Achillion Pharmaceuticals — Update 13 July 2016

Achillion is a biopharmaceutical company primarily engaged in the discovery and development of treatments for infectious diseases, in particular chronic hepatitis C (HCV), and other disease categories. In May 2015 the company entered into collaboration with Janssen Pharmaceuticals for the development and commercialization of its combined HCV assets focusing on a combination regimen, which holds the promise to be best in class. Achillion is also advancing a number of factor D inhibitors in house, having initiated lead candidate ACH-4471 in human trials in healthy patients in February this year ahead of the start of studies in PNH and C3G later this year. Achillion began trading on the NASDAQ in October 2006. The company was incorporated in Delaware in 1998 and has headquarters in New Haven, Connecticut.

We value Achillion at $2.4bn, which moves up from $2.3bn ($17.3/share from $16.5/share, or $16.5/share from $16.0/share on a diluted basis). The increase is primarily due to the first-time incorporation of its factor D inhibitor ACH-4471 in our calculations (in its lead indication of PNH only) given the recent start of a Phase I trial. This is offset by the push back of an oral HCV launch by one year to 2019. Our model assumes peak sales of ACH-4471 in PNH of $694m, representing a 12% share of the total available PNH market in 2029, which we believe is conservative given the ease of administration of ACH-4471 as an oral pill vs competitor Soliris’s weekly injections. We also assume that Achillion will take on all development costs for its factor D program – including all near-term R&D in our valuation for ACH-4471 – and self-commercializes ACH-4471.

In fiscal Q116 (end March) Achillion reported a loss of $18.1m. The company spent $13.3m on R&D in the quarter and $5.4m on SG&A. The operating cash outflow in Q116 was $16.2m and the company ended the period with cash and cash equivalents of $444m. The company provided first-time financial guidance for FY16 in February as follows: R&D costs of $65-70m, net cash used in operating activities of approximately $80m and a net loss per share of approximately $0.65-0.70. Achillion’s strong balance sheet, shored up through a share offer and an equity infusion from Janssen in the latter part of 2015, should enable adequate cash to further the factor D program well into clinical development. We model first sales of a potential triple HCV regimen in 2019. We expect that successful progression of its HCV portfolio with Janssen and growing recognition of its budding factor D franchise will generate increasing market appreciation and corresponding consideration in the share price.

Achillion is exposed to risks related to mid- to late-stage development companies including competitive threats, and the ability to achieve regulatory and commercial success on its own and through its partner Janssen. Given the intense competition in HCV, we believe that Achillion is appropriately placed with the benefit of a corporate partner with a strong financial position to commercialize its drugs. Achillion is a frontrunner in its discovery and development of drug candidates that target factor D and its approach is therefore unproven in demonstrating efficacy in systemic diseases. Factor D has, however, been validated in certain ophthalmic diseases, while in-house pre-clinical processes, including work in primates, points to a viable development program backed by in vitro research.

Achillion is well on its way to becoming a fully integrated pharmaceutical company through its own productive research capabilities. The company strives to leverage its strength in pharmaceuticals research through the development of small molecules to treat patients with infectious and complement-mediated disease. Further out the company is also looking to use its knowledge and experience to self-commercialize its products while continuing to develop compounds in additional areas of unmet medical need.

Achillion has advanced eight drug candidates into human clinical trials and two candidates into late- stage preclinical studies. Having discovered nine of these drugs, the company looks to continue to expand its drug portfolio focusing on the inhibition of essential proteins or enzymes with small molecules. The company pairs its extensive know-how in gene replication with an integrated drug discovery infrastructure aided by a number of proprietary systems to manage compounds efficiently, including an automated chemistry platform (AACP), a tool supporting lead compound identification and optimization (CART) and a data-mining software enabling analysis of compounds and their biological activities.

Achillion is focusing its research on its burgeoning complement inhibitor platform for the treatment of immune-related diseases associated with the complement system, initially advancing novel small molecules targeting factor D, a protein activated upstream within the complement system and part of the alternative pathway. The alternative pathway looks to play a crucial role in numerous areas such as ultra-rare diseases (including PNH and C3G) and other difficult to treat illnesses such as myasthenia gravis, dry AMD and COPD. Achillion’s research efforts in complement factor D inhibitors have thus far produced more than 1,000 potential compounds and its most progressed program, ACH-4471, recently advanced to trials in humans in February of this year.

