Selvita — Update 14 October 2016

In July 2016, Selvita and Epidarex Capital announced the formation of a new company, Nodthera, headquartered in Edinburgh, Scotland. Nodthera centres on NLRP3 inflammasome inhibitors, a first-in-class small-molecule technology developed internally by Selvita.

The inflammasome was discovered (and given its name) by a team led by Professor Jurg Tschopp at the University of Lausanne in 2002, when his team identified it as the molecular mechanism behind the activation cascade of interleukin (IL)-1. IL-1 is a family of pro-inflammatory cytokines (a broad term for small proteins responsible for cell signalling) that has been widely implicated in pain, inflammation and autoimmune conditions with several approved drugs targeting IL-1 subtype IL-1beta.1,2

There are two immune system types: innate and acquired. Innate is in-born, non-specific ability to defend against infections; acquired immunity is specific to a pathogen and is responsible for a long-lasting effect, eg vaccination. There are several classes of innate immune system receptors, with the two most researched ones being toll-like receptors (TLRs), located on cell membranes; and nucleotide-binding oligomerization domain-like receptors (NLRs) located inside the cells.3 Both classes recognise microbial infection, which leads to secretion of proinflammatory cytokines like IL-1beta. Inflammasomes (there are several subtypes described) are molecular mechanisms in the middle of this cascade and in some cases can also be stimulated by internal chemical signals without the presence of an infection. This may lead to autoimmune disorders. A unique subtype of inflammasomes – NLRP3 – is able to sense both external and internal signals.

Nodthera’s technology is first-in-class, small molecule and targets NLRP3 inflammasome, therefore it is clearly differentiated and acts more upstream than therapies targeting IL-1beta. The first drug to target IL-1beta was anakinra (Kineret), an IL-1beta receptor antagonist, developed by Amgen and approved by the FDA for rheumatoid arthritis in 2001 and later licensed by Swedish Orphan Biovitrum (now Sobi). Inconsistent clinical results, a short half-life requiring daily dosing and painful subcutaneous injections discouraged practitioners from using it. Currently the drug is also approved for cryopyrin-associated autoinflammatory syndrome (CAPS), a very rare condition characterised by a number of inflammatory responses such as fevers, rash, joint pain, headaches, conjunctivitis and many other symptoms. Kineret peak sales flat-lined in 2008-11 at around $60m, increasing to $96m following the approval of an additional indication in 2015 (EvaluatePharma).

Several other IL-1beta targeted therapies aim to address issues related to anakinra, with the marketed ones being rilonacept and canakinumab, and there are other projects at different stages of R&D. Canakinumab (Ilaris, Novartis) is a neutralising humanised monoclonal antibody originally approved in 2009 for CAPS, with the label now expanded to acute attacks in gouty arthritis and systemic juvenile idiopathic arthritis. Peak sales reached $236m in 2015. Rilonacept (Arcalyst, Regeneron Pharmaceuticals) is a decoy IL-1beta receptor and was first approved for CAPS in 2008, with sales reaching $14m in 2015 (EvaluatePharma).

Inflammasomes can either cause the inflammation or aggravate the underlying condition. Besides CAPS there are several other rare conditions that have been explored as potential targets for targeted inflammasome and IL-1beta therapies, such as familial Mediterranean fever, pyogenic sterile arthritis, hyperimmunoglobulinemia D syndrome and TNF receptor-associated syndrome.4 However, these conditions are rare to extremely rare, and therefore more of a subject of academic research. Industry funded research is focused on more prevalent diseases, including neurodegenerative diseases (multiple sclerosis, Alzheimer’s disease and Parkinson’s disease) and metabolic disorders (atherosclerosis, type 2 diabetes and obesity).5 Although neurologic and metabolic disorders are not traditionally considered to be inflammatory, the contribution of the inflammatory component is increasingly being recognised.5

While Nodthera’s technology is still in an early preclinical stage with few details released, the inflammasome’s role in immune system response and its modulation is attracting private funding, with Inflazome and IFM Therapeutics being recent examples. In September 2016, Dublin-based Inflazome closed a Series A funding round with €15m in new capital co-led by Novartis Venture Funds and Fountain Healthcare Partners. The company is developing small molecule inhibitors of the inflammasome. IFM Therapeutics finalised a Series A financing round with $27m co-led by Atlas Ventures and Abingworth in June 2016. The company is developing inflammasome modulators for cancer and inflammatory diseases. Notably, IFM was seeded with just $2m in October 2015.

We consider this approach, to carve out the asset and fund the research together with specialist investors such as Epidarex, as innovative, with the potential to speed up the preclinical development in Selvita’s portfolio. Potentially we could see more asset financing solutions like Nodthera. For the time being we do not include this asset in our valuation due to its early stage and the lack of development details, eg indications. However, as the R&D progresses, we will revisit Nodthera.

