Abzena — Update 21 June 2016

Abzena is a provider of biological research services aimed at creating more effective and safer biological products. The group initially evolved through the combination of three key businesses: PolyTherics, Antitope and Warwick Effect Polymers. More recently, it has also acquired PacificGMP (contract, development and manufacturing) and TCRS (specialist contract chemistry and bioconjugation). This enables Abzena to offer a more comprehensive and integrated offering. Abzena listed on AIM in July 2014 and in 2015, from a secondary placement, raised £20m net of expenses from the sale of 35m new shares at 60p. The group is primarily based on the Babraham Research Campus in Cambridge (UK) and, following two recent acquisitions, is also based in San Diego (PacificGMP) and Philadelphia (TCRS). The company employs 180 staff.

Our fair value is adjusted to £133m (from £130m) or 98p per share (vs 96p), based on a three-phase DCF of the services business (£56m) and risk-adjusted royalties from existing and future licensed products (£64m). We include FY16 cash of £13.7m. For future royalty revenues we estimate peak sales, launch dates, probabilities of success and small royalties (up to 1%) for the programmes in clinical development. There are currently eleven of these programmes included in our valuation model. We also include three preclinical ADC projects, earning up to an estimated 2.5% royalty and up to a total of $50m of developmental milestones per product.

We do not include a terminal value or any estimates for potential milestones that Abzena could receive on successful development of the Abzena inside products (apart from for the three announced ADC candidates), providing upside to our current estimates.

FY16 service revenues of £9.6m included six months of the PacificGMP acquisition and around three months of the TCRS acquisition (£2.7m). We have increased our service revenue forecasts for FY17 (£18.5m) and FY18 (£24.3m) to include a 12-month contribution from the acquisitions and to reflect the expected growth resulting from cross-selling, expanded presence in the US and the broader service offering. We also expect capex to increase (FY17 £4m vs FY16 £2m), as the company invests in expanding its GMP manufacturing capacity in San Diego and chemistry services in Bristol (US) over the next 12 months.

With stable and growing revenues from its services business and a licensed portfolio of drugs that does not require investment to develop, Abzena operates a relatively low-risk business model. However, the biological services industry is highly competitive and will require Abzena to continually invest in enhancing its technologies and offering to the sector, which may require development and/or purchasing further assets. Having recently acquired two manufacturing businesses to expand its offering there is now the need to integrate and embed the broader offering, which is not without risk. While potential future royalty revenues on sales of products developed using Abzena’s technologies appear to offer pure upside, the development of these candidates is not within Abzena’s control. Advancing these candidates into late-stage clinical studies will require significant investment and/or a larger partner, so success of part of the pipeline will depend on the ability of Abzena’s licensees to secure the finance and/or partner. This does not include Gilead, Roche, two undisclosed major pharmas and private companies Opsona and Vascular Pharmaceuticals (large pharma investment).

Abzena operates in the large ($162bn in 2014) biopharmaceuticals market, forecast to grow at a CAGR 9.4% from 2014 to 2020, with six out of the global top 10 drugs by revenue a biopharmaceutical product. The outsourced early development and contract manufacturing services market is $5bn and growing. Abzena combines biology, chemistry and manufacturing to enable better biopharmaceuticals. It generates revenues from the provision of services and licences to its technologies, particularly protein/antibody engineering and bioconjugation and, as a result of two recent acquisitions, it now has a manufacturing capability to GMP standard for Phase I and II clinical trials. The investment story is built on two aspects, its:

Services accounts for 97% of group revenues today (£9.6m reported in FY16). We expect growth of approximately 40% in FY17 (c 90% including PacificGMP and TCRS contribution) and a combined c 30% growth in FY18. This is primarily due to the increase in the cross-group utilisation of the broader service and technology offering, underpinned by already in place FY2017 contract bookings of over £9m. Approximately 52% of the services revenue in FY16 was derived from repeat customers, yet the customer base is relatively broad with the top 10 customers accounting for ~43% of total revenues. Geographically, these revenues in FY16 were broadly split between North America (67%) and Europe (21% not including UK, 6% in the UK). In Exhibit 2 we summarise Abzena’s service and technology platforms and respective revenue streams.

The company indicates that it adds value to the services it offers due to the quality of the skill set of its employees, which enables them to be involved in understanding the research question, designing the study and interpreting the results.

