who is making her Industry Focus debut. So, please welcome her with me to the show. Shannon, welcome! It's good to have you!

Shannon Jones: Michael, thank you so much! I'm so excited! It's a bit surreal to be sitting in here with you on your birthday. I consider it a privilege, an honor. Thank you for that opportunity!

Douglass: [laughs] Sure. I'm certainly excited to have you in while I'm subbing for Kristine. So, let's talk about our two big news items. Truthfully, I did not oversell these, I think they're pretty major. The first one: Incyte had a major drug flop. Let's talk about that a little bit.

Jones: I would even say "major drug flop" is probably an understatement at this point. This was, and probably will be for 2018, one of the biggest pipeline blow-ups, I think. In particular, what happened: Incyte, last Friday, announced a failed Phase III study where basically, they were pairing Merck's checkpoint inhibitor Keytruda, which we have all known to grow and love, with Incyte's drug, Epacadostat, an IDO inhibitor, in patients with melanoma. Long story short, the study was stopped. They found that the combination of these two drugs together wasn't more than what was already being seen with Keytruda alone. So, in a lot of ways, I think this study is not only bad for Incyte, but really bad for the immunotherapy industry in general.

Douglass: Yes. We'll get into some of those broader implications in a minute. But first, why people were so excited about Epacadostat. By the way, dear listeners, we both looked this up before the episode, because we're used to reading these drug names, not saying them. I know Kristine has talked about this before, but here we are. So, if I pause beforehand, it's because I'm checking my notes for how to pronounce it, because it's kind of a mouthful, Epacadostat. 

So, the idea here is, PD-1 inhibitors are supposed to take the brakes off the immune system, and Epacadostat was supposed to essentially boost that. Now Keytruda and Opdivo, which is Bristol-Myers' (NYSE: BMY) drug, have both been at the center of this revolution that we've seen in cancer care with the PD-1 Inhibitors. The broad goal has been, these PD-1 inhibitors look like they're going to be some kind of standard of care. Maybe it's in second or third line, depending on the cancer and what the data says and all of that. But, if you can't beat them, join them. So, let's go ahead and try to join these drugs with our drugs and see what happens. This was, in many ways, a very surprising failure because past data had been so good.

Jones: Exactly. Last year at the ASCO healthcare conference, the American Society of Clinical Oncology, Incyte presented really compelling Phase II data. Investors were quick to jump on the Incyte bandwagon with this particular drug, and really, many expected this Phase III trial to be an easy home-run win. It was really anything but. And when you consider the fact that it failed in what's considered the low-hanging fruit of therapeutic indications, which is melanoma, it makes this failure that much worse.

Douglass: Yes. And it certainly says a lot of negative things about the drug's future, potentially. Let's hop into that. Of course, there are a number of other combo trials being conducted, where they're in process right now. The CEO has basically said it's, I'm quoting here, "an open question," as to what happens next. What's your two cents here?

Jones: The company is planning to go back and do a subgroup analysis, look to see if there are any patients that maybe did respond a little bit better than others. As you and I both know, Michael, and probably many of our listeners, retrospective subgroup analysis is usually not a good sign of confidence in the biotech industry. So, not feeling particularly confident about their decision to keep this an open question. They do have a pretty robust pipeline, and I'd rather see them focus their efforts on some of these other therapies that they're going after, some of these other indications. 

But, in particular, just looking at Incyte with IDO right now, in addition to melanoma, there were four other indications. There was lung cancer, renal cancer, head and neck cancer, bladder cancer, and these were being studied with other companies, too. AstraZeneca with their Imfinzi, Bristol-Myers Squibb with Opdivo. So, this will have ripple effects. I'd be really curious to see what they may get out of some of these analyses moving forward, but I'm not hopeful overall.

Douglass: No, I think that's very fair. Post hoc is never a great spot to be, because there are all kinds of artifacts in the data. So, Incyte got slammed --

Jones: Yeah, to say the least.

