Investment case

Mereo BioPharma is a clinical-stage biopharmaceutical company with four assets for oncology and rare diseases and two broader indication products. Selected commercialisation rights may be retained for discrete geographies, others will be outlicensed. The company was formed in 2015 to exploit opportunities arising from big pharma rationalising development portfolios or altering their strategic priorities. The maiden deal in 2015 saw Novartis take an equity stake of 19.5% with a subscription agreement for additional shares for three clinical programmes addressing diverse niche indications. Mereo BioPharma listed on AIM in June 2016. In 2017, a programme was in-licensed from AstraZeneca, with the option to acquire following key trial results. OncoMed Pharmaceuticals was acquired in 2019 for $57.4m by issuing c 23.7m new Mereo BioPharma shares (in the form of ADSs). This brought a NASDAQ listing, US infrastructure, the clinical assets egitilimab and navicixizumab, and c $51m in additional funds. Over £185m has been raised in equity to date: it also has a £20m debt facility, and c £22m of outstanding convertible loan notes.

Valuation

We believe an rNPV model is the appropriate way to value Mereo BioPharma. We use a risk-adjusted DCF to model each clinical programme, netting this sum against the costs of running the business and net cash/debt. Our prior valuation was £442m or $574m, equivalent to 412p/share or $20.60/ADS. Updating our model to reflect clinical and financial developments generates a new valuation of £560m or $728m, equivalent to 100.2p/share or $5.01/ADS (fully diluted).

Financials

At end-December 2019 cash resources were £16.3m. During H120, Mereo BioPharma strengthened its balance sheet through three transactions totalling $11m and a $70m private placement. These additional funds, coupled to existing cash and equivalents, and anticipated R&D tax credit receipts should fund Mereo BioPharma’s currently committed clinical trials, operating expenses, and capex into early-2022. Further funding may arise from partnering, with four clinical assets at or reaching points where partnering or out-licensing deals may be struck. The key questions are what the industry appetite is like and which potential partnering deal provides the best short- and long-term value.

Sensitivities

Mereo BioPharma’s strategy deliberately targets programmes at the later clinical stages, eschewing earlier stage programmes, where the risk profile tends to be lower. However, albeit reduced, the typical industry risks associated with clinical trial results, navigating regulatory hurdles, ensuring sufficient financing is in place, partnering discussions and, eventually, pricing and commercialisation still apply. Our main sensitivities are detailed later in the body of the note, with particular emphasis on each individual programme.

Mereo BioPharma: finally funded to deliver

Following the successful $70m raise, Mereo BioPharma is embarking on the next stage of its journey. Its orphan and rare disease products, setrusumab, for osteogenesis imperfecta (brittle bone disease), and alvelestat, for the treatment of alpha-1 antitrypsin deficiency (AATD), are approaching key partnering points. But it is the progression of etigilimab, the promising anti-TIGIT programme, that will be the focus of investor attention. Clinical success in a Phase II proof-of-concept trial would have a material impact on our rNPV valuation. Other value inflection events include tangible headway in partnering the other assets. The equity raise removes financial concerns but, more importantly, brings a host of quality, and knowledgeable, investors. Our valuation is £560m or $728m, equivalent to 100.2p/share or $5.01/ADS (fully diluted).

Mereo BioPharma’s product portfolio consists of six later-stage clinical asset: two in oncology, two in rare diseases, and two earmarked for partnering. The strategy is to build an oncology and rare disease pharmaceutical company. Etigilimab, an anti-TIGIT antibody, is the most promising programme. We expect it to be progressed through proof-of-concept Phase II studies, probably in smaller oncology indications, before the development strategy is finalised. Setrusumab, for osteogenesis imperfecta (OI), and alvelestat, for α1-antitrypsin deficiency (AATD), appear suitable candidates for certain geographic rights to be kept. Navicixizumab, the second oncology asset, was licensed to Oncologie in January 2020. Of the remaining two, acumapimod (acute exacerbations in COPD) and leflutrozole (male infertility), one is expected to be partnered soon.

Mereo Biophama successfully raised an impressive $70m (£56m) gross in June 2020 through a private placement with new and current US institutional investors. The fund raise was led by Orbimed and brought in Vivo Capital, Surveyor Capital (a Citadel company), Pontifax Venture Capital, Samsara BioCapital, Commodore Capital, and Janus Henderson Investors’ funds. Existing investors such as Boxer Capital (Tavistock Group) and Aspire Capital also participated, both of which also invested in February 2020 via a $3m equity purchase and an up to $28m equity issue, respectively. Novartis also invested in a $5m convertible financing deal in February. Based on our forecasts, the cash runway extends into early-2022.

The events of 2020 to date have transformed Mereo BioPharma’s outlook. The past two years have seen the shares hit by understandable concerns over the shareholder structure, which hampered financing and the ability to partner clinical assets. With funding in place and the overhang of the once 41.9% Woodford stake effectively removed, the focus now shifts firmly back to the pipeline. The COVID-19 pandemic has not had a major impact on business functions; but the possible constraints on clinical trial centres does bring the risk of timing delays on programmes such as alvelestat’s Phase II completion (currently expected in 2021) and initiation of the setrusumab paediatric Phase III study (currently planned for late 2020, subject to partnering).

