Regeneus — Japan clinical licence deal expected near term

Regeneus is an Australian (Sydney) biotechnology company, founded in 2007 to develop and commercialise the use of adipose (fat) derived cells, including mesenchymal stem cells (MSCs), to treat inflammatory conditions in animals and humans. In 2013, Regeneus acquired therapeutic cancer vaccine technology, which it is delivering for veterinary and human applications. Recent regulatory change in Japan offers a potential fast path to market for Progenza, its off-the-shelf human stem cell product, which has completed a successful Phase I trial. Regeneus has entered into a collaboration with AGC for the manufacture of Progenza in Japan and formed a joint venture, which is seeking to out-license rights to develop and commercialise Progenza for osteoarthritis and other clinical indications in Japan. Regeneus’s strategy is to focus on early-stage product development and to seek partners that will undertake the later stages of clinical development.

We value Regeneus at A$170m, or A$0.82/share, based on a sum-of-the-parts DCF model, using a standard 12.5% discount rate. This represents fair value for the stock today, based on the potential development of multiple programmes including Progenza, Sygenus, CryoShot, Kvax, the RGSH4K human cancer vaccine and potential milestones under the AGC deal. Progenza is the key long-term value driver, with peak sales estimated at A$2.1bn, so further partnerships and clinical and regulatory progress over the next few years would significantly de-risk the product, which currently has a 35% probability of success in Japan and 20% in other markets.

Regeneus is subject to the risks typically associated with biotech company drug development, including the possibility of unfavourable or ambiguous outcomes in clinical trials, success of competitors and commercial decisions by partners or potential partners. We have assumed timely clinical and commercial progress for multiple programmes across multiple geographies, but any delays/setbacks would have a negative impact on our valuation. Signing up AGC as a manufacturing partner for Progenza in Japan has provided significant validation of the commercial value of the company’s technology; this should make it easier to sign clinical development partners, which represents near-term potential upside. Progress in developing additional indications for Progenza would also represent valuation upside.

Regeneus reported an operating loss of A$2.7m in H1 FY18 (six months ending December 2017). Net cash used in operating activities in the period was A$1.0m, including the receipt of A$2.6m under the Australian government’s R&D tax incentive scheme in the period. We leave our near-term financial forecasts virtually unchanged, including our assumption that Regeneus will earn a US$5m milestone payment from AGC before the end of FY18. The cash balance of A$1.7m at 31 March 2018, combined with an estimated A$2.5m R&D rebate expected to be received in Q1 FY19, and A$0.9m of loans to shareholders that are repayable in June 2018, would fund operations into Q219 at the projected burn rate of A$0.6m/month. This projection does not include the US$5m AGC milestone that the company expects to earn in Q4 FY18 or any payments from future licensing deals, which would extend the funding runway further. The company has put in place a loan facility secured against the anticipated R&D rebate, which could provide up to $1.9-2.0m of funds over the next six months.

Regeneus is developing and commercialising regenerative medicines and cancer vaccines. Its key regenerative medicines, Progenza (human) and CryoShot (veterinary), are based on a proprietary adipose (fat) derived allogeneic stem cell technology platform. The company is also developing the RGSH4K therapeutic human cancer vaccine, the Kvax canine cancer vaccine and products based on the Sygenus cell secretions technology for dermatology applications. The product portfolio (Exhibit 1) offers a mixture of near- and long-term opportunities, with a number of fast-track routes to market.

Regeneus entered into a strategic collaboration and licensing agreement with AGC of Japan in December 2016, granting AGC exclusive rights to manufacture its Progenza allogeneic mesenchymal stem cell (MSC) product in Japan. Regeneus and AGC have established a 50:50 JV, Regeneus Japan, which holds the rights to develop and commercialise Progenza in Japan. Regeneus received US$5.5m upfront and a US$1m milestone in June 2017 following the successful completion of the STEP Phase I study of Progenza in patients with knee osteoarthritis (OA). Regeneus could earn two further payments of US$5m each if it achieves certain development milestones.