The company has also successfully developed a portfolio of compounds targeting the treatment of HCV, with a number of combination treatments now in proof of concept clinical trials funded and run by its partner Janssen Pharmaceuticals, Inc. (subsidiary of Johnson & Johnson). In May 2015, Achillion signed a collaborative agreement with Janssen granting exclusive worldwide rights for the development and commercialization of a portfolio of both Achillion and Janssen antiviral drug candidates in HCV. Achillion exchanged rights for its drug candidates – discovered and developed in house – for royalties from mid-teens to low-20s, an equity investment of $225m (18.4 million shares at a price of $12.25 per share effective 1 July 2015) and milestones as follows:

Achillion participates in collaborative matters in the partnership via a joint steering committee, although Janssen maintains a deciding vote.

Outside of its agreement with Janssen, Achillion intends to build its own sales and marketing capabilities for the commercialization of its drug candidates given the specialist nature of its targeted disease categories (particularly in rare diseases), which can be addressed by highly targeted salesforces. However, outside of North America and Western Europe management has indicated the likely intention to seek out partnership agreements for commercialization.

Following the success of its Hep-C portfolio, Achillion is now focusing its in-house research on a second discipline, targeting the complement pathway. The company is advancing a series of factor D inhibitors (small molecules) holding the potential to be used in the treatment of immune-related diseases, aiming to develop a pipeline of specific complement inhibitors for rare and other serious conditions. Achillion management has communicated its belief that factor D and its differentiated mechanism of action could provide improved efficacy, safety and convenience above other treatments targeting the alternative pathway.

Therapeutic approaches that enable targeted suppression of complement can overcome limits of existing treatments while enabling ease of administration for many sufferers of complement-mediated diseases. Complement is made up of a group of serum proteins activated sequentially in a cascade that supports the immune response. As shown in Exhibit 1, three segments (lectin, classical and alternative) comprise the complement pathway representing the first line of defense to numerous medical insults including trauma, infection and hemorrhage. Research is increasingly showing that the alternative pathway amplification is required to produce active complement components in quantities great enough to effect disease.

Factor D is a serine protease with the lowest plasma concentration of all complement components, activated upstream in the alternative pathway cascade. Factor D therefore holds a critical role for complement activation, holding promise for potential treatments spanning numerous complement-mediated diseases. In vitro data so far have shown a high degree of specificity, potency and potential for good tolerability of factor D inhibitors.

Achillion has presented its progress in detail in the preclinical evaluation of its factor D inhibitors, including potency, off-target activities, metabolism and pharmacokinetic properties. The novel small-molecule inhibitors are so far orally available and look to be both potent and highly specific, as shown in Exhibit 2.

As highlighted by the company, Achillion factor D compounds:

Results of Achillion’s ongoing research on factor D inhibitors (the first researched oral complement inhibitors) substantiate the therapeutic potential of the target for the treatment of complement-related diseases. Achillion’s research of more than 1,000 small factor D inhibitors has led to the selection of its current portfolio of compounds, which spans a variety of diseases utilizing various routes of administration. So far, the company has focused on their potential in PNH and C3G, while investigation is also ongoing in atypical hemolytic uremic syndrome (aHUS), myasthenia gravis, AMD and chronic obstructive pulmonary disease (see Exhibit 4).

In late 2015 at The American Society of Hematology (ASH), Achillion’s chief medical officer, David Apelian (MD, PhD), profiled the company’s lead molecule factor D inhibitor, ACH-4471, ahead of its IND filling in December and subsequent FDA acceptance in February. ACH-4471 has a mode of action that is highly specific for factor D/factor B interaction and in vitro and non-clinical safety data has shown the potential for a favorable pharmacokinetic and safety profile. In vitro research on the company’s library of compounds binding to factor D suggests an effective blocking of C3 fragment deposition on cells (in contrast to C5-targeted therapies).

ACH-4471, the first factor D inhibitor from Achillion’s complement platform, entered the clinic with a Phase I single-ascending healthy volunteer study assessing safety, tolerability and pharmacokinetic/pharmacodynamics (PK/PD) in February 2016. Recently announced interim data showed that ACH-4471 was able to achieve 100% complement inhibition and the potential for twice daily oral dosing. A multiple-ascending dosing in healthy volunteers is targeted to begin in June with an interim analysis in Q3, while Achillion expects to begin enrolment for a Phase II program in PNH and C3G patients following the completion of Phase I studies, anticipating interim results in treatment-naïve patients in both studies by end 2016.

