Expert Financial Analysis and Reporting

The investment thesis for Anadys is almost totally based on the prospects for its lead drug, ANA 598, which is being developed for treating hepatitis C. This drug has shown itself to be safe and phase I data supports the belief that it is an effective agent. It is now in a phase II trial scheduled for completion in late 2011 that should establish proof of concept. The concern with Anadys is that even if ANA 598 is shown to be safe and effective, it may not have a significant role to play in treatment of the disease because of a proliferation of competitive compounds at a comparable stage of development that may be superior to ANA 598.

Overview

The standard of care for treating hepatitis C prior to the recent arrival on the scene of Merck’s Victrelis (boceprevir) and Vertex’ Incivek (telaprevir) was interferon and ribavirin, a combination that has limited efficacy and troublesome side effects. Drug developers believe or hope that new drugs under development can be combined into a cocktail that will replace interferon and ribavirin. There is a furious race to develop new drugs that will combine with boceprevir and telaprevir in this hypothesized cocktail. Companies are focusing on the development of four classes of drugs that attack the hepatitis C virus in different ways to produce drugs that they are synergistic and less likely to allow resistance to develop.

The four classes of drugs in development are protease inhibitors (like boceprevir and telaprevir), nucleoside polymerase inhibitors, Ns5a inhibitors and non-nucleoside polymerase inhibitors. Wall Street is betting that nucleoside polymerase inhibitors will be the first new drugs to be added to one of the two drugs now being marketed. The two leading “nukes” are RG 7128 which was developed by Pharmasset and licensed to Roche and PSI 7977 which was developed by and is still owned by Pharmasset. Both are in phase II development similar to ANA 598.

Pharmasset carries a market capitalization of $4.1 billion. Anadys probably is in the lead in developing a non-nucleoside polymerase inhibitor with ANA598, but the market is saying so what as is evidenced by its market capitalization of $57 million. Obviously, investors perceive the non-nucleoside polymerase inhibitors to be the least attractive of the new classes of drugs.

The future of ANA598 may hinge on how many drugs might ultimately be part of the hepatitis C cocktail. Most investors think that the first combination will be of one of the currently marketed protease inhibitors with a nucleoside polymerase inhibitor, probably Pharmasset’s PSI 7977. If this combination is not sufficiently effective most investors look for a second protease inhibitor or an NS5a inhibitor to be the next and third drug in the cocktail. The non-nucleoside polymerase inhibitors are the Rodney Dangerfields of the hepatitis C world. They get no respect. It is generally felt that the hepatitis C cocktail would have to contain four or five different drugs if non-nucleoside polymerase inhibitors like ANA 598 are part of the combination.

Anadys strongly indicated last year that it would find a partner for ANA 598 that would eliminate the need to raise more equity. Then last October, the company did an about face and did raise more equity, persuading investors that an attractive partnering deal would require ANA 598 to have phase II data and that the capital raise was necessary to generate that data. The company also announced last year that it had hired a strategic advisor to evaluate options for the company. Many took this to mean that the company was putting itself up for sale. With nothing happening on the partnering or ”being bought” front, most investors interpreted this as a lack of interest in ANA 598 on the part of larger corporations interested in being a player in the hepatitis C space.

Investment Thinking

I can put together reasonable bear and bull cases for Anadys, but I lack enough conviction in either to act. So for the time being, I am on the sideline. For those who are interested, here are my bull and bear scenarios.

Bull Case

The bull case for the stock is that the phase II data will show that ANA598 is a safe and effective inhibitor of hepatitis C and can be a part of the emerging hepatitis C landscape. Large and sophisticated companies like Abbott, Boehrringer Ingleheim, Gilead, Pfizer and Vertex continue to develop non-nucleoside polymerase inhibitors which would seem to be a validation of this class of drugs. ANA 598 is at the front of the pack of non-nucleoside polymerase inhibitors being developed. If phase II results are impressive, it might be attractive for a larger player that lacks a non-nucleoside polymerase inhibitor to partner the drug or to buy Anadys outright. This has the potential to cause a very significant stock price increase that could be several multiples of the current price.

Looked at from a purely emotional basis, Wall Street analysts often take arguments to the extreme and it may be the case that they are way over-emphasizing the nucleoside polymerase inhibitors and under estimating the non-nucleoside polymerase inhibitors. The data for both classes of drugs is still early and far from conclusive. Holding Anadys is very uncomfortable given the bear case and the awful recent stock price action. However, it is often the case that uncomfortable situations turn out better than comfortable ones. From this point of view one would prefer Anadys over Pharmasset.

Bear Case

The bear argument is that ANA598 is an also ran in a field with a very large number of good horses. Even if it is shown to be safe and effective in the phase II trial, no one will care. ANA is effective against only genotype I hepatitis C and is a twice a day drug. There is also a prejudice that hepatitis C becomes more easily resistant to non-nucleosides than to drugs in other classes. Already, there are drugs from other classes at a comparable stage of development that are effective against other hepatitis C genotypes, can be dosed once a day and are less likely to allow resistance to develop. Bears then point out that Anadys had only $33 million of cash at the end of 1Q, 2011 and by the end of the year when the phase II reports out, the company will have cash of only $15 million or so and will be in severe financial straits. The stock could quickly drop to the $0.25 to $0.50 range.