Regulatory Viewpoints

The market punished Kite Pharma Inc (NASDAQ:KITE)’s shares during the first half of August selling off -30% from the close on August 5th through last Friday’s close on August 14th based on market rumors of a patient death and potential clinical hold being instituted by the FDA on KITE’s Phase 1-2 Multi-Center Study Evaluating KTE-C19 in DLBCL.

As a result, KITE’s management provided an unscheduled clinical update from their KTE-C19 Clinical Trial in aggressive NHL with the intent to dispel any misperceptions. Specifically, during the call KITE disclosed that the investigator’s review of the patient death determined it was unrelated to KTE-C19, and they emphasized that they maintained intimate contact with the FDA and IRB providing both with the required disclosures and documentation ahead of what was required of them by regulators.

Toxicities observed with KTE-C19 thus far were consistent with past NCI studies, with complete responses in patients with 4-5 prior therapies. Our view is that clinical trials in cancer patients are composed of the sickest patients with no remaining hope. Thus, the death confirmed today from the underlying disease is a non-event. We also believe management’s defenses that the investigator’s assessment was objective and unbiased. Furthermore, KITE’s clinical team appears to have adequately trained and prepared each clinical site in this multi-center trial for optimal clinical monitoring for safety.

Aside from the obvious takeaways from the call on the risks of adoptive cellular therapies, we view investors hypersensitivity to market rumors (in this case factual) as evidence of a non- committal investor base lacking confidence in their assessment of valuation. While the disclosure of safety events is always important, the impact on valuation, and in theory share prices, is determined by the clinical context in which they occur.

Recall, KTE-C19 was granted Orphan Drug Designation in the EU during the month of January, and Kite previously announced during March 2014 that the FDA granted Orphan Drug designation for KTE-C19 for the treatment of DLBCL. The first patient was subsequently treated with KTE-C19 during May 2015, and enrollment has continued unabated utilizing a centralized and proprietary manufacturing facility.

Based on a historical analysis from the FDA and elsewhere, safety was only cited 16% of the time as the FDA’s reasoning for denying an application for Breakthrough Therapy Designation (BTD), a designation that may expedite approval, and increases probability of approval (based on historical data). Importantly, the FDA’s data also demonstrates that other variables, which did not appear to influence the probability of approval, were the presence of orphan drug status or the existence of randomized trial evidence. Unsurprisingly, “lack of efficacy” was the most cited reason for denials representing 66% of the total.

Based on our observation of analyst models, we believe this is an area where market frequently misinterprets the connotations from gaining “orphan drug designation” as a read-through for a higher probability of gaining BTD, and ultimately approval.

One of the key valuation risks we identified with KITE and other cellular therapy companies is the prevalent optimism reflected with analyst risk-adjustments. Consequently, this in part has perpetuated a potential valuation gap between the market and what is currently justified.

Commercial Viewpoints

While we share their enthusiasm that KTE-C19 is likely to gain approval, perhaps even in excess of a 70% probability, but our caution stems from analyst’s lack of depth and simplistic assessment when considering the probability of commercial execution and its risks. Comments on the call stoked our inner-cynicism when KITE reaffirmed their commitment to a centralized manufacturing business model. Specifically, when risk-adjusting sales they too must consider the risk of attaining the forecasted market share, where patient access remains a major impediment. As this pertains to KITE, their strategy appears to be founded on an unstable foundation, and we question the viability of their approach that is likely to require a higher ramp in capital expenditures beyond levels exemplified by a traditional drug manufacturer. We believe the Street underappreciates this fact currently, but will become a focal point over the next 18 months and a topic we anticipate covering extensively.

The key caveat to this analysis is that all CAR-T companies remain ambiguous about their long- term commercial strategy for competitive reasons. Nevertheless, the facts we have before us allude to a scenario where KITE intends on becoming a large centralized manufacturer of cellular therapies.

Evidenced by two facts:

  1. On Feb. 19, 2015, KITE announced that it entered into a lease agreement for a commercial manufacturing facility in El Segundo, California, (44,500 square feet + an expansion option for an additional 17,000 square feet until July 1, 2017), which is conveniently located adjacent to Los Angeles International Airport for “easy patient access” we suspect. Kite also secured a lease for a clinical manufacturing facility in Santa Monica, California, (18,000 square feet). The facilities should be ready for FDA inspection by 3Q16, and should be ready for FDA inspection by 3Q16.
  2. The terms of KITE’s collaboration with AMGN, dictating that KITE will be responsible for all manufacturing requirements for both companies clinical development programs and upon commercialization.