Douglass: -- when they announced this data. With that in mind, the market cap is a lot smaller. But, as you pointed out, there's a lot more that the company still has in the pipeline. In fact, it already has a drug on the market, Jakafi, which did just over a billion dollars last year in sales. So, there's certainly still plenty of reason, potentially, to like the company. Personally, I think it's a little bit overvalued, because to some extent, I think that IDO looks like it's maybe dead on arrival. Maybe not dead on arrival, we can always hold out hope, but I'm not holding a lot of hope right now. But, they do have a number of other pipeline candidates.

Jones: They do. In particular, and coming up in just a couple of weeks, Olumiant, which is an Eli Lilly -partnered rheumatoid arthritis drug that is currently already approved in Europe, is set to have its day with the FDA here. They'll be having an advisory committee meeting on April 23rd. This drug has had its history, for sure. It sounds like, though, analysts are expecting that this particular advisory committee will go well. So, this could be some short-term boost for revenue for Incyte. 

As you mentioned, Jakafi, they do have a blockbuster cancer drug that you can't deny. Peak sales right now, estimated to be about $3 billion annually. And really, they have a pipeline with 10 different targets. So, I think, really, Incyte makes the case for a lot of these revenue-starved big biopharmas that are needing some short-term boost in cash. This could actually be a really good opportunity for them to pick up Incyte.

Douglass: Yeah. I think that's good insight on Incyte. I'm sorry. I warned you beforehand that I was going to do that at least once.

Jones: This is true, ladies and gentlemen. Michael Douglass will be here all day, on his birthday. [laughs] 

Douglass: Yeah, bad puns, I've built a career out of them. [laughs] But, let's talk about that. One of the things that you mentioned before we got on the show was, you saw Incyte as a potential takeout candidate for one of these late-term, pipeline-starved, bigger biotechs. Gilead Sciences (NASDAQ: GILD) is one that comes to mind. Biogen is certainly somewhat pipeline-starved, but maybe not as good of a fit. I think Amgen was on your list, as well. 

Jones: Yes.

Douglass: My big question, though, when I look at Jakafi, let's say it hits $3 billion in peak sales. That would imply that Incyte is priced at just under 5X peak sales. That works. That valuation works just off there, because usually we see takeouts in 3-5X peak sales. So, that's reasonable. And you've got some additional upside in this pipeline. We've talked primarily about two drugs now, but they have a PI3K inhibitor. Now, Gilead shareholders will remember, PI3K inhibitors have kind of a mixed history, with Gilead's Zydelig having a big, nasty black box warning for a lot of really terrible side effects. Most of the rest of the stuff is early to mid-stage, but it's a pretty deep and diverse pipeline. And you've actually turned me into a believer that it could reasonably be a buyout candidate.

Jones: As you and I both know, for a lot of these biopharmas that are strapped for some late-term revenue-driving drugs, they're generally not going to also look for bargains. They're sometimes going to go for really overpriced assets. I definitely don't think that Incyte, by any means, is a slam dunk M&A target. But now, with the market cap down over 50% just from a year ago, I think it becomes that much more attractive, especially for the Gileads that have an oncology pipeline that Jakafi could sneak right into and do really well.

Douglass: Yeah, especially because the drug is, to some extent, plug and play. It's already on the market, it's already gotten some scale, hopefully not as much scale as it will ultimately get, but it's certainly in a good spot in a lot of ways and there's a lot of opportunity there, as well, across the pipeline.

That's our take. I think, if you are an Incyte shareholder right now, you're probably doing some soul searching. I would be. I'm not. I don't think this is a stock that's a compelling buy on the dip, and we certainly don't believe in purchasing stocks based on potentially becoming an M&A target. That said, for me, the market reaction felt about right. So, I feel about Incyte now as I did then, which is, could be interesting, a little bit rich for my blood, personally.

