By Illumination Capital:
Envision the ideal scenario to launch a drug therapy - the treatment is, of course, safe and effective, has additional benefits such as improving patient compliance and eliminating errors from patient administration, reduces out of pocket costs to patients while increasing economics to physicians and treatment centers, health plan reimbursement is in place, and the therapy addresses a large market opportunity. This model scenario is missing only one additional factor, chronic dosing, however, in the post-ophthalmology surgery category, specifically cataract surgery, Ocular Therapeutix's (OCUL) Dextenza® has nearly all of the key attributes one would like to see in a new drug product. And this sets the stage for our thesis that OCUL has significant upside potential, as Dextenza has recently become available to ophthalmologists and their patients in the U.S., and offers benefits to all stakeholders.
Dextenza® is a bioerodible insert designed to deliver a 0.4 milligram dose of the steroid, dexamethasone, into the eye for up to 30 days to treat inflammation and pain after ocular surgery. The insert is placed into the lacrimal canaliculus or the duct that drains tears in the eye. Dextenza offers patients the convenience of a full course of steroid treatment with a single preservative-free insert that is administered by the ocular surgeon during a procedure, or an ophthalmologist after surgery. This single insert can replace the need for patients to self-administer eye drops for pain and inflammation over several weeks under a complex dosing regimen. The current standard of care can require up to 70 steroidal eye drops in total delivered over a month with dosing frequency that changes throughout the month. For physicians, Dextenza puts control of post-surgical steroid treatment back in their hands by mitigating the risk of patient noncompliance. Phase 3 results for Dextenza demonstrated a favorable safety profile and efficacy results that were statistically superior for reducing pain and inflammation, versus the current standard of care treatment.
With 6 million prescriptions written annually in the U.S. for steroid-based eye drops for pain and inflammation associated with ocular surgery, and Dextenza's estimated net price per treatment in the $400-$500 range according to equity analysts, company presentations, and other industry sources, the total addressable market ((TAM)) for Dextenza is estimated at $2.4 to $3.0 billion. Conservatively, if Dextenza takes 25% of this market, factoring in that it is launching simultaneously against a competing product, Dexycu® from EyePoint Pharmaceuticals (EYPT), Dextenza could achieve peak annual sales in the $600 million to $750 million range. Assuming a forward price to sales multiple of 3-4 times estimated peak revenues, it is not unreasonable to believe that OCUL could trade with a valuation of $2 billion or more on Dextenza alone, or approximately $40 per share fully diluted if the product's launch is successful. This does not factor in new indications for Dextenza, the rest of the company's drug pipeline, and OCUL's technology platform (extended-release hydrogel drug formulation technology), which includes a collaboration with Regeneron Pharmaceuticals (REGN).
OCUL is trading at a significant discount primarily because of the 3-year delay in Dextenza's approval with prior management disappointing investors many times in the past on issues such as Dextenza manufacturing compliance, and negative clinical trial results for other product candidates in development. We believe that new management is executing with Dextenza now approved and launched, earlier-than-expected approval of Dextenza's inflammation indication, as well as an earlier-than-expected J-Code from the Centers for Medicare and Medicaid ((CMS)) which will facilitate broad health plan reimbursement for the product. The stock is cheap on Dextenza alone, and we believe the company's technology platform and pipeline represent upside opportunities as that they are not priced into the stock. Key value drivers going forward include the sales ramp of Dextenza, as well as potential business development activities that the company has planned for monetizing pipeline assets and the technology platform. We believe that the patient benefits of Dextenza, the appetite of physicians to use the product and make money on the procedure, and reimbursement in place will coalesce to make this a widely used treatment for cataract and other ocular surgeries. Insider buying in the past few months indicates that company management and the board see the strong opportunity for Dextenza and the pipeline as well.
At Illumination Capital, we attempt to uncover stocks with high growth potential, yet are priced reasonably, or at times trading at deep discounts relative to the opportunity. OCUL fits our approach, but it is worth understanding why a company with a product that has such high promise is trading at only $165 million in enterprise value as of the writing of this article.
