Medgenics (NYSE AMEX: MDGN) - Nomura Code Securities Limited, London


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Medgenics (NYSE AMEX: MDGN) is developing and commercializing Biopump, a proprietary tissue-based platform technology for the sustained production and delivery of therapeutic proteins using the patient's own skin biopsy for the treatment of a range of chronic diseases including anemia, hepatitis C and hemophilia. Medgenics believes this approach has multiple benefits compared with current treatments, which include regular and costly injections of therapeutic proteins.

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Medgenics (NYSE AMEX: MDGN) - Nomura Code Securities Limited, London

  1. 1. Nomura Code Securities Limited, London Life Sciences Research Medgenics Entering a pivotal phase Medgenics is entering a pivotal phase during which events have the potential to further validate its technology and significantly enhance its valuation towards our risk adjusted, Buy (Unchanged) end of year fair value of £54m. This includes the completion of its phase I/IIa trial for UK / Equities EPODURE which is expected this year, with the possible signing of a development Price (MEDG.L) on 20 June 2011 at close partner and approval to start a more substantial US based phase IIb study. The Factor VIII pre-clinical programme has progressed well and the company hopes that its partner will 175p take up an exclusive option later this year to negotiate a definitive clinical development Date agreement with initial recruitment in the first clinical trial possible at the end of 2012. The 21 June 2011 INFRADURE treatment for hepatitis C could enter the clinic in early 2012 and positive Market capitalisation feedback from this open study would help to validate Medgenics’’ technology in a second application and help to strengthen sentiment further. Having successfully secured a dual £18.5m listing in the US and raised $10.6m net of expenses, the company has enough funds to Sector last until mid-2012 without any third party payments. However, the company is in Biotechnology discussions with a number of potential partners and the signing of development agreements could result in milestone payments or sharing of development costs that Reuters Ticker could fund the company’’s key projects for a much longer period. The company is also MEDG.L / MEDU.L investigating possible sources of US or EU government funding for clinical development. Share price performance Erythropoietin –– The initial 18 patient clinical trial of EPODURE (erythropoietin delivery to 250 treat anaemia) is set to recruit its final patients shortly and the company hopes to report the 230 210 190 results at the American Society of Nephrology meeting in November. Results reported to date 170 150 are very encouraging with a single EPODURE administration raising and maintaining 130 110 90 haemoglobin levels for up to 24 months without injections of erythropoietin. The company is in 70 50 the process of preparing an IND (Investigational New Drug) application for a phase IIb study Jun-09 Se p-09 De c-09 M ar -10 Jun-10 Se p-10 De c-10 M ar -11 Jun-11 MEDG FTALLSH that could start recruitment in the middle of 2012. Following changes to the reimbursement for dialysis patients in January 2011 the cost of erythropoietin has become an issue for dialysis Source: DataStream providers and we believe that some of the majors will have a significant interest in pursuing Analyst Medgenics’’ EPODURE technology. Michael King Factor VIII - Having signed a development agreement in 2009, an undisclosed major +44 20 7776 1243 pharmaceutical partner has paid Medgenics $4m to co-develop a Factor VIII Biopump for treating haemophilia. In November 2010, Medgenics took over the pre-clinical development as part of an extension to the agreement, while yields were improved. The company now indicates that this work has gone well and the yields improved, so news that its partner has Institutional sales signed a definitive agreement would provide significant validation for this project. Dominic Wilson Interferon –– The INFRADURE pumps have been shown to produce interferon-alpha in +44 20 7776 1221 sufficient quantities, that if used similarly to EPODURE should be therapeutically effective in treating hepatitis C. Medgenics is hopeful that it will be able to get approval to begin clinical Brough Ransom +44 20 7776 1227 studies by the end of this year, with the studies due to start in early 2012. As an open study, initial feedback should be available as the year progresses, helping to validate this product. Guillermo Serrano +44 20 7776 1228 Year end December 2010 2011E 2012E 2013E 2014E Sales and other income($m) 4.4 4.0 47.5 52.5 217.5 Catherine Isted EBITDA ($m) -3.2 -6.8 31.1 33.8 198.4 +44 20 7776 1223 Net profit ($m) -4.1 -6.9 30.9 33.5 198.0 EPS ($) -0.95 -0.81 3.21 2.61 15.00 Source: Company data and Nomura Code estimatesThis research is non-independent and is classified as a Marketing Communication under the FSA’’s rules. As such it has not been prepared in accordancewith legal requirements designed to promote the independence of investment research and it is not subject to the prohibition on dealing ahead of thedissemination of investment research in COBS 12.2.5. However, Nomura Code Securities has adopted internal procedures which prohibit employees fromdealing ahead of the publication of non-independent research, except for legitimate market making and fulfilling clients’’ unsolicited orders.
