e-Therapeutics — Update 19 May 2016

e-Therapeutics is a UK-based drug discovery and development company, founded in 2003 as a spin-out from Newcastle University. It listed on AIM in November 2007 (raising £1.33m; post-money market cap of £37m). Since IPO, it has raised a further £62m in equity, with two significant fund-raisings: February 2011 (£17.6m gross, £16.6m net) and March 2013 (£40.0m gross, £38.9m net). These funds have been used to develop, strengthen and industrialise its proprietary network analysis platform from prototype to a “fully operational, highly engineered and efficient discovery engine”. In 2012, the company opened a dedicated network pharmacology hub outside Oxford to expand its drug discovery capabilities. It now employs 27 staff. The investment made in boosting the discovery engine appears to be paying off, with a stream of new product leads emerging. Over the next 18-24 months, the priority for management is to secure commercial deals (for either the platform or product leads) with pharma partners to progress these assets into the clinic and beyond. The proposed £2.32m Searchbolt acquisition will consolidate e-Therapeutics’ IP ownership, positioning it ahead of future deals; the approval vote will take place on 27 May.

e-Therapeutics’ two main sources of value creation are its discovery platform and legacy pipeline. We have re-evaluated our valuation approach away from a pipeline rNPV given the strategic shift to commercialising the platform and new product candidates within the next 18-24 months. First deals are yet to be secured, thus there is no benchmark for potential deal terms, nor any firm indication of deal format. Using an industry benchmark of a $23m (c £16m) upfront per preclinical asset, and assumed annual costs of £10m, we calculate that the current market cap is supported by six non-risk-weighted deals being secured over the next three years. Two deals a year would generate operating profit of £18m, excluding the impact of potential future milestones/royalties. The first deal is an important de-risking event, unlocking potential for more deals, possibly with better economics.

Cash of £24.8m at end-January 2016 coupled with expected R&D tax credits of c £8m in the next two years should be sufficient to fund operations into FY19, based on plans to take five or more projects to completion of preclinical testing and assuming the initial Searchbolt consideration is paid for with new equity. e-Therapeutics has guided that platform costs of c £2m pa remain broadly flat, while external project costs will remain high due to the number of active discovery projects in preclinical testing and their increasing maturity. We do not include any forecast revenue from potential deals in our model at this stage due to uncertainty regarding timing and deal structure. However, candidates selected from the discovery projects are expected to be ready to enter clinical development in 2017, offering potential for high-value partnerships during the next two years. We forecast an FY17 net loss of £9.7m and cash of £14.5m.

e-Therapeutics’ key sensitivity is execution risk in relation to securing development or discovery partnerships. Its strategy is centred on securing partner(s) for its drug candidates or discovery platform through commercial deals. These will be critical for future revenue generation through upfront payments, as well as downstream milestones and royalties. The company has increased its business development activities, although the timing of the first deal is uncertain. A deal should provide important validation for the network pharmacology platform and may act as a catalyst for additional partnerships to be secured. Conversely, the absence of near-term deals may mean that e-Therapeutics will have to raise additional funding.

e-Therapeutics is approaching a watershed in its history. Over the past five years, it has invested its substantial financial resources into developing its proprietary network pharmacology discovery platform. With investment, the platform’s capabilities have expanded significantly and it is now fully operational and generating active and potent compounds with ‘hit rate’ magnitudes higher than standard high-throughput screening processes. The next step for the company is to realise value by commercialising its assets: by advancing more discovery projects into preclinical development and securing development or discovery partners for its pipeline and platform. At end FY16 (31 January 2016), e-Therapeutics had cash of £24.8m, with a £2.5m R&D tax credit receipt expected in financial H117, which provides sufficient runway into FY19.

The strategic shift towards commercialising the discovery platform is the near- to mid-term priority. Collaborations will provide validation for the platform, as well as funding for future discovery work, and identification of the next wave of lead candidates. The pipeline is shown in Exhibit 1.