In short, Ocular has had a messy past, putting many investors through changes as the promise of the company's pipeline took way longer to play out than anyone would have expected, with manufacturing and regulatory delays, as well as clinical trial setbacks along the way. Because of this history, OCUL is now a "show me" stock but offers an opportunity for tremendous upside.
Our research indicates that newer management, which took the reins in the second half of 2017, has finally worked through the company's legacy issues and appears to be executing, with several recent positive surprises that have moved the shares off of the bottom. These include Dextenza's approval in late 2018, an earlier than expected regulatory approval for Dextenza's post-surgical inflammation indication, as well as earlier than expected issuance of a permanent reimbursement code by the Centers for Medicare and Medicaid Services ((CMS)) - Dextenza's unique "J-code".
In this article, we will discuss the significant upside for OCUL, as Dextenza fits an important medical need, is just rolling out, and has attractive characteristics for rapid market adoption. However, we believe that it is important for investors to understand the background of the company to make a more informed decision on the stock.
Below we have summarized the stock history of OCUL, which is intended to offer important insights into the company itself, as well as how deep value stocks in the biotech industry can be created. Despite the tough company history, those in a position to be opportunistic have potential to capitalize on OCUL. A common saying on Wall Street is: "Trouble is Opportunity" and this may be one of those times.
Please refer to the stock chart directly below as the 5-year saga of OCUL is explained.
OCUL's 5-year peak on March 11, 2015 ($43 per share) coincided with positive trial results for Dextenza's first Phase 3 clinical trial for the treatment of intra-ocular post-surgical pain and inflammation. However, this was followed in April 2015 by the second Phase 3 trial results, which met the post-surgical pain endpoint but missed the post-surgical inflammation endpoint. Importantly, safety data were favorable in both pivotal trials, but OCUL subsequently met with the FDA and guided that it would file its NDA for Dextenza in the second half of 2015 for the pain indication only. The company informed investors that it would have to run a third Phase 3 trial to demonstrate efficacy on the post-surgical inflammation indication. This did not make investors happy, and a subsequent capital raise in early June at $22 per share sent the shares sliding into mid-2015. To make matters worse, in October 2015, the company's glaucoma trial for OTX-TP seemed to have an unexpectedly robust placebo arm result, muting the positive effect that OTX-TP had on patients in the Phase 2b trial. Despite positive results at the end of 2015 for Dextenza in allergic conjunctivitis, as well as favorable exploratory data in dry eye disease, investors continued to exit the shares.
2016 started off with optimism after the company conducted a positive Analyst/Investor Day in April, and FDA commented that OTX-TP could be developed for glaucoma without comparing it in subsequent clinical trials to treatment with timolol eye drops (the comparator drug that performed extremely well in the Phase 2b trial). But that optimism was short-lived as Dextenza missed statistical significance in a trial for allergic conjunctivitis, and the FDA also issued a complete response letter ((CRL)) to Ocular for Dextenza due to manufacturing issues. The stock went from over $14 per share to just over $4 per share from April to the end of July, once again taking investors on a rollercoaster ride. But the shares did recover through the end of 2016, as the CRL for Dextenza did not seem too onerous (only one specific manufacturing issue), and the third Phase 3 trial for Dextenza reported out with positive results for both post-surgical pain and inflammation. Also, in October 2016, the company announced a collaboration with Regeneron Pharmaceuticals to develop sustained release treatments for retinal diseases, such as Regeneron's blockbuster drug, Eyelea®. While 2016 ended on a high note, the volatility in the stock continued.
Building on the momentum from the prior year, 2017 also started out strong for OCUL with the company's resubmission of Dextenza's NDA for the post-surgical pain indication. However, in July 2017, a second CRL was issued by the FDA crushing OCUL shares once again, bottoming in the $5.00-$6.00 range. And at that point, investors were at their breaking point, and the board responded by making changes. New management was appointed in mid-2017, with the hiring of a new CEO, CFO, Chief Medical Officer and SVP of Regulatory Affairs. All of these executives joined the company within a month of each other and started their positions in August/September 2017. Despite the promise of Dextenza, the hangover with investors continued, and several lawsuits throughout the back half of 2017 kept pressure on the stock. OCUL ended 2017 in the mid-$4.00 range.
