Investment case

Hutchison China MediTech (‘Chi-Med’) is a China-based, globally focused, biopharmaceutical company, active in discovery, development, manufacturing, and commercialisation. The investment case rests largely on the success of its China Oncology and Global Innovation platforms; these have multiple near-term clinical and regulatory catalysts from the respective oncology and immunology pipelines of novel highly selective small molecule TKIs (tyrosine kinase inhibitors). Prospects for the China Commercial business remain compelling, as the Chinese healthcare market is still one of the fastest growing in the world. Continued success within China Oncology, and progress with Global Innovation, has opened the opportunity for management to create a global direct marketing presence. This would see Chi-Med becoming a world-class biopharmaceutical innovator that, while continuing to be China-based, sells its products directly in China and major Western markets.

Valuation

We value Chi-Med using a sum-of-the-parts approach. The China Oncology and Global Innovation pipelines are a classic drug discovery and development play, and a DCF-based model is particularly suitable. We calculate an rNPV (risk-adjusted net present value) of the various clinical projects (adjusted for success probabilities), sum them, and net this against costs, adopting conservative assumptions throughout. The China Commercial business generates meaningful sales and profits, so earnings-based metrics are appropriate. Our valuation is £3.51bn ($4.56bn), equivalent to £5.08/share or $32.99/ADS. (1 ADS = 5 shares).

Financials

Chi-Med’s cash resources at end-FY19 were in excess of $300m ($217m in cash and equivalents, $120m in unused bank facilities, and $63m at non-consolidated JVs), with a further $110m (net) in equity raised in Q120. FY20 guidance is for Innovation Platform adjusted (non-GAAP) operating loss of $180-210m (vs $133.3m in FY19) and a negative adjusted (non-GAAP) group net cash flow of $140-160m, reflecting investment into global registration studies, small molecule manufacturing, and commercial infrastructure. This guidance assumes no material impact from the COVID-19 pandemic.

Sensitivities

As a fully integrated biopharma company, typical industry risks (clinical, regulatory, funding, partnering, competition, commercialisation, pricing and reimbursement) apply. However, the TKI pipeline’s breadth and scope reduces technical risk, covering various mechanisms of action, with potential across a range of cancers. Investor concerns about China (economic, political, regulatory) are mitigated by regulatory reforms that favour innovation, strong domestic management, and increasingly global operations. CK Hutchison remains supportive despite reducing its holding from c 60% to c 48% (with no intention of further secondary offerings in the foreseeable future). The free float is limited, although daily volumes are >$1m. Chi-Med has made significant corporate progress: since 2018 it has been included in the NASDAQ Biotech and MSCI China indices. Key sensitivities are detailed later, but in summary we believe the issues are well known and containable, with a strong investment case more than offsetting any investor concerns.

Hutchison China MediTech: entering a new era

Hutchison China MediTech (‘Chi-Med’) has entered a breakthrough year in which it intends to capitalise on the clinical, regulatory and commercial progress made in 2019. NRDL listing of Elunate (partnered with Eli Lilly) from January 1st should significantly boost its commercial potential. Preparations are underway for Chi-Med’s first in-house launch with expansion of the China Oncology commercial organisation in anticipation of surufatinib’s NDA approval in non-pancreatic NET. Two further China NDAs should be filed this year: surufatinib (pancreatic NET) and savolitinib (MET ex14/del NSCLC). Progress is also ongoing in the Global Innovation pipeline. The SAVANNAH registration-intent trial is underway (savolitinib + osimertinib in 2L/3L EGFR/T790M NSCLC), and global pivotal trials for fruquintinib (3L/4L CRC) and surufatinib (NET) are set to initiate following conclusion of regulatory discussions. We value Chi-Med at £3.51bn (£5.08/share) or $4.56bn ($32.99/ADS), ahead of news flow over 2020-21.

Chi-Med has reached an important point in its evolution, with the prospect of several product launches in numerous indications over the coming years. Continued clinical and regulatory success, coupled with clear commercial execution, should lay the foundations for it to become a global science-focused biopharmaceutical company. Chi-Med was established in 2000 to exploit the huge opportunities that exist in healthcare in China (a pharma market second only to the US in terms of size) but has since broadened its activities and outlook beyond its home market. The recent equity raise strengthens the balance sheet, removing near-term funding concerns as the pipeline is progressed, manufacturing capacity is expanded, and the China Oncology commercial infrastructure established.

Chi-Med is carving out a world-class reputation for discovering, developing and commercialising innovative either best or first-in-class small molecule tyrosine kinase inhibitors (TKIs). The potential of this broad and diverse pipeline is confirmed by the clinical data presented so far, and its internationally competitive profile has opened the opportunity to build a global oncology franchise. Our February 2019 Initiation, provides a detailed overview of Chi-Med’s assets and the compelling demographic, regulatory, and commercial aspects of the China oncology market. Chi-Med’s twentieth anniversary (traditionally the China wedding anniversary) is a fitting moment to reflect on the progress achieved and the potential for upcoming catalysts to unlock material shareholder value as it transitions from a China-focused company to an international oncology player.

The 2018 China regulatory approval of its first product, Elunate in third-line colorectal cancer (3L CRC) and subsequent launch by Eli Lilly were major milestones. Listing on the National Reimbursement Drug List (NRDL) from January will widen availability which, coupled with plans to expand the label into several other indications, will boost its commercial potential. Impending China approvals and launches of two more drugs, surufatinib and savolitinib (the former through its growing in-house commercial team) in 2020-22 are also anticipated. Alongside this, Chi-Med is leveraging the expertise of its US clinical and regulatory teams in progressing the Global Innovation pipeline, with important data (savolitinib) and global registrations studies (surufatinib, fruquintinib) to initiate this year.

Building blocks in place to execute on global vision

Chi-Med is a dual-listed global science-focused biopharmaceutical company, founded in 2000 by Hutchison Whampoa (a wholly-owned subsidiary of Hong Kong-listed multinational conglomerate, CK Hutchison Holdings). In May 2006, Chi-Med went public with a £40m (gross) AIM flotation, which was followed in March 2016 by a $110m ($96m net) NASDAQ IPO. Subsequent NASDAQ offerings raised $301m ($293m net) in October 2017, and $118m ($110m net) in January/February 2020. CK Hutchison remains the largest shareholder but has reduced its holding to 48% (previously c 60%) following its secondary offerings (June and September 2019) and non-participation in the latest capital raise.

Chi-Med has grown strongly organically since inception, building a fully integrated commercial business in China (China Commercial) through acquisition and joint ventures with established pharma and consumer health peers. With an eye on broader horizons, Chi-Med (via its Hutchison MediPharma, HMP, subsidiary) has discovered and developed an innovative high-quality pipeline of highly selective small molecule tyrosine kinase inhibitors (TKIs) for the domestic and global oncology and immunology markets (collectively the Innovation Platform, which includes China Oncology and Global Innovation). This has been well-funded by IPO and follow-on proceeds, payments from partners and collaborators, and by the profitable and cash-generative China Commercial business.

Exhibit 1: Important milestones in Hutchison China MediTech’s evolution

Source: Hutchison China MediTech

Exhibit 1 illustrates key achievements on Chi-Med’s path to becoming a globally recognised and influential science-driven biopharmaceutical player, with a sizeable commercial footprint in China. Its unique business model and global outlook sets Chi-Med apart from its domestic Chinese biopharma peers. A more common model for China peers is the in-licensing of Chinese rights to late-stage or already approved drugs from US/European partners. In contrast, Chi-Med has struck two large pharma deals for its own assets – China rights to fruquintinib with Eli Lilly, and global savolitinib rights to AstraZeneca – that have facilitated the internationalisation of its outlook, brought in non-dilutive funding, and provided valuable external validation. Chi-Med intends to self-commercialise the rest of its pipeline and thus is unlikely to out-licence China commercial rights in future

China Oncology and Global Innovation: pipeline progress

Chi-Med’s novel, potentially best or first-in-class, pipeline of TKIs is now maturing, and spans the spectrum of early-stage development through to commercialisation (Exhibit 2). Various programmes are approaching significant clinical and regulatory inflection points. This is focusing investor attention onto the China Oncology and Global Innovation pipelines, which respectively have eight and five TKI drug candidates in clinical development.

