Expert Financial Analysis and Reporting

Investment Thesis

Cytokinetics looks to me to be seriously undervalued when I contrast its market value (stock price multiplied by shares outstanding) of $430 million to that of other early stage biotechnology companies. In this note I look at key investment attributes of CYTK in comparison to those of a number of other biotechnology companies and then contrast market values. Based on this relative value analysis, I suggest that an appropriate valuation would be on the order of $1 billion (possibly much more) or $20+ per share.

Cytokinetics Has Pioneered and Dominates a Promising New Technology Platform

CYTK has pioneered a new technology based on increasing the contractility of both skeletal and cardiac muscle and this sets CYTK aside from most biotechnology companies. So much of drug development is directed at evolutionary research in which companies are trying to improve upon technology developed by others. I would cite engineered autologous T-cell therapy and checkpoint modulation as recent examples. I don’t mean to imply that there is something wrong with this as such competition can lead to significant improvements in the technology. The point is that companies like CYTK that dominate a unique technology base are rare.

The Company came public in 2004 and has had its ups and downs over the interim as it honed its product development. Now it has two drugs in phase 3 development and one in phase 2. These drugs bring a unique approach to address unmet medical needs in a broad range of diseases. Omecamtiv mecarbil brings a new approach to treating heart failure that could result in its becoming part of standard of care; it is about to begin a phase 3 trial. Tirasemtiv has just completed enrollment in a phase 3 trial in ALS with topline results scheduled for 4Q, 2017. CK-107 is in phase 2 trials in spinal muscular atrophy (SMA) and chronic obstructive pulmonary disease that will report out data in 2017. Two additional trials phase 2 trials of CK-107 will begin in 2017.In my opinion, each of these three drugs, if successful in clinical trials, are multi-billion sales opportunities.

Omecamtiv Mecarbil

Investors like to look at partnering deals to provide validation and to help assess the potential for a developmental drug in clinical trials. Omecamtiv mecarbil is partnered with Amgen and Servier. Very impressively, the head of research at Amgen, Dr. Sean Harper said this about omecamtiv. He said Amgen has shown the phase 2 data to heart failure experts from all around the world. Dr. Harper said it has been quite unique in his experience to see such a uniformly enthusiastic response to the phase 2 data. In one way or another each expert has essentially said that they see this as the most compelling heart failure data set of all the drugs they have ever seen.” See my note Amgen’s R&D Chief Expresses Great Optimism About Omecamtiv Mecarbil for Treating Congestive Heart Failure."

The GALACTIC-HF phase 3 trial will enroll about 8000 heart failure patients. This will be the one of the most extensive trials ever done in heart failure. The PARADIGN-HF trial of Entresto is the only heart failure trial of comparable size. This trial will likely cost over $500 million dollars and overwhelmingly attests to the promise that Amgen and Servier see in the drug. Cytokinetics has the option to let Amgen and Servier completely fund the trial and receive double digit royalties and huge milestone payments. It also has the option to apply part of the scheduled milestone payments to improve its economics in the drug to the extent that it might receive 50% of US profits. In either case CYTK does not have to raise huge amounts (if any) of capital to fund the trial. CYTK has stated that it expects to co-fund and its goal is to secure non-dilutive capital through a royalty monetization deal.

The really exciting thing about omecamtiv mecarbil is that it could potentially be added to all existing treatments. It has a distinct mechanism of action and should produce an additive effect to the currently used standard of care therapies. It does not produce the effects relating to blood pressure, renal function and potassium levels that current drugs do; consequently it should not worsen the side effect profile. All of this suggests the potential for omecamtiv to become a component of first line treatment for the vast majority of heart failure patients. Rehospitilization for recurrence of heart failure is an enormous unmet medical need. If phase 2 results are replicated in phase 3, I think omecamtiv mecarbil could reach worldwide sales of $10 billion or more. Topline results are probable in 2021.

Tirasemtiv

Cytokinetics completed the BENEFIT-ALS phase 2b trial of tirasemtiv in ALS that enrolled 711 patients making it the largest trial ever conducted in ALS. The trial failed to reach its primary endpoint based on improvement in the ALSFRS-r scale. The FDA has required that ALSFRS-r be the primary endpoint in ALS trials. However, no drug has ever been successful in achieving this endpoint. This could be because ALS is such a tough disease to treat, but it might also be because the endpoint is inappropriate in the timespan in which clinical trials are conducted.