To date, e-Therapeutics has generated a variety of novel preclinical assets, 12 of which are in active development (with three in lead optimisation), as well as legacy assets uncovered by an earlier prototype of the discovery platform. It intends to out-license its legacy assets for further development; ETS6103 is available for near-term out-licensing, with ETS2101 back in discovery to explore new formulations to build a partnering package. Our previous valuation approach, based on an rNPV of these two products, has been re-evaluated given the uncertainty surrounding timelines.

e-Therapeutics’ discovery capability is its core strength; its platform allows for shorter development timelines (project initiation to lead selection in 24 months rather than the typical three to five years), of potentially de-risked compounds (based on a multi-target footprint rather than a single target approach) and therefore reduces the cost of drug discovery. Through network analysis, this platform can identify highly potent molecules that potentially have improved efficacy, or improved tolerability, vs existing therapeutic options.

A key driver behind e-Therapeutics’ discovery pipeline is commercial opportunity and unmet medical need. The company is focusing on areas in which it can identify differentiated and potentially disruptive assets, which should prove attractive to partners. These include immuno-oncology (including targeted resistance) and antivirals. We believe that biotech and pharma partners will be interested in either licensing the existing preclinical pipeline or entering into a more collaborative arrangement whereby the engine is applied to their in-house compound libraries to identify promising candidates in areas of unmet medical need.

e-Therapeutics was founded in 2003 to exploit the proprietary network analysis technology originally developed by founder and CEO Professor Malcolm Young’s research group. Early discovery efforts generated the legacy pipeline. Equity raises in 2011 and 2013 provided substantial resources to enable the company to exploit advances in in-silico modelling and data analysis techniques, to accelerate and strengthen its discovery capabilities and infrastructure. Thus
e-Therapeutics was able to embark on a second wave of drug discovery focused on new chemical entities or NCEs (to exploit higher-value partnering opportunities). The company now has a wide range of NCE discovery assets in a variety of disease areas. As part of our presentation of
e-Therapeutics’ discovery approach and platform benefits, we highlight select programmes below.

With cash in the bank, e-Therapeutics had the resources necessary to establish the Oxfordshire-based technology centre in 2012, recruit a head of bioinformatics and build a bio- and chemo-informatics team. Over the subsequent years, the platform was developed and refined, improving by orders of magnitude. Construction and the ongoing development of the in-silico discovery platform has been a significant task, with the company having to resolve various technical issues integrating ‘big data’ and network science. Put simplistically, this has involved inputting detailed lists of proteins, protein-protein interactions, compounds (at present nine million are included in the database) and compound-protein data interactions (with removal of duplicates). Disease networks are constructed on the basis of these data, which are then analysed to identify compounds that have a multi-target effect on disrupting these networks. These compounds are then screened in relevant cell-based assays to establish potency. Improved efficacy could result from this multi-target approach rather than focusing on a single target. Discovery workflow is shown in Exhibit 2.

e-Therapeutics selected telomerase as a potential target due to its role in development of multiple cancers through a variety of mechanisms. The strategy was to find compounds that could disrupt the various aspects of telomerase biology. Applying an in-silico overlay to 15 different disease networks, e-Therapeutics was able to ascertain a common footprint, identifying compounds with the right disruptive interactions. 393 compounds were screened in two breast cancer cell lines, with 106 active hits (27%), of which 49 were selectively active (12.5%), ie having at least threefold selectivity for cancer cells vs fibroblasts at commercially viable concentrations. Multiple chemotypes were detected; this is important as it has the potential to increase the programme’s likelihood of success and provides more options to select the best leads for optimisation. Early data on cell proliferation suggest that ETS2300 has greater potency than best previous small molecule telomerase inhibitors and imetelstat (Phase II: Geron/Janssen), as well as a faster onset of effect vs imetelstat.

e-Therapeutics’ discovery platform has yielded a high number of potent compounds across multiple indications (Exhibit 3) and, in contrast to traditional drug discovery approaches, has identified these in considerably shorter timeframes and at lower cost/more modest investment.