Exhibit 2: Portfolio composition by stage

Source: Hutchison China MediTech Note: (1) in planning/imminent; (2) SXBX = She Xiang Bao Xin (cardiovascular)

Chi-Med’s strategy across its TKI pipeline is initial development as monotherapies for China. This offers a fast path to market given the opportunity provided by the relative lack of innovation in marketed cancer therapies in China vs the rest of the world. Alongside, it is seeking to develop its TKIs as part of combinations to improve clinical outcomes and maximise pipeline value in China and globally. The selectivity of Chi-Med’s TKI pipeline offers advantages in terms of targeted efficacy and cleaner toxicity profiles (often the limiting factor restricting potential combinations) making them ideal candidates for various combination approaches.

A key goal for the pharmaceutical industry is improving patient outcomes and overcoming issues such as acquired resistance to, and the high toxicity burden of, many current cancer drugs. Chi-Med’s internal discovery and development have focused on product innovation (better efficacy/safety, areas of unmet need), and it is applying a holistic approach to clinical development by covering various settings (1L/2L/3L; monotherapy/combinations) in multiple tumour types to diversify clinical risk and identify the most appropriate patient population(s) for each programme. Combination approaches and multiple lines of therapy are common in cancer, while advances in the understanding of tumour molecular genetics and emergence of acquired drug resistance creates opportunities for targeted therapies.

Chi-Med is evaluating combinations with other TKIs (eg savolitinib + osimertinib) and chemotherapies (eg fruquintinib + paclitaxel), as well as with PD-1/PD-L1 checkpoint inhibitors via multiple collaborations. This foray into the commercially important immuno-oncology field has potential to generate highly efficacious, and highly lucrative, therapeutic options in China and globally.

China Oncology is the more mature franchise. The first of Chi-Med’s internally developed assets, Elunate (fruquintinib) was launched in China for 3L mCRC by Eli Lilly in November 2018. Its September 2018 approval was the first unconditional approval of a novel oncology product that was both discovered and developed in China. NRDL inclusion, effective January 2020, and the associated improvement in patient access should stimulate an uptick in fruquintinib’s revenue growth.

Surufatinib will be the second of the China Oncology pipeline to reach the market, with a potential H220 China approval and launch in epNET. Surufatinib is set to be a trailblazer of a different sort: as an unpartnered asset, it would be the first to be launched and marketed through the dedicated China Oncology commercial infrastructure. In preparation, this is being significantly expanded from >140 staff to 300-350 reps by mid-2020. By end-2023, Chi-Med is planning for further expansion to a 900+ team to support future product launches.

Mid-2020 should see two further China NDA filings: surufatinib in a second indication (pNET) and savolitinib for 1L MET ex14m/del NSCLC (non-small cell lung cancer). The latter will be the first savolitinib NDA filing in any territory, although it would be marketed by global partner AstraZeneca.

The Global Innovation pipeline and infrastructure is also gathering momentum. We expect a growing proportion of R&D spend to be directed towards US/EU and Japan trials as multiple assets transition into registration studies. In anticipation, Chi-Med has expanded its international operations with the establishment of a New Jersey-based US office and growth in headcount, including several key hires. The 20-30 strong global clinical and regulatory team is now fully operational and is supported by the c 500-person scientific team in China.

Savolitinib is the most advanced global programme with potential for first launch as a combination with osimertinib in 2022. Mid-2020 interim analysis of the registration-intent SAVANNAH Phase II (savolitinib + osimertinib in c-Met+ 2L/3L osimertinib refractory NSCLC) is a prelude to regulatory interactions that should confirm the path forward and the potential, if any, for accelerated approval. This SAVANNAH interim data is not expected to be disclosed this year. However, further disclosures are anticipated concerning AstraZeneca/Chi-Med’s strategy for savolitinib in papillary renal cell carcinoma (PRCC) during 2020.

Pivotal global monotherapy studies for fruquintinib (Phase III FRESCO-2 trial in 3L/4L CRC) and surufatinib (Phase III study in NET) are pending the conclusion of ongoing US/EU/Japan regulatory discussions. Subject to a positive outcome, initiation of these studies is targeted for mid-2020.

These potential catalysts and others are outlined in Exhibit 3, which provides an overview of expected news flow for China Oncology and Global Innovation during 2020. The three most advanced and most valuable Chi-Med assets (savolitinib, surufatinib, and fruquintinib) are examined in more depth later in this report.

Exhibit 3: Potential 2020 upcoming events

Source: Hutchison China MediTech Note: * = submission to scientific conference, ** = subject to regulatory interaction, *** = subject to supportive data

China Commercial: dependable and cash generative

The China Commercial business, a highly cash generative and profitable enterprise that has been built up over the past 17 years, historically underpinned Chi-Med’s investment case. Since its inception, Chi-Med’s share of net income from China Commercial is c $300m (after allocation with JV partners), supporting investment into advancing the Innovation Platform. Recent progress in China Oncology and Global Innovation have shifted investor attention to their growth potential. However, China Commercial still has an important role to play as a respected player with an extensive presence in both the domestic prescription (Rx) and over the counter (OTC) markets through various joint ventures and subsidiaries, and as a springboard for commercialisation of China Oncology derived products. Key data is shown in Exhibit 4.

China represents c 20% of the world’s population, but currently accounts for c 30% of cancer patients globally. Historically the high cost and low quality of available oncology drugs meant that China was underrepresented in the global oncology market. Recent data suggest it is only 4% of the global oncology drug market, with oncology drugs only accounting for 9% of domestic drug sales. However, regulatory reforms have resulted in increased availability of innovative drugs and the NRDL has enabled access to various innovative oncology drugs in China at accessible price points. An ageing population coupled with lifestyle factors (eg smoking) and improvements in diagnosis mean cancer incidence continues to rise. The market opportunity in oncology is attractive, particularly given the relatively limited availability and low penetration of Western developed drugs. Hence there is strong rationale for the development and commercialisation of effective, high quality, affordable, and globally competitive therapies for the domestic market.

The priorities for China Commercial business over 2020-2021 include a continued focus on cash generation and organic growth, particularly from the proprietary high margin Rx drug products, where it is targeting high single-digit percentage growth in product sales. Other priorities include continuing to strategically evaluate M&A opportunities, the potential for divestment of certain non-core assets, and to expand synergies with the China Oncology organisation.

Chi-Med’s non-cancer Rx portfolio is well represented on the Essential Medicines List and hospital formularies with little pricing pressure expected even over the longer term. Key products also have exclusivity protection (eg She Xiang Bao Xin: FY19 sales of $239.5m; patent protected through to 2029). It is well positioned to continue to benefit from the various growth drivers that have supported the c 10% CAGR in the China pharmaceutical industry. These include an ageing population, rapid urbanisation, economic development, and supportive regulatory environment, and are covered in more detail in our February 2019 Initiation.

The integrated China Commercial platform covers the value chain from manufacturing (with two major GMP facilities employing c 1,200 staff) through to pan-China marketing and distribution via c 2,400 medical reps. Its established presence in China means that it has sound and long-standing relationships with governments (local and national) and regulators as well as valuable know-how in operating within the complex medical system, with proven expertise in tendering, price negotiations, and gaining market access. A solid track record in the China distribution and marketing of Western prescription drugs is exemplified by antipsychotic Seroquel (AstraZeneca) and beta-blocker Concor (Merck Serono). Chi-Med (through its Hutchison Sinopharm subsidiary) held exclusive China marketing rights to Seroquel from 2015-2019 and achieved a 6% market share prior to termination of the licensing deal by Luye Pharma. Similarly, Concor has achieved the number two position in the China beta-blocker market (c24% market share in 2018), with Hutchison Sinopharm distribution into in nine provinces with a total population of c 600m. Thus Chi-Med is in a strong position to leverage its domestic market knowledge and commercial infrastructure to help launch and drive market penetration of the China Oncology TKI drugs.

