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Expert Financial Analysis and Reporting

Northwest Biotherapeutics: My Rationale for Having a Buy Recommendation (NWBO; $3.29)

Crossing Swords

Adam Feuerstein of The and I crossed swords after I wrote an article in response to a very negative and stridently worded blog that he posted on Northwest Biotherapeutics (NWBO). I disagreed with his analysis (a one or two page blog) that accused the company of purposely deceiving investors and felt that it should not go unchallenged. I wrote a response that was published on Seeking and my website. Mr. Feurstein promptly responded with another blog called Why Seeking Alpha's Larry Smith Is Wrong Again About Northwest Bio.

This second blog did not contain any substantive new information on NWBO from the initial blog. Unfortunately, it primarily consisted of personal attacks on me, the most serious being that I was a stock promoter and ridiculed my objectivity and the quality of my research. I could try to respond tit for tat and throw some barbs back, but I don't see much value in doing that.

Instead, I would urge investors to read the Seeking Alpha article Northwest Biotherapeutics: A Critique of a Negative Blog on the Company by Adam Feuerstein of The " which started the little tete a tete between us.

You can make your own determination on our approaches to analysis, the amount of due diligence that we do, the balance and fairness of our arguments and the civility with which we present our cases. More importantly, at the end of that report there are 81 comments on the article (some quite sophisticated) that is a referendum on how other people view Mr. Feuerstein and myself; these comments are a must read. Let me give you a preview; Mr. Feuerstein did not come out as well in the opinions of others as he does in his own mind.

For those of you looking for a massive mudslinging contest in this report, you are going to be disappointed from my end. I think what is much more important for readers is to understand where Mr. Feuerstein and I agree and where we diverge. This can add great value to the debate. In this report, I trace again the thought process as I went from initial caution on NWBO to going to a buy. I must add that my conviction in the reasons for my recommendation have increased from this unfortunate and somewhat ugly exchange.


I Must Respond to Mr. Feuerstein's Charge That I Am a Stock Promoter

However, first I must respond to the allegation of Mr. Feuerstein that I am a stock promoter. He laid out this charge in the first paragraph of his response and this appears to a major reason for his opinion that I am wrong. This very serious and regrettable charge was based on my writing in-depth articles on the company and also owning the stock. Let me first say that at the time I wrote the initial buy recommendation on NWBO, I did not own the stock. I have a policy that I will not act on a new buy recommendation for 72 hours following the publication of the report. Following this period, I did invest in NWBO and this was clearly disclosed in my subsequent reports. I view this as putting my money where my mouth is.

Mr. Feuerstein cited as evidence of my stock promotion attempts that I have written six promotional pieces on the company in the last ten months. This is not correct. I wrote two articles on NWBO in 2012 (July and September), and I wrote one article on NWBO in January of this year. I did write another report in April of 2012 that was an article on dendritic cell cancer vaccines which is the core technology of Dendreon (DNDN), ImmunoCellular Therapeutics (IMUC) and Northwest Biotherapeutics (NWBO). I explained why I thought this technology could lead to a dramatic improvement in the treatment of cancer patients.

I have also written a response to Mr. Feuerstein's first blog charging NWBO with deceiving investors and this response to the second blog that directly attacked me. Neither of these reports was planned and would not have been published without the actions of Mr. Feuerstein. Ask yourself if you would have written responses or just sat idly by. He may choose to portray these as further promotion, but I saw no choice, but to respond.

In the report on dendritic cell cancer vaccine technology report written in April 2012, I initially rated NWBO as "neutral," and only progressed to a "buy" recommendation after lengthy further due diligence over months. In every one of my reports on NWBO, I have advised readers that an investment in NWBO could result in high returns but also carried the risk of substantial loss or conceivably total loss of their investment. I have carefully explained the reasons for my own belief that there is reasonable evidence to judge that the trial can be successful, but there can be no guarantee. This course of analyses and recommendations is clearly not the unbridled stock promotion that Mr. Feuerstein claims.

After further and extensive due diligence I decided to recommend buying the stock for investors who understood my reasoning for investing and were aware that they faced a downside risk of losing most of their investment. I emphasized that this had to be weighed against the potential for impressive upside. I will explain my asymmetric investment strategy that underlies my investment approach later in this report, but suffice to say my recommendations do not promise successful returns.

