Axonyx AXYX
July 11, 2005 - 3:41pm EST by
2005 2006
Price: 1.33 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 72 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Axonyx (ticker AXYX) is a biotech company that has disappointed the market and is now trading at a discount to its net cash. The company’s drug portfolio, including 3 main drugs targeted at Alzheimer’s Disease (AD), still possesses huge upside potential, and yet the stock trades as if the drug portfolio is worth less than zero. We believe that over a holding period of 12-24 months, the downside risk if things go poorly for the company, should be minimal from current price levels, while the upside potential if things go well for the company, is 2x to 10x. The ratio of risk relative to reward is the most attractive of any stock in our portfolio currently, and as such we’ve made it the largest stock position in our personal and managed accounts.

First, we’ll focus on the downside risk in AXYX stock:

Material events will occur over the next 12 months with respect to each of AXYX’s three main drugs, so for purposes of our downside analysis, we are only focused on that period of time – the idea being that if these events over the next 12 months go poorly, we want to know (1) how much cash will be left and (2) how much value, if any, will remain in the drug portfolio?

There are 53.7mm shares outstanding. At a stock price of $1.35/share, MV is $72mm, and net cash is $75mm (so the market has currently assigned a value of negative $3mm to the drug portfolio, which as we will explain later, is a “stupid” valuation). AXYX has no debt, but does have about $6mm of current liabilities, which is roughly offset by the market value of an investment AXYX holds in a public company called Oxis, so we just round off and view the $75mm of cash as “net cash”. We believe the company should burn no more than $20mm of cash over the next 12 months, so at that time net cash would still be $55mm or a bit over $1.00/share. (This is a reduced burn rate, relative to the most recent actual burn rate, reflecting reduced spending on clinical trials over the next 12 months.)

So, let’s look at two different bad-case scenarios:
a) The absolute worst case scenario for AXYX over the next 12 months is that all three of its main drugs are permanently killed (a truly extreme, and very unlikely, case). At such point, the company should still have $1.00/share net cash, and presumably the option value embedded in the remainder of its pre-clinical portfolio should be worth at least zero, so we believe such absolute worst case by mid-2006 yields a $1.00/share price.
b) The next-most-bad scenario should be that (1) AXYX’s lead drug (Phenserine) may become worthless (to be clear, this is NOT what we expect), but that (2) AXYX’s other 2 main drugs (Posiphen and BNC) move through their Phase I trials and on to Phase II, at which point they would still possess considerable option value. Trying to be rational but still quite conservative, we would argue that these other 2 drugs should still be assigned some positive value – let’s say somewhere between $50mm and $100mm ($.90 to $1.80/share), given the massive untapped market that each drug is targeting.

Thus, to summarize the downside scenario, we believe that even if most everything goes wrong over the next 12 months, AXYX stock should still be worth between $1.00 per share (just representing net cash) and $2.80 per share (net cash of $1.00/share plus up to $1.80/share representing option value for the two remaining drugs). So our downside argument boils down to this: If we can buy a stock for $1.35 which should still trade for $1.00-$2.80 per share one year from now even if the company disappoints during that period, then we are satisfied that our downside risk should be minimal.

Next we’ll take you through a brief summary of the AD drug market in general, how AXYX’s three main drugs work, recent major developments for AXYX’s drugs, and finally some reasoning as to our potential upside estimates for AXYX.

The AD drug market:

This market is extremely interesting, in that the number of AD patients is large and growing quickly, but the existing drugs on the market only marginally improve certain symptoms of the disease and do not stop or even slow the progression of AD. Doctors prescribe the approved drugs for AD because they’re a lot better than nothing, but they’re far from satisfying.

There are two classes of approved AD drugs on the market – several AChE inhibitors and one NMDA-receptor agonist. Both of these classes of drugs tweak brain chemistry to get brain cells to function and communicate more effectively in the wake of the damage caused by AD, but neither class impacts the AD disease process itself. Overall, while an AD patient is on these drugs, his cognition generally continues to get worse, but just at a slower rate than it would if he wasn’t taking them!