Jones: Yeah, I have to agree there. Incyte, without this clear combination strategy, leaves a lot of question marks for me. Until the company figures that out, I think I'll stay on the sidelines.

Douglass: So, let's talk about the broader industry very briefly, and then we'll head on to our second topic. This is just bad news for immuno oncology across the board, because we finally now have a really clear sign of a combo drug whiffing. And frankly, there are a lot of combo drugs being tested out there right now. The last time I checked, which was maybe a month ago, there were over 800 clinical trials involving either Keytruda or Opdivo, which are the two big leaders in PD-1.

Jones: Yeah, absolutely. Just on the IDO inhibitor space alone, you saw, when this news came out for Incyte, NewLink Genetics, for instance, fell 42%. This is a company relatively new on the scene. They have a pipeline; their core two assets are all IDO Inhibitors. They fell 42% on Friday alone. Nektar Therapeutics wasn't immune either, fell 7%. And even Bristol-Myers Squibb, with Opdivo, fell slightly on the news. I will make mention, though, Bristol's IDO inhibitor, same class, slightly different mechanism of action. So, time will tell how it plays out for Bristol. 

But really, across the board, I think what you're seeing is, investor sentiment is really changing for these combination strategies. There's a big question mark within the industry. And I think, from an everyday investor's perspective, this really drives home the point, take those Phase II result with a grain of salt. It is not uncommon for a Phase II drug to look really great, but then come in Phase III and utterly bomb out just like this drug did. So, take it with a grain of salt. Recognize that you might see some promising signs, but as it gets exposed to larger patient populations, if it's not a safety issue, it'll be an efficacy issue, and either way you need to use some caution.

Douglass: Yeah, absolutely. This is the classic thing with all biotech. There's a 90% failure rate once a drug enters Phase I. It's still not better than a coin toss even at Phase III. You just have to play those odds. That's why I think all of us, when we invest in healthcare, tend to try to go for fairly diversified portfolios. Some are going to do well, some will whiff, and predicting them beforehand is not the easiest thing in the world.

Let's turn to our second big story, which is a big buyout. If we sound like broken records, it's because every week there seems to be some kind of big buyout going on, if not in healthcare then in some other sector. On Monday, just two days ago, from recording, at least, Novartis announced that they were going to pay $218 per share for AveXis, for a total cost of $9.8 billion. That's an 88% premium over the previous closing price on April 6th, which is a pretty good return. Congratulations, AveXis shareholders! You have had a very, very good few days.

Jones: Yeah, absolutely. I must say, Novartis has been impressing me as of late. I'm normally not too bullish on big biopharma, but Novartis is actually making some really interesting, novel plays. They're not sitting on the sidelines, they're not going after me-too indications. They're going after some really novel things, and AveXis proves that. For listeners who are not as familiar, AveXis is a gene therapy company, could have the first gene therapy for SMA. For those Biogen investors out there, you'll recognize SMA as being spinal muscular atrophy, a rare neuromuscular disorder caused by a genetic defect in a particular gene, specifically the SM1 gene. AveXis here is hoping to make a play in a space that is still a huge unmet need, despite the fact that Biogen has the only approved drug for SMA right now.

Douglass: The thing with Spinraza is that it arrests, or appears to, at least, arrest, or delay, slow down, effects. The idea here of this gene therapy is that the potential -- of course, let's be clear here, it's only potential right now. We do not have Phase III data, which as we just discussed, is kind of important. But, the potential to possibly create a fix. If you can fix the gene, the genetic defect, then potentially you could see spinal muscular atrophy defeated. Perhaps. Again, we're speculating here. But, if that's how this drug ends up functioning, then you could see that unmet need basically be entirely met, at least for everyone who can pay.

Jones: And to that point, when you think about gene therapy, this could be a literal one-and-done therapy. Spinraza right now requires what's called a front-loaded dosing strategy, where you give more doses up front, and then you have to give ongoing maintenance doses. This could be a huge game changer, if approved, as a one-and-done fix-it therapy for these critically ill patients.