The initial report recommending purchase was published on July 19, 2012 and was followed by a report on September 28, 2012 and a third on January 14, 2013, with the September and January reports addressing major developments in NWBO since the time of my original report in July. This is normal analyst coverage.
On February 19, 2013, I also published my critique of Mr. Feuerstein's blog. The articles and the critiques can all be seen on my website or on my Seeking Alpha profile page; the reports were published on both sites. I would also point out that I have written articles on 41 other companies since I began publishing two years ago. I am not fixated on NWBO.

I would now like to put my expertise in evaluating NWBO in perspective and for this, you need to know a little bit about me. I am the son of an Indiana coal miner who came to Wall Street out of chance and desperation. I was attending Columbia Business School, but had to temporarily drop out because I ran out of money. I was fortunate to get an internship on Wall Street at the last minute and by the time I drew my first paycheck, I was down to $1.37 all of which was in pennies.

I earned enough money to return to school and complete my MBA and then was fortunate to be offered a permanent job as an analyst that launched me on a 30 year career. During that career, I was named to the Institutional Investor All Star team in pharmaceuticals for nine years in a row and was ranked as one of the top three analysts at Smith Barney for several years during my stay there. I went on to be named Director of Research and was on the Board of Directors of Smith Barney until it was acquired by Sandy Weill's Primerica. I went on to become Director of Health Care research and a member of the Operating Committee of Hambrecht & Quist, a pioneer in the research of biotechnology firms. At H&Q, I ran the annual healthcare conference (now called the J.P. Morgan) conference for several years.

My exposure to biotechnology began when I was an analyst at Smith Barney where I was the first analyst to cover Amgen (AMGN) after Smith Barney did the initial public offering. Prior to that, I had called on Genentech before they went public. Throughout my career, I have personally called on several hundred biotech companies and have seen countless more present at conferences. For more than a decade, I have run my own consulting firm DLS Research, of which I am the sole owner, and which specializes in the analysis of biotechnology companies. About two years ago, I initiated my own website called as an extension of DLS Research; DLS Research does not publish reports. There may be better and smarter biotechnology analysts around, but there are not a lot with this type of experience.

I have been fortunate in my careers and my own investing, and I do not need to work. However, I continue because I find biotechnology to be intellectually stimulating. There is an explosion of creativity in biotechnology that I believe will lead to dramatic breakthroughs that will extend and improve the quality of life and I am energized by this. I spend a great deal of time on small companies, but also follow larger ones and currently I am recommending Johnson & Johnson(JNJ) and Bristol-Myers Squibb (BMY), which in the judgment of some makes me a stock promoter of these two companies.

The rationale for SmithOnStocks is that Wall Street analysts are most focused on the giants of the industry, and small companies are often sparsely covered. These companies are often attacked by bloggers who are not constrained in what they can write and whose views often go unchallenged. There can be a lack of objective analysis of small companies to their detriment and that of investors. I think there is a great opportunity to provide in-depth and balanced research on small companies with promising technology and this is what SmithOnStocks is all about.

Mr. Feurstein states that he does not own any stocks and he only writes short reports (about one to two pages in the case of NWBO). He infers that in-depth reports are associated with stock promotion. He seems to believe that his style of writing short blogs and not having any stock ownership assures purity of purpose and allows him to be objective and balanced in his reports. Not all agree. You be the judge.


Asymmetric Investing: An Investment Strategy for Small Biotechnology Companies

Some investors have made enormous returns by looking for asymmetric investment opportunities. These stem from finding upcoming events that are not well understood and which have the potential to cause dramatic stock price movements in the case of a positive outcome. The chances for such a positive outcome may be modest, but if it does occur the potential reward dramatically offsets the risk of being wrong. This is asymmetric investing and biotechnology lends itself very much to this approach.

For an asymmetric opportunity there has to be lack of awareness or extreme skepticism that a positive outcome can occur. Small biotechnology companies fit this approach because most Wall Street analyst coverage in biotechnology is focused on larger biotechnology names (more symmetric investing) with the result that they are often poorly understood by investors. In addition, the large number of trial failures in small biotechnology has produced a pervasive skepticism that any clinical trial will succeed.