  2. 2. 21 June 2011 Nomura Code Securities Limited Contents Share structure .................................................................................................................... 3 Company summary.............................................................................................................. 3 Investment thesis ................................................................................................................. 4 Investment risks ................................................................................................................... 4 Valuation.............................................................................................................................. 5 Initial products...................................................................................................................... 5 EPODURE –– Anaemia ......................................................................................................... 6 Factor VIII –– Haemophilia .................................................................................................... 7 INFRADURE –– Hepatitis C .................................................................................................. 8 Niche application.................................................................................................................. 9 New protein therapies .......................................................................................................... 9 Finances ............................................................................................................................ 10 Appendix............................................................................................................................ 13 Breadth of application ........................................................................................................ 13 Erythropoietin..................................................................................................................... 14 Factor VIII .......................................................................................................................... 15 Hepatitis C ......................................................................................................................... 162
  3. 3. 21 June 2011 Nomura Code Securities Limited Share structure There are three lines of stock for Medgenics summarised in the table below, two traded in London on AIM and one on AMEX following the recent US IPO. With about 5.3m warrants and 1.1m options the fully diluted number shares in issue is currently 16.1m. Medgenics share structure summary Shares in Price M cap Ticker issue (m) (p) £m Details MEDG.L 2.178 175 £3.8 AIM listed - Reg S restricted, certificated settlement MEDU.L 1.797 170 £3.1 AIM listed - Depositary Interest, settles in CREST MDGN.U 5.661 $3.38 £11.67 AMEX listed Total 9.636 £18.53 Source: Medgenics Company summary Medgenics was incorporated in January 2000 and is headquartered in Vienna, Virginia. It has a wholly owned subsidiary, Medgenics Medical Israel Ltd (formerly Biogenics), based in Misgav, Northern Israel, which was incorporated in March 2000, where all of its 21 employees are based. The company has developed a Biopump tissue technology that has the potential to revolutionise the production and delivery of protein based therapies, removing the need for an expensive protein production plant and frequent injections, while lowering the cost of treatment and avoiding infringement of intellectual property. By sustained production and delivery of large molecules in this way, the technology has the potential to improve on the clinical efficacy achievable through injections where large boluses of the short-lived therapeutic agent are delivered that typically cause adverse reactions. Medgenics potential newsflow Timing Product Expected News Flow Q3 2011 EPODURE Completion of phase I/IIa trial enrolment Q4 2011 EPODURE Publication of phase I/IIa trial data Q4 2011 Factor VIII Partner could take up exclusivity option Q4 2011 INFRADURE Regulatory approval for phase I/IIa clinical trial Q1 2012 EPODURE Approval of IND Q1 2012 INFRADURE Start of phase I/IIa clinical study Mid-2012 EPODURE Start of phase IIb trial, once funding is secured Mid-2012 Niche application Demonstrate lab feasibility H1 2012 Factor VIII Partner could sign definitive agreement Q4 2012 Factor VIII Start of Phase I/IIa trial Source: Company data, Nomura Code estimates The company’’s technology provides a predictable, sustainable and controllable protein production and delivery system for therapeutic biological molecules in the body. A thin strip of live dermal tissue is extracted from the patient with a needle biopsy, usually from under the skin around the abdomen using a local anaesthetic. The dimensions and architecture of the tissue is a key subject of Medgenics’’ intellectual property as it allows the tissue to remain viable for extended periods of time while maximising the surface area through which nutrients and waste products, as well as expressed proteins, can pass. These strips, which the company refers to as ““micro-organs””, are then transferred to a processing centre where within 10-14 days the gene that codes for a specific therapeutic protein is introduced into the tissue. This is done by way of gutless adenoviral vectors which have no genetic material of their own and are used ex-vivo in preparing the Biopumps, with no virus applied to the patient. The gutless adenovirus is modified to include the required gene (that codes of Factor VIII,3
  4. 4. 21 June 2011 Nomura Code Securities Limited erythropoietin, interferon, etc.) and then exposed to the Biopump tissues in a proprietary protocol. The virus enters the cells in the tissue, introducing its genetic material, converting the ““micro-organ”” into a ““Biopump””. Once the dose secreted by each Biopump is known, and the required dose for a patient established, the required number of Biopump units to be re-implanted can be calculated. Between 1 and 10 Biopumps are typically used at one time, which are injected subcutaneously in a quick and simple procedure using a single use positioning aid under local anaesthetic, usually around the abdomen. Once in place, the Biopumps secrete the protein they are programmed to produce, and a constant stream is released into the body. Being the patient’’s own dermis, the re-implanted Biopumps heal, forming vascular connections and integrating back into the patient’’s tissue. Any genetic material is contained within a defined area so that expression can be terminated if and when required Medgenics is developing a processing station that would use single-use cassettes. Each cassette unit would contain samples from one patient that can be controlled and manipulated independently to bring about the gene transduction through application of the required solutions and gases. The processing station would also allow fluids to be sampled for testing, to ensure that the release criteria of sterility, tissue viability and protein production level are met. Investment thesis Medgenics offers a potentially disruptive technology that has the potential to revolutionise the production and delivery of therapeutic proteins in a broad spectrum of applications which could be commercialised through multiple partners, providing considerable scope of opportunity. Data from the first clinical trials look positive with the EPODURE Biopump (erythropoietin) sustaining haemoglobin levels in anaemic patients within the target range safely for at least 6 months, without the need for additional injections. The