We believe share price appreciation will now be driven by clinical progress, notably with etigilimab, and evident success in partnering assets. For example, a few well struck commercial deals would result in material upside potential, with multiple inflection points possible in the next 6 to 24 months.

A diversified portfolio of late-stage clinical assets

Mereo BioPharma’s current portfolio consists of six clinical assets, three from the original deal with Novartis, the fourth in-licensed from AstraZeneca, and two from the OncoMed deal (Exhibit 1). The portfolio is well diversified, with each of the product candidates employing a different mechanism of action and targeting a distinct indication. The risks have also been contained by selecting product candidates that have already generated positive clinical data either for the target indication or for a related indication. Further risk mitigation is achieved through selecting a mixture of drug candidates, with some having novel modes of action and others having proven safety and efficacy albeit in different indications.

Exhibit 1: Mereo BioPharma pipeline summary

Source: Mereo BioPharma, Trinity Delta  Note: NE – neutrophil elastase; HH – Hypogonadotropic Hypogonadism

In-house development centres on generating supportive clinical data that will improve a programme’s partnering potential. Three of the programmes have reached an appropriate partnering point and negotiations are thought to be underway for certain, unspecified, assets. The licensing agreement with Oncologie for navicixizumab has a potential value of over $300m but was struck with modest upfront payments. This suggests that management is keen to strike out-licensing deals with a balance between near-term upfront payments and longer-term earning potential. The proceeds from the partnering efforts will be used to support the development of the TIGIT programme and the rare disease products, including sourcing, over the longer term, additional programmes.

As no discovery work or preclinical development is undertaken in-house, further in-licensing of clinical programmes should be expected. The ideal candidate profile would be a compound that addresses an orphan disease for an oncology, respiratory, bone and musculo-skeletal, or endocrine indication. Timelines for the current development programmes suggests that this would not be on the horizon for another 12-18 months. The strategic goal is to create a specialty company that in-licenses, develops, and then selectively self-commercialises a suite of oncology and rare disease products.

Etigilimab: enjoying the TIGIT spotlight

Etigilimab, also known as OMP-313M32, is Mereo BioPharma’s lead speciality oncology candidate, having completed Phase Ia and Ib studies in a range of advanced solid tumours. Etigilimab is an antibody that targets the TIGIT (T-cell immunoreceptor with immunoglobulin and ITIM) domains.

TIGIT is a particularly exciting target in immuno-oncology. It is a receptor that stops T-cells from attacking tumour cells much like the PD-1 inhibitory protein. Such proteins are known as immune checkpoint receptors and their inhibitors (CPI) rank as the most studied ever. Monoclonal antibodies targeting checkpoints such as CTLA-4 (cytotoxic T lymphocyte‐associated antigen 4) and PD-1 (programmed cell death 1) receptors show impressive clinical efficacy and durable responses in more than 15 types of malignancy. Such therapy has transformed outcomes for a number of previously intractable cancers; however there remains a sizeable patient population who fail to respond or relapse. Hence the search is on for new CPI targets that may either be used alone or in combination with other treatments.

Exhibit 2: TIGIT plays a key role in immune suppression by cancer cells

Source: The Immunoreceptor TIGIT Regulates Antitumor and Antiviral CD8+ T Cell Effector Function, Cancer Cell, Volume 26, Issue 6, P923-937, December 08, 2014

TIGIT is a T-cell co-inhibitory receptor – an immunoglobulin “superfamily” member – that is consistently highly expressed across multiple solid tumour types. TIGIT expression frequently occurs in parallel with expression of other co-inhibitory receptors, most notably PD-1, where it acts synergistically to regulate anti-tumour response. These pathways consist of receptor–ligand pairs which, following receptor–ligand interaction, suppress the effector functions of T cells and natural killer (NK) cells and impair anti‐tumour immunity (Exhibit 2). TIGIT is a modest inhibitor of CD4⁺ T cell priming and NK cell killing; however, especially in the presence of PD-1, there is potent suppression of CD8⁺ T cells. The precise mechanism of action remains unclear and may have both cell-intrinsic and cell-extrinsic components; it may, for example, prevent tumour antigen release by NK cells, impair T cell priming by DCs, or inhibit cancer cell killing by CD8⁺ T cells.

There are ten TIGIT programmes known to be in clinical development, albeit four have only just entered Phase I (Exhibit 3). Roche/Genetech’s tiragolumab is the most advanced and, following positive data from the Cityscape Phase II trial, is being evaluated in two related Phase III studies, Skyscraper-01 and -02, for first-line NSCLC (non-small cell lung cancer) and SCLC (small cell lung cancer). An ambitious programme sees a further six pivotal Phase III studies also planned for other solid tumour indications. This sizeable commitment has spurred significant industry interest in exploring anti-TIGIT strategies in combination with a number of existing checkpoint inhibitors, as well as current gold standard regimens. The appeal of TIGIT is that it appears to act on the immune system through multiple mechanisms, suggesting inhibition could result in profound and lasting activity.

Exhibit 3: TIGIT programmes known to be in clinical development

Source: Evaluate, clinicaltrials.gov, Trinity Delta   Note: Adv = advanced, Met = metastatic

Etigilimab is an IgG1 monoclonal antibody that showed potent anti-tumour effects in preclinical studies. A Phase Ia/Ib open label dose escalation trial in locally advanced and metastatic solid tumours treating 23 patients, with doses up to 20mg/kg every two weeks, was completed successfully. Tumour types included colorectal, endometrial, and pancreatic cancer, plus eight other solid tumour types. A related 10 patient Phase Ib dose escalation study in selected tumour types in combination with nivolumab has also shown promising results. No dose limiting toxicities were observed in either study. A Phase Ib study of etigilimab in combination with a PDL-1/PD-1 is planned to initiate in Q420.