The AChE inhibitors are the market leaders, and there are three of these on the market today. The market leader is Aricept, doing about $1 billion in annual sales, Exelon does about $500 mm in sales, and Reminyl does about $250 mm in sales.

(Technically, AChE inhibitors help the brain maintain higher levels of the neurotransmitter acetylcholine; they accomplish this by inhibiting the brain’s production of a chemical called acetylcholinesterase which chemical actually clears out acetylcholine from the brain – that’s why they’re called “inhibitors”, as they inhibit the production of a chemical which otherwise clears out the “good” neurotransmitter.)

These existing AChE inhibitors have been approved based on clinical trial data showing that the cognition of patients on the drug declined somewhat more slowly than that of AD patients who were taking a placebo. Some tests of AChE inhibitors show a short term increase in cognition, before the cognition continues downward on the typical decline seen in AD patients. When the patient stops taking these drugs, cognition quickly falls to the level it would have been expected to be at if the patient would have never taken the drug. Thus, while these AChE drugs have all been approved on this basis and there is a lot of data to show they do affect cognition, the effects are not dramatic – on average they delay the decline in cognition by about six months, relative to if the patient wasn’t taking the drug at all. And this is the best that the major drug companies have created thus far to deal with a huge and devastating problem.

How AXYX’s drugs work and why they are so interesting:

AXYX’s lead drug Phenserine is an AChE inhibitor (just like the existing drugs on the market), but importantly also appears to have (through a separate mechanism, having nothing to do with AChE inhibition) a groundbreaking disease-modifying effect on AD through its ability to modify beta-amyloid (Ab). Ab is a protein fragment that accumulates in the brains of AD patients and results in the formation of so-called beta-amyloid plaques. We all produce Ab, but AD patients either produce too much of it, or their ability to rid the brain of it is impaired, so they end up with too much of it, which ultimately destroys normal brain cells. It is widely believed that excess Ab build-up is a major contributor to AD.

In addition, AXYX has created another drug called Posiphen which is an isomer of Phenserine – it’s the same chemically but is structurally the mirror image of Phenserine. In Posiphen they have eliminated the AChE effects of Phenserine, leaving it with only the anti-Ab effects. Note that all AChE inhibitors have side effects, such that there is a limit to the dosing levels, so it is possible that Phenserine, at its maximum safe dosing levels, may reduce Ab sufficiently in certain patients but not sufficiently in others. Posiphen could be a more powerful reducer of Ab levels, because it does not have any of the side effects of an AChE inhibitor and thus can potentially be dosed at higher levels.

It would be a gigantic breakthrough to actually come to market with a drug that could materially reduce Ab build-up, since today there is no way to stop or even slow the progression of AD otherwise. We don’t know that either Phenserine or Posiphen will come to market and become the next major AD drug breakthrough, but we believe they each have a reasonable shot at it, which creates major option value which is not even vaguely priced into the stock at today’s levels.

AXYX’s third major drug is BisNorCymcerine (BNC). Conceptually BNC works similarly to the AChE inhibitor drug class, in that it is intended to increase the levels of certain neurotransmitters in the brain. (Technically, BNC helps the brain maintain higher levels of the neurotransmitters butyrylcholine and acetylcholine; it accomplishes this by inhibiting the brain’s production of a chemical called butyrylcholinesterase which chemical actually clears out both butyrylcholine and acetylcholine from the brain – that’s why, once again, it’s called an “inhibitor”, as it inhibits the production of a chemical which otherwise clears out the “good” neurotransmitters.)

Butyrylcholinesterase is essentially a sister to acetylcholinesterase, and is found in high concentrations in the brains of patients who have died from AD. Like the AChE inhibitors, a BChE inhibitor on its own wouldn’t be expected to slow or stop disease progression, but would help manage the symptoms. There are some reasons to believe that an effective BChE inhibitor could be more important than the AChE inhibitors, since the concentration of butyrylcholinesterase is about 10 times higher than the concentration of acetylcholinesterase in advanced AD patients. Additionally, BNC may possess the same Ab lowering effect as Phenserine and Posiphen, so BNC could also be a dual acting drug.