company reports that initial discussions with the FDA indicate that the agency is not concerned with the principle of the technology given that new genetic material is contained within the Biopump, the dose delivered is predictable, tightly controlled and easily stopped if required, while the re-implanted tissue used is autologous (originating from the patient). The proteins being used in the initial applications (erythropoietin, factor VIII and interferon- ) are well understood and commonly used, so the risk associated with their use should be limited. Without the need to build expensive facilities and manufacture large amounts of product, dispense and distribute complex therapeutic proteins, Medgenics’’ technology has the potential to provide a much more cost effective method of delivering biological molecules. It also has the additional advantage of not being reliant on patient compliance needed to ensure injections are taken when required. Investment risks Medgenics is still at a relatively early stage in developing its technology with only 1 product validated in a phase I/IIa clinical trial. Although the initial data looks promising there is no guarantee that future clinical results will also be positive. While other pre-clinical testing suggests that the technology will work in other applications, this has yet to be confirmed in clinical trials. There are a number of projects that Medgenics could develop, but has been restricted by limited funds. The company has successfully raised capital over recent years ($8m in 2007, $1.3m in 2009, $6.6m in 2010 and $13.2m so far this year) and has received $4m from its first pharmaceutical partner, in addition to government funding from the Israel Office of the Chief Scientist. The company hopes that the existing deal and further development agreements will result in additional short-term income, but this will depend on certain milestones being reached4
  5. 5. 21 June 2011 Nomura Code Securities Limited and the outcome of ongoing negotiations and we expect that the timing of these payments will mean additional funds will need to be raised. Although the initial response from the FDA has been encouraging, with a new technology like this, there is a risk that concerns from regulators will prolong the development process and increase the investment required. The company is in the process of designing an automated processing system to produce Biopumps in high volumes. However, while the company can demonstrate it can currently produce small volumes, there are risks of technical problems and delays in the scale up process. When considering the competitive threat, Medgenics knows of no other technology of this nature being developed, and is confident that its intellectual property will present significant obstacles to competitors attempting to replicate the product. However, if successful, Medgenics’’ technology will be sufficiently disruptive that it will attract other players into this space. Valuation In the absence of any details on commercialisation strategy or partnership agreements we have forecast only potential milestones for each project, based on recently signed deals in the biotechnology sector, and we have not included any long-term revenue for royalties or sales based payments. In generating our sum of the parts valuation for Medgenics we have allocated specific R&D and other costs to each project to calculate the projected cashflow for each product. We have assumed that Medgenics funds the development work out of the earlier stage payments, up to phase IIb trials. We assume that later stage work and phase III trials are funded separately by Medgenics’’ partners. We have applied a tax rate of 25-28% and calculated the NPV of the net income for each product, using a discount rate of 15%. On this basis we would value the four forecasted products at about $470m, if not risk adjusted, but applying a chance of success of 33% for EPODURE and 20% for INFRADURE given that initial pre-clinical data looks promising. We have applied a 10% chance of success for Factor VIII and the Niche product, given the absence of data. This lowers our risk adjusted fair value to $88m (£54m). As projects progress within their clinical programmes, we would anticipate de-risking individual projects accordingly. Moreover, the signing of commercial agreements should also increase our confidence in projected milestones, and potentially allow the forecasting of long-term sales related milestones or royalties. On the down side, failure to progress clinical programmes or sign any further deals over time, we might expect the share price to trade at or below cash.Risk adjusted, sum of the parts valuation of Medgenics Rate of NPV ($m) Chance of Risk ajd Risk ajd Product return 2011 - 2019 success NPV ($m) NPV (£m) EPODURE 15% 151 33% 50 30 Factor VIII 15% 161 10% 16 10 INFRADURE 15% 90 20% 18 11 Niche 15% 65 10% 7 4 Central costs 15% -9 -9 -6 Cash (end 2011) 7 7 4 Total 457 88 54Source: Nomura Code estimates Initial products To date Medgenics has successfully generated and tested over 5,000 Biopumps with few failures, generated from tissue resulting from ““tummy tuck”” procedures. The company is5
  6. 6. 21 June 2011 Nomura Code Securities Limited confident about the robustness of the technique and has more recently applied the technology to specific applications. Although this technology could be applied to a wide range of biological therapies, Medgenics has initially focussed on three products. EPODURE –– Erythropoietin in the treatment of anaemia. Initial positive feedback from the initial patients in phase I/IIa clinical trials. Factor VIII –– In the treatment of haemophilia. In pre-clinical development, partly funded by an undisclosed pharmaceutical partner. INFRADURE –– Interferon- in the treatment of hepatitis C. Niche application –– An undisclosed niche/orphan drug candidate. EPODURE –– Anaemia EPODURE delivers erythropoietin, a commonly used glycoprotein that stimulates haemoglobin synthesis in patients that have anaemia as a result of kidney failure or cancer therapy (see appendix for further details on erythropoietin). A wide range of doses are available as each patient requires different amounts of the drug in order to sustain haemoglobin levels between a target range of 10-12g/dL. The existing erythropoietin injections are administered about three times a week although newer formulations can be given once weekly. Initial phase I/IIa clinical trial In November 2010, data presented at the American Nephrology Society showed that 12 patients had received an implanted EPODURE Biopump including 6 in the low dose arm (20 IU/kg/day) and 6 more dosed using ““mid-dose”” EPODURE (40 IU/kg/day). The results of the first seven patients in the Medgenics trial showed that five patients were maintained within the target range, with good responses from the other two. Six of the patients were treated with the lowest recommended dose of EPO (20iu/kg/day) while the seventh was treated with a mid-dose (40iu/kg/day). When variable dosing can be used the company expects that those patients falling short of the desired haemoglobin levels could be treated again (ie have another Biopump added) in order to reach the target levels. Conversely if haemoglobin levels are too high, Biopumps can be ablated or removed. Looking at the data for individual patients, it seems that the Biopump is having the desired effect in sustaining the haemoglobin in or near the target range for many months from a single administration. One patient has been successfully treated with an EPODURE Biopump for two years, keeping his haemoglobin levels within the target range of 10-12 g/dl throughout, without any adverse events or EPO injections. Since then the company has announced that the total number of patients recruited has risen to 14 and the company hopes that the final cases in the 18 patient study will be implanted shortly, with the last patients in the high dose group (80IU/kg/day). Recruitment has taken longer than anticipated due to the restrictions of the protocol and the novelty of the therapy, but its completion and presentation of data (the company hopes at the American Nephrology Society in November 2011) will represent a major milestone for the company. IND for phase IIb Medgenics is preparing an Investigational New Drug (IND) application to run a phase IIb trial in the US and discussions with the FDA are already underway. The company is hopeful that it will receive approval for its IND in Q1 2012 so that the trial could start in the middle of the year. We expect that the trial will involve about 100 patients and will take 18 months to complete, including 6 months follow up, so the study could be complete by the end of 2013.6