Exhibit 4: China Commercial – key data at a glance

Source: Hutchison China MediTech

COVID-19 and best laid plans

Chi-Med’s experiences in its domestic market mean it is better positioned than many biopharmaceutical companies to weather the potential impact of COVID-19 on its operations. As the origin of the pandemic, China was the first country to be materially affected. At FY19 results in March, management noted that there had been some operational challenges due to restrictions on movement in China (eg reduced patient hospital visits for clinical assessment; commercial team activities), but the impact on the China Commercial business was limited. At that point, business remained resilient with continued sales of its low-cost proprietary coronary medicines despite lower marketing spend, and there had been no material effect on any of the China manufacturing operations.

During Q120, COVID-19 has spread more broadly across the globe. This will likely have repercussions on business operations and on ongoing and planned clinical studies for both China Oncology and Global Innovation. Geographic differences reflect regulatory and government guidance and policies related to COVID-19 as well as the timing of planned activities. In common with many pharma companies, Chi-Med may experience slower clinical trial recruitment due to restrictions on movement (more likely to impact large late-stage trials) and limited availability of intensive care beds (an important safety net for Phase I first-in-man studies). Importantly, Chi-Med is well financed, with the January fund raise providing additional resource to invest in the Innovation Platform and a cash runway into 2021. Any potential delay to new trial starts could result in lower spend incurred, further extending the current runway.

For China Oncology, much of the planned activities for H120 are centered around data collation/analysis from recently completed clinical trials and on regulatory interactions with the NMPA. The surufatinib China NDA in epNET is under review, and pre-NDA discussions for surufatinib in pNET and savolitinib in MET ex14m/del NSCLC are underway. With respect to ongoing clinical studies, we anticipate some slowdown in new patient enrollment, but understand that existing patients are being well managed with various adjustments to ensure adherence to trial protocols, thus mitigating potential impact. These include telemedicine to facilitate virtual visits/follow ups, the mailing out of study drug (Chi-Med’s TKIs are oral pills and not infusions/injections), and CT scans at sites convenient for patients. The initiation of the HMPL-453 Phase II mesothelioma trial in March is a positive indicator that China Oncology operations are getting back on track.

There is currently less visibility on the situation in the US/Europe; COVID-19 is yet to peak in many geographies and is thought to be 6-8 weeks behind China. The next few months should give more clarity on whether Global Innovation timelines will shift as a result, and what learnings can be leveraged from the China experience. Chi-Med continues to work towards a mid-2020 start for US/Europe/ Japan Phase III trials for surufatinib (NET) and fruquintinib (CRC), subject to completion of regulatory consultations. Alongside this, early-stage studies are ongoing, but recruitment rates may be slowed.

Finally, Chi-Med intends to present clinical data at various unnamed scientific conferences in 2020. Due to COVID-19 restrictions, many key cancer conferences (eg AACR and ASCO) are moving to a virtual format and so remain potential fora for data presentations.

Savolitinib: addressing an unMET need

Savolitinib is a novel highly selective potentially first-in-class inhibitor of the c-Met receptor tyrosine kinase (RTK). It has been studied in over 1,000 patients to date and is at the centre of an extensive clinical programme run in conjunction with partner AstraZeneca. Savolitinib is under evaluation in multiple indications (Exhibit 5), as monotherapy and in combination with targeted AstraZeneca drugs (NSCLC: TKIs osimertinib and gefitinib; renal cell cancer: PD-L1 durvalumab).

Exhibit 5: Savolitinib clinical programme

Source: Hutchison China MediTech Note: Red = China Oncology, Blue = Global Innovation

Non-small cell lung cancer (NSCLC) is the priority indication, with potential for first launches in its respective settings in 2021 (China: as monotherapy in 1L MET exon 14m/del NSCLC) and 2022 (Global: in combination with osimertinib for MET+ 2L/3L EGFR/T790M refractory NSCLC), subject to positive trial read outs and subsequent approvals. Potential for Breakthrough Therapy Designation (BTD) means these commercially attractive settings could have a rapid path to market. Exhibit 6 depicts the patient populations that could be addressed by savolitinib.

Exhibit 6: Addressable NSCLC patient populations for savolitinib

Source: Hutchison China MediTech Note: General estimate based on EGFRm prevalence in approximately 10-15% of Caucasian NSCLC patients and 50-60% of Asian NSCLC patients

Savolitinib is a strategically important asset for both Chi-Med and AstraZeneca; the latter initially licensed global co-development/commercialisation rights in 2011. Deal terms were amended in 2016, increasing Chi-Med’s share of savolitinib’s longer-term economic value (via higher global ex-China royalties) in exchange for an additional near-term investment towards PRCC (papillary renal cell carcinoma) development costs (Exhibit 7). The PRCC strategy has been under review since the termination of the SAVOIR savolitinib monotherapy study in December 2018; however, the partners are now actively evaluating resuming the savolitinib clinical programme in Met-driven PRCC.

Exhibit 7: AstraZeneca / Chi-Med savolitinib deal terms

Source: Trinity Delta, Hutchison China MediTech

NSCLC: mechanisms to overcome resistance sought

AstraZeneca has carved out a leading position globally in EGFR-TKI resistant NSCLC, and savolitinib is an important facet of life-cycle management efforts and in boosting the commercial potential of its EGFR TKI franchise. AstraZeneca has two EGFR TKIs approved in NSCLC: the first-generation Iressa (gefitinib: 2019 sales of $423m) and third-generation Tagrisso (osimertinib: 2019 sales of $3.19bn). However, both are associated with the development of resistance. Acquired resistance to EGFR TKIs has emerged, mainly through two distinct resistance mechanisms: T790M mutation (T790M+) in the EGFR gene (c 50% of cases) and c-Met amplification (c 20-30% of osimertinib-resistant patients).

Osimertinib was designed as a treatment option for EGFR T790M+ patients that progressed after EGFR TKI therapy, and it has rapidly achieved blockbuster status. It was first approved in 2L EGFR T790M+ NSCLC in 2017, with label expansion in 2018 to include 1L EGFR exon 19 or exon 21 mutated NSCLC (based on a 8.7 month improvement in mPFS vs gefitinib and erlotinib in the Phase III FLAURA trial). Osimertinib has now become a new standard of care in the 1L setting, and increased use will likely increase the addressable pool of c-Met+ patients.

Exhibit 8: Mechanisms of resistance to osimertinib

 Source: AACR 2019

As Exhibit 8 illustrates, c-met amplification is one of the most frequent acquired resistance mechanisms to osimertinib with 20-30% frequency (depending on analysis of circulating tumour cells or from tumour biopsy).

A combination EGFR + c-Met TKI approach is a potential mechanism to circumvent this. Thus, a successful savolitinib + osimertinib development programme could provide another treatment option for 2L relapsed/refractory NSCLC and result in this combination becoming a new standard of care in NSCLC (depending on patient population and therapy line).

China MET ex14m/del NSCLC: potential for ‘21 approval

Savolitinib is the leading MET inhibitor in China, with potential for first approval and China launch in 2021 as a monotherapy for 1L NSCLC with c-Met exon 14 mutations/deletions (MET ex14m/del). This is a poor prognosis NSCLC population: MET ex14m/del are genetic alterations that occur in c 3% of NSCLCs, inhibiting degradation of the c-Met receptor and resulting in a persistent oncogenic effect. Subject to meeting an agreed efficacy threshold (objective response rate, or ORR) in the fully-enrolled c 70-pt single arm Phase II registration study the China NDA should be filed in Q220.

Data released to date in this indication indicates that savolitinib monotherapy shows promising anti-tumour activity (also in brain metastases) and is generally well-tolerated. Initial data from the first 41 patients treated (31 of which were efficacy evaluable) in the aforementioned Phase II study were presented at AACR 2019 (discussed in our April 2019 Update). As per the AACR abstract (December 2018 cut off), 12/31 patients evaluated had partial responses (39% ORR), with a median treatment duration of 34+ weeks. However, data presented at the meeting had a later cut off (February 2019), with 16/31 PR (ORR of 51.6%), and a disease control rate of 93.5% (29/31). A subsequent update was provided in an oral presentation at the Chinese Society of Clinical Oncology 2019 meeting. Full data from the study has been submitted for presentation at an upcoming major scientific conference.