The Regeneus Japan JV is seeking clinical development partners to progress the development of Progenza for OA and other indications in Japan. The positive safety data, early indications of efficacy and recently granted Japanese patent should all aid the JV as it negotiates with potential partners to progress the clinical development of Progenza for OA and other indications in Japan. Japan is a most attractive market for regenerative medicines because of laws that took effect in November 2014, which allow for expedited conditional approval of regenerative medicine products on the basis of safety and early evidence that is predictive of efficacy. Regeneus has guided that it expects the JV to grant a licence for the clinical development of Progenza in Japan by the end of FY18, which would trigger the first US$5m milestone payment; we model the second milestone being achieved in FY21.

The technology to manufacture Progenza is being transferred to AGC, which will undertake GMP manufacture of the cells for clinical trials and commercial sales in Japan. We assume that the technology transfer and validation of Progenza manufacture by AGC would be completed in H1 CY19, which would allow a Phase II efficacy trial in Japan in patients with knee osteoarthritis to commence in H2 CY19 or H1 CY20.

Regeneus retains 100% of the rights to Progenza outside Japan. It is in separate discussions with potential partners to develop Progenza for OA and other indications in territories outside Japan.

In a previous report in September 2017, we summarised a number of regenerative medicine M&A and licensing deals for allogeneic products involving Japanese companies. With the Regeneus JV expected to enter a clinical development and commercialisation licence deal in Japan in the near term, we have again reviewed recent Japanese licence deals, and have identified two additional relevant licensing transactions and further developments in two of the previously-described transactions. The two additional deals are:

The further M&A or licensing transactions between the parties to the previously described transactions are:

Exhibit 2 summarises the key points of the two additional deals listed above plus the three regenerative medicine licensing deals identified in our previous report that involve either development and commercialisation rights in Japan or deals with Japanese pharma companies. The average upfront and milestone amounts among these five deals were US$15m and US$230m respectively.

We have previously evaluated a scenario in which the Regeneus Japan JV licenses Japanese rights to develop and commercialise Progenza in all indications to a single partner in a deal with comparable terms to the Kolon/Mitsubishi deal, given that it is expected that both products will initially be developed for knee osteoarthritis. In this scenario we assume a US$24m upfront payment, US$205m in clinical and regulatory milestones, and a high 20% royalty rate instead of sales-based milestone payments (we assume half of the payments included in the Kolon/Mitsubishi deal would be for sales-based milestones).

Our updated valuation of Regeneus under this scenario is A$222m or A$1.06 per share (vs our base case valuation of A$170m or A$0.82 per share). This includes Regeneus’s half share of the risk-adjusted upfront and milestone payments, as well as the benefit from increasing our probability of success for knee OA in Japan from 35% to 40%. We note that a licence deal that included rights for Progenza outside Japan would likely increase the probability of success in those additional territories as well.

In this report we have also considered a second scenario where the deal payments are in line with the average of the five deals in Exhibit 2 (ie US$15m upfront, development and regulatory milestones of US$115m [50% of total deal milestones of US$230m]) and where other assumptions are the same as in the scenario above. Under this scenario, our valuation of Regeneus would be A$204m or A$0.97 per share.

Top-line results for the placebo-controlled Phase I STEP in knee OA patients were reported in May 2017, with detailed results included in a scientific publication in March 2018.1 The trial randomised 20 patients to receive either 3.9m or 6.7m Progenza cells or placebo via a single injection into the knee. Eight patients were treated with each dose of Progenza and four received placebo injections. Twelve months of follow-up showed that Progenza was both safe and well tolerated. There were no serious adverse events and the incidence and nature of adverse events were similar in the Progenza and placebo groups.

While safety and tolerability was the primary outcome of the trial, patients were also monitored to assess the effect of Progenza on knee pain and function, quality of life, knee structures as assessed by magnetic resonance imaging (MRI), and osteoarthritis biomarkers.

The majority of Progenza-treated patients experienced clinically meaningful reductions in pain as measured on the Western Ontario and McMaster Universities Arthritis Index (WOMAC) pain subscale, whereas the same pain reduction was not seen in the placebo group. The 16 Progenza-treated patients showed a statistically significant reduction in pain from baseline (p<0.001), whereas for the smaller group of four patients treated with placebo there was no statistically significant reduction in pain (Exhibit 3a).

The WOMAC stiffness and physical function subscale assessments (Exhibit 3 b and c) for the pooled Progenza groups showed statistically significant improvements at each time point except for month 9 stiffness. The placebo group showed improvement in stiffness and physical function scores of similar magnitudes, but these were not statistically significant.