Douglass: One of the things that's interesting about spinal muscular atrophy is that Spinraza costs, well, a lot. $750,000 for that first year of treatment, and about $375,000, a comparative bargain, for years after. And it generated almost a billion dollars in 2017, just under $900 million. So, with that in mind, there are plenty of reasons to think that insurers might be willing to pay a good deal more for a one-and-done drug. So, there's a lot of opportunity here if the drug succeeds.

Now, one thing we should point out is, fellow Gilead shareholders are probably remembering, this sounds a little bit like what happened with hepatitis C. And to some extent, yes, that is what could happen. So, what we could see here is, this drug burns hot in its first few years as it basically helps all the current patients -- again, if it succeeds -- and then probably tails off a little bit after that because it'll be just helping new patients as they are born and identified with SMA. So, that means we'll probably hit peak sales early and then taper off some and plateau for a long time period, because it's curing the disease. That's great. That's a great outcome. And if Wall Street analysts aren't thrilled with the growth curves there, tough. It's a win-win for everyone. And if it ends up panning out that way, there's every reason to think that Novartis is going to be well compensated for this long-term.

Jones: Absolutely. And I would even add to that, even beyond their lead candidate, which right now is AVX-101, Novartis is really inheriting a platform, a gene therapy platform. Novartis has already said they are committed to developing gene therapy drugs in neuroscience and ophthalmology. This could be exactly what they need to really springboard that growth long-term.

Douglass: And to that point, this isn't Novartis' first acquisition in this space. They licensed Spark Therapeutics' Luxturna, which is for an inherited form of blindness, just a few months ago. So, this is their second big play in this space. Novartis is signaling that they are definitely going to be playing heavily here, perhaps over the long term. And one of the questions for Novartis shareholders to ask themselves is, is AveXis' platform plus the Spark Therapeutics drug enough? Or is Novartis going to need to build out some more expertise and some more pipeline and perhaps a couple of more platforms? And that's an open question. It's something we'll just kind of have to watch for.

Let's talk a little bit about what this means for broader M&A.

Jones: I think what you're starting to see is a trend of a lot of these large biopharma companies no longer just looking at these individual pipeline candidates and saying, "I want to buy this asset." They're actually now beginning to look beyond that. Does this company bring manufacturing expertise or manufacturing capability that goes beyond that? Is there a platform that we can now launch more drugs off of? So, I think you'll probably start to see this more. We know that Gilead purchased Kite in 2017. Kite Pharma was, for the longest time, way behind Juno, but I think the reason why Gilead went after Kite, obviously there were some safety issues, but it was the fact that Kite had the manufacturing capabilities already in place. I think that'll be an important trend to watch as you're looking to see who could get picked up next.

Douglass: And it's this idea of plug and play, again. To some extent, these big biotechs and big biopharmas that are looking to either plug a hole in their platforms or in their pipelines or find something accretive and work with it. They're thinking not just about upfront costs, but they're also thinking about what those knock-on effects are. The FDA has certainly been sending plenty of drugs back to the drawing board for manufacturing issues. Well, if someone has already cleared those issues out, that's another potential problem that's just gone. You've paid up a little bit to de-risk that, but just like we pay for home insurance, there's a real reason to do so. The way I likened this to Shannon when we were chatting about it yesterday was, I bought a shed, and I'm assembling it this weekend. And by that what I mean is, I'm paying somebody else to assemble it, because I'm just not very good at building things, so it just makes sense in that case for me to pay up a little bit to de-risk that particular part of my yard. So, I'm very excited about that.

Another question that I think a lot of people watching this deal are probably thinking is, what was Biogen thinking? Why didn't Biogen make this purchase? This is a drug that could directly impact Biogen's biggest success over the last couple of years, which was, to be clear, a partnered drug, they could have gotten the full rights to it, to this drug that, again, could be a lot bigger. They've certainly indicated that they're interested in companies kind of like AveXis. How did Novartis beat them to the punch?