  7. 7. 21 June 2011 Nomura Code Securities Limited Potential development agreement and funding We believe that Medgenics currently has enough funding to take it through to the middle of 2012 but it does not have enough capital to undertake the EPODURE phase IIb trial on its own. It is in discussions with potential partners and is hopeful that an agreement will result in upfront milestones and/or significant contribution to the development costs, allowing this project to progress without the need to raise additional funds. In the absence of a deal and with the IND approved, the company is hopeful that it would be able to secure an additional round specifically to raise cash for this purpose. Reimbursement issues The reimbursement of EPO in patients with kidney failure changed significantly in January 2011 in the US. Previously, dialysis clinics generate a substantial part of their revenue from administering EPO, and much of this is dependent on Medicare reimbursement. However, following these recent changes, reimbursement has switched from the basis of ““cost plus”” regardless of the amount of EPO used, to a new flat rate with penalties if haemoglobin levels are not kept in target range. Consequently, renal dialysis clinics are likely to face considerable margin pressure, given the cost of EPO, if they are to maintain the best of care for their patients. Therefore, we believe that dialysis clinics will view Medgenics’’ phase I/IIa data with great interest, given that it presents a possible solution to the reimbursement shortfall. Projected licensing agreements and milestones We believe it is likely that Medgenics would sign a number of licensing agreements in different geographic regions. In our model we have included potential milestone payments that may be received by Medgenics as EPODURE reaches key stages of its development, but no long term sales related milestones or royalty payments. For EPODURE we have included two potential deals, one for the US/Europe and another regional deal although other regional agreements are also likely. Following a review of recent milestones paid in recent deals we have assumed payments totalling $20m on licensing, $100m on completion of phase IIb studies and $120m on submission and $120m on approval.Estimated timing for EPODURE clinical programme 2010 2011E 2012E 2013E 2014E 2015E 2016E 2017E Phase I/IIa Phase IIb Phase III Potential milestones project 1 $10m $30m $40m $40m Potential milestones project 2 $10m $70m $80m $80m Total projected milestones $20m $100m $120m $120mSource: Nomura Code estimates Factor VIII –– Haemophilia In 2009, Medgenics signed an agreement with an undisclosed major pharmaceutical company to develop a Biopump to deliver Factor VIII. Under the terms of the agreement, Medgenics embarked on the pre-clinical development of a Factor VIII and received $4m to work exclusively with its partner on the project for a year and to test the feasibility of the Biopump in this application. In November 2010, Medgenics announced a change to its collaboration with its partner so that Medgenics would assume all funding responsibilities for the project while certain issues were resolved. We believe that yield of the Factor VIII biopumps needed to be improved in order for the product to be therapeutically viable. The company has indicated that this work has gone well and has recently announced continuation of collaboration with the partner to perform a7
  8. 8. 21 June 2011 Nomura Code Securities Limited validation study through September to confirm the advances. Through this period the partner can exercise an option to retain six months exclusivity on payment of a $2.5m fee, while a longer term agreement is negotiated. We have assumed that the pre-clinical phase will be concluded by Q4 2011 at which point the intentions of the partner should become clear. If all goes to plan Medgenics would then aim to gain approval for a phase I/IIa study in 10-15 patients which we believe could start at the end of 2012, concluding about a year later. If the development agreement progresses we anticipate that initiation of this trial would result in a milestone payment of about $20m from the partner. On the basis that this is a global deal and assuming these trials are satisfactory we speculate that another $75m could be paid in 2013 before the product enters phase IIb, a $100m on completion of phase IIb, $100m on phase III completion/regulatory submission and $120m on approval.Estimated timing for Factor VIII clinical programme 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E Pre-clinical Phase I/IIa Phase II Phase III Potential milestone $3.6m $2.5m $20m $75m $100m $100m $120mSource: Nomura Code estimates INFRADURE –– Hepatitis C Medgenics has developed INFRADURE, a Biopump that produces interferon alpha for the treatment of hepatitis C. The product was introduced in April 2010 at EASL (European Association for the Study of the Liver) conference where two pre-clinical posters were presented. Pre-clinical studies In two posters presented at EASL in April 2010, data confirmed that in-vitro and in pre-clinical studies, the INFRADURE product behaves as Medgenics had expected. Initial in-vitro studies confirmed that the INFRADURE Biopumps could produce well in excess of the 1µg per day targeted interferon- production levels and that the dose generated corresponded to the amount of virus particles used to treat each micro-organ. The same poster also confirmed that IFN- production at above target levels could be sustained for at least 129 days. In a further study in SCID (Severe Combined Immunodeficient) mice Biopumps were implanted subcutaneously at a low (1,300ng/day) or high dose (4,000 ng/day). The resulting serum IFN- reflected the high implanted doses and were appropriate for a 70kg human, and secretion continued for over 100 days from a single INFRADURE implantation. The study showed no signs of toxicity after 123 days continuous treatment. In a separate study 12 SCID mice were implanted with INFRADURE Biopumps secreting at least 1µg/day of IFN- . A direct correlation was demonstrated between the IFN- levels and IFN- bioactivity confirming that the INFRADURE was secreting a potent form of the molecule. Clinical trial programme Medgenics is currently working to gain approval to start a clinical trial programme for INFRADURE. The company is hopeful that they would receive regulatory approval by the end of 2011 so it would be in a position to start recruitment in early 2012 and could take 12-18 months to complete. The initial study would probably involve 10-20 patients and would attempt to confirm the safety of the product while demonstrating that its use in place of interferon- or8