High-throughput screening (HTS), the standard lead generation approach in the pharmaceutical industry, has a ‘hit-rate’ reported to be between 0.01% and 3%, depending on the assay used and the type of molecule and target being screened. A ‘hit’ is a compound that has the desired activity in a compound screen and whose activity is confirmed on retesting. By contrast, the discovery yield from e-Therapeutics’ network pharmacology platform has averaged around 25% in the ongoing live discovery projects, with multiple active and potent compounds across multiple chemotypes identified in each (Exhibit 4). This alone is an endorsement of the network pharmacology approach to drug discovery. Further, this approach also enables an accelerated timescale for drug discovery, with the time from initiating a new project to identifying active compounds in cell-based laboratory assays potentially as short as six months. This has allowed the company to pick up the pace on its discovery programmes, undertaking in vitro testing of many thousands of molecules, each with a strong rationale from network pharmacology.

The 12 active discovery projects are all in areas of significant unmet medical need where there is general interest across the industry, and thus the potential for licensing deals. Three projects are in lead optimisation and two in hit confirmation and quality control/IP assessment. Exhibit 5 provides an overview of the preclinical workflow and an indication of the number of projects at each step.

The near-term challenge for e-Therapeutics is securing partners. Business development is a key area of focus; the company has engaged external business development consultants and is investing in in-house business development. The proposed acquisition of Searchbolt, an internet search engine technology developer, which was spun off from e-Therapeutics pre-IPO, is also part of the preparations. This acquisition enables e-Therapeutics to consolidate the ownership of its IP, bringing back in house a licence relating to its core IP.

Securing a partner will unlock the inherent value in the discovery platform and projects, as well as providing important validation for the network pharmacology approach. Cash inflows from potential deals would bring e-Therapeutics closer to the point at which it becomes sustainably funded, providing the resources to invest into additional discovery projects. On end-FY16 resources of £27.3m (including the yet to be received R&D tax credit for FY16), e-Therapeutics has sufficient funds to enable five or more existing projects to complete preclinical testing.

The 12 active discovery projects are all targeted in areas of high and immediate commercial demand, with a particular focus on cancer immunotherapy and mitigation of therapeutic resistance to targeted cancer therapies. Three projects are now in lead optimisation: ETS2300 (telomerase inhibition), ETS2400 (hedgehog pathway inhibition) and ETS3100 (anti-TNFα). The company anticipates that once the most promising candidates have been identified, pre-IND development and testing for the most advanced should be able to start by end-2016, with potential for clinical development to begin in 2017. These projects have significant commercial appeal and, as a result, the prospect of higher-value partnering opportunities or preclinical out-licensing is drawing closer.

Management is targeting potential partners globally that have specific expertise in the disease areas on which e-Therapeutics is focusing. Multiple conversations are ongoing, although the company is open-minded about the timing and stage at which it will partner an asset. We believe that once lead compounds have been selected and IND-enabling studies are underway, the attention of partners is likely to shift from being a ‘watching brief’ towards executing a deal. Deal timing is unknown at this point although, in our view, first deals are possible from H216 onwards once in vivo and toxicology data are available; this will be a significant de-risking step. Roughly one-third of drug discovery projects fail in preclinical development, with non-clinical toxicology findings being the most common cause. A second unknown is deal structure. However, given the company platform and pipeline, various deal structures could be contemplated, including:

Commercial opportunity and unmet need are central to building a discovery pipeline of differentiated and potentially disruptive assets, which should prove attractive to partners. A prime example of this is the targeted resistance rescue project, ETS2400. Targeted cancer therapies are frequently extremely effective initially; however, resistance often evolves, rendering the effect short-lived and allowing the cancer to return more aggressively. Thus, a therapy that can help overcome this resistance is significantly appealing. The therapeutic rescue project addresses resistance to the Hedgehog signaling pathway (this pathway is reactivated in many cancers enabling proliferation of cancer cells). The small molecules vismodegib (Roche) and sonidegib (Novartis) are inhibitors of SMO, a component of the Hedgehog signaling pathway, and are approved for the treatment of basal cell carcinoma (BCC). While patients initially respond well, many develop resistance, rendering the drug ineffective after a time, and consequently impeding its widespread clinical use. Genomic analysis of tumour biopsies has revealed that resistance is associated with Hedgehog pathway reactivation, predominantly through mutation of SMO. The finding of intra-tumour heterogeneity in BCC also suggests that targeting multiple components of the Hedgehog pathway is required to overcome resistance. As e-Therapeutics’ approach targets the network as a whole, it disrupts the potential for evolution of resistance. ETS2400 includes inhibitors of the Hedgehog pathway that do not bind to SMO, with nanomolar potency and no evidence of cytotoxicity.

The potential to extend the use of the SMO inhibitors with such a therapy, which in theory could transform them into blockbusters, would suggest it is of strong interest to Roche and Novartis and to any other companies with SMO inhibitors in development. Furthermore, as resistance is a problem common to targeted therapies as a whole, the platform's ability to address this issue could disrupt the oncology market, equating to considerable commercial potential.

e-Therapeutics has completed a number of clinical studies of its two lead assets, ETS2101 (cancer) and ETS6103 (major depressive disorders). These programmes form part of the legacy pipeline, which had been identified by an earlier generation of the network pharmacology platform when the focus was on reformation and repositioning of known compounds. Company strategy for these programmes centred on funding proof-of-concept studies and, following positive data, out-licensing for further development. Recent findings have prompted e-Therapeutics to refine its development plans for ETS2101 to focus on formulating and progressing an oral dose form, while a partner is sought for ETS6103, which has been shown to be an effective anti-depressant despite mixed clinical results. We provide more detail on current status and future plans below.

ETS2101 (dexanabinol) has completed three Phase Ia studies, establishing 30mg/kg as the MTD (maximum tolerated dose) of the infused form with no reported serious adverse events. In May 2015, recruitment began into a multi-centre Phase Ib study in hepatocellular carcinoma (HCC) and pancreatic cancer. The aim of this study was to investigate the safety, tolerability and anti-tumour activity of an infusion formulation of ETS2101 in both HCC and pancreatic cancer, with initial data expected in Q416. To date, 47 patients have been enrolled into the two-arm study: (1) eight newly diagnosed HCC patients and eight newly diagnosed pancreatic patients in combination with standard of care; and (2) 12 into HCC relapsed or refractory monotherapy and 19 into pancreatic relapsed or refractory monotherapy. However, the company has revealed that it intends to bring the Phase Ib studies “to an orderly close” as the focus of development is shifted towards potentially superior formulations that do not contain Cremophor.

Cremophor is a non-ionic solubilizer that is commonly used as a formulation vehicle for water-insoluble drugs such as ETS2101. However, it is not biologically inert and its use is associated with hypersensitivity reactions. The ETS2101 infusion formulation that has been the subject of clinical studies to date contains Cremophor, hence patients required dexamethasone pre-treatment to limit Cremophor-associated side effects. e-Therapeutics is pursuing oral (or other non-steroid) formulations for ETS2101 as it believes these would have a greater anti-tumour effect.

New data have demonstrated that in the presence of an inflammatory stimulus, ETS2101 is able to strongly and selectively modulate immune-potentiating cytokines (such as IL-10 and GM-CSF). The use of dexamethasone, a steroid with anti-inflammatory and immunosuppressant effects, as a pre-treatment is likely to counteract the selective immune-potentiation shown by ETS2101. We expect that e-Therapeutics will fund and carry out bioavailability studies exploring different ETS2101 formulations without steroid pre-treatment and, depending on the findings, will be able to articulate a new development and partnering strategy for this asset.

