Mereo BioPharma: focussed on execution

Mereo BioPharma’s now solid financial position allows management to focus on executing its development plans for its key programmes, notably its promising anti-TIGIT programme. Etigilimab is set to start a Phase Ib/II PD1 combination trial in a variety of solid tumour types during Q420. Although early stage, etigilimab is particularly exciting and, if successful, could transform Mereo’s prospects. Meanwhile, the orphan and rare disease products, setrusumab, for osteogenesis imperfecta (OI or brittle bone disease), and alvelestat, for the treatment of alpha-1 antitrypsin deficiency (AATD), continue to progress. Partnering discussions are known to be underway, with attractive deals being clear value inflection points. Our valuation is £570m or $741m, equivalent to 101p/share or $5.06/ADS (fully diluted).

Mereo BioPharma’s H120 results were in line with expectations, with cash of £56.8m at June (vs £36.1m at end-H119) following the £11.8m raised as equity and debt in Q120 and the impressive £56m ($70m) equity raise in Q220. Management now has the resources to progress its development plans through to early-2022. The product pipeline consists of six later-stage clinical assets: two in oncology, two in rare diseases, and two earmarked for partnering (Exhibit 1). The portfolio is well diversified, with each of the product candidates employing a different mechanism of action and targeting a distinct indication. Our recent Outlook note (September 2020) provides a detailed company overview and analysis of the portfolio.

Exhibit 1: Mereo BioPharma pipeline summary

Source: Mereo BioPharma, Trinity Delta  Note: NE = neutrophil elastase; HH = Hypogonadotropic Hypogonadism, * formerly known as Oncologie

Etigilimab, an anti-TIGIT antibody, is in our view the most promising programme. It targets the TIGIT (T-cell immunoreceptor with immunoglobulin and ITIM) domains, which is a particularly exciting area in immuno-oncology as it appears to stop T-cells from attacking tumour cells much like the PD-1 inhibitory protein. These are known as immune checkpoint receptors and their inhibitors (CPI), targeting checkpoints such as CTLA-4 (cytotoxic T lymphocyte‐associated antigen 4) and PD-1 (programmed cell death 1) receptors, have transformed clinical practice. However, a sizeable patient population fail to respond or relapse, and the search is on for new CPI targets that improve treatment outcomes. TIGIT is viewed by many as a next generation CPI, with extensive clinical programmes currently underway. There are ten TIGIT programmes known to be in clinical development, albeit four have only just entered Phase I.

Etigilimab showed promising results in a 23 patient Phase Ia open label dose escalation trial in locally advanced and metastatic solid tumours and a related 10 patient Phase Ib dose escalation study, in combination with nivolumab. No dose limiting toxicities were observed in either study. Management has confirmed that a Phase Ib/II study of etigilimab in combination with a PD-1 inhibitor is planned to start in Q420. This will involve 75 to 100 patients with a range of solid tumours, including a selection of less common types. We expect etigilimab will be progressed through proof-of-concept Phase II studies, with the data being pivotal in guiding the development strategy.

Setrusumab, for osteogenesis imperfecta (OI), is the most advanced programme in the rare disease portfolio. It has successfully completed a Phase IIb study (ASTEROID) and is expected to be partnered ahead of the pivotal Phase III registration trial programme. OI is a rare disease that is better known as brittle bone disease, where different genotypes are characterized by varying degrees of skeletal fragility. The hallmark of OI is that bone fractures happen with only minimal to moderate trauma. ASTEROID, a 112 adult OI patient Phase IIb clinical trial performed across 27 specialist sites in the US, Europe and Canada, formed the basis of discussions with the EMA and FDA.

The outline of a single international Phase IIb/III trial, involving c 165 children aged two to 18 with OI (Type I, III, and IV) and using fracture rate at 12 months as the primary endpoint, has been agreed with regulators to support a potential approval. The plan is to partner setrusumab ahead of the formalisation of the final trial design. Management is exploring a number of options but, given its strong relationships with the OI patient communities and KOL (key opinion leaders), is keen to retain commercial rights in certain regions. In September 2020, the FDA granted setrusumab Rare Pediatric Disease Designation, which could result in a grant of a priority review  voucher from the FDA. This could be redeemed to obtain priority review for any subsequent MAA/BLA or be sold or transferred to another company.

Alvelestat, for α1-antitrypsin deficiency (AATD), is the second rare disease product and another suitable candidate for the retention of certain geographic rights. A proof-of-concept Phase II trial (ASTRAEUS) in c 165 severe AATD patients is underway, with top-line results expected in H221. These results will form the basis of discussions with the FDA and EMA and guide the design of the pivotal Phase III trial. Interestingly, the acute lung injury that is often seen in COVID-19 infection may be ameliorated by alvelestat and a 15 patient Phase Ib/II trial (COSTA) has recently initiated in hospitalised adults with moderate to severe COVID-19 respiratory disease. Two additional investigator sponsored studies are underway: a Phase I/II in bronchiolitis obliterans syndrome (BOS) after allogeneic hematopoietic stem cell transplant, and a Phase II (ATALANTa) in AATD.

