Our take on Paradigm, one of Livewire's most-tipped small caps

Prior to the end of 2019, Fiftyone Capital shared an update with our investors in the Progressive Global Fund regarding our holding Paradigm Biopharmaceuticals (ASX:PAR). Given the growing interest in the company (it featured on Livewire's 10 most tipped small- caps), below is a snippet of what we believe are the long term prospects for Paradigm.

Firstly, finding a biotechnology company that can take a drug from the lab all the way to commercialisation is not easy, and is a path littered with failures. However, those who do make it through (without being taken over) can turn into juggernauts should they exhibit the right mix of characteristics.

The companies that reach biotech stardom typically have the following key attributes:

1) A Drug/Treatment that is far superior to existing treatments  & treats indication/s that have a serious unmet need and significant demand from a widespread patient population (i.e. treats a serious medical problem that impacts a lot of people) – ideally with disease-modifying effects as opposed to only treating symptoms.

2) Can produce, distribute and sell the treatment/drug under patent protection in a monopolistic environment with significant gross margin and pricing power. 

3) Have a pipeline of indications/drugs they can further develop past the generic competition cliff. 

4) Competent management experience with access to funding or partnership arrangements to take drug/treatment from the lab through to commercialisation. 

We believe that Paradigm ticks these boxes and could one day turn into a very large, successful pharmaceutical business.

Superior Treatment: Paradigm has repurposed a drug (PPS) to treat multiple indications. This is a small molecule drug (meaning it doesn’t act on any one specific part of the body) and has excellent inflammatory reducing properties. It can essentially treat multiple issues all at once when taken through its multi-method of action characteristics. The lead drug in development from Paradigm is called Zilosul and is used to treat Osteoarthritis (OA). OA is a very common disease that has serious unmet needs. It is progressive and has no cure and affects a huge population of people (over 100m in the developed world).

What Zilosul is demonstrating through real-world evidence and in clinical trials is that it slows or stops the progression of this disease (disease-modifying). It has demonstrated efficacy with patients experiencing pain reduction, improved joint function and stopping the cartilage from breaking down in the joint. Doctors and patients, we have spoken to continue to confirm that there has never been anything quite like it they have used/taken – in fact, some call it “magic juice”. This shouldn’t be too surprising though as this drug has worked in animals for decades and is well known by vets who give it to horses/dogs/cats. Now it is being adapted in humans by Paradigm and it is showing to have blockbuster potential. We believe Zilosul will become the first-line treatment option over time for people who have OA – potentially a very large and recurring revenue market. 

Patent & Repurposed Protections: As the drug is repurposed, it is progressing development under a 505(b) 2 pathway (which is a repurposed drug being adapted for a new indication). Should Paradigm receive a label from the FDA (post a successful phase 3 and NDA submission) they will also receive a period of exclusivity under this pathway. On top of this period of exclusivity, they also have several granted patents that provide additional protection beyond the initial 5 year exclusivity period. It should also be noted that currently there is only one FDA approved supplier of PPS (BenePharma) who Paradigm have an exclusive supply agreement with (who we visited and previously wrote about on livewire here. 

Robust Pipeline: While OA is the leading indication in development. The applications for PPS in other indications are exciting and the pipeline can only be described as robust. Hayfever, Asthma, COPD, Heart Disease, Kidney Disease, Cancer, MPS, Fabrys, Lou Gherigs, other Lysomal storage diseases, Cystic Fibrosis… the list goes on and on. Just looking at one other version of arthritis (rheumatoid arthritis or RA) it could be a multi-blockbuster treatment. 

Deals: The management of Paradigm are industry veterans and have helped build companies like CSL and executed multi-billion-dollar deals at Mesoblast. With an experienced board we take confidence they can navigate what is likely to transpire this year on the pathway to commercialization.  Post a successful IND meeting with the FDA and the phase 3 trial being approved, there is a very strong possibility a big pharma would be considered for a partnership arrangement. Our view is partnering with a strong distribution partner (big pharma) and who could also potentially fund the phase 3 trial is a prudent move by management. They can then invest the cash received in rapidly expanding their other drug pipeline. 