  9. 9. 21 June 2011 Nomura Code Securities Limited pegylated interferon- in combination with Ribavirin achieves comparable HCV eradication but with significantly reduced side effects compared with the standard of care. The company believes that if such data are obtained, and with the lower cost of economics, that INFRADURE would represent a much preferred alternative to injected interferons by patients, physicians and providers. Although we believe that Medgenics is in discussion with potential partners for this product, at this stage it is not clear when a development agreement might be struck. We have assumed that the company funds the initial phase I/IIa studies itself and signs a deal with associated milestones payable before entering larger phase IIb studies. On this basis, and assuming a global deal, we have forecast a $20m milestone on signing a licensing deal, $80m on completion of phase IIb and $100m on submission and $130m on approval.Estimated timing for INFRADURE clinical programme 2010E 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E Pre-clinical Phase I/Iia Phase II Phase III Potential milestone $20m $80m $100m $130mSource: Nomura Code estimates Niche application The company has also attracted interest from players that target small, niche applications and discussions are currently ongoing. This may provide Medgenics with an opportunity to establish a more rapid means of establishing initial regulatory approval of the technology. By targeting a rare indication that would attract orphan drug status, a 25-30 patient study might be sufficient to file for regulatory approval which could be faster and cheaper than the other indications being considered and may ultimately smooth the process of subsequent regulatory filings. We assume that if an agreement is reached for a project of this nature that an upfront payment of $5m could be made initially, with $30m payable on completion of Phase I/IIa studies and $40m on completion of phase IIb/III trials with $50m on approval.Estimated timing for Niche clinical programme 2009 2010E 2011E 2012E 2013E 2014E 2015E 2016E Phase I/IIa Phase IIb Potential milestones $5m $30m $40m $50mSource: Nomura Code estimates New protein therapies The applications discussed so far involve a new form of production and delivery of proteins already marketed in an injectable form. A potential source of licensing deals we have not considered in our model are a range of new protein therapies, including antibody therapy, not yet on the market but currently being developed. We believe that developers of biological molecules are likely to consider using Medgenics’’ technology as it provides a novel and effective means of delivery, but also because it would remove the need for setting up capital9
  10. 10. 21 June 2011 Nomura Code Securities Limited intensive and expensive production facilities, potentially shortening the time and cost to enter clinical trials, and lowering the cost of treatment while maintaining profitability. Finances Third party payments The business model of Medgenics’’ technology is still not clear as it will depend on individual commercialisation deals yet to be agreed. These deals may involve Medgenics in the manufacturing/processing of the Biopumps or merely as part of a royalty agreement. In the absence of further details we have only modelled the potential milestones that may be payable as specific stages are reached in the clinical programmes, significantly undervaluing the full potential of the business in the long-term. There are clearly a number of permutations in this respect, given that it is not clear which programmes Medgenics will be able licence out at an early stage and which trials it will fund itself. In attempting to quantify the potential milestones that Medgenics may receive, we have used a range of recent biotechnology partnering deals as a reference. Although we have no indication about the level of potential milestone payments beyond the those made for the Factor VIII product, our model assumes that the agreement on the Factor VIII product results in an additional $415m in milestones if the product is approved with payments being made on successful completion of clinical trial programmes and approval. For EPODURE, we have assumed that Medgenics signs development agreements (one for the US and one regional agreement) before phase IIb studies commence, but that Medgenics manages the trial itself, using part of the estimated $20m in upfront payments to fund the development. Our model includes more substantial payments ($100m in total) on successful completion of phase IIb studies and an additional $120m on phase III completion and $120m on approval. We have assumed that the company carries out the initial clinical trials for INFRADURE itself, and does not sign a licensing deal until it is ready to proceed with phase IIb studies, when we estimate a $20m payment. Our model factors in milestones of up to $330m if the product is approved. Although no details have been released, we have included up to $120m in milestones for a niche application with initial $5m payment made in 2012. R&D expenses and government grant Our R&D expenses forecasts assume that Medgenics funds or part-funds clinical trials up to phase IIb. Thereafter we expect that the company’’s partner will take over the clinical development. Medgenics qualifies for a government grant from the chief scientific officer of Israel who funds up to 60% of approved R&D spending. Grants of between $0.5m and $1.5m per annum have been paid to date, but the company expects that this would rise as its R&D spending in Israel increases.10
  11. 11. 21 June 2011 Nomura Code Securities LimitedMedgenics Income statement forecasts ($m) Year ending December 2010 2011 2011E 2012E 2013E 2014E 2015E $m Q1 Factor VIII 3.5 2.5 20.0 0.0 75.0 0.0 EPODURE 0.0 20.0 0.0 100.0 0.0 INFRADURE 0.0 0.0 20.0 0.0 80.0 Niche 0.0 5.0 30.0 40.0 50.0 Total third party payments 3.5 0.0 2.5 45.0 50.0 215.0 130.0 Government grants 0.9 0.0 1.5 2.5 2.5 2.5 2.0 Total income 4.4 0.0 4.0 47.5 52.5 217.5 132.0 R&D expenses -3.4 -1.2 -6.5 -12.0 -14.0 -14.0 -12.0 General admin expenses -4.4 -0.8 -4.4 -4.6 -5.0 -5.5 -5.5 Operating loss/profit -3.4 -2.0 -6.9 30.9 33.5 198.0 114.5 Financial expenses -0.8 1.6 Pre-tax profit -4.1 -0.3 -6.9 30.9 33.5 198.0 114.5 Tax -0.0 0.0 0.0 0.0 -8.4 -53.5 -32.1 Net loss/profit -4.1 -0.3 -6.9 30.9 25.1 144.5 82.4 Weighted average number of shares (000) 4,374 5,370 8,551 9,636 9,636 9,636 9,636 EPS ($) -0.95 -0.06 -0.81 3.21 2.61 15.00 8.56 Fully diluted no. of shares (m) 11,122 12,118 14,430 16,085 16,085 16,085 16,085 EPS ($) fully diluted -0.37 -0.03 -0.48 1.92 1.56 8.99 5.13 Tax rate 25.0% 27.0% 28.0%Source: Company and Nomura Code estimates11