Recent Phase III Clinical Trial on Phenserine:

AXYX’s lead drug (the furthest along in clinical trials) is Phenserine. AXYX’s strategy with respect to Phenserine, has been to get it approved by the FDA and on the market first as only a standard AChE inhibitor, with effects on cognition at least as good as other AChE inhibitors, and a side effect profile no worse than other AChE inhibitors. If not for its potential effect on Ab, Phenserine would be the 4th drug in its class on the market and would likely capture an unexciting market share.

Phenserine has received a lot of press in the AD community, has been heavily researched by AD scientists, and its proven ability to substantially reduce Ab in the lab and in animal models is well known. Thus, while Phenserine would likely not initially bear a label for its affect on Ab (because it will require substantial extra time and money to run all the necessary clinical trials), the company believes that Phenserine could capture a significant share of the AChE market because many doctors who treat AD patients would be aware of the potential Ab effect (even though not yet proven in humans) and would likely prescribe it rather than other AChE inhibitors on the theory that Phenserine would be at least as effective as the other AChE’s on symptoms, with the possibility that it could also actually have a disease-modifying effect.

In March 2005, AXYX announced the results of its initial Phase III trial on Phenserine, using the same endpoints as the other AChE drugs use (a series of cognition tests). In the trial, Phenserine failed to show a “statistically significant” improvement in cognition versus placebo. The average cognition level of the patients on the drug was better than those on the placebo, but not enough better to be statistically significant. (Interestingly, in past clinical trial results for the other AChE drugs, the improvement in cognition is quite small versus the placebo, so in reality the difference between an improvement which is “statistically significant” and an improvement which is not statistically significant, is also quite small – meaning that a very small change in the outcome of the trial might have caused Phenserine to show “statistically significant” improvement in cognition versus placebo.)

These March 2005 trial results are what has created the present opportunity -- AXYX stock dropped from about $5, to around its current level of $1.35 upon this announcement (also note that the stock had been over $7 in late 2004).

It is important to examine what happened in the Phase III trial, and what the company is now doing with Phenserine. The company is convinced that the trial and its results were flawed, and that Phenserine itself is an effective drug. In summary, the trial was confounded by a better than expected response in the placebo group. In these trials, you are comparing the rate of decline in cognition of patients on the drug versus a group of patients who are not on the drug. AD patients are supposed to be getting worse over time, yet in this trial, the placebo patients who didn’t get any drug actually improved initially, and at the end of the 6 month trial were about flat compared to the starting level. This unusual behavior of the placebo group made it a lot harder for Phenserine to show improvement relative to placebo. The results may have been unfavorably influenced by the following: (1) AD patients on the placebo may have received more attention and better care as part of a clinical trial, than they would otherwise, and for that reason alone they may actually have suffered less cognitive decline than expected, (2) there was a large amount of variability in placebo response, which made it tougher for the drug group to be statistically better, and (3) this was a multi-center trial, being held in various sites in Europe, and different centers had very different placebo responses. (A lot of data on this trial was presented in March and is available on the company’s website).

Note that this issue of getting a “placebo-like response” in trials for AD drugs is not unique, and in fact other existing approved AChE inhibitors have had failed clinical trials due to this issue, before ultimately getting approved. In fact, more so than in any other medical specialties, it is not uncommon for a neurological drug to have a failed trial before later overcoming such setback and getting approved.

Ongoing Phase IIb Clinical Trial on Phenserine:

In addition to the now-completed Phase III trial, AXYX has been conducting a separate Phase IIb trial on Phenserine, primarily to measure changes in Ab, and in March 2005 AXYX announced preliminary interim results covering a sample (about 25%) of the patients enrolled in this ongoing Phase IIb trial.