We expect Mereo BioPharma’s development programme, likely through to Phase II proof-of-concept trials, to focus on less common solid tumours, if only from the perspective of patient recruitment.

Setrusumab: ready for (regional) partnering in OI

Setrusumab 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. It was previously known as BPS-804 and acquired as one of the three original programmes from Novartis in 2015. Setrusumab is a fully humanised monoclonal antibody targeting sclerostin (SOST). Sclerostin is a protein secreted by the osteocyte cell (the cornerstone cell of bone structure) that plays a pivotal role in bone homeostasis. The appeal of sclerostin inhibition lies in how it could improve bone mass through reducing bone resorption (antiresorptive) and, importantly, through the activation of bone formation (osteoanabolic).

Setrusumab is being developed for osteogenesis imperfecta (OI), a rare disease that is better known as brittle bone disease, where different genotypes are characterized by varying degrees of skeletal fragility. Most types (usually classified into eight categories) are caused by disruption of or mutations in one or both of two genes (COL1A1 or COL1A2) that carry instructions for the production of type 1 collagen. Collagen is the major protein of bone and connective tissue including the skin, tendons, and sclera. The hallmark of OI is that bone fractures happen with only minimal to moderate trauma. Type I, the least severe form, is associated with relatively few fractures, whereas Type II is the most severe and causes babies to be born with multiple fractures and typically die within a few weeks of birth.

Exhibit 4: The mechanism of action of setrusumab for osteogenesis imperfecta

Source: Mereo BioPharma

ASTEROID was a c 112 adult OI patient, double-blind, placebo controlled Phase IIb clinical trial performed across 27 specialist sites in the US, Europe and Canada. The patients were Type I, III, and IV, with the defect in COL1A1/2 gene confirmed by genetic testing, and which account for c 80% of OI patients. A novel primary endpoint, measured at 12 months, was selected. This was the change in trabecular volumetric bone mineral density (Tb vBMD) of the radius measured by high resolution peripheral quantitative CT (HRpQCT) and changes in bone strength on finite element analysis (FEA). More established secondary endpoints included: BMD measured by traditional two-dimensional dual-energy X-ray absorptiometry (DXA); and additional measures of bone parameters on HRpQCT; bone turnover markers; and quality of life scores.

The study failed to achieve its headline primary endpoint, but the overall data were compelling. The typical measure for assessing bone mineral density (BMD) and indirectly bone strength, DXA, achieved clear positive outcomes. There were significant increases in BMD in various bones, which were materially greater than that seen with teriparatide or bisphosphonates in other studies. Consistent with the total BMD data, there was a trend of reduction in fractures (the trial was not powered for significance). The reasons for the missed primary endpoint appear to be exceptional heterogeneity in the Tb vBMD data and a number of OI patients with higher baseline vBMD than predicted. Such heterogeneity in the data meant significance was improbable. The details are in our November 2019 Update note.

The outline of an international Phase IIb/III trial to support paediatric approval has been agreed with the FDA and EMA. The study will treat c 165 children aged two to 18 with OI (Type I, III, and IV) who are currently on bisphosphonate therapy and use fracture rate at 12 months as the primary endpoint. Secondary endpoints will include BMD measured by DXA, bone turnover markers, and quality of life scores. Management intends to secure partnerships, most likely regional so as to maintain a degree of self-commercialisation potential, before finalising the format of this registrational trial. The trial start is planned for late-2020 but may be delayed by possible COVID-19 related restrictions on initiating new clinical trials.

If the data from this paediatric trial are also compelling, it is questionable if it would be ethical to require an additional placebo-controlled Phase III study in adults, as there is no approved treatment for OI. This, in turn, could lead to the Conditional Marketing Authorisation (CMA) of setrusumab in adults in Europe using data from the ASTEROID study and the paediatric Phase IIb/III trial. The US position is less clear, but a conditional approval, with a requirement for a Phase IV study to confirm the efficacy and safety profile, remains likely.

In our modelling we assume that a submission could be made to the EMA in mid-2023 and the FDA in late-2023, based on the results generated by pivotal Phase IIb/III trial, with possible approval in 2024 and first sales in 2025. We forecast peak sales of $915m (£704m) with only modest penetration of the adult market. We estimate that setrusumab will be used to treat c 25% of children with the appropriate types of OI in the US and c 20% in Europe, but only c 12% of adults in both markets. This reflects the clinical need for treatment being greater for children. We also estimate that the cost of treatment will be $200,000 per annum in the US and $150,000 in Europe, supported by the pricing precedent achieved with Ultragenyx’s Crysvita. The final pricing will depend on the clinical benefit observed in the clinical trials.

For context, OI is a debilitating disease for which there is currently no FDA or EMA approved treatment. Therapy is aimed at preventing and treating fractures, maintaining individual mobility, and seeking to strengthen bones and the related muscles. Surgical procedures, such as rodding (the insertion of metal rods in the bones), have shown benefit but carry the risks associated with such major surgery. Medication typically involves the use of anti-resorptives (off-label use), such as bisphosphonates, to ameliorate bone mass but it is not shown they reduce fracture rates. Denosumab (Amgen’s Prolia, RANK-L antibody) and teriparatide (Lilly’s Forteo, PTH analogue) are also employed, but both have severe limitations.