Asymmetric investing does not mean that an investor is smart enough to predict with certainty clinical trial outcomes. The premise is that the event has a reasonable chance of occurring, is unexpected and if it does occur the upside potential dramatically offsets the risk of losing much or all of the investment if the outcome is negative.

I have consistently advised people that companies like NWBO have very high risk, but may also afford the opportunity for high reward. Investors should be prepared to assume the risk that they could lose most of their investment. Now, let me give you some examples of dramatic stock moves that have occurred in biotechnology that show the dramatic upside potential that makes this industry so applicable for asymmetric investing.

Jazz Pharmaceuticals (JAZZ): The Company appeared to be on the verge of bankruptcy, but through brilliant restructuring of its balance sheet, regained financial viability. Investors should look at the recent restructuring of the NABO balance sheet in this context. This left Jazz free to focus on growing its key product Xyrem. The stock has increased from $0.55 on April 1, 2009 when the company looked like it was going bankrupt to a current price of $56.50, an increase of 10,273 % or a 103 fold increase.

Human Genome Sciences: Very few investors foresaw Benlysta approval and when this occurred, the stock went from $3.32 on July 27, 2009 before approval to $30.58 on December 31, 2009 after approval. This is a 921% or nine fold increase. The company was eventually acquired by Glaxo at $14.25 per share.

Arena Pharmaceuticals (ARNA): There was a pervasive view that the company's obesity drug Belviq would never be approved. The stock hit a low of $1.23 on October 4, 2011 and has a current price of $8.38, an increase of 681% or seven fold.

Medivation (MDVN): The Company was deemed a sham and management was reviled by most investors after they announced on March 3, 2010 that Demebon had failed in phase III trials in Alzheimers' disease. This was before Xtandi caught investors' attention and went on to show in phase III trials a 5.0 month survival advantage in post chemo metastatic prostate cancer. The stock dropped to $5.91 on March 8, 2010 but has since surged to a current price of $49.91, a price increase of 837% or eight fold.

Pharmacyclics (PCYC): It looked like just another struggling biotechnology company with an oncology focus. Then phase II data suggesting durable responses in chronic lymphocytic leukemia was the catalyst for a steady and impressive upward price movement. This data was based on small open label trials. The excitement stemmed from comparing this data to historical results as is now the case with the DCVax-L open label data. The stock was trading at $4.88 on January 4, 2011 before this and other positive news flow started and currently trades at $96.37, an increase of 1,974% or 20 fold.

Threshold Pharmaceuticals (THLD): The stock experienced a strong move following the release of results from a phase II open label study in pancreatic cancer in which TH-302 was added to standard of care. This showed an improvement in progression free survival from 3.1 months to 5.6 months, an improvement of 2.5 months. The stock traded at $1.22 on December 27, 2011 and then reached $8.99 on July 2, 2012 after the phase II data was released. This represents an increase of 735% or seven fold. Subsequently, other issues have surfaced that have caused the stock to decrease to $4.65. The initial move to $8.99 represented a 736% or 7 fold increase from the low of $1.29

Amgen (AMGN): I was at Smith Barney which brought Amgen public and was the first analyst to cover the company after it completed this initial public offering. I recommended the stock, but following the offering investors concluded that there was no future in biotechnology; the stock came public at $18 and plummeted to $4. Adjusted for stock splits, the stock has since climbed from that low of about $0.08 to a current price of $86.82.

Of all of these examples, I feel that if NWBO can replicate its phase I data in phase III trials, it would be most like Pharmacyclics' ibrutinib and Medivation's Xtandi. Actually, it might be considered much better than Xtandi. Think about an improvement in overall survival of 36.4 months in a disease in which median overall survival is about 17.0 months as judge by results for 119 matched patients; this is a 19.4 month improvement. In oncology, a 4.0 to 5.0 month increase in median overall survival in metastatic disease as was seen with Xtandi is considered a major advance. This type of improvement or even a fraction of that improvement would be a fabulous result for stockholders and of much more importance would be a fabulous result for patients with glioblastoma.

