Expert Financial Analysis and Reporting

Highlights of Dinner
Last night, January 9, pSivida held a dinner for analysts and investors in New York. The audience had a large number of retail investors and Dr. Paul Ashton; the CEO gave a general, introductory overview of the Company. However, Dr. Ashton did provide some useful information in regard to three potential catalysts for 2014.

pSivida developed Iluvien and licensed it to Alimera (ALIM). Under this agreement, PSDV has rights to all of the clinical data created by Alimera on the use of this product in over 1000 patients. Also, PSDV has the right to develop this product for other indications. It is developing Iluvien under a different name, Medidur, for a different indication.

Iluvien was developed for diabetic macular edema and Medidur is being developed for posterior uveitis, two very different diseases. Diabetic macular edema is caused by leaky vasculature in the eye and posterior uveitis is believed to be an auto-immune disease. Importantly, the VEGF inhibitors, Lucentis and Eylea, are the hottest ophthalmology drugs on the planet and are extensively used in diabetic macular edema. They are not effective in posterior uveitis.

Dr. Ashton gave an update on Alimera’s plans to refile the Iluvien NDA. For background, see my recent report. His speculation is that the FDA has no questions on the clinical data. The only things standing before its approvals are a few questions on manufacturing and the need to update an instructional booklet on the use of Iluvien. Alimera has indicated that it plans to resubmit the NDA on Iluvien before the end of 1Q, 2014. The FDA will probably set a six month PDUFA date so that the approval of Iluvien is likely to be in September, 2014. Approval requires that Alimera pay pSivida a $25 million milestone within 30 days or return the product rights to PSDV.

In regard to Medidur, Dr. Ashton gave the following timeline for development. The enrollment on the first phase III trial of Medidur will complete by the middle of the year and data will be available in 3Q, 2014. There is a high expectation that the data will be positive based on the efficacy seen with other steroid products in posterior uveitis. However, clinical trials always have a high degree of uncertainty and I have seen drugs fail in a trial because of trial design issues and then succeed in subsequent trials. Acadia (ACAD) and Neurocrine (NBIX) are two outstanding examples. There is no such thing as a sure thing when it comes to clinical trials.

My reading of Dr. Ashton is that he is probably most excited about the Tethadur technology. The product is still in animal studies and we may see the first pre-clinical results in mid-2014. This technology is very unique and was developed for use in the semiconductor industry. The hope is that this will be a way to deliver proteins like monoclonal antibodies in a sustained release formulation. This is a high risk and early stage product, but this type of technology, if successful, would be the Holy Grail for protein drug delivery that could enhance the product characteristics of monoclonal antibodies and extend their patent lives.

A Word on SmithOnStocks
I want to take this opportunity to discuss an important point in regard to SmithOnStocks with my valued paid subscribers. As you know, I publish articles on my website and on Seeking Alpha that are free in addition to the articles that are sent to paid subscribers. Some have asked what the incremental value is of being a paid subscriber. This note is an example. I had dinner with Paul Ashton, the CEO of pSivida last night and I am publishing this note today.

Next week, I will post the Highlights of Dinner section on Seeking Alpha and the free part of my website; it will not contain the Investment Thesis section that you are about to read and which is the high value added component of this note. The free articles will be primarily informational as opposed to interpretative.

I think that it is important to maintain my high profile on Seeking Alpha. If the potential catalysts that I am looking at come through, you will have had the opportunity to invest in advance. Also, it they occur, through the impact that I have on Seeking Alpha I can maximize the impact on the stock by putting the events in perspective and by getting other authors involved. I also need a platform to counter bear arguments that inevitably occur. Small stocks like pSivida are often targeted by hedge funds ganging up on them and publish negative reports with slanted points of view.

Investment Thesis on pSivida
PSivida has a small market capitalization and has been a disappointment for investors over the last few years and as a result of three consecutive Complete Response Letters on Iluvien that have blocked its approval in the US. It does not have a lot of “Street cred”, is not widely followed and may be inefficiently priced. Inefficiency spells potential opportunity.

Market Capitalization is Small
PSivida currently has 27.0 million shares outstanding, 1.2 million warrants and 3.7 million options for a potential total share count of 31.9 million shares. Based on 31.9 million shares and a current price of $4.00 the market capitalization is $128 million. Oftentimes, companies with drugs in phase III development like Medidur can sell at $300 to $500 million.

No Near Term Financing Risk
I think that with the highly probable approval of Iluvien and the subsequent $25 million payment that the Company will receive that it will not need to raise capital in 2014 nor probably in 2015. I estimate that at the current quarterly burn rate of $3.5 million per quarter, the Company will end calendar 2014 with $23 million of cash assuming that the $25 million milestone is paid and will end calendar 2015 with $11 million. This takes away the near term financing risk.

Consensus Opinion is That the Stock is Boring
I think that investors are lukewarm on pSivida as an investment. I believe that most people feel that the main catalyst for pSivida in 2014 will be the approval of Iluvien and the payment of the $25 million milestone. However this is well known and stocks usually go up or down because of surprises, not the actual occurrence of an event that is well anticipated. Skeptics also point out that the Iluvien launch in Europe has been very slow and disappointing.

There is every expectation that the Iluvien launch in the US also will be slow. Almost all recent product launches have been slow because of the increasing involvement of managed care. Also, Alimera is so cash strapped that it may not be able to raise the funds needed to launch Iluvien adequately in the US. It will be several years before Iluvien makes any significant contribution to pSivida’s P&L. Along with some credible Wall Street analysts, I believe that Iluvien can reach peak sales of $100 to $200 million in both the US and Europe and this will lead to about $30 to $60 million of pretax profits for PSDV, but this could be in the 2020 or so period and in 2014 and 2015, there may be little contribution.

