Expert Financial Analysis and Reporting

Key Investment Conclusions

• I believe that Juno will cease development of JCAR-015 and turn to JCAR-017 as its lead CAR-T product.
• I estimate that this will result in Juno dropping two years behind Kite and Novartis in the race to commercialize CAR-T therapy for the crucial r/r DLBCL market. I believe that this late entry will result in minimal sales of JCAR-017.
• I would be a seller of Juno.
• While Kite would seem to be a beneficiary from Juno’s problems, I would avoid the stock at this time.
• The critical stock market issue for Kite is if the complete response rate in r/r DLBCL patients in the ZUMA-1 trial remains at 33% as was seen at three months. This is the expectation of management and bullish analysts and is built into the stock price.
• If CR at six months drops to perhaps 25% or lower as is possible, it would be a major negative surprise and could cause a sharp decline in the Kite stock price.
• Kite says that it will release six month CR data from ZUMA-1 in 1Q, 2017. This will be very important event for the stock.

Introduction to Report

I have written extensively on CAR-T cell technology and the two emerging biotechnology companies, Kite and Juno that along with Novartis are the recognized leaders in CAR-T product development efforts. The immediate reason for this report is to comment on two more deaths that occurred in Juno’s ROCKET trial that led to Juno on its own accord placing a second clinical hold on the trial; this comes just five months after the FDA put a first clinical hold on the trial. ROCKET was investigating the use on Juno’s lead product JCAR-015 in r/r adult ALL. The first clinical hold was due to the occurrence of three deaths out of perhaps 25 patients treated (Juno hasn’t disclosed how many patients were treated) and the second hold was based on two deaths occurring in twelve new patients who were treated after the first clinical hold was lifted in July. The mortality rate in ROCKET could be around 14% (five of 37 treated).

In this report, I review and update my current investment thinking on Juno and Kite and CAR-T technology as a whole. If you would like more background on CAR-T therapy or my past research on Kite and Juno, I suggest you review reports I have written on Kite and reports I have written on Juno. This report extensively uses acronyms and may be difficult to follow if you haven’t done a lot of work in this area. If this is the case, I would refer you to a recent report Kite Pharma: Part 1- Glossary of Terms and Acronyms

Investment Position on CAR-T Technology

• The deaths in the ROCKET trial drive home that CAR-T cells, the first generation of the engineered autologous T-cells technology (e-ACT) cause severe, life threatening side effects that will greatly limit their use.
• CAR-T products in current development from Novartis, Kite and Juno only address certain hematological cancers that express CD-19, notably ALL, DLBCL, MCL and CLL. These types of cancers account for perhaps 6% to 8% of all cancer incidence.
• The CAR-T cell products of each company have produced dramatic results in some patients with relapsed/ refractory cancers who have exhausted other therapeutic options, but at the cost of dangerous side effects. Partly because of the side effect profile, I think use of the lead CAR-T cell products of Kite, Juno and Novartis will be limited to some small fraction of relapsed/ refractory, CD-19 expressing cancers. I view this as a modest commercial opportunity.
• CAR-T therapy will be extraordinarily expensive. Kite has hinted that its KTE-C19 cells will be priced at $300,000 to $400,000 per patient, but this is only part of the cost. The chemotherapy pre-conditioning program that is necessary prior to cell infusion also will be expensive.
• Managing side effects will further add to the cost. The combined incidence of serious grade 3 and 4 side effects could be on the order of 30% to 40% for the chemotherapy pre-conditioning and cell infusion. Because of this side effect risk, all patients in the current clinical trials are hospitalized so that side effects can be treated quickly as they occur or perhaps prevented.
• I am guessing that the chemotherapy preconditioning regimen, cost of hospitalization and cost of managing side effects could add $200,000 to $300,000 per average patient. If so, the all-in cost for treating one patient with CAR-T cells could be on the order of $500,000 to $700,000 and possibly more.
• The critical issue of benefit from this therapy is what will be the duration of response. If it is only a few months, the side effect profile and reimbursement burden could be prohibitive. There is no clear data on duration of response for the CAR-T products at this early stage. Hence I am focusing on complete responses (CRs) as a surrogate indicator for meaningful duration of response.
• Not all patients benefit from CAR-T therapy. In the interim look at the ZUMA-1 trial, Kite’s KTE-C19 product led to a CR in one-third of r/r DLBCL patients three months after cell infusion. It will be critical to the potential of KTE-C19 that these CRs are maintained at six months, nine months or longer and we are awaiting this data.
• If the three month CR is sustained, it means that three patients might have to be treated so that one would benefit resulting in a cost to the health care system of $1.2 to $2.1 million in this example.
• Kite and Juno dismiss reimbursement issues stating that breakthrough products always find a way to gain reimbursement. Perhaps this is so, but from my humble viewpoint, the reimbursement issues loom large.
• Some analysts are very excited about the developing e-ACT pipeline such as (1) CAR-T cells against BCMA in multiple myeloma, (2) next generation CAR-T cells that may improve efficacy and reduce side effects and (3) the TCR technology that could allow engineered autologous T-cells to address solid tumors, With the exception of the anti-BCMA, CAR-T cells, most of these products are still in pre-clinical stage.
• Engineered autologous T-cell therapy has great promise, but it may take decades for this technology to be refined and capable of producing effective and safe mainstream drugs that can be widely used. It is instructive to look at the time that it took to develop monoclonal antibodies which are the currently the driving force behind biopharma drug development.
• The first attempts to develop monoclonal antibodies as drugs took place in the early 1980s. However, the first major drug (Rituxan) stemming from this technology was introduced in 1997. It has taken another two decades to refine the monoclonal antibody technology as the powerful technology it is today. Maybe it won’t take four decades for engineered autologous T-cells to become mainstream drugs like monoclonal antibodies, but it will take some years, a decade or perhaps more.