Chi-Med estimates incidence of MET ex14m/del NSCLC in China is c 15,000 (c2-3% of 1L NSCLC). This is clearly a niche opportunity with high unmet need and potential for accelerated approval; however, there are wider prospects for savolitinib monotherapy in other MET-driven patient populations, eg MET gene amplified NSCLC (with c 15,000-30,000 incidence). The catalyst for significant revenue generation will come from longer-term use of the savolitinib and osimertinib combination across a broader NSCLC population in China.

The first therapy specifically targeting MET ex14m/del NSCLC, Merck KGaA’s tepotinib (Tepmetko), was approved in Japan in March 2020. Novartis/Incyte’s capmatinib is the leading MET inhibitor in the US, and is likely to be approved in this indication later this year, following FDA NDA acceptance and grant of Priority Review status in February 2020.

Global c-Met+ 2L EGFR/T790M NSCLC: not far behind

Global development in NSCLC is focused on combination studies. The Phase II SAVANNAH trial is the first step in the global registration strategy for a savolitinib + osimertinib combination in NSCLC, and AstraZeneca and Chi-Med may articulate plans for other potentially pivotal NSCLC combination trials this year.

The SAVANNAH trial evaluating savolitinib + osimertinib in c-Met+ 2L/3L EGFR/T790M refractory NSCLC is a 200-pt registration intent study, which is due to complete recruitment by end-2020, with an interim analysis of the first 50 patients in mid-2020. The interim analysis is a prelude to regulatory interactions, which should determine whether a larger randomised Phase III trial is needed to support a regulatory filing or if SAVANNAH alone is sufficient to file for accelerated approval. First global launch for this combination could occur in 2022.

Crucially SAVANNAH is closely aligned with AstraZeneca’s ORCHARD Phase II platform trial, an open label multi-centre Phase II study examining multiple treatment options for 2L/3L EGFRm NSCLC following progression on osimertinib (Exhibit 9). ORCHARD involves molecular profiling: those patients identified with c-Met+ EGFRm NSCLC (which meet relevant inclusion criteria) are prioritised for enrolment in SAVANNAH. This strategy will not only facilitate recruitment, but an enriched patient population should boost the chance of success for the trial.

Exhibit 9: SAVANNAH a global registration intent study

 Source: Hutchison China MediTech

If outcomes from SAVANNAH are comparable with the high response rates seen in the exploratory Phase Ib/II TATTON trial, AstraZeneca and Chi-Med could explore expedited approval pathways with the FDA. Breakthrough Therapy Designation (BTD) may be one such option given the significant unmet medical need in this late stage and heavily pre-treated NSCLC population.

TATTON B data suggests that savolitinib + osimertinib could offer an additional survival benefit as an effective targeted treatment option that can overcome MET-driven resistance mechanisms irrespective of prior EGFR-TKI therapy. TATTON B data at AACR 2019 (detailed in our April 2019 Update) in a similar, albeit not identical, patient population to SAVANNAH (as osimertinib approval in 1L EGFRm NSCLC occurred after TATTON has initiated), showed a 25% ORR (12/48 partial responses) and a median duration of response of 9.7 months. Full TATTON data was recently published in The Lancet Oncology (March 2020) showing a 30% ORR (21/69 partial responses) and a median duration of response of 7.9 months.

PRCC: defining a path forward

Savolitinib is also under evaluation in other c-Met driven cancers, most notably in renal cell carcinoma (RCC) and gastric cancer. Chi-Med and AstraZeneca have been reviewing their RCC, or more specifically c-Met-driven papillary renal cell carcinoma (PRCC), development strategy following suspension of enrolment into the Phase III SAVOIR savolitinib monotherapy study in December 2018. Subsequent encouraging findings from CALYPSO, an investigator sponsored all comers Phase II study of savolitinib + durvalumab (AstraZeneca’s PD-L1 Imfinzi), coupled to mature data from those patients enrolled in SAVOIR have reinvigorated the focus on this indication, with plans to resume clinical development of savolitinib monotherapy. Further updates on the clinical and regulatory strategy in PRCC are expected in due course.

The SAVOIR study was a multi-centre open-label 1:1 randomised controlled trial evaluating efficacy and safety of savolitinib vs sunitinib in c-Met driven 1L/2L PRCC. It was terminated early, after having enrolled c 60 of an intended 180 patients, following historic data from a molecular epidemiology study which suggested that the likelihood of success was low for savolitinib in the 1L setting and that few patients were using sunitinib in 2L PRCC, and in response to the changing treatment landscape in RCC with the availability of immuno-oncology drugs. Mature data from these c 60-pts, comparing savolitinib to sunitinib, is now available and will be presented at a major scientific conference.

Preliminary data from CALYPSO trial, a three-part study evaluating savolitinib monotherapy and in combination with durvalumab in RCC irrespective of c-Met status or PD-L1 expression, was presented at ASCO GU 2019 (February 2019 Update), with more mature data at ASCO GU 2020. Data showed encouraging efficacy signals for the combination with an ORR of 26.8% (n=41), with an ORR of 33.3% (n=27) in the 1L setting.

PRCC remains an attractive opportunity, representing 10-15% of total RCC incidence. It has a poor prognosis with a high proportion (40-70%) of c-Met driven disease and a lack of approved targeted therapies, raising the potential of accelerated approval. There is also industry enthusiasm for VEGFR TKI/PD-1 combination in RCC given the emergence of acquired resistance to VEGF TKIs/mTOR inhibitors and the synergistic potential. The first such combinations were approved by the FDA in 2019: axitinib (Inlyta, Pfizer)/pembrolizumab (Keytruda, Merck) and axitinib/avelumab (Bavencio, Pfizer) in 1L advanced RCC.

Savolitinib is also being studied in investigator-sponsored Phase II studies in gastric, prostate, and colorectal cancers. Results from the VIKTORY biomarker-based umbrella trial, run at the Samsung Medical Centre in South Korea, were recently published in Cancer Discovery (October 2019). VIKTORY data indicated that savolitinib monotherapy had promising efficacy with an ORR of 50% (n=20) in MET-amplified gastric cancer, suggesting further evaluation is merited.

We currently value savolitinib at $5.24/ADS ($724m) or £0.81/share (£557m).

Surufatinib: casting the NET wide

Surufatinib (formerly sulfatinib) is a novel selective oral small molecule TKI which targets three RTKs involved in tumour angiogenesis and immune evasion: VEGFR, FGFR (fibroblast growth factor receptor) and CSF-1R (Colony stimulating factor-1 receptor). It is Chi-Med’s most advanced wholly owned asset and, subject to timely regulatory review and approval, is on track for its first China launch, by Chi-Med’s own commercial team, in extra-pancreatic NET (epNET) in late-2020.

Surufatinib’s profile supports development in various cancers as a multi-functional monotherapy agent and in combination with PD-1 checkpoint inhibitors, and it is being studied in multiple China and global clinical trials (Exhibit 10). It has been dosed in c 800 patients to date. Momentum is gathering pace in China: NDA filing in a second indication (pancreatic NET, pNET) is likely mid-2020, and the interim (futility) analysis of the first 80-pts in the 300-pt China Phase IIb/III registration study in 2L biliary tract cancer (BTC) is expected in late-2020. The Global Innovation pipeline is also expected to deliver important news flow including the FDA end-of-Phase II meeting for NET targeted for H120, followed by potential initiation of US/Europe and Japan Phase III registration studies in mid-2020. In April, surufatinib received FDA Fast Track Designation for both pNET and epNET.

Exhibit 10: Surufatinib clinical programme

 Source: Hutchison China MediTech Note: Red = China Oncology, Blue = Global Innovation

Broadly addressing unmet need in NET

NET is an umbrella term for tumours that develop from cells in the endocrine and nervous systems, most commonly in the digestive and respiratory tracts. It can be split into two distinct populations based on molecular genetics and treatment options. Non-(extra)-pancreatic NET (epNET) is the more common representing c 90% of NETs; the remainder are pancreatic NET (pNET). epNET is typically treated with somatostatin analogues (lancreotide, octreotide) which inhibit release of various hormones. The global standard of care for advanced (unresectable or metastatic) pNET is targeted therapy: approved drugs include Sutent (sunitinib, Pfizer), a multi-kinase TKI (targeting VEGFR, PDGR, c-kit, Flt3, Ret), and mTOR inhibitor Afinitor (everolimus, Novartis). Sunitinib approval validates targeting VEGF pathways in pNET.