This is what I believe to be the consensus view on pSivida and most investors are kind of blau on the stock based on this outlook. I agree with these points, but I think that there are two additional catalysts that are not widely anticipated and could cause upside surprise. Remember that I believe that stocks go up based on positive surprises and there may be a couple in the works.

Medidur Could Produce Surprises
Let’s look first at Medidur, a drug for posterior uveitis that PSDV is developing on its own. The FDA usually requires two well controlled and successful phase III trials for approval. The first phase III trial will provide data in 3Q, 2015. Under the standard course of action by the FDA, pSivida would then have to begin the second phase III trial and data from that trial would not be available until perhaps 3Q, 2017. Assuming success in both trials, the product might be approved in late 2018 or early 2019. I think that this is how people look at Medidur; they see it as an interesting drug but too far off to pay much attention to.

This sets up the potential for upside surprise number one. Dr. Ashton said that he will be meeting with the FDA in the first half of 2014 to discuss Medidur. Dr. Ashton will try to persuade the FDA that Medidur’s potential approval for posterior uveitis should be viewed by the FDA as a supplemental NDA to the Iluvien approval. Why is that important? Because it would mean that Medidur could be approved on the basis of only one phase III trial and instead of potential approval in late 2018, it could be approved in 2016 on the basis of the first phase III trial that is now underway.

The potential for approval of Medidur in 2016 is not widely expected and would be a significant catalyst. There is a great unmet medical need for a new drug in posterior uveitis. This is a disease with a prevalence of 200,000 patients in the US and it is the third or fourth leading cause of blindness in the US having caused blindness in 30,000 patients. The market potential for Medidur in posterior uveitis may be comparable to Iluvien in diabetic macular edema and might approach $200 million of peak sales in the US five years after launch. This adds a whole new dimension to the pSivida story.

During the presentation, Dr. Ashton mentioned that in a small pilot study of Medidur in 12 posterior uveitis patients that was conducted prior to beginning phase III there were two very encouraging results. Two patients who were functionally blind had their vision restored to 20/60 and 20/80. This was a remarkable result but we must be careful in getting too excited because of the small number of patients involved. Still!!

Tethadur Could Also Produce an Upside Surprise
Dr. Ashton said that the first results in animals for Tethadur could be available in mid-2014. Very quietly and probably unappreciated by most people in the audience, he also said that this could lead to a collaboration with a major pharmaceutical or biotechnology company in 2H, 2014. This is a very important statement. My sources suggest that the intial study is being done in the delivery of Lunesta to the back of the eye.

Based on animal studies, the hope is that the Tethadur product could allow for an injection of Lunesta every six months instead of the seven or eight annual injections now required with Lunesta and Eylea. Why is that important? Let’s look at the example of Allergan’s DARPin, a new VEGF inhibitor comparable to Lunesta and Eylea. The promise of DARPin is that it might need only to be injected into the eye twice a year rather than seven or eight times as with Lunesta and Eylea.

I won’t go into the whole history of DARPin but in 2012 there was the expectation that the phase III trial of DARPin could be completed in 2014 or 2015 and would point a clear path forward for filing an NDA. Problems in trial design led to a delay in the program so that DARPin is now in phase II. This announcement shaved nearly $4 billion off of Allergan’s market capitalization. I take this as an indication of the potential value of a Tethadur based product that delivers Lunesta or Eylea twice a year.

I would not expect that the announcement of a commercial agreement with Roche for Lunesta or Regeneron with Eylea would have the same effect as DARPin on Allergan. It is much earlier stage and is based on an unproven technology. I am not looking for a DARPin like effect on pSivida’s market capitalization. However, with only a $127 million market capitalization, it doesn’t take much to have a major impact on the stock.

Upside Far Surpasses Downside Risk
There is no certainty in marriage, investing and most other things in life. In looking at pSivida as an investment, I first try to consider what the base investment case is for pSivida and I believe that this is that Iluvien is approved and brings the $25 million milestone payment. This is good because it takes away the financing risk, but the consensus believes it will be a few years before we begin to see any real impact on the pSivida’s P&L. There is not a great deal of awareness of Medidur as a product and few people think that one phase III trial might be sufficient for approval. Tethadur is viewed as being too early stage to place much value on. I think that if the consensus view is correct, PSDV is probably a stock without a lot of downside or upside in 2014.

OK, so boredom may be the risk in the investment. Now let’s put on our optimist’s cap and first assume that the FDA agrees that Medidur requires only one phase III trial. This could be a stunning surprise because it would mean that Medidur could be on the market in 2016; this is a big upside surprise. It might take awhile for investors to grasp this, but I could see the stock trading up to $6 or so on this news. Remember what I said that companies with drugs in late stage with comparable prospects to Medidur can sell at $300 to $500 million market capitalization and PSDV has a current market capitalization of $128 million.

Tethadur is a little more iffy, but since we are in an optimist stance let’s say that a collaboration agreement is reached in 2H, 2014 to develop Lunesta in the Tethadur delivery mechanism. Coupled with positive news on Tethadur, I could see the stock at $10. Net, net, I see the risk in the stock for 2014 as being boredom if the consensus view is correct. However, there is asymmetric upside if the positive case for Medidur and Tethadur prevail. This is why I won the stock.

The End Game
I think that pSivida is likely to be acquired in the next two to three years. The price will be dependent on the outcomes for Medidur and Tethadur.