Arrowhead Research - Ground-Floor Opportunity Or Biotech Bubble Baby?

Valuing a biotech, particularly one with no commercial products, is always going to be a controversial exercise. Having written on stocks for a public audience for over a decade (and for institutions before that), I'm still surprised at the number of people who will make comments like "that biotech has no earnings, it's worthless!"

It's an even more challenging exercise with a stock like Arrowhead Research (ARWR), though, as so much of the value of this company lies in its basic technology - technology that will really only show its worth over many years of clinical development work. It's dangerous to say that Arrowhead will be just like Alnylam Pharmaceuticals (ALNY) in a few years, so it deserves a similar valuation. I do believe that you can attribute almost half of the company's value today to its lead clinical compound and that leaves what I think is a pretty modest valuation for the company's overall technology platform.

Delivery Matters

Arrowhead Research is a small biotech looking to operate in the area of RNA interference (or RNAi). RNAi achieves a therapeutic effect by inhibiting the expression of genes, and in theory it is a highly promising approach from both the standpoint of efficacy and safety. I say "in theory" because RNA molecules are fragile and easily broken down by the body. This has made delivery technology a key factor in the development of RNAi therapies, and an area where I believe Arrowhead may have underappreciated value.

The heart of Arrowhead's delivery platform is its Dynamic Polyconjugate (aka DPC) technology that it acquired from Roche (OTCQX:RHHBY) in late 2011. Distinct from Alnylam's GalNAc and Tekmira's (TKMR) lipid nanoparticle technologies (previously known as SNALP), DPC uses small nanoparticles composed of shielding agents and targeting ligands attached to a polymer backbone that can be conjugated to, or co-administered with, siRNA. The targeting ligand basically guides the nanoparticle to the targeted cell type, where it attaches to the cell surface and is taken into the cell encapsulated in an endosome . Within the cell, the polymer lyses the endosomal membrane and releases the siRNA into the cytoplasm of the cell.

In principle, this is a delivery technology that should allow for the delivery of siRNA to a wide range of cell types. In comparison, the lack of active endosome release mechanisms with Alnylam's GalNAc and the lack of specific tissue targeting with Tekmira's LNP may make it difficult for these delivery technologies to work outside the liver.

Arrowhead does not have all of its delivery eggs in the DPC basket. The company has licenses to Tekmira's LNP delivery technology and also acquired a proprietary liposomal nanoparticle delivery approach developed by Roche. All told, that appears to give Arrowhead one of the largest delivery technology estates in the RNAi space.

Multiple Opportunities In Payloads As Well

Arrowhead hasn't put all of its resources and attention into building out its delivery technology options. The company has also licensed access to canonical siRNA structures from Alnylam, Dicer siRNA structures from the City of Hope Medical Center, and meroduplex siRNA structures from Marina Biotech (OTCPK:MRNA). With that, Arrowhead can experiment with multiple siRNA structures and delivery options to develop new therapies.

Arrowhead also has technology outside of RNAi. The company bought Alvos Therapeutics in 2012 and that company's peptide-drug conjugate technology with it. Similar to the better-known antibody-drug conjugates being developed by Seattle Genetics (SGEN) (among others), a peptide-drug conjugate using a peptide to selectively target particular cells and deliver a potent therapeutic drug to that cell.

An Aggressive Lead Program

Arrowhead's lead clinical program is ARC-250, an RNAi treatment for hepatitis B (aka HBV). This treatment works by blocking the virus from copying and replicating itself. Not only does it appear that ARC-250 knocks down the level of circulating HBV, but it may also reduce S-antigen and E-antigen, which could help restore the body's immune response to the virus.

This is a high-risk program. Preclinical work showed a significant reduction in circulating HBV DNA, but it's impossible to say at this point whether the drug can lead to seroconversion, and the preclinical work has shown liver and kidney toxicity (albeit at much higher levels than the expected human dosage). Nevertheless, HBV is an under-served disease and the company intends to start a Phase IIa relatively soon, with a multidose Phase IIb study later in the year if the data are good enough. If successful, it is not at all unreasonable to think that this drug could garner sales in excess of $1,500 million at its peak.

Arrowhead also has a Phase 1 Homing Peptide/peptide-drug conjugate candidate called Adipotide. Adipotide targets a protein on the surface of blood vessels that feed fat tissue and could offer a means of essentially starving fat cells in people with obesity.

Approaching The Valuation

At this point in its clinical development, I value ARC-250 on the assumptions of 50% market penetration in 2024 ($800 million in revenue), a 6x multiple to those sales, and a 15% chance of success. Discounted back, that works out to a value of almost $5.50 per share.

The question is how to approach the rest of Arrowhead's assets, specifically its delivery technology platform. Roche paid more than $450 million for the RNAi assets it sold to Arrowhead (delivery technology from Mirus and siRNA IP/licenses from Alnylam), and at the depths of RNAi pessimism in the stock market Alnylam traded at a market cap of around $300 million. Stripping out ARC-250 and pro-forma cash (around $90 million as of the start of the year), it looks like the market values Arrowhead's technology at only around $150 million.

The Bottom Line

It is entirely possible that Arrowhead's technology will not result in an effective or approvable drug, but that risk always goes with early-stage biotech investing. As I would value Arrowhead's technology at a minimum of $250 million today, I think a fair value for Arrowhead starts no lower than $14 today (and that's giving only partial credit to the company's cash, as it will be burning that). Should Arrowhead report strong data on ARC-250 and/or get another drug candidate into human testing, the valuation upside could be considerable.

Source: Arrowhead Research - Ground-Floor Opportunity Or Biotech Bubble Baby?

Disclosure: I am long ALNY, RHHBY, . I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)

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