The potential China NET opportunity could be significant (estimated prevalence is c 300k patients vs c 170k in the US), with Chi-Med assessments putting it at potential market size of $100-120m annually. There are several features of the NET market that could enlarge the opportunity further. Unlike many cancers, there is higher prevalence than incidence as NETs are typically slow growing compared with other tumour types. This means that NETs are associated with a relatively long duration of survival, and NET patients are typically on drug therapy for longer. At present, these patients have limited treatment options, with standard treatment protocols used despite the heterogeneity of the disease; hence a potentially universal treatment option should have good uptake. In addition, diagnostic improvements coupled with more treatment options could increase the recognition of NETs and raise current incidence.

The China NDA filing for surufatinib in pNET is planned for mid-2020 following the early stop of the SANET-p pivotal study for efficacy earlier this year. Both China pivotal trials in NETs met their mPFS (median progression free survival) primary endpoint at planned interim analyses (SANET-ep in June 2019; SANET-p in January 2020), expediting timelines to potential launches. The China NDA for surufatinib in epNET was accepted for review in November 2019 and it was subsequently granted Priority Review Status in this indication. Full SANET-ep data, presented at ESMO 2019, is covered in our October 2019 Update. The SANET-p interim data has not yet been disclosed but will be discussed at an upcoming pre-NDA meeting to determine next steps in the regulatory process in pNET and will be presented at a future scientific conference.

Extrapolating from our assumed timelines for epNET and factoring in the common submission materials (eg CMC and preclinical data) with the surufatinib ep-NET NDA, we believe the China NDA for pNET could be filed mid-2020. Clinical data disclosed to date suggests that surufatinib has utility across the spectrum of NET (Exhibit 11) and could rival everolimus. Surufatinib has shown anti-tumour activity in heavily pre-treated patients and across multiple tumour types, supporting the rationale for development in both NET populations.

Exhibit 11: Evidence landscape for G1/2 advanced NET by site

Source: Hutchison China MediTech, Yao ESMO 2019

Our January 2020 Update provides a comprehensive overview of available data and ongoing clinical studies for surufatinib. Consequently, we also believe there is potential for surufatinib to receive a broad label, ultimately resulting in use in all NET patients irrespective of subtype. There remains a significant opportunity in lung and other NETs, and surufatinib could be well-positioned to exploit this niche as either a 1L therapy, or as a 2L treatment option for NET patients who progress on everolimus. Assuming China approval, surufatinib pricing will be confirmed at launch, and we would expect Chi-Med to seek NRDL listing which is associated with a price discount. As context, everolimus and sunitinib are both listed on the NRDL priced at $1,320/month and $2,000/month respectively. Surufatinib data disclosed to date indicates PFS of 9.2 months in epNET (Phase III SANET-ep trial) and 19.4 months in pNET (pNET patients in Phase II study).

Surufatinib/PD-1 combinations progressing

Surufatinib is differentiated from other VEGFR TKIs as a novel selective oral small molecule TKI with an angio-immuno kinase profile. In addition to VEGFR, surufatinib targets FGFR and CSF-1R, and has a mechanism of action which involves:

• inhibition of angiogenesis and tumour growth,
• activation of T-cells through VEGFR/FGFR, and
• prevention of production of tumour-associated macrophages (TAM or white blood cells), which play a role in tumour cell immune evasion, via CSF-1R inhibition.

Surufatinib’s ability to inhibit TAM production amplifies the PD-1 induced immune response, and the potential for combining these treatment modalities is being evaluated in Phase I and Phase II trials as part of Chi-Med’s PD-1 monoclonal antibody collaborations. These include global partnerships with Shanghai Junshi for Tuoyi (toripalimab) and Innovent Biologics for Tyvvt (sintilimab).

The combination of surufatinib with a PD-1 inhibitor has the potential to unlock wider opportunities in multiple cancer indications, provided that clinical data supports the tolerability and effectiveness of the combination(s). Simultaneous targeting of multiple cell types and signalling pathways in the tumour microenvironment may elicit a potential synergistic anti-tumour effect. Since signing its first PD-1 collaborations in November 2018, Chi-Med and its partners have made steady progress towards and into the clinic with the first combinations.

The Shanghai Junshi global collaboration is the most clinically advanced. The China Phase I dose-finding study of surufatinib and toripalimab completed last year; preliminary safety and efficacy data is expected to be presented at an upcoming scientific conference. A Phase II combination trial in advanced solid tumours was initiated in January 2020. Global combination studies of surufatinib with toripalimab, and with sintilimab are in planning, with the likelihood of starting in late 2020.

We currently value surufatinib at $7.23/ADS ($999m) or £1.11/share (£768m).

Fruquintinib: a pioneering product

China approval of Elunate (fruquintinib) for third-line colorectal cancer (3L CRC) in September 2018 marked a watershed for both Chi-Med and the domestic pharmaceutical industry. Elunate, the first domestically discovered and developed innovative oncology compound to be approved in China, is a highly selective and potent small molecule pan-VEGFR (vascular endothelial growth factor receptor) inhibitor. Chi-Med intends to establish it as best-in-class.

Elunate was launched in November 2018 by Chi-Med’s partner Eli Lilly (which licensed China rights in 2013), and in the first five weeks generated revenues of $3.6m for Chi-Med ($3.3m from product purchases/manufacturing; $0.3m in royalties on $1.7m of in-market sales). In FY19, the first full year of sales, Chi-Med revenues from Elunate were $10.8m, broken down as $8.1m from manufacturing and $2.7m of royalties (15% of $17.6m in end-user sales). Chi-Med estimates that Elunate achieved 5% penetration in FY19.

Positive volume impact expected from NRDL

We expect Elunate revenues, and market penetration in 3L mCRC, to accelerate from 2020 onwards following its addition to the NRDL (National Reimbursement Drug List) effective from January 1, 2020. From this date, Elunate is automatically available in all state-run hospital pharmacies in China, and patients covered by NHSA (National Healthcare Security Administration) insurance schemes will be reimbursed. NRDL inclusion, as an innovative Category B drug, broadens Elunate’s availability, and should accelerate patient access across China. A positive impact is already being felt; in-market sales for January and February 2020 were $6.6m.

Chi-Med and Eli Lilly’s commercial strategy for Elunate has focused on ensuring affordability and therefore broad access from launch, even prior to securing reimbursement. The domestic Patient Access Programme (PAP), which limited out-of-pocket costs to a maximum of three cycles ($9.8k) vs expected average usage of 5.5 cycles (per FRESCO data), has been superseded by NRDL listing.

NRDL inclusion is associated with a c 64% gross discount to Elunate’s launch price (RMB 7,938 or $1.18k per four-week cycle vs the list price of RMB 21,960 or $3.26k per cycle), which translates to a 34% net price discount vs the PAP. However, the pricing discount is likely to be more than offset by higher volumes, driving both manufacturing revenue and royalties from sales growth. This is supported by a Chi-Med analysis of novel drugs (such as trastuzumab and bevacizumab), based on data from the R&D-based Pharmaceutical Association Committee (RDPAC) and McKinsey sales data, which showed that NDRL listing facilitates a c 4-fold increase in patient penetration, driving sales volumes.

Chi-Med assessments put annual China incidence of 3L mCRC at c 57,000 treated patients (c 15% of the 380k annual incidence of mCRC), with potential China peak sales of Elunate in this indication of $110-160m (assuming 20-25% penetration). This equates to c $20-35m in net income, based on 15-20% tiered royalties. We model Elunate (China 3L mCRC) peak sales of $122m pa.

The attractive China pricing/reimbursement coupled to Elunate’s clinical efficacy and safety profile should help Chi-Med and Eli Lilly to position it as the most attractive commercially available VEGFR TKI. The most relevant comparator, Stivarga (regorafenib, Bayer), is approved in mCRC, GIST, and HCC. However, regorafenib is a multi-kinase TKI and carries a black box warning for liver toxicity; a cause for concern as 65-75% of Chinese 3L CRC patients also have liver metastases. From January 2020, China pricing of regorafenib is also less favourable than Elunate.