PNH is an ultra-rare and life-threatening disease of the blood characterized by the deficiency of the complement regulatory proteins CD55 and CD59. Research at Achillion has shown that its factor D compounds block the breakdown of PNH cells mitigating the accumulation of C3 fragments on cells, which leads to the extravascular hemolysis experienced by PNH sufferers. The only approved treatment for PNH is Alexion’s Soliris, or eculizumab (2015 sales $2.6bn, and the company guides 2016 sales of $2.9bn), which has significant limitations including intravenous administration and a black box warning of serious meningococcal infections. Additionally, there remains a significant unmet need as approximately 25% of patients on Soliris have suboptimal response1 due to only partial protection in the prevention of alternative pathway deposition of C3 on red blood cells.2 Achillion aims to provide consistent and potent inhibition of complement for all PNH patients. Our forecasts for ACH-4471 remain conservative as we forecast Achillion will obtain 12% at peak sales of the forecast $6bn market for PNH in 2029, factoring in those patients with inadequate response to the Soliris treatment as well as modest market share gains on ease of delivery.

Due to the commercial success of Soliris, there has been significant interest in developing other therapeutics for PNH and aHUS. There are currently 16 development programs targeting these disorders (see Exhibit 5). The most advanced program is OMS721 at Omeros, which initiated a Phase III study in March 2016. Unlike the other development programs, it targets a component of the lectin activation pathway, which is uniquely implicated in the pathology of aHUS. Additionally, the protein is implicated directly in thrombotic pathways and may improve the risk of blood clots associated with the disorder. This therapeutic mechanism, however, is of limited utility in PNH. The results available from the Phase II dose-ranging study in a small number of patients showed significant increases in levels of circulating platelets, suggesting that the drug may improve thrombosis. However, levels of serum lactate dehydrogenase (LDH) were only reduced 24% on the treatment compared to 86% during Soliris trials.

C3 glomerulopathy, a rare renal disease, is thought to result from overactivity of the alternative pathway, causing an increase of C3 protein fragments in the blood. As ACH-4471 looks to inhibit the alternative pathway in in vitro models, it is postulated that a factor D inhibitor could potentially decrease the formation of the C3 protein fragments. There is no cure for C3G and approximately 40% require dialysis or transplant after diagnosis. We do not yet include forecasts for C3G in our forecasts given the as yet speculative nature of the role of the alternative pathway in the disease.

Achillion is also evaluating additional compounds capable of alternative routes of administration. The company is looking to advance potential factor D inhibitors tailored to specific indications suitable to alternative delivery routes, including ophthalmic indications such as dry AMD and respiratory conditions like COPD and we expect an announcement regarding a timeline for these compounds in the current year.

Achillion’s in-house research capabilities have produced a comprehensive portfolio of preclinical and development-stage HCV compounds. In mid-2015 Janssen Pharmaceuticals (fully owned by Johnson & Johnson) purchased the worldwide rights to three of the more advanced in Achillion’s HCV line-up: odalasvir (second-generation NS5 inhibitor), ACH-3422 (NS5B HCV polymerase inhibitor) and sovaprevir (NS3/4A HCV protease inhibitor). Together with its own HCV drug candidates, Janssen is developing a multi-regimen, short-duration, highly effective, pan-genotypic HCV treatment with the promise of being best in class.

HCV treatments have moved towards combination therapies to support sustained virologic response (SVR) across genoypes. Achillion’s collaboration with Janssen increases the odds for both companies of commercializing the first triple combination – NS5A, NS3 and nucleotide polymerase – and most potent Hep-C treatment through enhanced positioning by adding multiple potential combinations. The collaboration also gives Achillion access to Janssen’s considerable development capabilities, worldwide commercial infrastructure and financial muscle.

According to the Worldwide Health Organization, an estimated 180 million people suffer from HCV worldwide. There is no vaccine for the disease, which is spread by blood-to-blood contact, through intravenous drug use, poor sterilization of medical equipment, needle stick injuries and transfusions. The highly lucrative HCV market, reaching sales of $23bn in 2015, has inspired a high level of competition among pharmaceutical companies. Gilead has been in a dominant position since releasing Sovaldi (sofosbuvir) in late 2013 and Harvoni (ledipasvir/ sofosbuvir) in late 2014, which together achieved $18bn in sales in 2015. Merck is poised to take ground with Zepatier (elbasvir/grazoprevir) launched in January. However, the newer triple-regimen candidates in development currently hold the promise of improved response rates over shorter treatment lengths.

Janssen has embarked on a series of studies since acquiring Achillion’s HCV assets:

Olysio was previously heavily prescribed with Gilead’s Sovaldi before Gilead’s launch of Harvoni (ledipasvir/sofosbuvir NS5B polymerase inhibitor) in late 2015. We expect therefore that Olysio is being pursued as a component in the mix given its status as a currently marketed PI, which Janssen has indicated could allow for a potential accelerated time to commercialization for the triple regimen.