Alvelestat: Addressing a respiratory rare disease

Alvelestat, the second product in the rare disease portfolio, is in development for the treatment of severe AATD (α₁-anti-trypsin deficiency), a rare and potentially life-threatening genetic condition. Previously known as AZD-9668 or MPH-966, it is an oral small molecule that selectively and reversibly inhibits neutrophil elastase (NE). Alvelestat was licensed from AstraZeneca in 2017 in a deal structured to minimise risk; Mereo BioPharma would only acquire alvelestat if the outcome of the current proof-concept Phase II study is positive. The already agreed price has not been disclosed, but would be a combination of cash and shares. AstraZeneca initially developed alvelestat for the treatment of COPD, cystic fibrosis (CF) and bronchiectasis, where these NE pathways are known to be disrupted.

NE is an aggressive and cytotoxic protease enzyme that is associated with the destruction of lung tissue. It is implicated in the signs, symptoms, and disease progression of many lung disorders through its role in the inflammatory processes, mucus over-production, and lung tissue damage. Normally NE activity is tightly regulated by endogenous protease inhibitors including α₁-antitrypsin (AAT), secretory leukoprotease inhibitor, and α₂-macroglobulin.

Alvelestat’s mechanism of action appears particularly well suited to negating the impacts of α₁-antitrypsin deficiency. AATD is a relatively common inherited genetic disorder where the liver produces an abnormal version of the AAT protein or none at all. Normally AAT plays a protective role in the lungs and its lack can allow the destructive effects of NE to go unchecked. The damage to the lungs is progressive, cumulative, and irreversible, with therapy[1] limited to symptomatic treatments, such as inhaled steroids and bronchodilators, or augmentation therapy with plasma-derived AAT (typically weekly one-hour IV infusions). As an inherited genetic disorder, AATD should be an ideal candidate for gene therapy, however the complexities mean progress is slow.

AATD has been identified in virtually all populations, but most commonly in individuals of Northern European (Scandinavian and British) and Iberian (Spanish and Portuguese) descent. AATD affects one in 1,500 to 3,500 individuals with European ancestry but is uncommon in people of Asian descent. The severity of disease depends on the type of variations occurring on the SERPINA1 gene; the highest risk of disease occurs in the ZZ allele (both emphysema and liver disease) and Null/Null allele (very high for emphysema but little liver risk). This results in a severe AATD population estimated at 60,000 in Europe and 50,000 in the US. Mereo BioPharma is developing alvelestat to treat this population, where NE inhibition could protect these AATD patients from further lung damage.

A proof-of-concept Phase II trial is underway, with the first patient dosed in November 2018, although it took longer than hoped to initiate certain centres. The study examines around 165 severe AATD patients with the PiZZ or NULL genetic mutations who have confirmed emphysema, declining FEV1, and have not undergone augmentation (or similar) therapy. The study period is 12 weeks and consist of three arms (placebo and two MPH-966 doses); it examines elastin breakdown and biomarkers of NE inhibition. Desmosine, a breakdown product of elastin and a good biomarker for lung damage, is a primary endpoint. Secondary endpoints such as plasma Aα-Val³⁶⁰ (a validated biomarker of NE activity), NE levels in sputum, and a battery of lung function tests are also included.

The top-line results will form the basis of discussions with the FDA and EMA and guide the design of the pivotal Phase III trial. The risks of COVID-19 infection in this vulnerable patient group has seen recruitment delayed, with the preliminary data now expected in H221 (although this may be subject to further revision).

The nature of the AATD market means that alvelestat is well suited to being commercialised through a small, targeted sales team. This suggests a partnering deal could seek to retain an element of commercialisation rights, which would imply regional partnership(s); however, if the out-licensing economics are attractive, a global partner ahead of Phase III is also likely. We have assumed that a pivotal Phase III trial could start in 2022, with headline results in 2023/4 and a typical 12-month approval process, could lead to first marketing in 2025. We have modelled peak annual sales at $375m (£288m), and a modest adoption profile. As a reference point, augmentation therapy is currently only reimbursed in the US and some European countries, with around 9,000 patients treated and an annual cost of c $150,000.

Stop press: Alvelestat starts Phase Ib/II in COVID-19

A Phase Ib/II double-blind, placebo-controlled clinical trial has initiated with alvelestat in adult patients with moderate to severe COVID-19 respiratory disease. The study involves c 15 patients that are hospitalised, but not yet ventilated, and initially examines safety and potential efficacy. The first element will last 10 days with safety and tolerability as primary endpoints, a 90-day safety follow-up will also be performed. Secondary endpoints will examine efficacy parameters, including blood biomarkers, inflammation, oxygen deficit, and clinical outcomes.

The rationale is COVID-19 infection typically results in acute lung injury (ALI); the neutrophil elastase pathway may be a key element in this and results in the formation of neutrophil extracellular traps (NETs). NETs are not only involved in lung inflammation but are seen in arterial and venous thrombus formation. Alvelestat has shown promising results in preclinical models, hence the inhibition of neutrophil elastase may have an important role in treating COVID-19 complications. We have not, as yet, included any contribution from alvelestat in our valuation model.