Key Investment Points on Juno

• I believe that as a direct result of the deaths that have led to the second clinical hold in the ROCKET trial that Juno will cease development of JCAR-015, its lead product, and turn its focus to JCAR-017 which Juno states that based on early phase 1 trials, could be a much better product.
• Juno probably cannot hope to gain approval for JACR-017 until 2020, roughly two years behind Novartis’ CTL-019 and Kite’s KTE-C19.
• Falling so far behind in reaching the market will likely be a commercial disaster for Juno as JCAR-017 is likely to have very limited sales potential as the third product in a modest sized market.
• Beyond JCAR-017, Juno’s e-ACT pipeline is in the pre-clinical stage and any potential new products are years away from approval or even meaningful clinical data.
• Importantly for Juno, investors have showered the Company with cash. It has $820 million of cash and at the current burn rate of $160 million can sustain itself for five years.
• With a $2.1 billion market capitalization, Juno seems dramatically overvalued when viewed (as I do) as having limited commercial potential for its lead drug and a pipeline that is largely pre-clinical. The only thing standing between an immediate price collapse is its extremely strong cash position and the support of some fervent Wall Street analysts who see the world very differently from me.
• I would be a seller of the stock. I could see the market capitalization declining to $500 million to $1.0 billion over the next two years. This translates into a share price of $5 to $10 versus the current $20 or so.
• The only event that I can think of that might enable Juno to retain a good part of its current $2.1 billion market capitalization would be the development of an exciting new drug based on e-ACT technology. However, its pipeline consists of pre-clinical products and there is no way to judge their potential and indeed meaningful clinical data is two or more years away. It seems to me that current bulls are betting on a Hail Mary.

Investment Position on Kite

• Juno’s misfortune is a positive for Kite in that the CAR-T space is now a two horse race between Kite’s KTE-C19 and Novartis’ CTL-019 to be first to market. Both companies are expected to file for approval in r/r DLBCL in 2017 and Novartis will also file in r/r pediatric ALL in 2017.
• My guess is that if the data for these two products is positive that the FDA will approve both drugs at about the same time.
• DLBCL is the big initial opportunity for KTE-C19 and CTL-019. Chemotherapy is curative in about 60% of DLBCL patients with the result that there are about 6,000 patients who fail and eventually could be eligible for CAR-T therapy. At a price of $300,000 per patient this results in an estimated addressable market of $1.8 billion.
• In the case of Kite only one-third of r/r DLBCL patients have experienced a complete response at three months as of the recent interim look in the ZUMA-1 trial. This means that three patients have to be treated to achieve one positive outcome raising the cost per effective therapy to $1.2 to $2.1 million to the healthcare system.
• Kite management dismisses the dangerous side effect profile and reimbursement issues as manageable. I am more skeptical. I think both will limit the penetration of the market. Also, Novartis is a formidable competitor in the cancer space and if KTE-C19 and CTL-019 come to market at the same time, Novartis should gain more market share.
• I can only make a wild guess that the sales potential of KTE-C19 after five years on the market in the US is $150 to $250 million. The potential in Europe might be comparable. Like Juno, the product pipeline of Kite is in pre-clinical development. With this type of outlook, Kite seems fully valued at a $2.5 billion market capitalization. Note that my sales guesstimates are low as I think that bulls on the stock are looking for US sales after five years on the market of $700 million and European sales also of $700 million.
• There is one investment issue that causes me concern and which isn’t factored into the KITE stock price and if it breaks badly could cause a sharp drop in the stock. In the phase 2, ZUMA-1 trial that Kite will use to file for approval of KTE-C19, there are two cohorts to the trial, one for r/r DLBCL and the other for tFL and PMBCL patients.
• The number of patients with tFL and PMBCL is very small relative to DLBCL, which is the key commercial opportunity. Importantly, the CR rate for tFL and PMBCL is much better that for DLBCL. For these reasons, I believe that the FDA will consider each arm separately and not lump trial results together.
• In the interim look at the ZUMA-1 trial, the CR rate at three months was 33% in DLBCL (it was 39% if PMBCL and tFL results are lumped in) and I believe that Kite was looking at 40% as a minimum CR rate in DLBCL although they never stated this publicly.
• Kite management and bulls maintain that the three month complete response rate of 33% will be maintained at six, nine and perhaps more months. I am not as sure. Response rates for almost all cancer drugs decline over time; why would CAR-T be different?
• I think that it is critical that the CR rate not drop much below 33%. At meaningfully lower rates (perhaps less than 25%), it becomes very hard to justify use with the dangerous side effect profile and the very high cost of therapy.
• Kite has said that it will release six month complete response rates from ZUMA-1 in 1Q, 2017. If the CR rate drops to 25% or lower, it would be a real blow to the stock. It is for that reason that I am avoiding the stock at this time.