This analysis suggests that when asymmetric opportunities produce an upside surprise, it is not unusual to see a big increase in price. Excluding Amgen, the price of the examples shown above produced a 24 fold increase in price with a range from 6 fold for Threshold to 103 times for Jazz Pharmaceuticals. Throwing out Jazz, the average increase was 11 fold. It is not lunacy to think that if the results for DCVax-L are viewed positively that we could see a 6 to 11 fold increase in price for NWBO from $3.50 to perhaps $21.00 to $38.50. Please see the section at the end of this report that further explains this strategy and is called Further Explanation of the Asymmetric Investing Concept.

For all of the successful outcomes, some of which I have highlighted above, there are many more high profile failures in biotechnology. Based on pure numbers, there are more failures than successes. At present, NWBO has only phase I/II data on 20 patients (although these results were substantially replicated in a separate trial in academia at Cedars Sinai as previously reported and published). The major difference between Mr. Feuerstein and me is that he seems to believe that there is negligible or no chance of success for DCVax-L in its current randomized phase III trial even though he is open-minded about whether there may be success in IMUC's current randomized phase II trial of its dendritic cell cancer vaccine ICT-107.

I think there is a reasonable chance of success in the DCVax-L trial. My view is based partly upon NWBO's prior trial results and the comparable results achieved in an independent academic trial, partly upon the partners and the regulatory decisions NWBO has obtained and partly upon my analysis of NWBO's current Phase III trial. I have taken the time and care to look closely at NWBO's Phase III trial and the features built into its trial design to enhance its chances of success, which I describe below. I have not seen any such analysis in Mr. Feuerstein's work.

Reasonable people may take differing views in assessing clinical trials, and their bases and prospects. However, Mr. Feuerstein has a discomforting style in presenting his ideas. Instead of presenting his views in a civil manner with proper respect for the ideas of people like me who differ from his point of view, he feels the need for hyperbole and to diminish his protagonist. In my opinion, this diminishes his arguments.


The Thought Process That Led to my Recommendation of Northwest Biotherapeutics

I am going to reproduce the thinking that led to my decision to recommend NWBO as an asymmetric investment opportunity. All of the subsequent text that appears in italics is a cut and paste from previous articles. There are three major points that have shaped my recommendation.

Point 1 : DCVax-L has begun a phase III trial on the basis of data from two phase I trials. Like many phase I trials, these involved a small number of patients (twenty), had no control arm and were done at a single clinical site. Seasoned biotech investors will quickly point out such results are often not replicated in larger studies and this has certainly been the case with prior cancer vaccines.

I understand this and I initially viewed the phase I trial results with conventional skepticism, but as I looked closer, I found the results just too striking to ignore. Investors often get excited with cancer drugs if phase I/II results in difficult to treat cancers like glioblastoma multiforme show objective responses of 30% to 40% (defined as shrinking the tumor mass by more than 50%). Usually improvements in progression free survival (time for the tumor to start growing again) and median survival are measured in a few months or even weeks.

DC Vax-L showed median progression free survival of 26.4 months which compared to 8.1months shown for 119 matched pairs and median overall survival of 36.4 months versus 17.0 months for the matched pairs. The data suggests that after three years, roughly 55 of every 100 patients treated with DC Vax-L would be alive versus 16 of every 100 treated with standard of care. Even with all of the phase I caveats, this strong signal of activity suggesting a nearly unprecedented increase in survival was just too much for me to ignore. Also important in my thinking was that ImmunoCellular's ICT-107 produced comparable results.

I am heartened that smarter people and institutions than me find the phase I results sufficiently credible to warrant the conduct of a phase III trial. These are r egulators in both the US and UK who have approved the phase III trial, the Fraunhofer Institute in Germany that is collaborating in the German part of the phase III trial, Kings College that is collaborating on the UK part of the phase III trial, the German government that has given a sizable $5.5 million grant for partial funding of the German part of the phase III trial and the investigators and Internal Review Boards at 41 medical centers across the US serving as sites in NWBO's Phase III trial, . Their approval or involvement with NWBO's programs suggests to me that they view the data on the median progression free survival and median overall survival benefit in the phase I trial as being credible and affording a reasonable chance for success in the phase III trial.