A wealth of opportunity in China and beyond

3L mCRC is the first of multiple oncology indications pursued for fruquintinib in China, which could collectively represent a $500m-$1bn potential China sales opportunity. Fruquintinib’s second indication, 2L gastric cancer, has the potential to be highly lucrative given the limited treatment options and high incidence in China. A pivotal Phase III study (FRUTIGA) of fruquintinib in combination with paclitaxel in 2L gastric cancer study is ongoing; the second interim analysis is expected in mid-2020, with the trial due to complete enrolment in late-2020. Other China studies are earlier-stage and include proof of concept studies in combination with PD-1 inhibitors.

Ex-China, Chi-Med retains full rights to fruquintinib and is seeking the expand the opportunity for the drug geographically. The next step towards this goal is the initiation of a global Phase III study (FRESCO-2) of fruquintinib in 3L/4L CRC, which is targeted for mid-2020 pending completion of regulatory interactions. The FDA end-of-Phase II meeting occurred in February 2020, and similar meetings with the European and Japanese regulators will be taking place in the near-future. Exhibit 12 details the fruquintinib clinical development programme.

Exhibit 12: Fruquintinib clinical programme

Source: Hutchison China MediTech Note: Red = China Oncology, Blue = Global Innovation

Freedom to operate with China LCIs

Chi-Med’s plans for fruquintinib, as it seeks to explore opportunities to fully exploit its potential as a best-in-class VEGFR in China and globally, are supported by its revised China deal with Eli Lilly. China rights were originally licensed to Eli Lilly in 2013; however, a strategically important deal amendment was announced in December 2018 (Exhibit 13). This amendment provided Chi-Med with greater control over R&D plans (including freedom to operate in relation to life cycle initiatives, LCIs) in exchange for bearing associated costs. As Chi-Med is able exploit the LCI opportunity beyond the three indications originally under evaluation (CRC, NSCLC, gastric cancer), the potential market opportunity in China is significantly increased as there are various solid tumours that are currently not treated with an appropriate VEGFR inhibitor. This coupled to potential co-promotion rights (from 2021+) significantly improves Chi-Med’s share of deal economics, with higher potential milestone receipts and royalties from a larger commercial opportunity.

Exhibit 13: Eli Lilly / Chi-Med fruquintinib deal terms

Source: Trinity Delta, Hutchison China MediTech

In addition to being able to fully exploit the LCI opportunity in China, Chi-Med is well-positioned to further leverage its commercial acumen. It has secured co-promotion rights in provinces representing 30-40% of China sales, assuming certain commercial milestones are achieved, meaning that fruquintinib could become an additional product to be marketed by Chi-Med’s China Oncology commercial organisation. This improved future revenue stream will support other strategic initiatives such as progressing the Global Innovation pipeline.

Fru combinations greater than the sum of its parts

An important facet of LCI centres on combination approaches, which have the potential to improve efficacy, and depending on the combination, could support expanded use of fruquintinib in earlier lines of therapy, driving its uptake and market potential. Fruquintinib’s potency (better target coverage fully inhibiting VEGFR) and selectivity (ensuring that off-target toxicities are reduced) means that it has a differentiated safety/efficacy profile vs other small molecule VEGFR inhibitors (either marketed or development stage). Indeed, many approved VEGFR TKIs are non-specific multi-kinase inhibitors, which due to their broad targeting leads to higher incidence of serious adverse events.

Fruquintinib’s selectivity lends it to combination with various anti-cancer agents, such as chemotherapy, targeted therapies (including TKIs), and immunotherapies. The manifold potential development and commercial opportunities for fruquintinib that may merit exploration include combination with PD-1/PD-L1 inhibitors, as well as potential proprietary TKI combinations, such as fruquintinib plus epitinib in EGFRm+ NSCLC, or fruquintinib plus savolitinib in CCRCC. Clinical evaluation of PD-1/fruquintinib combinations is a focus of Chi-Med’s early-stage development plans for the first wave of LCIs. Combining fruquintinib with a checkpoint inhibitor could achieve an improved therapeutic outcome due to the potentially synergistic mechanisms of action, ie simultaneously inhibiting tumour angiogenesis and tumour cell signalling or immune evasion.

PD-1 combinations move into the clinic

Chi-Med is currently assessing the combinability of the first fruquintinib + PD-1 checkpoint inhibitor combinations. The China Phase I dose-finding/safety study of fruquintinib in combination with sintilimab (Tyvyt, Innovent Biologics) is approaching completion, while the China Phase I study of fruquintinb + genolimzumab (Genor Biopharma) is underway. A global Phase I with the former combination is also in planning.

Results from Phase I studies would inform the decision to progress into Phase II, with indication selection for a potential PD-1 or PD-L1/fruquintinib combination likely to be determined by the different competitive dynamics in the China and Global markets. For example, in China an opportunity to move into RCC or HCC remains, whereas in the US and Europe gastric and colorectal cancers would be a more level playing field competitively.

We highlight that the future strategy for fruquintinib in NSCLC is likely to be based on an immuno-oncology combination approach. This follows the miss of the overall survival primary endpoint in the pivotal FALUCA China monotherapy study in 3L NSCLC (see September 2019 Update) and is a response to the fast evolving competitive landscape. We note that post hoc sensitivity analysis of FALUCA data presented at WCLC 2019, suggested use of subsequent anti-tumour therapies following disease progression was a likely contributor to the negative trial result.

Elunate is currently Chi-Med’s most valuable China asset, contributing $7.66/ADS ($1,058m) or £1.18/share (£814m) to our Chi-Med valuation.

Early stage differentiated assets with multiple targets

Chi-Med’s longer-term growth potential will be bolstered by further product opportunities emanating from its early-stage pipeline of wholly owned clinical drug programmes and its in-house discovery work. The latter is focused on innovation, with activities concentrated on the creation of a broad, differentiated and high-quality range of assets against multiple novel targets that will form the basis of future oncology combination regimens.

Exhibit 14: The next wave of differentiated clinical assets

Source: Hutchison China MediTech

Exhibit 14 is illustrative of various classes of targets that are being explored and is based on the seven stages of the Cancer-Immunity Cycle. In cancer patients the cycle does not perform optimally and, employing a variety of techniques to evade immune recognition, tumours become established. Increasingly the focus is shifting away from using treatments with a single mechanism of action, which a tumour may evade or escape from, towards engaging a combination of differing mechanism that work synergistically, thereby preventing tumour escape.

Further out, the aim is to replenish the pipeline with a range of novel small molecule programmes that exploit the expertise that has been built up in-house. These will maintain the ethos of having the potential to be either best-in-class or first-in-class. R&D management is also exploring a variety of options to broaden the discovery reach into other modalities (notably larger molecules), which would likely, in our view, entail an appropriate acquisition rather than seeking to create the expertise from scratch.

A China IND was filed in H119 for HMPL-306, a novel selective small molecule TKI of isocitrate dehydrogenase (IDH) 1/2, which is the newest candidate to emerge from the Chi-Med’s discovery engine. The intention is to progress further novel development candidates into early clinical development each year.

Progress has also been made in proof of concept clinical trials, particularly with Syk inhibitor HMPL-523 and PI3Kδ inhibitor HMPL-689 (profiled in more detail below). Both feature in the China Oncology and Global Innovation pipelines, and have the potential to address a major unmet medical need in B-cell malignancies: emergence of Bruton’s tyrosine kinase (BTK) refractory disease (Exhibit 15).

Exhibit 15: Potential to address unmet medical need in BTK-refractory NHL

Source: Hutchison China MediTech

Both HMPL-523 and HMPL-689 have cleaner side effect profiles than competing drugs and thus have the potential to overcome acquired resistance (most commonly through mutations in C481S or PLCγ) as part of a combination approach with BTK inhibitor Imbruvica (ibrutinib, Janssen). Chi-Med is targeting progressing HMPL-523 and HMPL-689 into registration trials in 2020 in China, assuming supportive data in the ongoing Phase Ib dose-escalation studies.

A third programme, HMPL-453, a potentially first-in-class pan-FGFR (fibroblast growth factor receptor) inhibitor targeting FGFR1/2/3 initiated a China Phase II study in advanced malignant mesothelioma in March 2020. Current status of these programmes is shown in Exhibit 16.