Exhibit 4 shows that pain measured on the widely used visual analogue scale (VAS) revealed very similar findings to the WOMAC pain subscale, with highly statistically significant improvement from baseline for the pooled Progenza groups, and much smaller improvements in the placebo group. The improvement in VAS pain scores was maintained at 12 months for the low dose group, while for the high dose group the improvement had diminished somewhat by 12 months to be comparable to the placebo group. However, given the small patient numbers in this study and the fact that the combined data from both dose groups showed a highly significant improvement vs baseline at 12 months, it is not clear whether or not the effect of Progenza treatment was waning by 12 months.

The STEP study also produced some encouraging evidence which suggests that Progenza treatment may act as a disease modifying OA drug to slow or halt knee cartilage degradation and the progression of knee OA.

When knee cartilage volume that was measured by MRI 12 months after Progenza treatment was compared to baseline measurements, the low dose group showed a 0.4% increase in the amount of cartilage on the lateral (outside half) of the tibia (shinbone), whereas in the placebo group there was a statistically significant 5% loss of cartilage (Exhibit 5). The difference between the low dose and placebo groups was also statistically significant and corresponds with preclinical evidence of halting disease progression. The high dose Progenza group showed a statistically significant 3.5% decline in lateral tibial cartilage volume over the 12 month period.

However, the same benefits of Progenza therapy were not seen in the medial (inside half) of the tibia. When the medial tibial cartilage was measured, the placebo and low dose groups showed similar small losses in cartilage volume (-1.7% and -1.5% respectively), whereas in the high dose group there was a larger -3.5% loss in cartilage volume. None of the changes in medial tibial cartilage volume was statistically significant.

Other groups have also reported a greater protective effect of treatments on lateral vs medial tibial cartilage2. In knee OA the medial cartilage is generally more severely affected than the lateral cartilage, and one possible explanation for the observations in the STEP study could be that the lateral cartilage may have greater capacity to repair because it is less severely damaged.

Overall, the exploratory efficacy data from the Phase I STEP trial suggest that intra-articular injection of Progenza results in long-lasting improvements in pain, which is the most important clinical symptom of osteoarthritis. The clear separation in pain scores between pooled Progenza groups and placebo is encouraging and suggests there is a good prospect that a Phase II study of Progenza in knee OA could demonstrate the “probable efficacy” that is required for conditional approval of regenerative medicine products in Japan. The MRI findings seen with Progenza treatment indicate a potential for disease modification, especially as this concurs with preclinical findings. If this effect is confirmed in larger trials it would be an important advantage of Progenza because other treatments for knee OA provide symptomatic relief but do not change the course of the disease.

Regeneus is positioned to take advantage of the favourable regulatory environments for cell-based therapies that are in place in a number of countries in addition to Japan.

In December 2017, the Chinese FDA (CFDA) announced new guidance on the regulatory pathway for cell-based products. Cell therapies will now be regulated as drugs but, unlike the standard protocol for drug development, cell therapy products will only need to go through two clinical phases: an early phase (focused on safety, dosing, and pharmacokinetics and pharmacodynamics) and a confirmatory phase. Importantly, regulation as drugs will give cell therapy products a more direct pathway to reimbursement via inclusion on national drug reimbursement lists.

This more favourable regulatory environment is likely to see increased interest in licensing cell therapies for the China market, in a similar fashion to the way that Healios is seeking to add development rights to MultiStem cell therapy in China to its existing licence deal with Athersys for Japan. Regeneus might well encounter similar interest in the rights to develop Progenza in China.

The 21st Century Cures Act allows the US FDA to grant accelerated approval to regenerative medicine products, and gives the FDA wide discretion in creating new approaches to regenerative medicine. The new accelerated approval pathway allows certain regenerative medicine products to be designated as a Regenerative Medicine Advanced Therapy (RMAT). To qualify for this pathway, the product must be aimed at a serious disease and have the potential to deal with currently unmet medical needs.

Notably, MiMedx’s micronized amniotic tissue injectable AmnioFix was granted RMAT designation by the FDA in March for use in the treatment of knee OA. This is a significant development because previously it had not been clear whether the FDA would consider OA to be a sufficiently serious disease to warrant the RMAT designation. This precedent suggests that Progenza could also potentially qualify for RMAT designation and access to the associated accelerate approval pathway in the US.