Shares of OCUL actually traded in a relatively tight range throughout 2018. The year began with a capital raise, and investors seeing an opportunity for Dextenza with all of the efficacy and safety data, and the progress that the Company was making. The lawsuits were behind the company, new management was at the helm, the pipeline looked good, and a partnership with Regeneron was also advancing. What could go wrong? An announcement in May 2018 that Phase 3 results for glaucoma treatment, OTX-TP, would be pushed out from 2H 2018 to 1H 2019, started a new downtrend in the stock. This was fueled by a weak biotech tape, and also an FDA Warning Letter for the company's ReSure Sealant product, which no one cared about, but served as a reminder that OCUL might still have regulatory troubles in the manufacturing area. Despite FDA APPROVAL for Dextenza in December 2018, which alleviated those manufacturing concerns, OCUL shares remained at the lows of the year. We believe this was due to three key factors. 1. Biotech stocks and the market, in general, remained weak, 2. The launch of Dextenza would not be imminent with the product in need of Medicare and health plan reimbursement approvals, and 3. Dextenza had a label that was not optimum because the post-surgical inflammation indication was still under review.
So with that extensive, but important history, investors should now have good context into OCUL's past, and how a potentially valuable asset can get wrapped up in a stock vehicle with significant bad will. So much so that it can create a potential "diamond in the rough" scenario. And one might have guessed, the lesson still had another chapter to unfold. The company began 2019 by submitting a supplemental NDA ((SNDA)) for Dextenza's post-surgical ocular inflammation indication and it raised capital with the issuance of convertible debt (conversion price of $6.50). In early May, the company announced that CMS recommended Dextenza for a unique J-code, a significant positive in that Medicare and other health plans will reimburse for the drug once the J-code goes in to effect. As expected, the stock responded positively to the J-code news. And then in late May, the company announced that OTX-TP missed its primary endpoint in the Phase 3 glaucoma trial. Despite positive data trends in the OTX-TP trial, the market took the stock down hard on this news. This was also the beginning of a very tough time for biotech stocks in general, and of course, the long-time investor hangover headache with OCUL seemed to be back again. So with the stock getting crushed once again, this time to a 5-year low of $2.50, the market seemed to forget about (or stop believing in) the Dextenza opportunity.
And now, back to our thesis….
With OCUL shares bottoming in May, and Dextenza approved and being readied for launch, the stock began to look attractive. We emphasize that the history lesson on OCUL above makes clear the durability of Dextenza's positive clinical performance through three Phase 3 trials. 567 patients were treated in Phase 3, and the therapy demonstrated very favorable safety and efficacy results - statistically significant higher proportion of patients that were pain free after surgery in all three trials vs. the comparator arm, no serious adverse events, and no need to remove the Dextenza insert (known as an explant) from any patient in Phase 3.
One who bottom-fished at this time was rewarded as two positive developments occurred since the stock's low point in May of this year - 1. FDA approval of the SNDA for Dextenza's post-surgical inflammation indication, ahead of expectations, and 2. CMS' preliminary assignment of a new unique HCPCS J-Code for Dextenza, also ahead of guidance. The J-Code, which is key for broad reimbursement, is now expected to become effective on October 1, 2019, vs. prior expectations of January 2020.
The company is now demonstrating that it is executing on its strategy, with key accomplishments since newer management was appointed including:
- Manufacturing issues have been resolved and Dextenza is approved for both pain and inflammation post ocular surgery
- Dextenza currently is reimbursed by Medicare under a temporary C-Code and will have J-Code reimbursement on October 1st, 3 months earlier than expected
- The company is capitalized, with cash through 3Q 2020, not factoring in a stronger-than-expected Dextenza launch and other potential non-dilutive sources of capital
- Ocular's term debt has been favorably restructured with a lower interest rate and interest-only payments through January 2021, which could be extended by an additional year if Dextenza exceeds $40 million in net sales
- The company has done a good job with pre-commercial activities, per our research which indicates high awareness with potential prescribers (examples to follow)
- Ocular's commercial team is now in place and beginning to roll out the product
- The company is pursuing various business development strategies to potentially leverage the value of Dextenza, other pipeline products, and its hydrogel drug delivery technology with pharma and biotech companies in the U.S. and abroad.