We note also that in the latter part of 2015 Achillion announced positive confirmatory results in a second cohort of its Phase II proxy study evaluating its own NS5A inhibitor, odalasvir (ACH-3102) and Gilead’s sofosbuvir for genotype 1 HCV. As shown in Exhibit 7, the company reported 100% SVR12 (HCV undetectable after 12 weeks) in the second cohort of patients treated for just six weeks, which followed previously announced SVR24 in two earlier cohorts receiving eight and six weeks of therapy. The results provide confirmation as to the potency of odalasvir, boding well for its role in the triple regimen.

Janssen aims to initiate Phase III development for a triple regimen in the early part of 2017 with the study design dependent on results from the double and triple regimen Phase IIb studies.

We expect that, if successful, Janssen’s triple-regimen HCV compound could be launched in 2019 and reach our forecast peak sales of $3.6bn in 2023. In accordance with its agreement with Janssen, Achillion is eligible for up to $905m in milestones and mid-teen to low-twenties percentage royalties on worldwide sales.

Risks related to Achillion include the successful execution of the clinical trials related to the proof of concept of its factor D program and the outcome of the ongoing Phase II trials for a combined regimen in HCV. Achillion is also exposed to those risks related to a mid/later-stage development company including competitive threats, and the ability to achieve regulatory and commercial success on its own and through its partner Janssen. Achillion is a front-runner in its discovery and development of drug candidates that target factor D and its approach is therefore unproven in demonstrating efficacy in systemic diseases. Factor D has, however, been validated in certain ophthalmic diseases, while in-house, preclinical processes, including work in primates, point to a viable development program backed by in vitro research. Given the intense competition in HCV, we believe that Achillion is appropriately placed with the benefit of a corporate partner with a strong financial position to commercialize its drugs. Achillion is currently well capitalized and we expect that proceeds from the eventual successful launch of a triple-regimen HCV product by Janssen will finance the company’s ongoing clinical trials. However, a delay in the timing of a launch of a triple combo in HCV would lead to a funding shortfall and the need to raise additional money, the timing for which could become vulnerable to the state of the capital markets. At this time, all clinical programs in factor D and HCV remain on track and data collected to date related to Janssen’s HCV program have proven robust.

Our valuation moves to $2.36bn from $2.26bn ($17.3/share from $16.5/share, or $16.5/share from $16.0/share on a diluted basis). Our valuation now incorporates factor D inhibitor ACH-4471 in its lead indication of PNH, given its entry into human trials in February 2016 with the start of the Phase I study. Our model assumes peak sales of ACH-4471 in PNH of $694m, representing a 12% share of the total available PNH market, which we believe is conservative given the ease of administration of ACH-4471 as an oral pill vs competitor Soliris’s weekly injections. We also assume that Achillion will take on all development costs for its factor D program – including all near-term R&D in our valuation for ACH-4471 – and commercialize ACH-4471 in house. We also push the launch of the combined-regimen HCV treatment to 2019 from 2018, which seems prudent given the Phase III trial start is targeted to commence in the early part of 2017.

Additional subtle differences in our valuation relate to cash spend and rolling forward our discounted cash flow by one quarter since our last note on the company in March 2016. As announced by the companies, Janssen will wholly fund all development and commercialization costs related to HCV, while Achillion is eligible to receive up to $905m in development, regulatory and commercial milestone-based payments.

Achillion announced first quarter 2016 results in early May. In Q116 (ending March 2016), the company reported a net loss of $18.1m (vs a net loss of $19.3m in Q115). R&D expenses of $13.3m in Q116 fell from $15.2m in Q115, as considerable costs related to the company’s HCV development program were transferred to Janssen (vs prior costs from trials related to ACH-3422, the odalasvir and sofosbuvir combination studies and ACH-2684 clinical and manufacturing costs). G&A expenses in Q116 of $5.4m were up from those in Q115 of $4.2m, with the increase attributed primarily to increased salaries and non-stock compensation charges due to the addition of personnel. Achillion provided first time financial guidance for the full year 2016 in February as follows: R&D costs for the full year of $65-70m are expected, net cash used in operating activities of approximately $80m anticipated and a net loss per share of approximately $0.65-0.70.

We adjust our near-term forecasts from our last published report on Achillion in March 2016, primarily to reflect higher than previously expected R&D costs associated with the company’s burgeoning factor D program.

Achillion has a strong balance sheet, with cash and cash equivalents of $444m at end Q116, which we expect will be sufficient to fund operations through to profitability when significant milestone and royalty payments from Janssen should begin feeding through from the regulatory approval and commercialization of its triple regimen in Hep-C.