Valuations: So, what is the company worth? Without cash flows and profits, it is very difficult to value such a business beyond looking at the potential future opportunity and discounting the valuation back relative to the chance of success/execution risk. The other method is looking at what a pharma deal may look like and how this might value the business.

Paradigm has around 200m shares on issue currently and at $3.65 it has a valuation of about $710m. The company has a firm cash balance of around $70m and so has an EV of about $640m currently.

To value the company based on the OA indication it is important to try to look at some comparable deals. The Anti-NGF drugs are particularly interesting as Paradigm also recently announced an additional method of action data showing the downregulation of NGF in bone cells. This was big news as these billion-dollar deals on novel NGF drug development have all yet to be commercialized and have unsuccessfully treated NGF for OA (they have failed in clinical trials).

The above table showing deals in OA, in particular, the Anti-NGF drugs.

These deals were also signed with far less data than what Paradigm has reported on. Yet, these Anti-NGF drugs were valued between US$1.25b and US$1.8b based on the potential to be a treatment for OA. In AUD and share price equivalent for PAR this is a value of $8.93 to $12.50 per share. Assuming the company could achieve a $1.5b USD deal for the global rights to OA this would likely see an upfront cash payment of ~US$150m to >US$400m. The royalties’ stream (likely around 15-20% on sales) would be an annuity that could be valued on sales on top of the remaining ~$1.35b - $1.2b cash payments. There is upside to this expectation in that the company could potentially receive a deal in this vicinity for a single region, meaning the total deal size or value of the asset may be more in the range of US$3b - $5b.

Looking then at potential cash flow from the value of future sales, the company has provided indicative numbers around the potential market size and penetration that could be achieved at various price points. While all very preliminary, the company indicated at the recent AGM they would be hiring a bio-economist to provide research and analysis regarding the addressable market, pricing power, and potential penetrations. This is also likely being done for the potential big-pharma transaction that would be forthcoming (i.e. need to show the value of this asset as well as the potential price could sell drug for).

As indicated in the table above, the US market alone, even at only a 10% penetration and a US$1.5k per course of treatment (which we think is very conservative should it show further disease modifying characteristics in the phase 3) is revenue of US$4.7b. Assuming a conservative 15% royalty (post a pharma deal) would generate revenue of over AUD$1b to Paradigm. Screening on Bloomberg across the various pharma companies with over $1b in revenue across developed US/EU/Aus the average EV/Sales is 4.5x - which would put a valuation at this point at $4.6b or a share price of $24. At higher penetrations, higher sales, royalty and/or accounting for the rest of the world population this would add significantly to the company valuation. 

By way of example when looking at the leading rheumatoid arthritis drug (Humira). This drug has annual sales of around US$20b yet this market is significantly smaller than the market for OA (about 1/10^th size). 

Considering the market penetration for Humira is ~65% in the US for RA. There is no reason that Zilosul couldn’t grow to a similar penetration for OA should it slow the progression of the disease as well as treating the painful symptoms. Assuming a 50% penetration and a conservative US$1,500 price. This would generate annual revenues of US$23b or in AUD over $34b. Assuming a deal had been struck and Paradigm only keeps 15% of this, it would still be over $5b in revenue to Paradigm. Using the same 4.5x multiple this would give a share price over $110 per share. We will let readers apply their own risk and valuation calculations on this. Although considering the company could potentially reach over 50% penetrations and price the drug over $5000 per treatment, the valuation could stretch a lot higher all things going right. 

While the OA indication has astronomical upside based on these penetration rates and pricing, it is still only one part of the story. We believe the company will also accelerate the development of other indications within their patent portfolio. While MPS is the next most advanced indication after OA, it is difficult to ascribe a value to until more clarity is given around the forthcoming trials. But should more clinical data be produced in the phase 2/3 trial showing efficacy, we would be more confident in ascribing value to these indications. The MPS indication could achieve a deal we estimate in the range of US$500m - US$1b (more than the current market cap of the company).

Hayfever (allergic rhinitis) is potentially one of the more lucrative indications in the pipeline. The company previously failed a trial in this indication which was due to the delivery method used (nose spray) which didn’t result in an adequate amount of PPS being absorbed into the body. That said, we have heard anecdotal stories of people who have not experienced any Hayfever after their injections of Zilosul for their OA. This along with the pre-clinical work would suggest that a different delivery method could achieve success in relieving symptoms of hayfever. Again, this is early stage, but should the company achieve a reformulation and treatment protocol for hayfever this market is estimated to be over US$15b.