In BENEFIT-ALS, tirasemtiv did show a statistically significant improvement in slow vital capacity (SVC) which was a secondary endpoint in the trial. SVC is probably the most widely used measure of respiratory function in ALS patients. ALS patients track SVC like diabetics track insulin levels as most ALS patients ultimately die of respiratory failure. Cytokinetics after carefully reviewing SVC and other results of BENEFIT-ALS with key opinion leaders and regulatory agencies decided to conduct a new phase 3 trial in ALS called VITALITY-ALS, which uses SVC as the primary endpoint.  There is strong reason to hope that the SVC endpoint will be reached and lead to approval See my report “Phase 3 Trial for Tirasemtiv About to Begin with Topline Results Possible in 2H, 2016; Successful Outcome Could Make the Stock a Homerun” .

VITALITY-ALS has completed enrollment and topline results are expected in late 2017. In previous reports, I have estimated that if this trial is successful that tirasemtiv has $1 billion or more of sales potential in the US and the same abroad. Cytokinetics has retained all rights to tirasemtiv in the US, Canada and Europe and has licensed rights in some other markets to Astellas. It is rare that a small biotechnology company can retain so much (almost all) economic rights in a potential blockbuster product.

CK-107

This is an improved version of tirasemtiv which addresses a key negative aspect of tirasemtiv. CK-107 does not cross the blood brain barrier as does tirasemtiv and therefore averts dizziness and other CNS effects that make tirasemtiv difficult to tolerate for some patients. High dropout rates in BENEFIT-ALS from this side effect may have played a significant role in its failure to meet the primary endpoint. CK-107 is partnered with Astellas and phase 2 trials are underway in the orphan disease spinal muscular atrophy (SMA) and hugely prevalent chronic obstructive pulmonary disease (COPD). As mentioned earlier, two other phase 2 trials will start in 2017. CK-107 does not address the direct cause of these diseases, but by increasing muscle contractility, it can improve muscle function and breathing. This would improve quality of life and potentially lengthen survival. It would be combined with other drugs in treatment of these diseases.

CK-107 is partnered with Astellas which is providing extensive funding. This relationship was recently expanded significantly. See my report Collaboration with Astellas is Expanded and Will Bring in $65 Million of Cash  The collaboration with Astellas brings both validation and deep pockets to help fund potential phase 3 trials in SMA and COPD as well as to pursue new disease states. Astellas and Cytokinetics are also planning a phase 2 trial of CK-107 in ALS. This makes sense because the CNS effects on tirasemtiv are a drawback and CK-107 might represent a significant improvement over tirasemtiv.

What Should the Market Capitalization of Cytokinetics Be?

Early stage biotechnology stocks are exceedingly hard to value in any absolute sense. Their market valuations are generally based on clinical trials which may take years to complete. Moreover, the results of clinical trials are very difficult to predict even for the largest of pharmaceutical companies. I would cite the recent failure of Bristol-Myers Squibb’s checkpoint inhibitor Opdivo in first line lung cancer as a painful example. In addition, successful trial outcomes do not guarantee commercial success especially with reimbursement hurdles that managed care puts in place.

The common valuation approach of Wall Street analysts is to bravely predict the timing and outcome of clinical trials and the sales and earnings that result. They then use a discounted cash flow model of future earnings to come up with a net present value that allows the calculation of a price target. While this gives the appearance of a sophisticated approach, it is virtually worthless because of the huge number of variables and resultant subjective judgments (outright guesses) that must be made. I think that most seasoned investors take these price targets with more than a grain of salt. In the end, I believe that investors look at the uniqueness of the technology, the products under development, unmet medical need and make a subjective judgment.  This is very much an art and not a mathematical exercise.

Because of the inexactness of the valuation exercise, investors usually place great emphasis on relative valuations. This can present problems because no two biotechnology companies are alike. Also, valuations can be swayed by unrealistic expectations that cause huge distortions in stock prices (remember Valeant). Expectations are usually set by Wall Street firms (especially their analysts) but they are compromised because they often reap huge benefits from successful public offerings. For example, Kite has raised nearly $1 billion of capital in the last two years which has resulted in a financial return to investment banks of perhaps $50 to $75 million. It is virtually impossible for an analyst employed by an investment bank underwriting a company to be negative. Indeed, all of the incentives are for an analyst to be overly optimistic. This can create a treacherous loop in which analysts inflate expectations and the companies capitalize on this by raising huge amounts of capital. This is good for the companies and investment banks, but not so much for investors.