Thoughts on CAR-T Technology

For some time I have been at odds with the vast majority of mainstream Wall Street analysts on the commercial potential for CAR-T drugs and the investment outlook for the three leading companies in the space- Juno, Kite and Novartis. In my view, using CAR-T drugs is like weeding your garden with a nuclear weapon. You can certainly eliminate the weeds (cancer cells) but at considerable cost to the plants (normal cells) you are trying to nurture. CAR-T has produced dramatic results that are close to cures for some patients who have exhausted all other therapeutic options. However there is a very heavy side effect penalty to be paid from the chemotherapy pre-conditioning program used before cell infusion and then the cells themselves. The deaths in the ROCKET trial vividly illustrate the risk as perhaps 5 of 37 patients treated (14%) have died. Juno has not disclosed the side effects incurred by other patients, but based on earlier trials at NCI and academic centers, I would guess that 30% to 50% have incurred serious grade 3 and 4 toxicities.

In my view, Kite, Juno and many Wall Street analysts who are staunch supporters of CAR-T have over-stressed the anti-cancer effect while skipping lightly over the side effects. The benefit/ risk question to be answered is in what types of cancer does the potential for a cure justify the risk of dangerous side effects or death.

The first generation of CAR-T drugs address certain types of hematological cancers. Altogether, hematological cancers account for less than 10% of all cancer diagnoses and CAR-T drugs are only applicable to a very small subset of such patients who are refractory to or have relapsed after other types of cancer therapy.

Second Clinical Hold for ROCKET Trial is a Disaster for Juno

Juno announced a second clinical hold of the ROCKET trial of its CAR-T product JCAR-015 on November 23, 2016. You may recall that the first clinical hold was announced after two patient deaths on July 7, 2016. The hold was quickly lifted on July 12, 2016. Since then twelve new patients were treated. Alarmingly, the last two treated died suddenly of cerebral edema. Juno concluded that the deaths that led to the first clinical hold were due to the pre-conditioning chemotherapy regimen and addressed the problem by eliminating the chemotherapy drug fludaribine. The two new deaths clearly show that the infusion of CAR-T cells also play a major role in the deaths.

I think that it is clear at this point in time that Juno can only speculate and does not really understand the reasons for the deaths. Management now hypothesizes that in the treatment of r/r adult ALL, the CAR-T cells kill tumor cells much more rapidly than in other cancers such as r/r pediatric ALL and r/r DLBCL. This could cause a greater release of cytokines directed at the tumor which also attack normal cells. They attribute this to the unique nature of r/r adult ALL in which there are .proportionally more cancer cells floating freely in the blood relative to cancer cells lumped in a solid mass as in DLBCL. Juno in its conference call focused on this as being the primary cause of the cerebral edema.