Regeneus has developed products for topical treatment of inflammatory skin conditions such as acne and wound healing. The Sygenus technology harnesses the anti-inflammatory properties of the secretions released by MSCs during cell culture.

In February the company reported results from a six-week study of twice-daily application of Sygenus gel in 33 healthy volunteers with mild to moderate facial acne. The study found that the Sygenus gel was well tolerated and showed that there was an overall improvement in the appearance of acne as early as three weeks. There was a statistically significant reduction in the number of inflammatory and non-inflammatory acne lesions from baseline to week 6. In addition, the acne global severity score showed significant improvement at week 6 compared to baseline.

Supported by the acne clinical trial data, Regeneus is in discussions with potential partners regarding development and commercialisation of Sygenus for acne and other inflammatory skin conditions. The company has been granted patents in Australia, Europe, China, the US and Japan covering composition manufacture and use of Sygenus technology for topical treatment of acne.

The market research group Persistence Market Research estimated the global acne market to be worth US$4.9bn in 2016 and forecast it to grow at 4.6% per year to reach US$7.3bn by 2025. It further estimated the inflammatory acne segment to comprise 60% of the global market, equivalent to US$3bn in 2016.

Separately, Sygenus has shown promising results in a preclinical pain model. In that study, Sygenus applied topically to the site of a minor surgical wound produced a significantly greater and longer-lasting analgesic effect than an injection of morphine; the beneficial effect of the highest Sygenus dose lasted for up to three hours, whereas the morphine had lost its effect by this time (Exhibit 6). Regeneus is further investigating the use of its stem cell technology for the treatment of pain in collaboration with the University of Adelaide and Macquarie University.

The RGSH4K human therapeutic cancer vaccine uses a chemical modification of the patient’s own tumour proteins to couple them to the bacterial adjuvant streptavidin to make them more immunogenic. This relatively simple manufacturing process would be expected to translate to a low cost of manufacture for a personalised cancer vaccine.

The Phase I ACTIVATE trial is a single-centre, open-label, dose-escalating study of the safety and preliminary efficacy of the vaccine. The initial target was to treat 21 patients with a range of advanced cancers to test varying levels of the streptavidin immunostimulant in order to identify a biologically active dose. Patients have been treated in all three dose levels without any unexpected safety concerns. After discussions with the principal investigators it was determined that a lower number of patients would provide sufficient safety and tolerability data and support subsequent development decisions. Recruitment has been closed and the study results are expected to be reported by the end of June.

Regeneus has commenced preclinical studies for RGSH4K in combination with an anti-PD1 immune checkpoint inhibitor (ICI). We see potential for the RGSH4K vaccine to improve response rates to ICI immunotherapies by stimulating an initial immune response that can be made more powerful by the ICI drug, which strengthens the ability of “primed” T lymphocytes and other white blood cells to attack the tumour. We await the outcome of the ICI combination studies with interest because, based on the mechanisms of action, we would expect the combination of the RGSH4K vaccine with an ICI drug to be more effective than either therapy on its own.

We currently base our valuation of the RGSH4K human cancer vaccine on an indicative peak sales estimate of A$500m. There are no comparators for RGSH4K in the market – for reference we note that a niche monotherapy, Provenge, a therapeutic prostate cancer vaccine launched in 2011, achieved sales of US$303m in 2016 and ~US$330m in 2017. While RGSK4K is potentially applicable to a wide range of cancer types, at this stage we do not know which cancers will be targeted for initial regulatory approval. When we have more information about the efficacy of the vaccine and/or the cancers that will be targeted for initial approval we are likely to revise our peak sales estimate.

Regeneus is developing a cancer vaccine for dogs based on the same technology as RGSH4K. This therapy, known as Kvax, is currently being tested in a randomised trial in 45 dogs with lymphoma being conducted in Sydney. In a previous US-based study in 13 dogs with osteosarcoma, the principal investigator concluded that Kvax was well tolerated and appears to confer an improved progression-free interval and improved overall survival compared to a historical control group.

Kvax does not require specific regulatory approval to be sold in the US. Therefore, it could be launched commercially in that country once sufficient efficacy data are available to support marketing efforts. The company continues to build clinical data to support licensing opportunities for Kvax.