Partnering portfolio: one done, two to go

The three remaining clinical programmes have commercial merit but are not well suited for marketing by a specialist rare disease focused sales team. The strategy is to develop each programme to a point that establishes proof of concept or eases the partnering pathway. The nature of clinical development means some will progress and attain the hoped-for profile, whilst others will disappoint. We would argue that a portfolio that does not have its share of disappointments has not been structured to optimise returns on development investment.

Navicixizumab: bi-specific oncology antibody

Navicixizumab, also known as OMP-305B83, 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. A Phase Ia clinical trial showed encouraging activity and manageable toxicities as monotherapy, especially in ovarian cancers.

Data from a Phase Ib study in combination with paclitaxel in 44 heavily pretreated patients with platinum-resistant ovarian cancer were presented at SGO (Society of Gynecologic Oncology) 2020 virtual meeting. The results showed an overall response rate (RECIST 1.1) of 43% (n = 19), including 2% (one) complete response and 41% (18) partial responses, with 34% (15) with stable disease as best response for a clinical benefit rate of 77% (n= 34). Progressive disease occurred in seven (16%) patients and three (7%) patients were not evaluable. The patients had received a median of four previous therapies; all had received prior paclitaxel, 69% had received prior bevacizumab (Avastin), and 41% had received a PARP inhibitor. The most common adverse events (AE) of any grade were hypertension (68%) and fatigue (46%).

In October 2019, navicixizumab received an 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. An outline of the Phase II clinical programme required has been established, with the pathway to an expedited approval mapped out. The primary endpoint will be confirmed ORR, and the secondary endpoints include duration of response, CA-125 response rate, PFS (progression free survival) and OS (overall survival). The dosing regimen is the same as the current Phase Ib trial.

In January 2020 navicixizumab was licensed globally to Oncologie for a $4m upfront payment, and an additional $2m payment conditional on a CMC (chemistry, manufacturing and controls) milestone. A total of up to $300m 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. Oncologie will be responsible for all future development and commercialisation of navicixizumab. It is a well-funded partner, having closed an $80m Series B in June 2019, and has three other assets in its current clinical development pipeline: lefitolimod (partnered with Mologen), bavituximab, and varisacumab.

Navicixizumab was acquired by Mereo BioPharma through its April 2019 merger with OncoMed and is the subject of a CVR (contingent value right) with former OncoMed shareholders. If a milestone occurs prior to the fifth anniversary of the closing of the Mereo/OncoMed merger (ie April 2024), CVR holders are entitled to receive, in cash, 70% of the aggregate amount received by Mereo BioPharma (net of agreed costs), subject to a cash consideration cap of $79.7m.

Acumapimod: Reducing exacerbations in COPD

Acumapimod, also known as BCT-197, is a small molecule, orally active inhibitor of p38 MAP (mitogen-activated protein) kinase. This is a key pathway^[2] in many chronic inflammatory states and has been studied extensively for conditions such as rheumatoid arthritis, Crohn’s disease, asthma, and COPD. Novartis undertook a comprehensive early clinical evaluation, with three Phase I and two Phase II studies, involving 459 treated patients, that showed a clean side-effect profile and promising anti-inflammatory activity. A Phase II trial in 183 AECOPD patients showed dose-dependent improvements in inflammatory markers for AECOPD with a reduction in hospital stay, but statistical significance was not reached.

Acute exacerbations in COPD (AECOPD) are a major concern, both medically and economically. An AECOPD is defined as a sustained (24-48 hours) increase in cough, sputum production, and/or dyspnea. Many patients experience around two episodes of AECOPD per annum, with more than 10% requiring hospitalisation. The average duration is 7 to 12 days and onset is often linked with an infection. AECOPD accounts for 13% of all acute hospitalisations[3], and contributes significantly to morbidity, death, and quality of life issues. For context, COPD is the third largest cause of death in the US and the frequency and severity of exacerbations are among the principal factors that determine the prognosis. The five-year survival rate for those experiencing three or more exacerbations per annum is 30%, whilst those without any have an 80% survival rate.

Mereo BioPharma undertook a 282 patient Phase IIb study (AETHER) with two different dosing regimens (high and low dose) versus placebo, on top of standard of care, over a five-day dosing period. The primary endpoint was FEV1 (forced expiratory volume in one second), with additional endpoints including hospital stay times, patient reported outcomes, recurrence rates of AECOPD and hospitalisations. The results showed a statistically significant improvement in FEV1 for both the low and high dose groups from baseline to day 7 (p=0.012). A potent anti-inflammatory effect was evident, with sustained reductions in inflammatory markers, fibrinogen and hsCRP (high-sensitivity C-reactive protein), seen in a dose-dependent manner. A significant reduction in severe exacerbations of COPD, and the use of antibiotics and corticosteroids was seen in the follow-up phase of the study.

Positive meetings with the FDA and EMA have provisionally mapped out the Phase III clinical pathways. There are no approved therapies to treat AECOPD currently, and acumapimod offers the potential to treat and prevent exacerbations over extended periods. The clinical and economic benefits of a successful disease-modifying treatment are compelling. Management is seeking to partner acumapimod ahead of further clinical development.