Exhibit 16: Next wave of innovation clinical programmes

Source: Hutchison China MediTech Note: Red = China Oncology, Blue = Global Innovation

HMPL-523: targeting Syk in haematology-oncology

HMPL-523 is a potential best-in-class oral Syk-inhibitor. Syk (spleen tyrosine kinase) is a non-receptor kinase which plays a key role in B-cell signalling. It was designed to have high tissue distribution and selectivity to avoid severe off-target toxicities (ie diarrhoea, hypertension) seen with first-generation Syk-inhibitors, and to have a more favourable side-effect profile to second-generation programmes such as entospletinib (Gilead).

Syk is a clinically validated target in rheumatoid arthritis (RA), thus HMPL-523 has significant potential in inflammation. It has shown superior selectivity for Syk compared with fostamatinib and, importantly, lower affinity for KDR (which is linked to hypertension), with strong efficacy seen in preclinical RA models. However, the near-term development focus for HMPL-523 is in B-cell malignancies, which require smaller clinical programmes. In China, this will include multiple non-Hodgkin’s lymphomas (NHL), that may have fast track designation potential. Global development will centre on indolent NHL.

Two Phase I/Ib proof-of-concept trials in haematological cancers are ongoing in Australia and China: Phase I dose escalation (n=60) is complete with the recommended Phase II dose (600mg once daily) identified, and Phase Ib dose expansion enrolling (n=40 AUS; n=152 CHN). This data will guide the China registration strategy, with potential for a late-2020 start for the Phase II/III study subject to positive data. In the US, the first patient has been dosed in the US Phase I/Ib study.

HMPL-689: PI3K of the bunch?

HMPL-689 is a novel oral PI3Kδ inhibitor, designed to be best-in-class (first-in-class in China) due to improved isoform selectivity, potency, and pharmacokinetic activity. These characteristics are key to global plans to develop HMPL-689 as part of novel combinations, with potential to tackle treatment resistant tumours.

PI3Kδ is one of four different isoforms of PI3K (phosphoinositide-3-kinase) an enzyme associated with allergy, inflammation, and cancer. Activating mutations are commonly found in solid tumours, with the PI3K pathway also implicated in development of drug resistance. Each isoform is differentially expressed in various tissues (which in part defines their toxicity profiles), with PI3Kδ preferentially expressed on leukocytes, and playing a role in Treg function and peripheral T-helper cell differentiation.

FDA and EMA approvals of Zydelig (idelalisib, Gilead) in 2014 validated PI3Kδ inhibition as a target for B-cell malignancies, and provided evidence that inhibiting PI3Kδ is effective in ibrutinib-resistant populations. However, idelalisib is associated with liver toxicity, and most PI3Kδ inhibitors in development across a broad range of indications are multi-kinases (except Amgen’s Phase I AMG-319) which have shown frequent and severe adverse events. HMPL-689 is engineered to have lower toxicity through improved potency (>5x more potent than idelalisib) and improved isoform selectivity (reducing the risk of severe infection seen with Verastem/Infinity’s PI3Kγ/δ duvelisib and Bayer’s PI3Kα/δ copanlisib [Aliqopa]).

HMPL-689 has completed an Australian Phase I dose-escalation in haematological cancers, which according to management generated highly encouraging albeit early data. Two trials are currently underway in indolent NHL (non-Hodgkin’s lymphoma). The 83-pt China Phase I/II has so far dosed c 40 patients; the dose selection stage is complete and dose expansion is ongoing. The US Phase I/II proof of concept study has also dosed the first patient.

Sensitivities

As a fully integrated biopharmaceutical company, Chi-Med is subject to the typical risks associated with drug development and commercialisation. These include failure or delay in clinical development or the regulatory process, patent litigation, partnering, financing, and commercial risks such as competition, as well as pricing and reimbursement decisions. More specifically, the major near-term risks relate to the outcome of clinical trials and regulatory decisions for the key late-stage assets, surufatinib and savolitinib, and commercial progress of fruquintinib.

Overall, Chi-Med’s TKI pipeline breadth helps de-risk the company technically; it covers a variety of mechanisms of action with potential across a range of cancer indications. Its best-in-class assets have been de-risked as the MOA is known, while first-in-class TKIs – with an expected clean safety profile and potential for use in combination settings – should prove to be commercially attractive (both to potential partners and payors).

Chi-Med’s sustained commercial success in China is due to the established infrastructure, which has significant national and local expertise. The company recently established, and is expanding, its China Oncology commercial footprint through which it will self-market the products emerging from its R&D pipeline. Increased competition for quality staff from existing domestic and multinational players, as well as emerging Chinese companies, may hinder the scale-up required.

Two of the most advanced programmes, savolitinib and fruquintinib, have been partnered with large multi-nationals (AstraZeneca and Eli Lilly respectively). Whilst the relationships have worked well to date, there is a risk that their development and commercial priorities may alter to the detriment of Chi-Med’s best interests.

Political/economic concerns are inevitable with such a large and influential market as China, and as Chi-Med’s operations become increasingly global. Regulatory risks are highly relevant as Chi-Med’s activities are subject to extensive oversight from a variety of international, national, and regional bodies. In this context, the strong domestic management helps mitigate many of these sensitivities with a more nuanced approach, supplemented by ex-China expertise in the growing US operations. However, we highlight that potential regulatory interactions with, and decisions by, the China NMPA, FDA, EMA, and Japan PMDA may be subject to delays as a result of the impact of the global COVID-19 pandemic.

At FY19 results, Chi-Med commented on potential sensitivities faced as a result of COVID-19, although there remains limited visibility on the long-term impact. There have been some operational challenges due to restrictions on movement in China (eg reduced patient hospital visits for clinical assessment; commercial team activities). To date, none of the China manufacturing operations have been materially affected, and management continue to monitor the evolving situation.

Finally, in 2019 Chi-Med’s largest single shareholder, CK Hutchison, significantly reduced its stake (from c 60% to c 48%) to enable the deconsolidation of Chi-Med in its accounts, and has stated that it has no intention of further secondary offerings in the foreseeable future. CK Hutchison’s holding (and that of other large long-term holders) is perceived by some as reducing the genuine free float and constraining liquidity. However, liquidity has been steadily increasing and Chi-Med is a constituent of the NASDAQ Biotech Index and MSCI China Index.

Valuation

We continue to value Chi-Med using a sum-of-the-parts methodology, with an rNPV model for the Innovation Platform and an earnings-based multiple for the Commercial Platform. We have updated our comprehensive model (see Exhibit 18) to reflect the most recent company guidance on clinical trial starts and read outs (and the ensuing impact on potential approval and launch timelines). We also reinstate savolitinib in PRCC after AstraZeneca and Chi-Med confirmed that they are once more pursuing development in this indication, but conservatively remove epitinib and theliatinib until their respective development paths are clarified.

Our Chi-Med valuation is now £3.51bn (equivalent to £5.08/share), or $4.56bn ($32.99/ADS). The Innovation Platform contributes £2.50bn (£3.62/share) or $3.25bn ($23.55/ADS), while the Commercial Platform adds £772m (£1.12/share) or $1,003m ($7.26/ADS).

The Innovation Platform consists of the Hutchison MediPharma drug discovery and development operations, and as a classic emerging biopharmaceutical play it should be valued using a DCF approach. We calculate a rNPV (risk-adjusted net present value) for each clinical programme, with suitable adjustments for success probabilities that reflect the nature of the compound (eg novel or proven mechanism of action) and proposed indication (eg degree of expected competition and likely rate of adoption). Intuitively it follows that later stage projects have a higher rNPV, with the step-change occurring on completion of Phase II proof-of-concept trials. The individual programmes (which explore the lead indications) are summed and netted off against costs of running the company and net cash/debt. Following the recent equity raise, we assume proforma net cash of £300.4m in our valuation.