  12. 12. 21 June 2011 Nomura Code Securities LimitedMedgenics cashflow forecasts ($m) Year ending December 2010 2011 2011E 2012E 2013E 2014E 2015E 2016 $m Q1 Net loss/profit -4.1 -0.3 -6.9 30.9 25.1 144.5 82.4 150 Depreciation 0.1 0.0 0.1 0.2 0.3 0.4 0.4 0 Loss, disposal of property and equipment 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0 Stock based compensation 1.8 0.1 0.6 0.6 0.6 0.6 0.6 0 Change in fair value of convertibles 0.6 -1.7 0.0 0.0 0.0 0.0 0.0 0 Accrued severance pay 0.0 0.0 0.1 0.1 0.1 0.1 0.1 0 Exchange 0.0 -0.0 0.0 0.0 0.0 0.0 0.0 0 Increase in payables -0.2 0.3 0.1 0.1 0.1 0.1 0.1 0 Decrease in receivables -1.6 -0.0 0.1 0.1 0.1 0.1 0.1 0 Increase in other accounts payable -0.8 0.1 0.0 0.0 0.0 0.0 0.0 0 Cash used in operating activities -4.2 -1.5 -5.9 32.0 26.3 145.8 83.7 152 Decrease in prepaid lease payments 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0 Increase in restricted lease deposit Purchase of PP and E -0.1 0.0 -0.5 -1.0 -1.0 -1.0 -1.0 -1 -4.3 -1.6 -6.4 31.0 25.3 144.8 82.7 151 Proceeds from issuance of shares 2.1 0.0 10.6 0.0 0.0 0.0 0.0 0 Proceeds from exercise of warrants 0.5 0.0 0.0 0.0 0.0 0.0 0.0 0 Issue of debenture and warrants 4.0 Proceeds from a convertible Note 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0 Increase/(Decrease) in short-term bank credit 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0 Decrease in cash and equivalents 2.4 -1.6 4.2 31.0 25.3 144.8 82.7 151 Cash and equivalents at start 0.5 2.8 2.9 7.1 38.1 63.3 208.2 336 Cash and equivalents at end 2.9 1.3 7.1 38.1 63.3 208.2 290.9 487Source: Company and Nomura Code estimates12
  13. 13. 21 June 2011 Nomura Code Securities Limited Appendix Intellectual Property Medgenics has a range of intellectual property, summarised in the table below that covers the principle and method of producing and processing of micro-organs, but also includes patents surrounding the design of the processing system. The specific techniques used in harvesting and processing the micro-organs are critical to the success of this technology and the company believes that the aspects covered by its intellectual property would present significant barriers to entry for any competitors.Summary of Medgenics’’ intellectual property Patent US Filing Family Title date Status Claims P-5884 Dermal micro-organs, methods and Apr-04 Granted in US, Use of a genetically modified micro-organ of apparatus for production pending in Europe specific shape that allows nutrients and gases to and elsewhere diffuse into and out of structure. P6687 Closed automated system for May-04 Granted Australia, Processing system that allows the containment of processing tissue based therapy India, China, micro-organs with fluidic and gas control to sustain Pending elsewhere tissue, allow transduction to be performed and measure quantity of agent being produced. P-8571 In vitro micro-organs and uses. Dec-02 Pending A genetically modified micro-organ that expresses at least one recombinant gene products P-8574 Efficient methods for assessing Jul-02 Pending Method for assessing the presence of a and validating candidate protein pharmaceutical/therapeutic agents from micro- based therapeutic molecules organs encoded by nucleic acidsSource: Medgenics Breadth of application Medgenics’’ technology is designed to provide a more effective and safer means of producing and delivering protein based therapies without the need for frequent injections or a protein production plant. In principle, this technique can be used in therapy currently requiring regular injections of a biological molecule, the most common of which are summarised in the table below. Medgenics development pipeline summary Disease Protein Medgenics development phase Est market size ($bn) Anaemia Erythropoietin Phase I/II 11.5 Hepatitis C Interferon- Pre-clinical 3.5 Haemophilia Factor VIII Pre-clinical co-development 3.6 Growth Failure Growth 2.8 Future candidate target Hormone Multiple Sclerosis Interferon-ß Future candidate target 5.2 Diabetes Insulin Future candidate target 11.2 Arthritis IL-1 Ra Future candidate target 12.9 Wound Healing PDGF-BB Future candidate target NA Obesity Peptide YYS- Future candidate target 36 NA Chronic Pain IL-10 Future candidate target NA Cancer recovery G-CSF Future candidate target 4.8 Source: Medgenics Potentially more effective and safer than injected therapies Injections deliver a bolus of the therapeutic agent resulting in a spike of serum levels of the protein, after which the concentration tails off as the molecule is distributed and metabolised. Most agents of this nature have a short half-life but need to be sustained within a therapeutic13
  14. 14. 21 June 2011 Nomura Code Securities Limited window in the blood. Below this range the product is not effective and above it there is a risk of adverse events. Most injectable therapies involve a compromise between dose and frequency of injection in order to achieve this. The need for frequent injections is clearly undesirable, but is often an inevitable consequence of needing to maintain serum levels within the optimum range in view of the short half-life of the agent. Even with frequent administration it is not always possible to achieve this and the nature of delivering a bolus will result in fluctuations in blood concentration. Medgenics’’ Biopumps are designed to release a sustained stream of protein into the body and so should be able to maintain a steady level in the body, similar to the action of an infusion pump. If the dosing is calculated correctly, or subsequently adjusted by administration of additional Biopumps or ablation to reach the desired level, the agent can be sustained within the therapeutic window, avoiding troughs whereby efficacy is impaired, or peaks which could cause side effects. The Medgenics system has the additional advantage of not being reliant on patient compliance required to ensure injections are taken when needed. Erythropoietin Erythropoietin (EPO) is a hormone produced in the kidney that stimulates the production of red blood cells in the bone marrow. It was first approved as a therapeutic agent in 1989, branded as Epogen, produced by Amgen and since has been one of the most successful biologically based drugs currently in use. EPO is administered to patients in end stage renal failure as their kidneys are unable to produce enough of the hormone in order to sustain adequate levels of red blood cells. It can also be used in cancer patients prior to radiation and chemotherapy that affects the bone marrow. Without boosting the red blood cells in this way, patients may not be able to survive the anaemia caused by the cancer treatment. Most EPO treatments require patients to be injected three times a week, although more recently developed forms, such as Amgen’’s Aranesp, only require once weekly dosing. EPO is associated with a number of adverse events including cardiovascular complications and a review of clinical data in 2007, resulted in a ‘‘Dear Doctor’’ letter being issued by the FDA about off-label use and a black box warning on the label of erythropoietin. Medgenics believes that these adverse events are related to the bolus injections of high doses and haemoglobin cycling caused by injecting EPO. Market Summary of erythropoietin market leaders Supplier Product 2010 sales ($ billion) Growth Amgen Aranesp 2.48 -6% Amgen Epogen 2.52 -2% J&J Procrit 1.90 -14% Roche NeoRecormon/Epogin 1.52 -15% Source: Company reports The global market for erythropoietin is about $12 billion with Amgen, J&J and Roche the key branded players, although some biosimilars have already reached the market. The entrance of other biosimilar competitors has been hampered by regulatory concerns about adverse events and the requirement to perform long and expensive safety studies. Reimbursement Much of the controversy surrounding the use of EPO has been associated with the reimbursement of its use in kidney dialysis patients. When EPO was first reimbursed for use in the treatment of end stage renal patient, Medicare paid $40 a dose (wholesale price for 4,00014