In February, e-Therapeutics released top-line data from a 164-patient, eight-week Phase IIb study of ETS6103 (tramadol) in major depressive disorder (MDD), which showed that low-dose ETS6103 did not meet its primary endpoint of statistical non-inferiority to amitriptyline in patients refractory to SSRI (selective serotonin reuptake inhibitor) therapy. Nevertheless, more detailed data analysis (Exhibit 6) indicated that the study confirmed ETS6103’s expected overall profile as having antidepressant activity, with responders seen at both dose levels (70mg and 20mg) and, importantly, a more benign side effect/tolerability profile than amitriptyline.

The results of the detailed analysis, coupled with an earlier Phase IIa study, where high dose ETS6103 (200-400mg) was demonstrated to be non-inferior to amitriptyline in the same patient population, underpin e-Therapeutics’ contention that ETS6103 could represent an attractive therapeutic option for depressive patients who do not respond to SSRI therapy (around 30% of MDD sufferers). Another important consideration for the Phase IIb study design is the fact that tramadol is an off-patent analgesic. Demonstrating ETS6103’s efficacy at a lower, sub-therapeutic pain dose in MDD has identified a commercially viable dose level that is protected by strong IP, which should ensure that the use of ETS6103 in this indication is not cannibalised by generics.

e-Therapeutics will not fund further development of ETS6103, but is assessing various options for out-licensing. There is no indicative timeline for a deal. In our view, the likely development and commercialisation partner will not be a large pharma major, but one who is attracted to ETS6103’s profile as an IP-protected drug that can address SSRI non-responders with a low therapeutic dose and an improved side effect/tolerance profile vs current second line tricyclic anti-depressants.

e-Therapeutics’ key near-term sensitivity is execution risk in relation to securing licensing deals. Its strategy is centred on securing partner(s) for its preclinical drug candidates or discovery platform collaborations, which will be critical for future revenue generation through upfront payments, as well as downstream milestones and royalties. The company has increased its business development activities, although timing of the first deal is uncertain. A deal should provide important validation for the network pharmacology platform and may catalyse additional partnerships. Conversely, the absence of deals in the next 24 months may mean that e-Therapeutics will have to raise funds.

The usual risks associated with drug discovery and development also apply to e-Therapeutics, including development delays/failures, IP protection, regulatory risks, competition, and financing and commercial risks. Other specific sensitivities, both on the upside and downside, are as follows:

e-Therapeutics has two main sources of value creation: the discovery platform and the legacy pipeline. Given the significant investment into, and development of the discovery platform, the company’s strategy has shifted emphasis onto commercialising its platform and new product candidates. As a consequence of this, and the fact that there is limited visibility on the partnering and development timelines of the legacy portfolio, we have re-evaluated our valuation approach.

Management has stated that over the next 18-24 months, their key focus will be on platform validation through execution of collaborations. The first deals are yet to be secured, thus there is no existing benchmark for potential deal terms, nor any firm indication of deal format. In our view, either simple preclinical asset out-licensing, or a discovery collaboration (coupling a partner’s compound library with e-Therapeutics’ discovery engine) is likely.

Analysis of disclosed out-licensing deal metrics for preclinical/research-stage assets as collected by BioCentury (Exhibit 7) indicates that average upfront payments have increased to >$20m since 2014, whereas upfront payments were typically mid-teen million dollars between 2009 and 2013.

Using $23m (c £16m) as a benchmark for the upfront payment per deal that e-Therapeutics might expect to obtain and what we believe are reasonable assumptions on costs (Exhibit 8), we have attempted to back-calculate what is implied by the current market cap. Assuming a 12.5% discount rate applied to annual risk-weighted spend of £10m, we calculate that the current market cap of £38m is supported on the basis of securing six non-risk weighted deals over the next three years (one in 2017, two in 2018, two in 2019 and one in 2020). This indicative methodology does not ascribe value to potential future milestones/royalties, the technology platform or the IP estate.