Valuations of Comparable Companies

I want to emphasize that there are no two biotechnology companies that are exactly comparable and most vary widely in their fundamentals from one another. That said and understood, I am going to list the market capitalizations of some companies that share fundamental characteristics with CYTK. Anyone who wanted to could easily argue the point that numerous aspects of the following companies that are not comparable and I would agree. Still, I think there is value in looking at them. The following is a group of companies whose valuations I would like you to consider.

bluebird Bio (BLUE) is a leader in the field of gene therapy. While this is a technology that is likely to be one of the next great product development areas in biotechnology, it will probably take many years (decades) to refine because the technology actually alters the human genome. It will take many years to become comfortable with both the safety and efficacy profile of gene therapy products. Detractors might characterize this as still a science project. Optimists see a first product approval in 2020, but it is likely to be longer. I use BLUE as an example of a Company valued on its relatively unique and highly promising platform technology. Importantly, I think the CYTK platform has much more potential over the next decade. Market capitalization of BLUE is $1.5 billion. CYTK’s market valuation is $420 million.

Alnylam (ALNY) is the undisputed leader in RNAi therapeutics, another very exciting development area for biotechnology. It has a broad pipeline of drugs in development and has an extensive partnership with Genzyme (now owned by Sanofi) to develop orphan drugs. Its lead drug fitursan is an anti-thrombin inhibitor that is scheduled to enter phase 3 in early 2017. Its other lead drugs are at phase 2 or earlier stages. Again, I think the CYTK platform has much more potential over the next decade. Market capitalization of ALNY is $2.7 billion.

Kite Pharma (KITE) is one of three leading companies in CAR-T development along with Novartis and Juno. Again I see engineered autologous T-cells of which CAR-T is the first generation as being a hugely promising technology. I have written extensively about Kite and my feeling that it is overvalued. See Highlights of October 18, 2016 Analysts' Day- I Remain More Cautious on the Stock than Mainstream Wall Street Analysts  An important issue with Kite is that it and Novartis and Juno are all initially targeting the same hematological cancers. It does not have a dominant position like CYTK. Again I favor CYTK. Market capitalization of KITE is $1.9 billion.

Juno Therapeutics is trailing Kite in its clinical trial timelines because of the setback caused by the brief clinical hold in ROCKET. I favor Kite over Juno and obviously CYTK over JUNO. Market capitalization of $2.4 billion.

Galapagos (GLPG.AS) has taken a broad and deep pipeline into clinical development. The lead candidate filgotinib is a JAK1 inhibitor in development for rheumatoid arthritis and inflammatory bowel disease; it is partnered with Gilead. InCyte has pioneered the JAK-1 technology as its product Jakafi is projected to have sales of $850 million in 2016. Filgotinib produced impressive results in four phase 2 trials in rheumatoid arthritis and one in Crohn's. It will enter a phase 3 rheumatoid arthritis in 3Q, 2016. Phase 3 trials in Chrohn’s disease and ulcerative colitis are scheduled for 4Q, 2016. There is one JAK-1 inhibitor approved and several others in development. Omecamtiv is on the same clinical timeline development, but has greater commercial potential. Market capitalization of GLPG.AS is $2.4 billion.

Ariad (ARIA) has gained approval and is marketing an oncology drug Iclusig which targets certain mutations of chronic myeloid leukemia. Its pipeline is centered on oncology. Side effect issues have hindered its uptake and Iclusig is growing primarily through price increases; it should have sales of about $120 million in 2016. Iclusig is not a great product and the Ariad pipeline is less than stellar. I use this as an example of how the market values of companies with commercialized products. Please note that I expect omecamtiv and tirasemtiv, if successfully developed, to register billions of sales. Market capitalization of ARIA $1.7 billion. Imagine the market capitalization of CYTK if either omecamtiv mecarbil, tirasemtiv or CK-107 achieve $1 billion of sales. And hold your breath, what if all three were to reach this degree of success.

Seattle Genetics (SGEN) has a technology platform based on antibody drug conjugates which it uses to develop drugs internally and which it also licenses to other companies. It has one marketed product, Adcetris that is approved for Hodgkin’s lymphoma. Adcetris sales are projected at $270 million in 2017 and aided substantially by price hikes, it is growing at 20% per annum. This is another example of the value placed on a company with an approved product. Market capitalization of SGEN is $8.0 billion.

Key Conclusion

In the above comparisons, there are five development stage companies that I think provide the best comparisons to Cytokinetics-bluebird.bio, Alnylam, Kite, Juno and Galapagos. I would rather own Cytokinetics than any of these companies if they were valued at equal market capitalizations and yet those five are valued at 5 to 7 times the market capitalization of CYTK. In my subjective judgment, something is out of whack on relative valuation. If these valuations are reasonable, I think that it is very easy to argue that CYTK should be valued at $1 billion or more as compared to the current $430 million. This would result in a doubling of stock price.