  15. 15. 21 June 2011 Nomura Code Securities Limited units) with an additional payment of $30 for any dose over 10,000 units. This policy resulted in lower than anticipated use of EPO, so in 1991 the reimbursement rate was changed to $11 per 1,000 units and then again in 1994 to $10. However, over the next ten years the average dose of EPO used on dialysis patients doubled. By 2005, with about 390,000 patients being treated at an overall dialysis cost of $7.9 billion, the cost of separately billable drugs was $2.9bn of which $2 billion was EPO. The drug had become Medicare’’s largest single pharmaceutical expense. The cost of EPO to the large dialysis providers was about 12% below the reimbursement rate, partly due to ““overfill”” (overfilling of EPO vials). From 2006, Medicare reimbursed the average selling price of EPO plus 6%, lowering the margins being generated by the clinics, but the overall cost of the drug to Medicare remained a concern. In January 2011, a new US reimbursement rates for dialysis came into force so that each dialysis patient is now eligible for a single bundled rate, including additional pharmaceutical treatment such as EPO. This presents a dilemma to the dialysis clinics as they attempt to balance the new reimbursement rate with the high cost of EPO and the quality of care they provide for their patients. A consequence of this is likely to be that the dialysis providers will be looking at alternative means of treating patients with EPO and would expect that they will look at the outcome of Medgenics’’ EPODURE clinical trial with interest. Factor VIII Haemophilia A Haemophilia is a group of bleeding disorders caused by genetic defects resulting in a lack of blood clotting factors necessary to stop bleeding. Haemophilia A is a rare genetic condition in which patients are deficient in Factor VIII, an essential blood clotting factor, which leads to a significant risk of bleeding. People suffering from haemophilia B are deficient in Factor IX and people suffering from von Willebrand disease have a part of the Factor VIII molecule (known as von Willebrand) reduced. Haemophilia A is more common than haemophilia B. Generally, cuts and grazes are not significant issues (pressure and a plaster are usually enough to stop the bleeding), the main problem is internal bleeding into joints, muscles and soft tissues. Haemophilia A affects approximately 18,000 people in the US, mainly males The incidence of haemophilia A is about 1:7,500 males and 1:25,000,000 females. There are about 18,000 people living with haemophilia A in the US and approximately 30,000 people in Europe. Although the disease has an X-linked inheritance pattern, as many as 30% of people with haemophilia A may have developed it from a spontaneous mutation of the Factor VIII clotting gene on their X-chromosome. The full blown version of Factor VIII deficiency is very rare in women, and would only result from having a father that is affected and a mother that is a carrier, or having two affected parents. Haemophilia A is typically classified as either: a) Mild - about 25% of the haemophilia population. Usually have problems with bleeding only after serious injury, trauma, or surgery. In many cases, mild haemophilia is not discovered until an event (such as injury, surgery, tooth extraction etc.) results in unusual bleeding. The first episode may not occur until adulthood; b) Moderate - about 15% of the haemophilia population. Tend to have bleeding episodes after injuries. They may also experience occasional bleeding episodes without obvious cause. These are called "spontaneous bleeding episodes"; c) Severe - about 60% of the haemophilia population. Have bleeding following an injury and may have frequent spontaneous bleeding episodes, often into their joints and muscles. Replacement therapy is the main treatment option There is no cure for haemophilia. In mild haemophilia cases treatment typically involves injection of the hormone desmopressin to stimulate the release of more clotting factor to stop the bleeding. For moderate to severe haemophilia, replacement clotting factor is typically15
  16. 16. 21 June 2011 Nomura Code Securities Limited infused and if the internal bleeding is serious, preventative infusions may be given two to three times a week. The replacement Factor VIII market is currently worth over $3.5 billion globally. First generation Factor VIII products were plasma-derived From the 1960s to the beginning of the 1990s, patients with haemophilia A were treated with plasma-derived Factor VIII. Unfortunately, in the 1980s these plasma-derived products were discovered to be infecting patients with HIV (50% of haemophiliacs were infected between 1980-1985) and with hepatitis B and C (80% of haemophiliacs were infected with hepatitis C before 1987). In 1987, the widespread use of heated blood plasma fractions put an end to the transfer of these infections. Recombinant products were first sold in the 1990s and have since been improved Following the sequencing of the Factor VIII gene in 1984, the first recombinant Factor VIII reached the market at the beginning of the 1990s. While this first generation of recombinant Factor VIII (Recombinate from Baxter and Kogenate from Bayer) eliminated the risk of infection, the preparation and formulation still required the use of human albumin and certain animal products. The second generation recombinant products (ReFacto from Wyeth/Biovitrum, Kogenate FS from Bayer) replaced human albumin with sucrose, but still incorporated proteins or raw materials derived from human or animal sources. Of these Kogenate is the biggest seller, achieving sales of about $1.5 billion (+10%) in 2010. Xyntha and Advate are the latest generation recombinant products Third generation recombinant Factor VIII products are now available (Advate from Baxter which achieved sales of nearly $1.8 billion in 2010 and Refacto/Refacto AF/Xyntha from Wyeth/Biovitrum with revenues of $379m in 2010). The manufacturing process for these products excludes proteins or raw materials derived from human or animal sources, thereby removing the risk of transmitting potentially infectious agents. High cost per patient The cost per patient for treatment with Factor VIII varies depending on the severity of the disease, but for severe cases can exceed $100,000 a year. Hepatitis C Hepatitis C is a blood-borne viral infection that mainly causes inflammation and damage to the liver but can also affect the intestine, lymphatic system, immune system and the brain. The hepatitis C virus (HCV), which is transmitted by coming into contact with infected blood, was identified in 1989 and a diagnostic test was available in the early 1990’’s. It is estimated that about 200m people are infected with HCV worldwide, although prevalence varies between countries and ranges between 1% of the population (Northern Europe), 2% (US) and 10% (Egypt). The progression of disease can vary between patients with symptoms taking many years to emerge while others experience a rapid onset of problems associated with the virus. As a result, many of the infected population are unaware they that they have the disease and initial symptoms (fatigue, pain and intestinal problems) are attributed to other causes. However, in the more aggressive form of the disease scarring of the liver and ultimately end stage liver disease can mean that a liver transplant is the only option. Strangely, there is little correlation between the level of symptoms and the amount of damage to the liver. Treatment Treatment of the disease over recent years has proved to be relatively successful with success rates at about 50% for one form of the virus (genotype 1) and 80% for two other genotypes (genotypes 2 and 3). The most common form of treatment involves subcutaneous injection with interferon- and ribavirin, an oral antiviral therapy. Initially, formulations of16
