Summary

Merrimack’s Onivyde was approved recently.

The black box warning will not have an impact on Onivyde sales.

Merrimack’s current valuation does not reflect Onivyde’s potential.

A lot of research in the current global pipeline scenario is focused on life-extending drugs for cancer. If successful, these drugs are likely to be approved faster and are invariably expensive. Merrimack (NASDAQ:MACK) is a fully integrated biopharmaceutical company with five potential oncology drugs in clinical trials making it a formidable player in the oncology space. The company's new drug Onivyde which is part of pancreatic cancer therapy has strong positive results and recently received FDA approval. At an average cost of treatment of $43,000, Onivyde could well be a blockbuster drug in the coming years. Based on just the potential of this one drug in the approved indication, Merrimack looks significantly undervalued.

Pancreatic Cancer

The pancreas, an organ positioned behind the stomach, helps in digesting food and regulating several other bodily functions through the hormones that it secretes. Pancreatic cancer arises when cells in the pancreas multiply out of control and form a mass. These cancer cells have the ability to invade other parts of the body. The most common type of pancreatic cancer is an adenocarcinoma, accounting for about 85% of cases. Pancreatic cancer most commonly occurs in those over 70 years of age. In 2012, pancreatic cancerresulted in 330,000 deaths globally and is the fourth most common cause of death from cancer in the United States. Pancreatic adenocarcinoma - the common type - has a very poor prognosis with 25% of the patients surviving only one year.

The current standard of care is surgery if possible and adjuvant chemotherapy with gemcitabine or 5-FU. Onivyde is a liposome injection of Irinotecan, a topoisomerase inhibitor indicated in combination with fluorouracil and leucovorin, for the treatment of patients with metastatic adenocarcinoma of the pancreas after disease progression following gemcitabine-based therapy.

Onivyde

Irinotecan liposome injection is a topoisomerase 1 inhibitor encapsulated in a lipid bilayer vesicle or liposome. Topoisomerase 1 relieves torsional strain in DNA by inducing single-strand breaks. Irinotecan and its active metabolite SN-38 bind reversibly to the topoisomerase 1-DNA complex and prevent re-ligation of the single-strand breaks, leading to exposure time-dependent double-strand DNA damage and cell death. In mice bearing human tumor xenografts, irinotecan liposome administered at irinotecan HCl-equivalent doses 5-fold lower than Irinotecan HCl achieved similar intratumoral exposure of SN-38. Onivyde has been demonstrated effective in a triple-arm study of 417 patients with metastatic pancreatic adenocarcinoma whose cancer had grown after receiving the gemcitabine or a gemcitabine-based therapy. The study was designed to determine whether patients receiving Onivyde plus fluorouracil/leucovorin or Onivyde alone lived longer than those receiving fluorouracil/leucovorin. Patients treated with Onivyde plus fluorouracil/leucovorin lived an average of 6.1 months, compared to 4.2 months for those treated with only fluorouracil/leucovorin. There was no survival improvement for those who received only Onivyde compared to those who received fluorouracil/leucovorin. In addition, patients receiving Onivyde plus fluorouracil/leucovorin had a delay in the amount of time to tumor growth compared to those who received fluorouracil/leucovorin. The average time for those receiving Onivyde plus fluorouracil/leucovorin was 3.1 months compared to 1.5 months for those receiving fluorouracil/leucovorin.

As with any cancer chemotherapy, strong intravenous cytotoxic drugs can all cause neutropenia, distant-cell death and a variety of other unintended effects on normal cells elsewhere in the body. In patients receiving Onivyde

  • Fatal sepsis (from neutropenia) occurred in 0.8% of the patients
  • Severe or life-threatening neutropenic fever or sepsis occurred in 3% and severe or life-threatening neutropenia occurred in 20%
  • Severe diarrhea was seen in 13% of the patients

Onivyde has been approved with a black box warning for severe neutropenia and severe diarrhea. In fact, the market reacted negatively to the black box warning as MACK shares fell sharply after Onivyde approval. Of course, the concern was that the black box warning would have a negative impact on sales. However, I believe that this should not have any significant impact on Onivyde's sales because it is the only approved treatment option in second-line setting. Also, a black box warning is not surprising considering that Irinotecan has already had warnings about neutropenia and diarrhea. I therefore do not see the black box warning as posing any risk to Onivyde sales.

I think Onivyde has the potential to be a game changer because

  • Pancreatic cancer affects a large population and current diagnosis is usually in later stages, leading to chemotherapy being given with or without surgical intervention
  • The drug is an adjuvant to standard therapy and will be quickly taken up by treating physicians and will have better compliance than an existing prescription
  • As an Orphan drug, Onivyde and its demonstrated life-extension and fast approval paves the way for not just other newer formulations exploiting adjuvant therapy, but also the associated survival rate improvement
  • The other pipeline products that are cancer-focused will also most likely benefit from the Merrimack approach of "engineering cancer therapies."

Valuation

According to the American Cancer Society, an estimated 49,000 patients are diagnosed with pancreatic cancer in the U.S. each year. A similar number are diagnosed in Europe, according to data from the International Agency for Research on Cancer. Merrimack holds the full commercialization rights to Onivyde in the U.S. Baxalta (NYSE:BXLT) is responsible for development and commercialization outside the U.S., excluding Taiwan. BXLT has already submitted a Marketing Authorization Application ('MAA) for Onivyde in Europe with the European Medicines Agency ('EMA) in May this year. PharmaEngine, which holds the commercial rights to Onivyde in Taiwan, has also filed a new drug application in May this year.

In order to value Merrimack, I have only considered the potential of its approved product and that too in just one indication. Remember that Onivyde has potential in multiple indications, including colon cancer and even as a front-line therapy in metastatic pancreatic cancer. In addition, MACK has an extensive pipeline in oncology.

For Onivyde, I have taken into account the U.S. and European sales from 2016 onwards. In the U.S., around 19,000 pancreatic cancer patients are eligible for treatment with Onivyde. Given that there is no other treatment option in second-line setting, it is safe to assume that Onivyde will capture a significant share of the market. In the first year itself, I have assumed 60% of the addressable market will be treated with the drug. The cost of the average course of treatment is expected to be $43,000, according to Edward Stewart, Merrimack's head of commercial operations. At peak, I have assumed 80%. Similar assumptions have been made for Europe. I have assumed royalties of around 20% for Merrimack from Europe.

Based on these assumptions, Onivyde has the potential to cross $1 billion in sales by 2025. I have assumed a CAGR of 5% in addressable market for Onivyde. The discount rate is assumed at 8.50%, which is based on data from Stern. The continued growth rate is assumed at 3%. Onivyde has patent protection until 2028 so I have assumed a sharp drop in market share in 2029 and calculated the terminal value in 2030.

Based on these set of assumptions, I get a fair value of $14.74 for MACK. As I noted above, the fair value is based just on the potential of Onivyde in one indication. If you consider the fact that Onivyde has potential in multiple indications then the fair value would be much higher. But even based on the potential in just one indication and without taking into account the pipeline, MACK is currently trading around 50% below its fair value. Read the complete valuation here.

The main risk with MACK of course is failure to meet Onivyde's commercialization potential. MACK certainly does not have the commercialization experience, however, one must remember that Onivyde is addressing an area where there is significant unmet need. Considering all the above, I think the dip is actually a great time to buy into Merrimack.