Leflutrozole: Holistic male fertility therapy

Leflutrozole, also known as BGS-649, is an aromatase inhibitor that is being explored as a once-weekly oral treatment to improve infertility associated with hypogonadotropic hypogonadism (HH) in obese men.

Obesity often results in reduced male fertility as excess aromatase activity in adipose (fat) tissues results in testosterone conversion to oestradiol. This reduces gonadotropin secretion and lowers intratesticular testosterone production. Testosterone replacement therapy (TRT) frequently results in a negative feedback suppression of follicle stimulating hormone (FSH) and luteinizing hormone (LH), which further impairs semen fertility. The most effective way to cure obesity-related hypogonadism and the associated infertility is weight loss but, realistically, most patients will not achieve the desired result in a suitable time frame.

Aromatase inhibitors are used commonly in hormone-sensitive breast cancers in women, but their mode of action lends itself to the treatment of other conditions where there is an imbalance between androgen and oestrogen activity. Inhibiting the excess aromatase increases testosterone levels endogenously and also blocks the inhibitory feedback on the HPT axis and improves, rather than reduces, the levels of LH and FSH. Early aromatase inhibitors, such as testolactone (steroidal) and anastrozole (non-steroidal), have been tested in a number of small studies and have been used successfully as “off-label” treatments. Although encouraging, proper randomized double-blind controlled trials are needed to assess the extent of benefit aromatase inhibitors could offer (and to support reimbursement).

Leflutrozole is a highly selective non-steroidal reversible inhibitor and achieves the rebalancing without an increase in circulating oestrogens. Novartis, which had a strong background in this area having developed Femara (letrozole, now generic), carried out a total of eight clinical trials that showed a clean safety profile and encouraging signs of efficacy. 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.

Leflutrozole appears well suited to addressing such male infertility but, as it not a programme that Mereo BioPharma would commercialise itself, a partner or alternative funding is being sought to undertake further development. The commercial potential would depend largely on how a potential partner would position leflutrozole, with its fertility profile potentially helping to differentiate it in a fragmented and competitive market.

Sensitivities

In common with most innovative pharmaceutical companies the three main sensitivities relate to clinical and regulatory aspects, execution of commercialisation plans, and the financial resources required to accomplish these. More specifically, the key near- and medium-term sensitivities are directed to the clinical and partnering progress on the three main clinical programmes:

• Etigilimab is facing strong and well-funded competition. Its clinical profile has only been examined in early-stage clinical studies, whereas several of its peers are further advanced. Importantly, the key competitor has the resources to deploy multiple extensive trial programmes in large oncology indications, such as NSCLC. This suggests management will target selected cancer types, where the need is such that recruitment should not be an issue and time can be made up. Successes here would be an invaluable proof of concept.
• Setrusumab showed compelling results across most parameters in the ASTEROID study, despite failing to reach significance in the primary endpoint. A paediatric Phase IIb/III registration study in Europe and North America is planned and, subject to sourcing suitable partner financing and COVID-19 limitations (notably patient enrolment due to travel restrictions), could initiate by year-end. The OI setting is in clear need of effective treatments and setrusumab has the most promising profile of any treatment currently in development.
• Alvelestat is completing a proof-of-concept Phase II trial in severe AATD. It can be difficult to demonstrate clinical significance in such respiratory disorders within the time and structural constraints of a clinical study. Similarly, the endpoints and biomarkers selected may not reflect the full extent of alvelestat’s activity. Additionally, we believe a material milestone is due to AstraZeneca upon entry into Phase III.

The two programmes that have yet to be partnered may, in our view, struggle to gain traction. For example, acumapimod has impressive data in AECOPD, yet over the past decade the p38 MAPK inhibitors have not lived up to their expectations. It may take compelling evidence to overcome inevitable scepticism within a target company’s R&D management. Similarly, leflutrozole has produced strong results from the Phase IIb study in HH, yet demonstrating efficacy in the target indication of fertility improvement in obese men will likely require lengthy, and costly, trials that may not be warranted by the commercial potential.

Further out, the sensitivities centre on execution of the commercial strategy for any programmes that will be marketed directly. Whilst this is a sensible approach and addressing these well-defined therapy segments should not be unduly onerous, management has yet to demonstrate its competence in this area.

Longer term, the reproducibility of the model needs to be demonstrated. The future deal flow will likely depend on the rate, and degree, of success achieved with these existing programmes. Inevitably, the better opportunities will be offered not simply to those with the bigger pockets but to those that have a proven track record of delivery.

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. The rNPV of each individual clinical project is assessed and the success probabilities adjusted for the inherent clinical, commercial, and execution risks each carry. The success probabilities are based on standard industry criteria for the respective stage of the clinical development process but are flexed to reflect the inherent risks of the individual programme, the indication targeted, and the trial design. We also factor an element for the execution and commercial risks, notably on the two programmes earmarked for partnering.

We employ conservative assumptions throughout our modelling, particularly regarding market sizes and growth rates, net pricing, adoption curves, and peak market penetration. Previously, our model resulted in a valuation of £442m or $574m, equivalent to 412p/share or $20.60/ADS on a fully diluted basis. We have revisited the underlying assumptions in our model (Exhibit 5) to reflect the impact of changes to development priorities and the fresh funding, as well as introducing etigilimab and navicixizumab into our rNPV valuation. Our updated valuation of Mereo BioPharma is £560m or $728m, equivalent to 100.2p/share or $5.01/ADS (fully diluted).