  17. 17. 21 June 2011 Nomura Code Securities Limited interferon- required injection three times a week, but more recent forms of the drug are pegylated (made larger through a chemical process) and the longer lasting drug only needs to be administered once weekly. Interferon is a protein produced normally by the body as part of its defence against viruses. However, large bolus injections are associated with a number of side effects including nausea, anaemia, flu-like symptoms, insomnia, hair loss, and rashes. The recommended duration of treatment will depend on the genotype of HCV causing the infection and whether combination or monotherapy is being used. For peginterferon monotherapy, a 48-week course is normally used regardless of genotype, while the recommended therapy course can last for 24-48 weeks depending on the genotype. Treatment is normally recommended for patients who have histological evidence of progressive disease regardless of whether they are symptomatic. Interferon- market Roche and Schering-Plough (Merck & Co) dominate the interferon- market for treating hepatitis C. The first products to be launched, Roferon-A (Roche) and Intron A (Schering- Plough) required injections three times a week, but these have been superseded by their Pegylated forms, Pegays (Roche) and Peg intron (Schering-Plough/Merck) that need to be injected once a week. Over time we believe that this market will be affected by biosimilar (generic) products. Summary of market leaders in the hepatitis C interferon- market Supplier Product 2010 sales ($ billion) Growth Roche Pegasys 1.96 +2% Merck & Co Pegintron 0.74 -12.6% Source: Company reports New products Hepatitis C is one of the most active areas of development for the pharmaceutical industry and there are a number of new classes of oral drugs in the pipeline including protease inhibitors (including products from Vertex and Merck that have been recently launched), nucleoside inhibitors of HCV polymerase, non-nucleoside inhibitors of HCV polymerase inhibitors and NS5A inhibitors. Many of these compounds show impressive reductions in viral load, but only as part of a triple therapy, including ribavirin and interferon- . Consequently, the need for interferon is unlikely to be significantly impacted by the approvals these new products, but in the long-term pharmaceutical companies may attempt to demonstrate the efficacy of the oral products as a monotherapy in the treatment of some of the HCV genotypes.17
  18. 18. 21 June 2011 Nomura Code Securities LimitedDISCLOSURESAnalyst certifications:I, Michael King, a research analyst employed by Nomura Code Securities Limited (““Nomura Code””), hereby certify that all of the views expressed inthis research report accurately reflect my personal views about any and all of the subject securities or issuers discussed herein.In addition, I hereby certify that no part of my compensation was, is, or will be, directly or indirectly related to the specific recommendations or viewsthat I have expressed in this research report, nor is it tied to any specific investment banking transactions performed by Nomura Code or any otherNomura Group company or affiliates thereof.Analysts may forward a draft copy of the research, prior to publication, to the subject company in order to verify facts. Where such verification issought, the analyst must remove any rating or investment summary from the research prior to forwarding it to the subject company. Any subsequentamendments to the research are to correct factual inaccuracies only. Any matters of judgement are the authors own and our analysts will not amendthe research on the basis of an issuers contrary view.Explanation of Nomura Code Securities Limited’’s rating system:(a) Valuation:Stock recommendations are based on absolute valuation upside (downside), which is defined as (Fair Value - Current Price) / Current Price, subjectto limited management discretion. In most cases, the Fair Value will equal the analysts assessment of the current intrinsic fair value of the stockusing an appropriate valuation methodology such as Discounted Cash Flow or Multiple Analysis etc. However, if the analyst doesnt think the marketwill revalue the stock over the specified time horizon due to a lack of events or catalysts, then the fair value may differ from the intrinsic fair value. Inmost cases, therefore, our recommendation is an assessment of the difference between current market price and our estimate of current intrinsic fairvalue. Recommendations are set with a 6-12 month horizon unless specified otherwise. Accordingly, within this horizon, price volatility may causethe actual upside or downside based on the prevailing market price to differ from the upside or downside implied by the recommendation(b) Stocks:A rating of ““Strong Buy”” indicates that the Analyst expects the stock to outperform the Benchmark by 15% or more over the next six months.A rating of ““Buy”” indicates that the Analyst expects the stock to outperform the Benchmark by 5% or more but less than 15% over the next sixmonths.A rating of ““Neutral”” indicates that the Analyst expects the stock to either outperform or underperform the Benchmark by less than 5% over the nextsix months.A rating of ““Reduce”” indicates that the Analyst expects the stock to underperform the Benchmark by 5% or more but less than 15% over the next sixmonths.A rating of ““Sell”” indicates that the Analyst expects the stock to underperform the Benchmark by 15% or more over the next six months.Stocks labelled ““Not Rated”” or shown as ““No Rating”” are not in Nomura Code’’s regular coverage. Investors should note that additional researchreports on this company may not be published by Nomura Code.(c) Sectors:A ““Bullish”” stance indicates that the analyst expects the sector to outperform the Benchmark during the next six months.A ““Neutral”” stance indicates that the analyst expects the sector to perform in line with the Benchmark during the next six months.A ““Bearish”” stance indicates that the analyst expects the sector to underperform the Benchmark during the next six months. stBenchmarks are as follows: Pharmaceuticals: FTSE Euro 1 300 Pharma & Bio Index; Biotechnology: Nomura Code European Biotechnology IndexPrice targetsPrice targets, if discussed, reflect in part the analysts estimates for the companys earnings. The achievement of any price target may be impeded bygeneral market and macroeconomic trends, and by other risks related to the company or the market, and may not occur if the companys earningsfall short of estimate.18
  19. 19. 21 June 2011 Nomura Code Securities LimitedMaterial InterestsInvestment Banking services: Nomura Code or its affiliates in the Nomura Group is party to an agreement with Medgenics [MEDG.L] relating to theprovision of investment banking services which has been in effect over the past 12 months or has given rise during the same period to a payment orto the promise of payment.Market maker: Nomura Code or its affiliates in the Nomura Group is a market maker or liquidity provider in the securities / related derivatives ofMedgenics [MEDG.L].Corporate broker: Nomura Code or its affiliates in the Nomura Group has a corporate broking relationship with Medgenics [MEDG.L]Share price and rating history Recommendation changes in last year 260 Date Recommendation change price 240 220 200 180 160 140 120 100 80 Jun-09 Se p-09 De c-09 M ar-10 Jun-10 Se p-10 De c-10 M ar-11 Jun-11 MEDGSource: DataStream and Nomura Code SecuritiesDistribution of Nomura Code recommendations % of recommendations published during % for which material investment banking the quarter to March 2011 services have been provided Buy 71% 100% Neutral 20% 0% Sell or reduce 9% 0%Source: Nomura Code19
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