Total Q216 revenues of PLN15.1m grew 11.7% quarter-on-quarter (Q216 vs Q116) and 19.6% year-on-year and came in somewhat below our forecast of PLN17.2m. Excluding subsidies and other revenues, this corresponded to a contraction of 1.0% quarter-on-quarter, and growth of 27.5% year-on-year. The main reason for the flattish quarter-on-quarter performance was lower sales from the Innovation segment (to external clients and excluding subsidies), with Q216 revenues of PLN2.6m versus PLN3.9m in Q116 (Exhibit 1). Notably, the Innovation segment (R&D activities) includes revenues in the form of milestones payments from drug discovery partnerships, which tend to be volatile from quarter to quarter. Since this segment includes advanced research agreements with large international pharmaceutical corporations offering potentially higher margins, it is a long-term focus for Selvita.

The profitability- driving Services segment (excluding subsidies) on the other hand delivered growth of 14% quarter-on-quarter and an impressive 71% year-on-year. The newly established bioinformatics segment (Ardigen spin-out in October 2015, which Selvita consolidates, see our previous reports) recorded H116 external sales of PLN1.25m in its first full six-months of operations.

Group subsidies, which are reported as a part of Innovation or Services segments, were PLN3.7m, flat year-on-year, but up 88.4% quarter-on-quarter as subsidies in Q116 were exceptionally low compared to 2015, as Selvita switched EU Financial Frameworks (completed significant R&D projects in 2015 and started new ones in 2016). Selvita so far has been very successful in obtaining subsidized funding for its innovative projects and we expect that this should continue in the near term.

Total Q216 operating expenses of PLN16.8m included a non-cash cost of PLN899k (PLN4.0m in H116 so far) related to the employee stock options programme (ESOP). Adjusted for this, operating loss was PLN792k versus operating profit of PLN581k in Q116 and PLN1.9m in Q215, mainly reflecting increased internal R&D spend and the capacity expansion, including new personnel hires as well as the opening of new facilities and international sales offices. For example the total number of employees increased from 264 in August 2015 to 368 in August 2016.

The commercial backlog (Exhibit 2) as of August was PLN55.9m for 2016, a 25% increase compared to the same period last year. The reported order backlog amounts to 84% of our FY16 revenue forecast. Notably, actual 2015 sales ended up 26% higher than the mid-year’s backlog, while our 2016 sales estimate is 19% higher than the mid-year backlog. We believe the attractive organic sales growth will be further underpinned by the rapid expansion of Selvita’s capacity.

Selvita is not slowing down with its capacity increase. In February 2016, the company initiated an expansion to a new location in Poznan with employee numbers increasing by 70 to 368 in 2016 alone. On 21 September 2016, Selvita announced a new laboratory infrastructure development to be located close to the current Selvita facilities in Krakow, with the works estimated to be completed in 2019. The plan includes a newly built laboratory and office complex with a total area of 150,000 sq ft and space available for c 1,000 employees. To finance the project Selvita will use a mix of cash, bank financing, tax incentives (the property will be located in a special economic zone) and public grants. The purchase price for the land is PLN7.5m, while the total costs of the development project are being refined. The final decision on the investment will be made during the extraordinary general meeting on 25 October. Subject to it being approved, we will revise our model to reflect the new capex requirement, as well as future growth rates given the additional capacity. Notably, Selvita has also signed a separate agreement with the Ministry of Development, which will provide a grant of PLN9.0m for the expansion of Selvita’s current research facilities with the total value of the project PLN19.9m. This will add to the company’s R&D capacity.

Meanwhile, we have made several revisions to our estimates (Exhibit 3). Q216 Services sales (excl. subsidies) were spot on our estimate; we therefore leave it virtually unchanged. We have cut our expected 2016 and 2017 Innovation revenues and also slightly reduce the Subsidies figure, but slightly increase sales from the Bioinformatics segments. The net effect on our 2016 revenue forecast is negligible. The main effect on our profit estimates was from our revision of operating costs reflecting the company’s expansion. Total operating expenses were PLN12.9m in Q116 (excluding ESOP) versus PLN15.9m in Q216. We increase our total 2016 opex estimate from PLN55.5m to PLN58.2m, which results in a reduction to our 2016 operating profit forecast from PLN5.8m to PLN2.6m.

As of August 2016 the cash position was PLN30.7m with virtually no debt. Based on this and combined with the profitable research services business, we believe there is sufficient cash for the internal drug candidates SEL24 and SEL120 to complete Phase I and pre-Phase I studies, respectively. For these programmes to progress thereafter we anticipate additional financing and/or a partnership deal will be needed.

While we are reducing our short-term profitability forecasts to reflect increased costs, our long-term growth expectations remain intact. In line with the progress of SEL24 to the Phase I/II stage, we increase our success probability from 7.5% to 15%, while keeping other R&D assumptions unchanged. Applying this and including a slightly higher cash position together with rolling our model forward in time, we calculate Selvita’s valuation at PLN376m or PLN28.0/share, compared to PLN363m or PLN27.0/share previously. Although our combined DCF and risk-adjusted NPV valuation is PLN376m, we note that due to the early stage of the lead R&D projects, the success probabilities typically range from 5% to 15%. In other words, if all programmes (in Exhibit 4) are a success, as per our model, the valuation would be PLN963m.