Jones: That is the question of the ages, Michael. That is the reason why a lot of Biogen investors are probably scratching their heads right now. Of course, we can't see right now if this was some sort of a bidding war. If so, I really hope that Biogen was at the table for that conversation. If not, then I'm really disappointed that Biogen didn't at least try. 

To your point, not only did this make sense from their own pipeline perspective, they are strategically refocusing themselves on neuroscience assets, they already have a preclinical gene therapy in play, so this would have made total sense for Biogen. The CEO has mentioned wanting to do more deals, and we really haven't seen that. There's been a couple of deals here and there, but we really haven't seen that yet. So, if it does come out that Biogen didn't even come to the table, if I was a Biogen investor, I would be really concerned.

Douglass: Yeah, I think that's very fair. And frankly, you look at Biogen, and they're incredibly concentrated. You look at their current revenue, it's basically multiple sclerosis. There's a little bit more, but that's pretty much it. You look at their pipeline, late-stage, we're looking at primarily Alzheimer's, which, companies unfortunately have an atrocious record at successfully bringing an Alzheimer's drug to market. It basically doesn't happen. Or at least, it hasn't happened historically, I suppose. So, it feels like there's a lot of concentrated risk there for a company that's that big. This could have been a great opportunity for them to diversify.

Of course, one of the things that Biogen's management said -- and I want to be clear here, they're not unique in this, pretty much everybody says this -- is that they want to buy things that will be accretive, but of course, they only want to buy at the right price. I'm not aware of any company that says, "We'll buy things at any price." But, it bears thinking here, did Biogen step away because they thought that the premium got too high?

So, the final question for us, then, is, did Novartis overpay? $9.8 billion, not cheap.

Jones: Yeah, not cheap at all. When we're looking just at AVX-101, right now, analysts are pegging peak sales in about the $2.4 billion range. So, we're looking at about 3.5-4X sales right now. Which is not terrible. This is certainly within its range. But, I think with an 88% premium for a company that has no approved drugs, gene therapy is still pretty novel and unproven for the most part, I think time will tell. I don't want to automatically say they've overpaid. I know AVX-101 will be filed later this year, so we'll get the data, hopefully, right before that. We'll have to see if they overpaid. I don't know.

Douglass: Yeah. And of course, no one can know. To be honest, I'm of the opinion that Novartis paid a pretty good price because it's getting that platform. That's the thing, if you're able to get that 3-5X just with the lead candidate, everything else is gravy, I start getting pretty interested. And as you pointed out earlier, Novartis is making some smart moves. Increasingly, my view on companies is that those that allocate capital most efficiently and most effectively tend to really be your big winners. And, well, basically, this means that Novartis is going to have to get a second look from me, after I had largely written off big pharma, as I think you have. So, that'll be certainly a long conversation for us to have in the future.

Jones: Absolutely. And of course, just to underscore the fact -- this is assuming the drug works, right?

Douglass: [laughs] Right.

Jones: Really, I think the theme of this entire Industry Focus has been, be very careful with Phase II, because Phase III can come up and blow things away. But, I do think it presents some really compelling investment opportunities long-term.

Douglass: Absolutely. Shannon, thanks for joining us!

Jones: Thank you!

Douglass: Folks, that's it for this week's Healthcare show. Questions, comments, you can always reach us at industryfocus@fool.com. As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so, don't buy or sell stocks based solely on what you hear. This show is produced by Austin Morgan. For Shannon Jones, I'm Michael Douglass. Thanks for listening and Fool on!

Michael Douglass owns shares of Gilead Sciences. Shannon Jones owns shares of Spark Therapeutics. The Motley Fool owns shares of and recommends Gilead Sciences. The Motley Fool has the following options: short May 2018 $85 calls on Gilead Sciences. The Motley Fool recommends Biogen. The Motley Fool has a disclosure policy.