Our investment thesis on OCUL is based on the following key points:
Large market opportunity: Of the 6 million ophthalmic surgeries in the U.S. each year, there are 4 million cataract surgeries. With the temporary C-code for reimbursement in place, the initial target of the company is the 2 million cataract surgeries performed on Medicare Part B patients. These should be relatively accessible to Ocular's sales force, as roughly 60% of these surgeries are conducted in approximately 900 surgical centers - approximately 40 centers for each of the company's 21 sales reps. Assuming Dextenza net pricing at $450 per treatment, and 25% penetration, this market segment alone could be worth $225 million in Dextenza revenue. Once the J-code becomes active, this can double the target population and opportunity for Dextenza revenues for cataract surgery in the U.S. Analysts estimate Dextenza peak revenues in the range of $100 million to $800 million, with cataract surgeries representing around $300 million to $400 million, and the top of the range including other types of ocular surgeries and uses. We believe that the midpoints of these ranges are reasonable, and demonstrate a compelling opportunity for Dextenza and OCUL shares. As for the very low end of these sales forecasts, we believe that there may be opportunities to see those analysts raising their estimates going forward.
Dextenza is a win for both patients and physicians. For patients, the Dextenza insert means not having to administer eye drops for pain and inflammation post-surgery and also eliminates the need to comply with burdensome dosing regimens. Typical regimens require patients to administer over 70 drops per month, with a different frequency each week. In addition to automatic dosing and improved consistent pain relief, patients will no longer need to pay a copay for the prescription since it is administered by their surgeon or ophthalmologist.
For physicians, they can ensure that their patients comply with aftercare, reducing calls from patients or caregivers after surgery. Importantly, doctors earn additional revenue by administering Dextenza. Physicians get reimbursement for the procedure (estimated $150-$220 per insert), and the surgery center can bill for the drug plus a mark-up (ASP +4.75%). And one may surmise that when physicians and surgical centers can make money on a therapy, market penetration and utilization tends to be strong.
Given that the barriers to adoption for Dextenza are largely non-existent, particularly given the strong reimbursement expected in October with the J-code, and the benefits and incentives that physicians and patients can derive from the therapy, we believe the ramp of Dextenza will be strong.
Physicians are aware of Dextenza and are interested in adopting the product. There are many data points that demonstrate the high awareness of Dextenza with physicians, and that ophthalmic surgeons and ophthalmologists are very interested in adopting the product in their practice. These include physician surveys and phone interviews by analysts and other expert services that support this early market momentum. While most of these data points are proprietary, one can see testimonials with physicians HERE and HERE that are favorable on the product. In addition to these videos, we have included quotes from Dr. Steven M. Silverstein in Kansas City, Missouri who performs roughly 2,000 cataract surgeries per year. The first is his opinion on the use of Dextenza:
"I think every single person should be considered [for Dextenza]. Every single cataract surgery should be considered for this, except for patients who are known steroid responders. Those patients should not receive the Dextenza implant, but every other person, high risk or low risk patients should be considered".
We note that "steroid responders", or those patients that are known to have elevated intraocular pressure (IOP) when given a steroid in the eye, is estimated to be about one-third of the population, however only 4-6% of individuals have very high IOP elevations ("high responders"). Most patients do not know if they are steroid responders or not. As a result, Dr. Silverstein said that most patients will get either Dextenza or Dexycu and 100% of them are manageable for elevated IOP, even the high responders. Therefore, we conclude that most patients are candidates for either Dextenza or Dexycu and that the market for these new steroid implant technologies will be large.
Another quote from Dr. Silverstein related to his view on Dextenza vs. Dexycu, the direct competitor marketed by EYPT:
"I've used Dexycu on about 25 people. I would say it takes about the same amount of time as Dextenza. It has the same potential risk of a steroid response as Dextenza. It has one additional issue that Dextenza doesn't have and that is this white blob has an affinity to kind of leak out from behind the iris and stick to or adhere to the intraocular lens implant blocking some or all of the pupil for a few days. It has the potential to limit vision for a few days while it's dissolving. It's not a harmful thing. It's not a bad thing, but it can be disconcerting to patients."