Paradigm has a very robust and deep pipeline of indications that could achieve blockbuster status. With cash flow from a deal in OA, they would be able to self-fund future trials in new indications and develop and expand their pipeline significantly. We believe developing this pipeline further is where the company should invest capital as further clinical success would add materially to the share price and valuation of the business which currently is mostly valued from the more advanced OA asset.

Risk vs Reward As we have written about on several occasions in our deep-dive notes, we believe the long term potential for Paradigm is absolutely enormous. While we take a very long term outlook for our investment in the business (+10 years) it will have many ups and downs along the way. Ultimately, it is this long term view that led us to create the sidecar to warehouse this position for investors. It is extremely rare to find a company with such a massive upside relative to what we considered moderate risks. Our thesis remains simple. The drug works and people need it. Should our analysis prove correct we want to be able to ride this investment for years to come. 

The biggest risk comes down to whether they can pass the forthcoming clinical trials that stand between them and sales revenue. We are confident that with ongoing feedback from the SAS in Australia (not to mention the demand for this drug before it's even available), solid-phase 2 clinical trial results and a robust pipeline of indications that the company has mitigated these risks as much as possible. With a larger patient population in phase 3, we are confident they can achieve success in the forthcoming clinical trials. 

Other risks we see to our overall valuation and thesis are if the FDA approves a generic PPS for oral use. While there is no PPS for injectable use, it may create some confusion and a potential discount towards the company. While no injectable can be approved until it is formally on the market (Paradigms Zilosul) it is potentially more of a market perception risk. We expect should the company succeed there will be more attempts at creating a generic while the company patents are still in effect.

The next risk is that someone successfully challenges the patents around the various indications. We don’t think this is a high risk as many of the patents have already been granted and with its numerous layers of patents, the portfolio has multiple levels of protection. The asset is extremely valuable, and the company has taken every measure to mitigate this risk, however, it is still a potential risk should challenges occur. This may even just be in the form of sapped resources from defending a potential claim on the patent (even if unsuccessful). While this is a risk, should the FDA approve Zilosul for OA, Paradigm will likely receive a period of 5 years exclusivity under the 505(b)2 pathway (repurposed drugs) on top of the patent protection.

Another risk is that global equity markets see a major risk-off or correction. While short term this would see increased volatility, the long-term fundamentals of this business haven’t changed (has the drug stopped working?). However, healthcare can typically be a defensive ‘safe haven’ during times of increased volatility and given the potential revenue/earnings from this business would be defensive and recurring it would likely be supported by new buyers. This is a risk at a macro level and one that can’t be avoided. 

As we have indicated above, we think the risk relative to the reward is skewed significantly in favor of current investors. That said, we do foresee major catalysts over the 2020 year that could bring significant interest to the stock that could see the price re-rate significantly higher. While the company is still relatively under the radar (there are still no funds on the register who are substantial shareholders >5%) we think that will change this year as the company further progresses towards commercialization and further reduces the risks. 

It is exciting to think that should Paradigm succeed, they could bring relief to millions of people suffering from pain around the world. Being a part of and supporting something so beneficial to humanity has been very rewarding. So, for our investment and also the hopes of millions of people around the world, we are excited about the future in Paradigm! 

Due to the appreciation of Paradigm, our fund's main series (open to investors) no longer holds any shares in PAR AU due to the position exceeding our 20% limit for a single stock position. Our holdings are now retained in a sidecar fund (B & C) which is not open to new investors. This means that new investors into our fund will not get exposure to Paradigm. We loved sharing our research and the options with our investors and plan to release notes on a new company soon! 

Disclaimer: This is not a recommendation to buy Paradigm and investors should undertake their own research and discuss their financial position with a qualified advisor before purchasing shares in any company.

All views and information provided should be considered general in nature and are the opinion of Fiftyone Capital and are not to be considered statements of fact. Our fund owns shares in Paradigm and has previously received compensation in the form of options. As such any appreciation in the share price will result in financial gain for the fund and individual unitholders.