Using the same upfront and cost assumptions as detailed above, e-Therapeutics’ target of securing two out-licensing deals per year would generate an annual operating profit of £18-22m, and enable the company to become self-funding. We highlight that this excludes the impact of potential future milestones or royalties, which would represent upside. However, the downside sensitivity is that in the absence of deal(s), and therefore revenues, e-Therapeutics would need further funding in 2018.

The first deal will represent an important de-risking event. It also unlocks the potential for execution of deals at a faster pace, or with larger upfront payments (particularly with respect to competitively attractive targets). Additional deals would unlock upside as this commercial strategy is highly scalable. As we gain greater visibility on the pathway for the lead projects and deal economics, we will refine our valuation accordingly.

e-Therapeutics reported cash of £24.8m at end-January 2016 (vs £30m at end-July 2015 and £33.8m at end-January 2015). Our model continues to suggest that this should be sufficient to fund operations into FY19 given current spending plans, the anticipated receipt of a £2.5m R&D tax credit in financial H117 and up to a further £6m in the subsequent two years. We currently assume that the £1.76m initial consideration for the Searchbolt acquisition is paid for via issue of new equity at 14.55p, but that the £563k retained consideration is paid out of existing cash. We do not include any forecast revenue from potential deals in our model at this stage given the uncertainty regarding timelines and deal structure. However, we highlight that candidates selected from the discovery projects are expected to be ready to enter the clinic in 2017, offering potential for high-value partnerships during the next two years. Business development initiatives for ETS6103 and ETS2101 may also lead to licensing deals.

FY16 operating loss was £11.6m, an increase on FY15 (£10.2m loss) due to higher R&D spend. R&D costs increased to £9.97m (FY15: £8.5m), albeit with a change in mix. Discovery costs rose by £1.6m to £4.3m, reflecting the higher number of active projects (12 vs six), while development expenditure fell £0.3m to £5.5m due to less cost associated with ETS2101 (Phase Ia UK and US trials have completed; oral formulation trial costs were incurred in FY15). Internal R&D costs were broadly flat year-on-year; however, external spend (all clinical and preclinical work is subcontracted to CROs) increased to £6.8m (vs £5.2m in FY15). This increase was driven by external discovery spend, which rose from £0.7m to £2.3m as a result of an increasing number of active discovery projects and their progress into lead optimisation/lead compound selection (which is more costly than initial assays). G&A costs for FY16 were modestly ahead of FY15 (£1.63m vs £1.59m), albeit masking a £0.3m increase in business development spend to £0.4m, largely during H2 FY16.

An R&D tax credit of £2m (relating to FY15) was received in H116, offsetting some of the full-year operating loss, and reducing cash burn to £9m. Receipt of a £2.5m R&D tax credit for FY16 is expected in H117, with further tax credits of up to £6m anticipated in the following two years. Tax credits should help offset cash burn and support our view that e-Therapeutics is funded into FY19.

We have updated our FY17 and FY18 forecasts. We now forecast R&D costs of £11.5m for FY17 (up from £10.8m previously) to reflect the cost of winding down the ES2101 clinical trials, and £8.5m in FY18 relating purely to investment in discovery. Admin costs are estimated at £1.43m (modestly up from £1.35m) for FY17 and £1.48m for FY18. Additionally we have adjusted our assumptions for future tax credit receipts.

e-Therapeutics has guided that platform costs of c £2m pa remain broadly flat, while project costs will remain high due to the number of active discovery projects in preclinical studies and their increasing maturity. External project spend will rise: outstanding external project orders at end-FY16 stood at £1.7m. The company has also indicated that current funds would enable five or more existing projects to complete preclinical testing, although we understand that there is a discretionary element to this spending. Timings and magnitude are likely to vary in response to the rate of preclinical development progress, the results generated and deal timings. Our forecast normalised net loss for FY17 increases to £12.9m (from £12.3m), and our forecast end-FY17 cash, reflecting the Searchbolt acquisition is now £14.5m (from £14.3m).