Point 2 : My experience with Dendreon's Provenge taught me that in living cell based products, the manufacturing process is the product. I believe that NWBO has a superior approach to manufacturing as compared to Dendreon with Provenge. Both start with the collection of monocytes through a blood draw. These monocytes are then matured into the dendritic cells that are the basis for Provenge, DCVax-L and also ICT-107. The Provenge manufacturing process results in a mixture of cells in which monocytes are only about 20% of total cells while the DCVax-L process produces 80% monocytes. This greater potency allows DCVax-L to be given as simple intra-dermal injections versus a one hour infusion for Provenge. I think that this low monocyte yield might also impair the efficacy of Provenge, but this is just speculation on my part.

The Provenge manufacturing process requires making fresh product for each of three infusions given over a one month period. The DCVax-L process makes sufficient quantities in one batch production process to allow for treatment over three years. Unlike Provenge, this allows for booster shots which intuitively I think might increase efficacy. The vials of DCVax-L are cryopreserved until needed. They are delivered to a doctor's office where they are simply thawed and injected unlike the one hour infusion needed for Provenge.

The more efficient manufacturing process for DCVax-L should sharply reduce the cost of manufacturing relative to Provenge. Because of high cost of goods sold, Dendreon had to price Provenge aggressively and management has suggested that it will take $500 million of Provenge sales to break even. DCVax-L is expected to be priced more in line with other types of new cancer therapy and carry normal pharmaceutical margins. Importantly, DCVax-L is given as seven injections over the first year so that it doesn't have the dose density that created a reimbursement issue for Provenge.

Point 3 : The Fraunhofer and King's College Collaborations put me over the top. I was intrigued with the phase I data and the superior manufacturing process, but I kept thinking what am I missing? It is not comforting to like a company that everyone else seems to be indifferent to or negative on. Understanding Northwest's collaborations with Fraunhofer Institute and Kings College London and King's College Hospital provided third party validation and gave me the investment courage necessary to push me over the top and go out with a Buy. I thought that if these two prestigious and knowledgeable institutions were willing to team up with Northwest after extensive due diligence in which they looked at the individual case reports on the 20 patients in the phase I trial as well as a number of patients who have received DCVax-L as compassionate use, that I might be on to something.

Fraunhofer is a prestigious and well respected research institute in Germany that over 60 years has gained a reputation for advancing science in healthcare and many other areas. Kings College Hospital is the premier teaching hospital in London and serves a catchment area in the U.K. of 4.9 million patients. King's College London is a sister institution that does contract manufacturing and has expertise in production of living cell products.

I think that the Fraunhofer and the King's College collaborations bring to Northwestern's European development efforts the same benefits for manufacturing, clinical trial support and interaction with regulatory agencies that small companies look for when they partner with a big pharma company. Importantly, these collaborations do not produce the significant dilution to shareholders caused by sharing profits with a pharma partner. Northwest also does not risk losing control over product development if the big pharma company moves too slowly or becomes distracted, a not uncommon occurrence. These unique and highly valuable collaborations are a critical aspect of Northwest that investors have overlooked.

The two manufacturing operations of Fraunhofer and King's College London provide significant benefits. Because the manufacturing process is so crucial to the product, it will bear close scrutiny if the time comes for regulatory agencies to consider approval of DCVax-L. At that time, the European regulatory agencies will have thorough knowledge of the DCVax-L manufacturing process. It is also desirable to have European manufacturing to cope with the logistics associated with personalized medicines. These facilities also mitigate the risk of any manufacturing disruption that might occur in the US, UK or Germany the other two may be able to offer backup.

Both Fraunhofer and King's College London had existing clinical grade manufacturing facilities for living cell products, a portion of which they are dedicating to the DCVax-L program. Thus Northwest was able to avoid the capital expenditures and a time delay of two years that would have been involved in constructing new facilities assuming that somehow Northwest could have raised the necessary funds."

I hope this makes clear how my thinking evolved and moved me past my initial caveats on the small number of patients in the phase I study.


The Phase III Clinical Trial Design

The phase III trial is now underway and one of the things that must be focused on is the phase III trial design. There are lots of examples of clinical trials in biotechnology, in which drugs that were ultimately approved produced disappointing results in initial pivotal trials because of trial design and/or execution. Here are some points to be made on the phase III clinical trial design of DCVax-L.