CryoShot is an allogeneic (off-the-shelf) product containing MSCs derived from the fat tissue of donor animals and expanded in cell culture. A pre-pivotal trial of CryoShot in 80 dogs at the University of Pennsylvania is expected to report results in H1 CY19. In November 2015 Regeneus entered into a collaboration with a major animal pharma company, which has an option to exclusively license global rights to the CryoShot Canine technology at the completion of the pre-pivotal study. Under the terms of the licence, Regeneus will receive an upfront fee, milestone payments and a royalty on sales. The results of the study will be used to finalise the design of a pivotal US FDA trial, which would be funded by the partner.

The most important potential catalysts in FY18 are the ongoing discussions with potential clinical development partners for Progenza in Japan. Securing a clinical partner for one or more indications would provide further validation of the commercial potential of Progenza, as well as providing additional non-dilutive funding.

Anticipated milestones in 2018 include:

Our valuation of Regeneus is increased to A$170m (vs A$146m), or A$0.82/share (vs A$0.70/share). We have rolled forward the DCF model and introduced an indicative valuation of Sygenus in acne for the first time. We assume a 20% probability of success and indicative peak sales of A$115m in 2025, equal to 2% of the global market for inflammatory acne. Given the lack of visibility as to the likely deal structure for this indication we do not include any upfront or milestone payments in our model, and instead assume that all of the income from this product would be in the form of a 20% royalty on net sales.

Our sum-of-the-parts DCF valuation model is summarised in Exhibit 7, with key assumptions shown in Exhibit 8.

Our valuation model applies a standard 12.5% discount rate and includes net cash of A$4.1m at end June 2017. We assume that product sales reach peak market share six years after launch, grow in line with the market for the next four years (five years for Progenza in Japan) and then decline at 10% per year. For simplicity, we do not include upfront and milestone payments from any potential future licensing deals that have not yet been signed, and instead assume that the full value of the product will be paid as a royalty. We note that there is a risk adjustment applied to each programme, appropriate to the status of development. Risk adjustments would unwind as programmes advance through clinical studies, gain regulatory approvals and secure commercial partners, etc.

With regard to Progenza, RGSH4K, Sygenus, CryoShot and Kvax – the key long-term valuation drivers – we have assumed timely clinical and commercial progress in multiple regions, which should be achievable, but any delays/setbacks would have a negative impact on our valuation. Signing up AGC as a manufacturing partner for Progenza in Japan has provided significant validation of the commercial value of the company’s technology; this should make it easier to sign clinical development partners, which represents near-term potential upside.

Progenza could potentially be developed for a range of disease indications. At present we include only the single osteoarthritis indication in our valuation model, so progress in developing additional indications or licensing deals that include additional indications for Progenza represent potential sources of upside to our valuation.

If the Regeneus Japan JV signs a clinical development partner in Japan with comparable terms to the Kolon/Mitsubishi deal (US$24m upfront and US$205m of development and regulatory milestones), this would increase our valuation to around A$222m or A$1.06 per share (up from A$170m or A$0.82 per share). Under a scenario where the licence deal included US$15m upfront and US$115m in development and regulatory milestones, our valuation would be A$204m or A$0.97 per share.

We currently base our valuation of the RGSH4K human cancer vaccine on an indicative peak sales estimate of A$500m, as we currently have limited information about potential efficacy and do not know which cancers will be targeted for initial regulatory approval. When we have more information about the efficacy of the vaccine and/or the cancers that will be targeted for initial approval we are likely to revise our peak sales estimate.

Regeneus reported an operating loss of A$2.7m in H1 FY18 (six months ending December 2017). Net cash used in operating activities in the period was A$1.0m, including the receipt of A$2.6m under the Australian government’s R&D tax incentive scheme in the period. We leave our near-term financial forecasts virtually unchanged, including our assumption that Regeneus will earn a US$5m milestone payment from AGC before the end of FY18.

The cash balance at 31 March 2018 of A$1.7m, combined with an estimated A$2.5m R&D rebate expected to be received in Q1 FY19, plus A$0.9m of loans to shareholders that are repayable in June 2018, would fund operations into Q219 at the projected burn rate of A$0.6m/month. This projection does not include the US$5m AGC milestone that the company expects to earn in Q4 FY18 or any payments from future licensing deals, which would extend the funding runway further. The company has put in place a loan facility secured against the anticipated R&D rebate, which could provide up to $1.9-2.0m of funds over the next six months.