Based on this small sample (the first 37 patients out of a total of 150 enrolled), the patients experienced a substantial decrease in Ab, but the company cautioned that the results were not statistically significant, given the small sample size and the variability in starting and ending levels. However, coming on the heels of the Phase III “lack of statistically significant” results, we believe the market misinterpreted the meaning of this Phase IIb information. The company actually believes that this was encouraging information, as such a small sample size was not ever expected to yield statistically significant results, but the market focused on the words and the dry tone of the press release (written by cautious lawyers in light of recent, and typical, shareholder lawsuits), so we think this led many investors to believe this trial was failing also, while in reality the interim results are a positive snapshot showing that the early data is leading towards something important.

(To be clear, note that if a drug can reduce Ab, which in turn may slow or stop progression of the disease, that this in itself wouldn’t actually improve cognition, but presumably would prevent cognition from getting worse. AXYX is only hoping that the 6-month Phase IIb trial will show a material change in Ab. Longer term trials will be needed to determine how reductions in Ab correlate to stabilization in cognition.)

The full data set on this Phase IIb trial is expected to be available in late Q1 or early Q2 of 2006. If the trend from the first 37 patients extends to the full data set, the results would likely be statistically significant, which would be very exciting since it would validate the huge option potential of Phenserine. By implication, it would also be very encouraging for the super-charged Posiphen, since Posiphen should have an even larger impact on Ab.

Current Company Strategy:

Given the failure of the Phase III trial, AXYX disclosed its updated strategy for Phenserine in April 2005. The new plan for Phenserine is to develop an extended release or slow release version of Phenserine, which will allow AXYX to deliver a higher dose of Phenserine. As noted earlier, all the AChE drugs have certain side effects (nausea being most common) which are linked to the peak amount of the drug in the bloodstream just after administration, yet the efficacy of the drug is linked to the total amount and duration of drug exposure. The idea is that by developing an extended or slow release version of the drug, the peak is smoothed out, so a larger dose can be administered which should increase the total amount and duration of drug exposure. The company believes that when a new Phase III trial is conducted, using this higher dose, the results should be very clear that Phenserine works as well as, or better than, existing AChE inhibitors. The reformulation process and some Phase I safety trials on the reformulated version, should be complete by early 2006.

At around the time the Phase I trials for the reformulated version of Phenserine conclude, the full Phase IIb trial results for the existing (non-extended release) version of Phenserine should be available. Thus AXYX’s hope and belief is that less than 12 months from now, they will have accumulated sufficient data from these studies to show that (1) the existing (and thus relatively low dose) version of Phenserine has the ability to reduce Ab in humans, which would be a huge and distinctive development, and (2) they have created an extended release and thus higher dose version of Phenserine which should enable it in a future Phase III trial to have a statistically significant impact on cognition and be approvable as an AChE inhibitor. At such point, Phenserine should be recognized as a quite valuable property by major pharmaceutical firms, since (1) AChE inhibitors are already an established drug class with an existing market, and (2) the Ab lowering effect would be truly novel and would differentiate Phenserine from the existing AChE’s and could ultimately allow Phenserine to be marketed as a disease modifying agent.

AXYX does not have a sales force (in fact, it has an incredibly small infrastructure), and AXYX believes its competitive advantage lies in developing early stage neurological molecules and taking them through Phase II. AXYX expects that by the first half of 2006 it will have the data to be able to put together an attractive out-licensing deal with a major pharmaceutical firm who would likely pay AXYX upfront payments, milestone payments, royalties, and fund the next Phase III trials on the reformulated version of Phenserine.

As well as developing Phenserine, AXYX will continue to develop Posiphen and BNC. Posiphen and BNC should enter Phase I trials, in late 2005 and early 2006 respectively. Assuming the Phase I trials go well, both should be in Phase II testing in 2006. Despite these being early stage drugs, they could draw a lot of attention in the near term in that if the Phase IIb trial successfully shows that Phenserine can lower Ab, then AXYX will essentially have three drugs (Phenserine, Posiphen, and BNC) in a new drug class which addresses what is generally considered the key issue in stopping or slowing Alzheimer’s. That would be a huge development. (Conversely, if the Phase IIb trial fails to show that the old immediate release formulation of Phenserine reduces Ab meaningfully, it’s still quite possible that the reformulated higher dose version of Phenserine, and/or Posiphen, and/or BNC, will meaningfully reduce Ab.)