Once the services detailed above have engineered and developed human antibodies from cell lines or Thiobridge linker technologies for antibody-drug-conjugates, they require scale-up from small laboratory quantities to larger ‘good manufacturing practice’ (GMP) levels of product. Abzena’s two recent acquisitions, PacificGMP and TCRS provide the GMP manufacturing route for antibodies and (after further investment of c $4m from Abzena) GMP manufacturing for linkers and payloads and other conjugation technologies respectively. We expect this investment in FY17.

This has been an important step for Abzena for the following reasons:

A further drive to expand its range of offerings is its marketing alliance with antibody discovery services company, FairJourney Biologics. The alliance enables Abzena to offer antibody discovery services to its partners and FairJourney Biologics to offer immunogenicity assessment and analytical services to its clients. This allows Abzena to offer a continuum of services from antibody discovery to GMP manufacture for Phase I and II clinical trials. Exhibit 4 below provides an overview of the services and technologies offered across the drug development process.

Longer term, it is the successful clinical development and subsequent commercialisation of products that have been created using Abzena’s technologies that offer significant revenue potential (secured from small royalties on the sales of its customers’ products created using Abzena’s technologies). This potentially provides risk-free upside as Abzena benefits if the product successfully reaches the market (a small royalty figure); however, it assumes none of the R&D or partnering risk and is not restricted by indication as its ‘inside’ is applied across a broad range of indications. Products that have a future licensing agreement are termed Abzena inside and are based on two core inside platforms: Composite Human Antibody (CHA) and Thiobridge (antibody-drug-conjugates).

Immune responses to therapeutic protein products can be an issue for both patient safety and product efficacy. As a result, immunogenicity is an important factor for late-stage development failure, which can be expensive. Multiple techniques exist for the humanisation of antibodies (modifying antibodies produced from animal cell lines to increase their similarity to antibodies produced in humans), although these do not always lead to complete removal of the T-cell epitopes. Abzena’s Composite Human Antibody technology significantly reduces the potential immunogenicity of a therapeutic antibody while maintaining its affinity, specificity and (and as a result) desired activity. Further details of the Abzena CHA technology can be found in our initiation here.

To date, 11 antibody candidates (up from five at the time of Abzena’s IPO in July 2014), developed using Abzena’s humanising technology (Composite Human Antibody), have been disclosed as in active clinical development with customers currently conducting Phase I, II and III studies. Most notable are Gilead Sciences’ simtuzumab (undergoing Phase II studies for NASH and PSC) and GS-5745 (currently undergoing Phase I to III studies for gastric cancer, ulcerative colitis, Crohn’s disease, pancreatic cancer, COPD, cystic fibrosis and rheumatoid arthritis), all significant opportunities given the unmet medical need in these indications. Recent positive news flow has been good Phase I efficacy data for Gilead’s GS-5745 in gastric cancer, ulcerative colitis and pancreatic cancer, and True North Therapeutics Complement component C1 in Cold agglutinin disease. For a presented abstract of each please click on the link under the indication in the table below, where the 11 clinical antibody candidates disclosed by Abzena are summarised.

Beyond this disclosed clinical-stage pipeline, we note that Abzena has announced a number of collaborations with biotech companies and research organisations over its licensable antibody/protein humanisation and bioconjugation (ADC/PK optimisation) technologies. Also, these are just the ones where the partner has agreed to Abzena’s disclosure, as some companies would prefer such licences to remain confidential for competitive reasons. Abzena has stated publicly that it has 40 licence and licence option agreements, including some that cover multiple potential products (eg de-immunised toxins for cancer and ADC products).

Antibody drug conjugates (ADCs) are an emerging class of cancer therapeutics, harnessing the tumour-targeting properties of antibodies with highly potent cytotoxic drugs. ThioBridge enables this without materially disrupting the structure and function of the antibody and may offer a number of advantages over the competition including better stability, homogeneity (consistent drug to antibody ratio) and tolerability. Exhibit 6 outlines the issues with current ADC technologies and the ThioBridge conjugation. Also, when coupled with Abzena’s immunogenicity tools, antibody engineering and manufacturing cell line development, the company has an increasingly strong ADC offering. Further details of the ThioBridge technology and its competitors can be found in our initiation report.

In January 2016, Abzena signed a significant licensing deal with Halozyme, a publicly listed US biotech company that is developing and commercialising oncology therapies, including biological agents. The deal included an initial licence fee and the potential to receive up to $150m ($50m per ADC product assumed) in development/commercial milestones if Halozyme successfully develops each of three ADC products; so far the research collaboration with this partner has screened multiple ADC candidates and one has been selected for further development. We anticipate the first ADC product will enter the clinic in 2017.