The three remaining clinical programmes have commercial merit but are not well suited for marketing by a specialist oncology, or rare disease focused sales team and are either already partnered or being prepared for partnering:

• Navicixizumab, the second oncology asset, was licensed to OncXerna in January 2020. It is an anti-DLL4/VEGF bispecific monoclonal antibody that targets and inhibits both Delta-like ligand 4 (DLL4) in the Notch stem cell signalling pathway and vascular endothelial growth factor (VEGF). The dual mechanism offers the potential of anti-angiogenic, anti-cancer stem cell, and immune-modulatory effects. It has FDA Fast Track designation for the treatment of patients with high-grade ovarian, primary peritoneal or fallopian tube cancer who have received at least three prior therapies and/or prior bevacizumab. Deal terms included a $4m upfront, and an additional $2m payment conditional on a CMC (chemistry, manufacturing, and controls) milestone. Up to $302m in future clinical, regulatory, and commercial milestones could be achieved; with tiered royalties (mid-single-digit to sub-teen) on global annual net sales; and a negotiated percentage of sub-licensing revenue from certain sub-licensees.
• Acumapimod is a small molecule orally active inhibitor of p38 MAP (mitogen-activated protein) kinase that is in development for acute exacerbations in COPD (AECOPD). A 282-patient Phase IIb study (AETHER) with two different dosing regimens (high and low dose) showed a statistically significant improvement in primary endpoints, with a significant reduction in severe exacerbations also seen in the follow-up phase of the study. Management is seeking separate funding to develop acumapimod further.
• Leflutrozole is an aromatase inhibitor being explored as a once-weekly oral treatment to improve infertility associated with hypogonadotropic hypogonadism (HH) in obese men. Results from the 24-week Phase IIb study showed normalisation of testosterone levels in over 75% of patients at all dose levels, with over 90% of patients normalising at the two higher levels (the lower dose was trending towards, but failed to achieve, statistical significance). All three doses saw significant improvement in FSH and LH levels. Total sperm motility and levels of fatigue also improved. The six month extension study corroborated these results. Discussions with potential global licencing partners are progressing.

In terms of news flow, the near-term value inflection points centre around greater detail on the etigilimab’s development plans, notably the format of the forthcoming Phase Ib/II study, and the successful closing of a setrusumab partnering deal which will enable its Phase III programme to start. Management has stated its intention to detail the plans for the etigilimab trial, and provide more information on its positioning, through a webcast in Q420.

Valuation

We value Mereo BioPharma using an rNPV model of the clinical pipeline, which is then netted out against the cost of running the business and net cash. We have updated our model post-H120 reporting, and it now yields a valuation of £570m or $741m, equivalent to 101p/share or $5.06/ADS (fully diluted).

Exhibit 2 summarises the contributions of each clinical programme, with additional detail regarding our expectations available in our September 2020 Outlook.

Exhibit 2: Mereo BioPharma rNPV-based valuation

Source: Trinity Delta; Note: *The rNPV of acumapimod and leflutrozole includes a deal success factor of 40% and 30%, respectively.

Financials

Mereo BioPharma posted a H120 operating loss of £16.7m (H119: £18.8m), mainly due to the £3.4m drop in R&D costs to £8.5m (H119: £11.9m). This decrease was largely owing to timing, with the completion of the Phase IIb setrusumab study and pause in patient recruitment in the alvelestat trial. R&D spend is expected to rise once the etigilimab Phase Ib/II study programme starts in Q420. G&A rose by £1.3m to £8.2m (H119: £6.9m), mainly reflecting a one-off £0.9m increase in legal and professional fees to £2.4m.

The company ended H120 with cash resources of £56.8m (FY19: £16.3m) and total debt of £27.8m (FY19: £20.5m). Net cash outflows from operating activities were £11.2m (H119: £27.6m). The £1.7m net cash inflow from investing reflected the navicixizumab out-licensing, while net cash inflows from financing activities of £49.6m resulted from the convertible loan notes, securities purchase agreements, and private placement.

In February 2020, Mereo BioPharma strengthened its balance sheet through three transactions totalling £11.8m, which was followed in June by a $70m (£56m gross) private placement. A detailed breakdown of the financing transactions is presented in the September 2020 Outlook. We note that the H120 accounts included a one-off, non-cash, financing charge of £94.7m in connection with the private placement. This represented the change in fair value of the embedded derivative and warrants between the deal announcement and the passing of shareholder resolutions at the June 2020 General Meeting.

Following the General Meeting, £21.7m of the June 2020 Convertible Loan Notes (CLNs) automatically converted into 125.1m new ordinary shares. As no new ordinary shares will be issued which would result in any investor holding more than 9.9% of voting rights in Mereo BioPharma as a result of the relevant conversion, an aggregate principal amount of £18.87m of CLNs remain outstanding and are held on the balance sheet.

The additional funds raised during H120, coupled to prior cash resources, and anticipated R&D tax credit receipts (R&D tax credits for FY19 are expected to be received in Q420) should fund the company’s currently committed clinical trials, operating expenses, and capex into early-2022. In early October, Mereo BioPharma filed a $200m shelf registration and an $50m at-the-money facility, which in our view provides the company with additional flexibility.

Following the H120 results, we have updated our forecasts. The key P&L changes in FY20e concern the non-recurring financing charge and accounting treatment of the navicixizumab out-licencing to OncXerna. We had previously recognised the $4m upfront payment as revenue; however, the transaction has been recognised as a ‘loss on disposal’ of £11.3m (net) in the H120 accounts. We treat both these items as exceptionals. In addition, we continue not to include in our estimates any potential upfront payment that may be associated with a near-term setrusumab deal. Our financial summary is presented in Exhibit 3.

Exhibit 3: Summary of financials

Source: Company, Trinity Delta Note: FY20 exceptionals include aggregate non-cash finance charges of £94.7m (changes in fair value of the embedded derivative and warrants in connection with the June private placement), and a £11.3m net loss in disposal (navi licence agreement with OncXerna).