Full enrollment may be reached in 1H, 2014, and topline results will be available perhaps 3 to 5 months after full enrollment. Both time points are hard to be precise on. The primary endpoint of the trial is median progression free survival (PFS) and the key secondary endpoint is median overall survival (OS). The Company has designed and powered the Phase III trial so that it only needs to show one-third as long as the 18.3 months extension of PFS as was seen in the Company's Phase I/II trials to be a successful trial.

The Company hasn't disclosed the p value that would result from the 312-patient size of its Phase III trial if the difference in median progression free survival (PFS) is six months, as the powering assumes. My guess based on a look at the size and powering seen in other cancer drug trials is that, if obtained, this would produce a two sided p value of about 0.02 or a one-sided p value of about 0.01.

There will be one or more interim looks in 2013 at the data from the Phase III trial, looking for safety and efficacy, by a Data Monitoring Board. Such examinations are part of the statistical plan approved by the FDA; this is part of all cancer drug trials. The DMB is first and foremost concerned with safety. However, it also performs statistical analysis on efficacy and comes up with one of three recommendations: (1) the data shows that the drug is so effective that it is unethical to withhold the drug from control patients and the trial should be ended and control patients should be switched to DCVax-L, (2) the trial is unlikely to be successful and it is futile to continue, and (3) the trial should continue. My expectation is that the DMB at these interim looks will recommend that the trial continue.

There are also several other important features of NWBO's Phase III trial design which may enhance its chances of success. NWBO's trial is also powered for the secondary endpoint of OS, in addition to the primary endpoint of PFS. Also built into the statistical analysis plan approved by the FDA is an interim analysis of the trial size before the end of enrollment, and the ability to expand the number of patients in the trial if the trial looks under powered at 312 patients.

Of course, I cannot guarantee that NWBO's Phase III trial will be successful and I have never claimed that it will definitely be successful. There is never any certainty of success in clinical trials, and if this is the criteria for investing then no one would ever invest in a biotechnology company. My point is that there is enough evidence as I have just lain out to believe that NWBO's Phase III trial might be successful.


Further Explanation of the Asymmetric Investing Concept

Let me try to put a further focus on my asymmetric investing strategy. If it applied to just one company, you can think of the stock as an option except that it does not expire and the price does not erode with time as is the case with options. Just imagine if you applied the asymmetric investment principal to Amgen, bought stock when it was at $0.08 and never sold. If you invested $1,000 then you would have a little over $1 million now. This affords a great advantage for asymmetric buying of stocks when compared to buying an option.

Let me tell you how I play out my asymmetric investment strategy. I try to find as many opportunities as I can and spread my investment out over several companies. Let me show how this may offer more protection from the risk of just investing in one company. Let us imagine that we perceive 10 companies as asymmetric opportunities and for the sake of mathematical simplicity, let's assume that each is selling at $1.00. We then buy 100 shares of each for an investment of $100 in each company and $1000 in total. Let us further assume that each company that succeeds enjoys a fivefold increase in stock price and that each company that fails loses all value.

For each company that succeeds we would have $500 of value in that one company. If two companies succeed, we have $1000 in value in two companies. If the other eight companies fail completely and have no value, we have broken even and gotten our $1000 back. However, it is not likely that each will fail and go out of business. Let's say that they lose 75% of their value so that the $800 invested in those companies is now worth $200. The total value of our investment is $1,200 and we have made a $200 profit. With all of these assumptions, if we are right just 20% of the time in our selections, we could break even or perhaps make a 20% profit.

The above calculation is just to give you an idea as to how the arithmetic works. If we make some other assumptions, the numbers can be quite different. Let's assume that we are right on 40% of our stock selections, that the successful companies experience an eight fold increase in price and that the value of our six losers decreases by 75%. Under these assumptions, our $1,000 investment is now worth $3,350.

My basic approach is to invest a small amount of money relative to the value of my portfolio in asymmetric opportunities and to invest in as many situations as I can find that meet my criteria. This doesn't mean that you go out and haphazardly throw money at every company that comes along with a good sounding story. This is where analysis comes in. I currently have about 15 companies that I am considering as asymmetric investments and have actually invested in six of them, with NWBO being one of them. I hope this helps.

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