From this statement, we note that Dextenza seems to have a major competitive advantage over Dexycu in that it does not lead to the "white blob" and visual impairment after surgery. Some patients temporarily go blind in one eye with Dexycu. We believe this may cause the market to favor Dextenza over Dexycu, and if that is the case, our peak penetration estimate for Dextenza (25% of the total market) could be low.
Lastly, according to a survey from Cowen and Co., the analyst that commissioned the survey said that Dextenza could be used in greater than 90% of cataract surgeries. Additionally, the survey indicated that 79% of ophthalmologists thought Dextenza could become their next standard of care. We believe that this level of enthusiasm is a positive sign for the product.
Company is well capitalized. With $81 million in cash as of August, the company stated that it currently has the resources to fund operations through the third quarter 2020. It also will seek other non-dilutive sources of capital to lengthen its cash runway via business development initiatives such as licensing commercial rights to Dextenza in non-U.S. territories, licensing its technology platform, or monetizing other pipeline assets. The company's debt refinancing in late 2018 also reduces the operating cash need, and if the stock performs well, Ocular has access to additional capital through its ATM facility with investment bank, Jefferies.
Insider buying is a good sign. One attractive feature of the OCUL story is recent buying by insiders including the company's senior management team and Board. We like to think that insiders have the best information on the company, hence an indication on what the "smart" money is doing. According to the company's SEC filings, insiders have acquired 229,000 shares at prices ranging from $2.51 - $4.40 in the May-June time frame, based on our analysis, increasing our confidence in the launch of Dextenza.
Potential upside is large. We calculated above that OCUL could trade with a valuation of between $1 billion to $2 billion if Dextenza can achieve sales in the half-billion dollar range. In our view, this is a compelling opportunity, with a stock that is beyond the binary risks of clinical trial results for its primary value driver.
Pipeline offers potential upside. If one believes that OCUL shares are discounted relative to the Dextenza opportunity, then this implies the company's drug pipeline is "free". If any of Ocular's programs show promise from here, or if the company can monetize some of these assets, we believe such an event would represent upside to OCUL shares. We like free call options and believe that OCUL shares offer several chances for unexpected value creation. In addition, the company may seek to license out Dextenza in non-U.S. territories, which may also offer cash upside from up-front payments, as well as upside to revenue expectations.
Expected news flow. In addition to investors coming back to the OCUL story, there are several potential events that we believe could support the recovery of the stock. The key focus will be on Dextenza volume metrics and initial sales. We would expect that Dextenza sales in the first quarter out of the gate (3Q 2019) will be minimal, as the company will likely provide free product to physicians to train them and enable them to trial it in several patients to stimulate adoption. It appears that analyst estimates are reasonable with the Consensus calling for total company revenues of $3.0 million in 3Q 2019 and $6.4 million for 4Q 2019. If Dextenza begins to beat numbers over time, and we expect an inflection in sales to take place 1-2 quarters post launch, OCUL shares are likely to respond. Meanwhile, any business development activities that can increase Dextenza's market potential in non-U.S. territories and/or those that can bring in non-dilutive cash, could also favorably impact the stock. Other activities such as licensing other pipeline products or the technology platform, as well as any news on the Regeneron collaboration have potential to increase shareholder value. With limited or no value from the pipeline factored into OCUL shares, we see these potential opportunities as skewed to the upside.
Commercial/competitive risks: Company execution on Dextenza's commercial launch and against competition are key risks to owning OCUL shares. Although we believe that Dextenza provides a competitive advantage over the current treatment paradigm in post-operative pain and inflammation, clinicians may be resistant to change their prescribing practices. In addition, Dextenza will be competing with Dexycu, another new ocular insert for the same indication that could cause Dextenza's uptake to be more modest than expected.
Financing risk: With $81 million in cash as of August 2019, the company stated that it currently has the resources to fund operations through the third quarter of 2020. It also will seek other non-dilutive sources of capital to lengthen its cash runway via business development initiatives such as licensing commercial rights to Dextenza in non-U.S. territories, licensing its technology platform, or monetizing other pipeline assets. Nevertheless, an equity financing would cause dilution to the share base and is a risk to owning OCUL shares.
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