Exhibit 5: Our updated rNPV-based valuation of Mereo BioPharma

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

Etigilimab is, as we described earlier, an early-stage product with significant prospects. The TIGIT space is currently extremely exciting given its potential to enhance checkpoint inhibitor activity; a positive outcome in a Phase II trial could transform Mereo BioPharma’s outlook. However, our conservative approach means our valuation is based on its early development stage, currently limited visibility on the development strategy, and the well-funded competition. We acknowledge that we may be overly cautious with our current egitilimab valuation of £74.4m or $96.7m, equivalent to 22.0p per share or $1.10 per ADS.

Greater detail on the development strategy for egitilimab would prompt us to revisit our assumptions, particularly with respect to likely peak sales and timelines. At present, the risk adjustment we employ reflects the fact that while TIGIT is becoming an increasingly validated, and valued, target with proof of concept in several tumour types, egitilimab itself remains early-stage. Roche has the most developmentally advanced programme, tiragolumab, which is in pivotal trials in lung cancer (see Exhibit 3); and Merck’s MK-7684 is in Phase II studies in combination with Keytruda in melanoma.

Despite the competitive landscape, with several large pharmaceutical companies rapidly progressing the development of their TIGIT assets, there remains an attractive opportunity for smaller players. Lucrative deals have been struck, such as the 2020 Gilead/Arcus Therapeutics collaboration and Astellas Pharma’s up to $405m acquisition of Potenza Therapeutics in 2018. There remain unencumbered TIGIT assets, of which egitilimab is one, which would give potential acquirers a head start versus internal development. The spectre of M&A may be one factor behind the valuations of peers with Phase I TIGIT programmes such as Compugen (NASDAQ: CGEN, $1.43bn market cap) and Iteos Therapeutics (NASDAQ: ITOS, $970m market cap) which closed a $125m Series B2 financing in April 2020 and subsequently raised $201m in an July 2020 NASDAQ IPO.

Setrusumab remains the largest component of the valuation, amounting to £337m or $439m, equivalent to 99.6p per share or $4.98/ADS. We assume first material sales occur in 2024, with peak sales of $915m (£704m) occurring some six years later with an operating margin of 60%. We employ a 60% probability that it will reach the market. Our new peak sales estimate reflects higher pricing than previously (supported by competitive benchmarking) but lower market penetration. Although the precise terms of the payments to Novartis are not known^[4], we have assumed c 10% is paid away in the equivalent of royalties.

Alvelestat is valued at £70m or $91m, equivalent to 20.7p a share or $1.03 per ADS. Trial timings remain uncertain, but we estimate that the first market launch will be in 2025, with peak sales of $375m, a 65% operating margin, and a clinical success probability of 25%. We view alvelestat as suited to self-commercialisation in some markets, with a royalty equivalent rate of c 10% of revenues payable to AstraZeneca^[5].

Navicixizumab, partnered with Oncologie in a deal potentially worth up to $300m in downstream milestones and tiered global net sales royalties (mid-single-digit to low-teen), is valued at £32m or $41.7m, equivalent to 9.5p/share or $0.47/ADS. This programme is subject to a CVR where holders are entitled to receive, in cash, 70% of the aggregate amount received by Mereo BioPharma (net of agreed costs), subject to a cash consideration cap of $79.7m.

Acumapimod has significant uncertainty within our model as the drug class is currently out of favour. We have a success probability of a suitable deal taking place within 12 months of 40%, which gives a valuation of £27.5m or $35.7m, equivalent to 8.1p per share or $0.41 per ADS. Leflutrozole is valued at £13.9m or $18.0m, equivalent to 4.1p a share or $0.20 per ADS. We employ a 30% success probability that a deal happens in 2021.

Our valuation is underpinned by modest assumptions, but share price appreciation will be driven by clinical progress and evident success in partnering assets. A few attractively struck commercial deals would result in significant upside potential, with multiple inflection points possible in the next six to 24 months.

Financials

Mereo BioPharma posted a FY19 operating loss of £39.5m (FY18: £34.5m) and net loss of £34.8m (FY18: £32.0m). FY19 R&D costs increased by £0.9m (+4%) to £23.6m (FY18: £22.7m), largely due to higher expenses related to the setrusumab and alvelestat clinical studies and the first period of costs associated with OncoMed-derived programmes, offset by lower expenditure on leflutrozole and acumapimod. G&A in FY19 also rose, to £15.9m (FY18: £11.8m, +35%), reflecting increased spend following the OncoMed acquisition, mainly due to payroll, managing a larger business in two jurisdictions, and maintaining a NASDAQ listing.

Mereo BioPharma ended FY19 with cash resources of £16.3m, vs £27.5m at end-FY18, and had total debt of £20.5m (FY18: £21.5m). We highlight that £5.3m of R&D tax credits relating to FY18 is expected during H120. In addition, the R&D claim for FY19 will be submitted around mid-2020, with receipt of the estimated claim amount of £5.2m in H220.

A £20m credit facility was originally established with Silicon Valley Bank (SVB) and Kreos Capital in 2017, which was fully drawn during FY17. In September 2018, a new secured loan agreement was entered, replacing the prior facility, and increasing the total commitments to £20.5m. In April 2019, the terms were amended, extending the interest-only period to December 2019, with interest and capital then repaid in 15 equal monthly instalments through to March 2021. Under certain conditions the repayment term may be extended by a further 12 months. The interest rate is fixed at an equivalent of 8.5% annually, with an additional amount equivalent to 7.5% of the principal (£1.5m) due on repayment.