Exhibit 17: Relative contributions of Chi-Med programmes to valuation

Source: Trinity Delta

The relative contributions of each drug asset to our valuation are shown in Exhibit 17, while the detailed components of our Innovation Platform rNPV valuation are presented in Exhibit 18. Looking at the elements of our rNPV valuation in more detail: fruquintinib is the largest contributor, amounting to £1.18/share (£814m) or $7.66/ADS ($1.06bn), with surufatinib (£1.11/share, $7.23/ADS) and savolitinib (£0.81/share, $5.24/ADS) being the next most valuable clinical assets

Exhibit 18: rNPV-based valuation of Hutchison China MediTech

Source: Trinity Delta   Note: * = currently not focus indications for Chi-Med; pRCC = papillary renal cell carcinoma; ccRCC = clear cell renal cell carcinoma; NSCLC = non-small cell lung cancer; CRC = colorectal cancer; NET = neuroendocrine tumours.

Our house philosophy is to employ conservative assumptions throughout. When modelling product lifecycles, we assume seven years to achieve peak sales, against the typical five, and essentially steady state (ie no price rises at all and, in certain cases, price erosion) through to patent expiry where 100% of sales are lost within the year. Such assumptions may appear harsh, but we believe they are reflective of the marketplace for even truly innovative treatments. Royalty rates, on partnered programmes, are based on publicly available information and where no guidance is available, we have used rates of between 15% and 20%.

The Commercial Platform (wholly owned and JV operations in China) generates material revenues and profits so examining earnings-based metrics is appropriate. We highlight that as the sales of the JVs are not consolidated any simple revenue-based ratios will significantly undervalue these operations. We have applied revenue-based multiples to the wholly owned assets and the JV entities as a reality check and have found that they do support the earnings-based results.

To arrive at the earnings multiples, we examine 42 Chinese listed pharmaceutical companies, with market capitalisations ranging from c $300m to c $4bn. All are revenue generating (with sales arising mainly within China) and post recurring profits (loss-making companies are excluded). We ignore companies where the multiples appear to be distorted by non-recurring events or are outliers. We also exclude companies where the multiples appear too high, suggesting an element of speculation within the share prices rather than simply reflecting the operating businesses. While there is an element of subjectivity in this peer group selection, the logic driving the decisions is to maintain our cautious approach throughout.

The result is a valuation of $1,003m for the Commercial Platform: which equates to a multiple of 18.8x on FY20e earnings of $53.4m. The range of valuations from the various scenarios examined is quite tight, spanning from $992m to $1,051m.

We emphasise that any number of incremental improvements on our base case scenarios (notably with the Innovation Platform) could result in sizeable uplifts in our valuation. We are also conservative regarding a couple of areas where we expect transparency to increase in the near-term. For example, for fruquintinib, we apply the 2013 deal royalty rate (15-20%) ahead of approval of the first LCI in China, and aggregate NSCLC and LCIs in ‘other tumours’ pending more details on the next steps for clinical development. Additionally, development strategy clarification (lead indications, clinical trial timelines) for early stage assets epitinib and theliatinib would prompt their inclusion in our valuation.

Equally importantly, the visibility for the outlook of late-stage clinical programmes is increasing, with a rich news flow over the coming years. This suggests that there is significant upside potential, with multiple catalysts expected in the next 12 to 24 months. We intend to review our model regularly to reflect clinical, regulatory, and commercial progress.

Financials

Chi-Med’s FY19 group revenue of $204.9m, down 4% (11% CER) from $214.1m in FY18, was made up of collaboration sales (service fees and milestones) and consolidated revenues from the Commercial Platform. This revenue decrease was attributable to lower revenue from the Innovation Platform (FY19: $16.0m vs FY18: $37.6m); FY18 included a $13.5m milestone from Eli Lilly on Elunate China approval and in FY19 service fees from Nutrition Science Partners was $7m lower. Commercial Platform revenues were up 7% to $188.9m (FY18: $176.5m) primarily due to a 13.2% increase in revenues from Rx drugs (to $154.5m) and from Elunate-derived income.

FY19 group operating loss was $106.0m vs a loss of $74.8m in FY18, reflecting increased investment into the R&D pipeline and into the growing China Oncology commercial organisation. By division, the Innovation Platform (China Oncology and Global Innovation) posted a net loss of $133.2m (FY18: net loss of $104.4m), while a $47.4m net profit (FY18: net profit of $43.4m) was generated by the Commercial Platform. Profits from the Commercial Platform are used to support investment in the Innovation Platform (Hutchison MediPharma).

As we have highlighted previously, the reported accounts tend to downplay the scale of the Commercial Platform. FY19 total Commercial Platform revenues (China Business and China Oncology royalties and manufacturing fees) were $676.4m, but because of the manner in which the JVs are reported, only $204.9m was reported as revenue under US GAAP. For context, the Shanghai Hutchison Pharmaceuticals prescription JV (Rx) posted 2019 sales of $272.1m and net income of $61.3m, and the Hutchison Baiyunshan consumer health JV (OTC) posted 2019 sales of $249.8m and net income of $19.8m. The contributions from these operations, $47.4m in 2019 ($37.5m Rx and $9.9m OTC), are included within the Chi-Med accounts as net income (after tax) from equity investments.

R&D investment is steadily rising as the broad China and Global development pipeline advances into later-stage trials and the organisation grows to support this. FY19 R&D expenditure was $138.2m (up 21% from $114.2) and is expected to rise further as various pivotal studies initiate and increased global investment is made. Looking ahead, we expect an R&D spend of some $196.9m and $216.6m for FY20 and FY21 respectively. Capex is also expected to increase, mainly to support investment in a new manufacturing facility, with our forecast being c $120m in aggregate over 2020-22.

Selling expenses fell 22.6% to $13.7m in FY19 (vs $17.7m in FY18) primarily due to the discontinuation of Seroquel distribution. Administrative expenses rose to $39.2m (up 26.9% on FY18’s figure of $30.9m), with $5m of the increase connected to organisational expansion and professional fees associated with equity capital markets transactions (including preparation for a potential Hong Kong IPO, and the NASDAQ ADR issuance), and an increase of $2.5m associated with the expansion of China Oncology and Global Innovation clinical activities.

Chi-Med’s guidance for FY20 is for Innovation Platform adjusted (non-GAAP) operating loss of $180m to $210m and a negative adjusted (non-GAAP) group net cash flow of $140m to $160m. This guidance reflects investment into advancing the pipeline (including global registration studies for surufatinib and fruquintinib), capital investment into small molecule manufacturing, and supporting the China and US commercial infrastructure. Growth in Commercial Platform cash generation is also expected. Notably, this guidance also assumes no material impact from the COVID-19 pandemic.

Changes to our key estimates are shown in Exhibit 19.

Exhibit 19: Summary of changes to estimates

Source: Trinity Delta

At end-December 2019, Chi-Med had cash resources in excess of $300m, which consisted of cash, cash equivalents, and short-term investments of $217m and unutilised bank facilities of $120m. Additionally, the non-consolidated JVs (notably Shanghai Hutchison Pharmaceuticals, Hutchison Baiyunshan, and Nutrition Science Partners) held a further $63m in available cash resources.

In Q120, Chi-Med raised an additional $110m (net) to progress its R&D pipeline and build up the China Oncology commercial infrastructure during 2020. We believe that Chi-Med now has ample funding into 2021, but, in our view, a further capital raise of $200-250m would help maintain pipeline momentum given the clinical opportunities and support planned commercial infrastructure expansion. We also note that should COVID-19 impact the timing of initiation of new clinical trials, Chi-Med’s cash runway would be extended.

Given the rising visibility of the commercial operations, coupled with the acknowledged value of the pipeline, we feel Chi-Med should have a number of funding routes. For instance, sizeable debt financing, at attractive rates, is an option not generally available to similar sized biopharmaceutical companies as Chi-Med would benefit from the backing, both explicit and implicit, from CK Hutchison.

Exhibit 20: Summary of financials

Source: Company, Trinity Delta  Note: Adjusted PBT excludes exceptionals, Cash includes short-term investments, Adjusted EBITDA includes equity in earnings of equity investees. *2021E cash figure includes assumed raise of $250m

Company information

Contact details

Level 18, The Metropolis Tower,
10 Metropolis Drive,
Hung Hom, Kowloon,
Hong Kong
Tel: +852 2121 8200

www.chi-med.com

Top shareholdings

Source: Hutchison China MediTech Note: *Wholly owned subsidiary of CK Hutchison Holdings