In addition to the type of tumor addressed, questions arise as to whether co-stimulatory domains that are part of the CAR-T construct used to bolster differentiation of CAR-T cells play a role. JCAR-015 (and Kite’s KTE-C19) uses a CD28 costimulatory domain that leads to more rapid cell expansion than the current alternative 4-1BB costimulatory domain. The cell manufacturing process itself might also play a role. It may be (is likely) the case that the intricate interplay between all of these factors as well as the chemotherapy pre-conditioning lead to the deaths. At this point in time, it is clear that Juno does not understand the cause of or how to address this cerebral edema.

The second clinical hold for the ROCKET trial is a significant investment event for both Juno and Kite that brings into sharp focus the enormous risk associated with the therapy. This is a setback for CAR-T therapy as a whole, but for Juno, this is a disaster. Novartis and Kite will likely be approved in 2017 or 2018 and will have first mover advantage. I think that Juno in coming to market now lags these companies by two years. For reasons explained in more detail later in this report, I think that the commercial potential with Juno’s CAR-T drugs will be minimal. e-ACT technologies beyond CAR-T are largely at the conceptual stage. I think it is very hard to come up with a scenario that justifies the $3 billion market value of Juno. The one saving grace for Juno is that it is well capitalized as it has $820 million of cash and an annual burn rate of $160 million. My concern is that the return on this cash could be negligible.

Juno Falls Far Behind in Race to Commercialize CAR-T; Will Likely Abandon JCAR-015

Juno had a strategy of developing JCAR-015 in r/r adult ALL as a fast path to regulatory approval. This would be followed by JCAR-017, which they maintain is a safer and more effective product. I think that it would take a long and sustained effort (possibly years) to try to determine the factors that caused the cerebral edema and even then there might be great uncertainty. Because of this, I predict that Juno will drop clinical development of JCAR-015 and focus all efforts on JCAR-017.

This is a disaster for Juno in the CAR-T development race against very similar products from Kite and Novartis. Each of these products has a similar mechanism of action by targeting the CD-19 antigen on certain hematological tumors. To this point in time, there is very little data on each of these products, but the data that we do have from phase 1/2 trials doesn’t really show meaningful differentiation. If it is true that there is little differentiation, being first to market is critical.

Novartis will likely gain approval for r/r pediatric ALL in 2017 and it appears that Kite and Novartis are on the same time line to gain approval in r/r DLBCL in late 2017 or early 2018. If now appears that Juno will switch its lead product to JCAR-017 for the treatment of r/r DLBCL. This product is currently in phase 1 and a potentially registrational phase 2 trial could begin in 1H, 2017. Based on the experience of Kite and Novartis, topline data from this trial might take two years to create suggesting completion in 1H, 2019. This could lead to approval in 1H, 2020. It appears that JCAR-017 is two years or more behind Novartis and Kite in gaining approval.

Being first to the market will be even more critical for the CAR-T products than for conventional drugs because of their complex treatment regimen. Patients are started with a chemotherapy pre-conditioning program and then hospitalized to administer the CAR-T cells and to manage serious, sometimes life threatening side effects arising from both the chemotherapy and the cell infusion. Novartis has suggested that it will market its CAR-T product like a medical device. In medical technology, salesmen work alongside physicians to aid them in the placement of the device so that there is much more of a cooperative relationship rather than the salesman to doctor relationship used to market drugs.

The conclusion that I draw is that firms that are first to market will be able to build very strong technology and reimbursement relationships that create enormous barriers to entry. It will be extremely difficult for Juno to build a marketing niche unless JCAR-017 is dramatically superior to Novartis’s CTL-019 and Kite’s KTE-C19. Based on very early data in handfuls of patients, Juno maintains JCAR-017 is superior in both efficacy and side effects. Show me, I am from Missouri.

Commercial Overview for CAR-T Drugs

I have a very different view of CAR-T therapy from most mainstream Wall Street analysts. Some of the best known and respected analysts view this as a major breakthrough that is potentially curative of certain cancers that respond to no other therapies. I recognize that there have been some impressive responses in relapsed and refractory cancers, but this comes at the expense of horrendous side effects.

I see the role of the current products in development as limited to the relapsed/ refractory setting in certain hematological cancers which account for less than 10% of cancers and probably having perhaps no role in solid tumors. Most of the clinical work so far has been in r/r adult and pediatric ALL and r/r DLBCL. The ALL opportunities are relatively small; the largest near term opportunity is in r/r DLBCL where Kite and Novartis appear to be in line to be first to market. Juno is now trailing by over two years. Both Juno and Kite make arguments that their products are best in class, but this is based on highly subjective and self-serving arguments. There are unlikely to be comparative trials for many years if ever, and I am working under the assumption that the three products are pretty much the same. I thought that Juno was in a poor position after the first clinical hold. I now see their position as disastrous.