In our view, the supply chain is likely to advance into a structure dramatically different than what analysts and KITE’s management currently model, and may lose any perceptions of competitive commercial advantages prior to peak sales to other approaches beyond the depth of this discussion.

One major flaw in the markets assessment of the oncology space is its failure to account for the rapidly shifting competitive landscape that could continue to erode the CAR-T’s ultimate addressable market in DLBCL that accounts for no less than half of consensus’ valuation. Canaccord Genuity attributes $40/share in NPV for KTE-C19 in DLBCL and applies a 70% probability of success to their model delivering a risk-adjusted peak sales value of $691M. The majority of other sell-side estimates is roughly in line with these and is not shown. While we ultimately think that CAR-T’s will be successful, our contention is that the probability of success applied to sales is too generous and should be somewhere near the 40-50% region at this stage, applying this more reasonable risk adjustment to their estimates implies a risk- adjusted NPV value of $900- $1.1B or $23-$29/share for DLBCL. KITE’s strategy does not resemble an ideal approach for broad patient access or high operating margins. Forecasting COGS in this emerging therapeutic area remains opaque, but represents the potential for an edge. With consensus at 20-25% this could prove low, and fails to consider additional costs toward broad commercialization that go beyond the depth of this report.

Clinical Viewpoints

Approximately 50% of DLBCL’s are of the non-GCB subtype and are driven by NF-kB signaling. Front-line treatment for DLBCL remains R-CHOP with a mOS at 24-months of 78% in GCB, but only 46% in non-GCB DLBCL. Three drugs (Revlimid, Bortezomib, Ibrutinib) already approved in other hematologic malignancies are currently being evaluated in combination with R-CHOP in Phase 1/2 DLBCL trials based on the mechanistic rationale to perturb NF-kB activity equalizing clinical outcomes between the ABC and GCB subtypes (see table below). Briefly, 75% of GCB and 83% of non-GCB patients were alive at 24-months with Revlimid + R-CHOP, Ibrutinib + R- CHOP demonstrated 100% ORR in both subtypes with mOS and mPFS assessment ongoing. The commercial implications for CAR-T companies are straightforward. If these therapies continue demonstrating similar responses rates and survival benefits it poses a threat to the CAR-T estimates. As the available pool of eligible patients each year declines because a larger proportion of patients are responding to earlier lines of therapy for longer durations, this implicitly reduces the addressable market for CAR-T’s. The consequence of delaying time to treatment further reduces its NPV. The net impact is both a reduction in magnitude of the peak and its NPV. These concerns are only exacerbated in an environment where there will potentially be the presence of 3 or more other CAR-T’s competitors. With front-line DLBCL patients already achieving 45-50% durable response rates with standard R-CHOP the potential risk for meaningful improvements in survival and response rates with oral based therapies in the relapsed/refractory setting with Imbruvica based combination therapies is a significant threat. The end result of such a scenario may reduce the available pool of patients who are eligible for CAR-T therapy each year.

Closing Thoughts

The events currently transpiring with KITE are likely indicative of things to come with JUNO, BLUE, ZIOP, and CLLS (among many others) where the patient populations treated to date are immaterial to assess the safety with their platforms. Thus, the headline risk only increases from here with each successive company progressing through development. As demonstrated with KITE, the market’s rationality remains clearly divergent from the notion of an efficient market in the space.

Consequently, for short-term oriented market participants its best to expect the unexpected, plan for it, and opportunistically take advantage of it. By remaining conservative with risk- adjustments and accounting for how the competition will alter both the treatment paradigm and the total addressable market one can then ascertain a more coherent outlook. The commercialization risks are not an impediment to considering a bullish view; rather it limits the duration that one’s bullish view may hold true. Indeed, multiple long and short opportunities will present themselves ahead of approval and commercialization risks.

For long-term investors, attention should center on patient access and commercialization strategy, as these are the most important competitive differentiators toward becoming the sustainable market leader. To be clear, our caution on KITE is not rooted on a bearish outlook for their innovative discovery platform, but is founded on their seemingly outdated commercialization strategy that is very reminiscent of Dendreon’s business model where excessive Capital Expenditures in PP&E weren’t offset by higher patient volumes. As a result, KITE’s rapid manufacturing expansion could prove premature.

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