A total of 1,248,908 warrants have been granted to SVB/Kreos. In 2017, warrants, exercisable through to August 2027, were issued with the first £10m loan tranche (363,156 with an exercise price of £3.03) and the second £10m loan tranche (333,334 with an exercise price of £3.30). Further warrants exercisable to October 2018 were issued in September 2018 (225,974 with a £2.31 exercise price) in connection with the new loan agreement, and in May 2019 (321,444 with a £2.95 exercise price) following the closure of the OncoMed merger.

In February 2020, Mereo BioPharma strengthened its balance sheet through three transactions totalling $11m. This was followed by a $70m private placement in June. These additional funds, coupled to existing cash and equivalents, and anticipated R&D tax credit receipts should fund Mereo BioPharma’s currently committed clinical trials, operating expenses, and capex into early-2022.

These financing transactions were structured as follows:

• $5m convertible equity financing with Novartis: Novartis provided a $5m (£3.84m) unsecured convertible loan note (CLN) with a three year maturity and annual interest of 6%, which is convertible at any time at a fixed price of 26.5p per share. In addition, Novartis was issued with warrants to purchase up to 1.4m ordinary shares at an exercise price of 26.5p per share, exercisable at any time before February 10, 2025.
• Securities purchase agreement up to $28m with Aspire Capital Fund: An initial $3m tranche for 11.4m ordinary shares, to be exchanged into 2.3m ADS, was priced at an equivalent of $1.31 per ADS. The agreement allows for additional shares to be issued for up to a further $25m at any time and amount of Mereo BioPharma’s choosing over a 30-month period (to August 2022), with the price based on the prevailing ADS price at the time. 2.8m ordinary shares (equivalent to 572k ADS) were also issued to Aspire to cover the $300k commission for this agreement.
• $3m securities purchase agreement with Boxer Capital: Boxer Capital purchased 12.3m ordinary shares, to be exchanged into 2.45m ADS, priced at 18.8p per share.
• $70m June private placement: The private placement, led by OrbiMed, with several new and existing US-based institutional investors generated net proceeds of $64.2m (£51.4m). It was structured with three components that include: (1) $19.4m (£15.5m) from the sale of 89.1m new ordinary shares at a price of 17.4p per share; (2) the sale of $50.6m (£40.5m) of loan notes convertible at a price of 17.4p per share; and (3) the issuance of warrants for 161,047,366 new ordinary shares exercisable at price of 34.8p per share until June 30, 2023.

Following the passing of resolutions at the June 2020 General Meeting, £21.7m of the June 2020 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.

Net proceeds will primarily be used to fund clinical development for lead product candidates, reduction of indebtedness and for general corporate purposes. We note that the Novartis and June 2020 CLNs are unsecured and subordinate to the SVB/Kreos loan.

Exhibit 6: Summary of changes to estimates

Source: Trinity Delta

Following the FY19 results and with $81m of new funds secured, we update our estimates, with key changes summarised in Exhibit 6. We highlight that FY20e revenues consist of the gross $4m upfront received from Oncologie in January on licencing navicixizumab; however, c$0.5m of this has been paid to CVR holders (after deductions of costs, charges, and expenditures). A conditional $2m payment is expected to be received following achievement of a CMC milestone: as the timing is unknown, this is not yet included in our estimates. In addition, our estimates do not include any potential upfront payment that may be associated with a near-term setrusumab deal. Our financial summary is shown in Exhibit 7.

Exhibit 7: Summary of financials

Source: Company, Trinity Delta

[1] Treatment of lung disease in alpha-1 antitrypsin deficiency: a systematic review. Edgar RS et al Int J Chron Obstruct Pulmon Dis. 2017; 12: 1295–1308.

[2] Mechanisms and functions of p38 MAPK signalling. Cuadrado A & Nebreda A Biochem J (2010) 429, 403–417

[3] The costs of hospitalization in patients with acute exacerbation of chronic obstructive pulmonary disease. Sevket Ozkaya et al Clinicoecon Outcomes Res. 2011; 3: 15–18.

[4] Novartis is entitled to tiered royalty payments based on annual worldwide net sales at percentages ranging from the high single digits to low double digits. These are payable for ten years following the first commercial sale in each market. Novartis also receives an undisclosed, but small, percentage of the value of any out-licensing type of agreement. Antibody products (ie BPS-804) will pay low single-digit royalties on a country-by-country basis for the later of patent expiry or ten years from first launch in that country, with a maximum period of 12 years. Additionally, up to $3.25m is payable in development and regulatory milestones for each and any antibody product.

[5] The royalties payable to AstraZeneca are ascending based on tiered world-wide net sales and range from high single-digit to low double-digit. These last for the later of ten years or patent expiry in that particular country. Development, regulatory, and commercial milestones are payable up to a total of $115.5m in aggregate (which may be a combination of cash and/or shares). A small, unspecified, payment is due on any out-licensing deal.

Contact details

1 Cavendish Place,
London,
W1G 0QF,
United Kingdom
Tel: +44 (0) 330 023 7300

www.mereobiopharma.com

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Source: Mereo BioPharma