Abzena’s licensed portfolio of antibodies developed using its Composite Human Antibodies technology (outlined above) offers the prospect of small royalties (~1%) on sales, given the greater technological and IP input with ThioBridge we expect that Abzena secures greater economics from deals over its ADC products (potentially royalties up to 5%). The deal, outlined above, with $50m milestones per ADC supports this assumption.

With stable and growing revenues from its services business and a licensed portfolio of drugs that does not require R&D spend to develop, Abzena operates a relatively low-risk business model. However, the biological services industry is highly competitive and will require Abzena to continually invest in enhancing its technologies and offering to the sector. This may include the need to acquire new assets/companies, which adds an element of execution risk, but with shrewd selection of targets this should only help strengthen Abzena’s position and therefore the investment case. Abzena recently acquired two manufacturing businesses to expand where there is now the need to integrate and embed the broader offering. Although the potential future revenue streams from royalties on sales of products developed using Abzena’s technologies appear to offer pure upside, the development of these candidates is not within Abzena’s control. With the exception of Gilead, Roche, two undisclosed major pharmas and private companies Opsona and Vascular Pharmaceuticals (large pharma investment) a number of candidates are being developed by relatively small private companies that may struggle to secure the finance required to develop their products in a timely and effective manner. Advancing these candidates into late-stage clinical studies will require significant investment and/or a larger partner, so success will depend on the ability of Abzena’s smaller licensees to secure the finance/partner.

Our fair value is adjusted to £133m (from £130m) or 98p per share (vs 96p). We have included the updated financial forecasts (see financials section) and FY16 reported cash of £13.7m. Within the rNPV for product royalties, we also now include the 11th Abzena inside product with an undisclosed US biotech. We note that five of the Abzena inside products are being developed by four leading biopharmaceutical companies: Gilead, Roche and two undisclosed. This is a strong endorsement of Abzena’s Composite Human Antibody technology platform and expertise in the field. Exhibit 8 and 9 outline the valuation metrics and key assumptions and valuation assumptions by product.

Abzena has demonstrated rapid creation of value as shown in Exhibit 10, an overview of the changes to our valuation model since we initiated coverage in March 2015. This, we believe, supports the overall investment case (growing and advancing partnered pipeline) alongside a growing service business.

It has been an important year for Abzena with the two acquisitions bolstering its service offering and the integrated business model of services and technology licences beginning to demonstrate its worth. We expect a number of inflection points as the company continues to grow and progress toward royalties from Abzena inside products. Potential newsflow that would provide uplift to the valuation includes progression of Gilead Sciences simtuzumab Phase II studies for NASH and PSC, GS-5745 Phase I to III studies including the initiation of Phase II studies in COPD, cystic fibrosis and rheumatoid arthritis, expected this year and Roche’s RG6125 (formerly known as SDP 051), which is Phase IIa ready.

Abzena’s reported group accounts reflect the inclusion of six months of the PacificGMP acquisition and around three months of the TCRS acquisition. As a result, reported total revenue growth for the group was 74%, with 28% like-for-like growth. We forecast an increase in service revenue, FY17 £18.5m and FY18 £24.3m as a full 12 months benefit from the acquisitions are included and growth resulting from cross-selling and the ability to offer a continuum of services. We expect a small reduction in the gross margin following the acquisition and therefore forecast 41% in FY17, increasing to 47% in FY18. The company intends to invest slightly less in R&D in FY17 and therefore we have reduced it slightly to c £3.8m in FY17, although this is broadly offset by an increase in SG&A costs relating to a full year impact of the acquisitions and the overall increase in administrative costs from the enlarged group. We also forecast an increase in capex (to c £4m) as the company executes its investment plan into the expansion of its GMP manufacturing facility in San Diego and its facilities in Bristol (US).

We note our valuation and financial models do not currently include the potential dilution effect from the exercise of warrants, or the issue of new shares under the performance-based incentive scheme, related to the PacificGMP and TCRS acquisitions. For the PacificGMP acquisition the warrants cover 564,762 Abzena shares (0.58% of current issued share capital), which are valued at approximately £0.5m and valid for three years with an exercise price of 80p. Under the performance-based incentive scheme, PacificGMP's executives and key managers are eligible to receive up to 5,129,939 Abzena ordinary shares (5.3% of current issued share capital), dependant on the business's performance over the next two years.