In Closing:

Effectively the stock market has completely written off AXYX due to the failure of a Phase III trial of its lead drug, yet the market has misunderstood that this drug is far from dead and still has huge potential value. Additionally, while AXYX’s two other main drugs are early stage, each could be important Alzheimer’s drugs over the coming years, and as such we believe they should be attributed some material positive value as well.

Management knows its stock is substantially undervalued, but like all small biotech companies, they feel the need to conserve cash rather than use it to buy back stock. On a related note, we are encouraged that Steve Ratoff, who was formerly the Chairman and interim CEO of Cima Labs (which was sold in 2004 to Cephalon under his leadership), opted to join the AXYX board in May 2005, and about two weeks after joining Mr. Ratoff purchased 250,000 shares in the open market at around current prices. Interestingly, only a few weeks later, he was appointed Chairman of the Board. Mr. Ratoff is an experienced pharmaceutical company executive – in addition to his Cima role and other senior level positions (such as CFO of Brown-Forman), he was CFO of the Pharmaceutical Group of Bristol Myers Squibb. We believe he is getting involved only because he sees a lot of potential here (he’s not looking for a “job”), and he has indicated that his objective is to maximize shareholder value. Assuming that the company succeeds with its drug development as outlined above, we believe he will guide the company to a lucrative out-licensing arrangement or outright sale. Assuming instead that the company fails in its drug development, we believe he won’t allow the company’s cash to waste away, and will instead preserve as much value as possible. Thus, Mr. Ratoff’s presence helps validate our low risk/high reward thesis.

Neither we nor anyone else knows at this point how AXYX’s drugs will ultimately work out. And 12 to 24 months from now, we still won’t know how they will ultimately work out. What we are betting on, however, is that looking at a range of possible outcomes, AXYX stock is simply grossly mispriced. If events develop well for AXYX over the next 12 to 24 months, the stock price should rise a lot to reflect this fabulous potential, and if events develop poorly, we think the stock should fall little (or perhaps even rise a little). This means AXYX, at $1.35/share (and probably at meaningfully higher levels as well), represents outstanding risk/reward. We aren’t making a long term illiquid venture capital-type bet that AXYX’s drugs will ultimately change the world for AD treatment, but instead we’re making a bet on a liquid stock whose price could rise dramatically in a short time period.

Given that the market has assigned a negative EV to the drug portfolio currently, consider that merely on improved sentiment, if the market assigned an EV of even a conservative $125mm to this high potential drug portfolio (which is still on the low side relative to the valuations of many biotech companies with early stage drugs), the stock would trade at $3.75, nearly a triple from here but still well short of where AXYX was recently trading. And if Phenserine proves to have a real impact on Ab, speculation could abound that this could be a multi-billion dollar drug, and even if licensed out, AXYX could have a multi-billion dollar market cap in the future, so discounting that to the present, plus adding in some value for their other drugs, analysts might easily assign a market value in the $500mm to $1 billion range (the $15/share area, give or take).

But putting all that aside, we also wish to point out that we will likely be out of the stock well before it hits it highs. We’re very conservative and have a healthy sense of what we don’t know. No matter how much good news comes out about a potential blockbuster drug, there’s always the risk (before or after it is approved), that something goes wrong. So, we’ll always be adjusting our estimates of downside and upside potential, and at some point we’ll probably sell into optimism. But around current levels (and probably at meaningfully higher levels as well), we think we’ve got a compelling risk/reward ratio, and that’s why it’s our favorite stock at present.

Disclaimer: We and our affiliates are long AXYX, and may increase or decrease our position at any time. We have no obligation to inform anybody of any changes in our views of AXYX.


Trading at less than current net cash, yet still has big optionality in drug portfolio. Risk-reward compelling at these prices.

Clinical trial data from Phenserine Phase IIb trial, data on reformulation process for Phenserine, progress on development of Posiphen and BNC, etc. should highlight much more value in the drug portfolio than currently being ascribed by the market.
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