Investment case

Mereo BioPharma is a clinical-stage biopharmaceutical company with a portfolio of rare and speciality diseases assets; those for smaller indications will be self-commercialised and the others will be out-licensed. It was created 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 a total equity stake of 19.5% of the company with a subscription agreement for additional shares in return for three clinical programmes addressing diverse niche indications. In 2017, a product candidate was licensed-in from AstraZeneca, with the option to acquire following results from a clinical trial.

Mereo BioPharma listed on AIM in June 2016. Over £125m has been raised in equity to date and it has a £20m debt facility. The largest shareholder was Woodford I.M. (41.9%), these shares are now owned by Schroders (8.0%) and temporarily by Link Fund Solutions (19.6%). In December 2018 the company acquired OncoMed Pharmaceuticals for $57.4m by issuing c 23.7m new Mereo BioPharma shares (in the form of ADSs). This brought a NASDAQ listing, US infrastructure, a couple of clinical assets, and around $51m of additional funds.

Valuation

We believe an rNPV model to be the most appropriate way to value Mereo BioPharma. We built a risk-adjusted DCF model of each clinical programme, and netted the sum against the costs of running the business and net cash/debt. Our prior valuation was £541m or $704m, equivalent to 506p/share or $25.59/ADS. We have taken the opportunity to update our model to reflect the changes in the clinical programmes and the financial situation (detailed in the note). The update, based on conservative assumptions, results in the new valuation being £442m or $574m, equivalent to 412p/share or $20.60/ADS (fully diluted).

Financials

Management has contained costs astutely and has been admirably transparent on the amount of R&D expenditure on each clinical programme, how the costs are allocated, and the level of administrative expenses. At June 2019 cash resources were £36.1m, which suggests a runway through to mid-2020. Clearly further funding is required, and management has several options. Five clinical assets have reached 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. Despite these opportunities, we expect additional equity funding will also feature as an option.

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: a rare disease specialist

Mereo BioPharma is approaching a defining point as several programmes are ready for partnering. The outcome(s) will determine the success of the strategy to source and acquire/in-license late clinical stage compounds, typically for rare diseases or specialist indications, and progressing them to value-inflection points. The aim is to retain commercial rights for selected rare disease assets with discrete markets and so build, over time, an integrated and self-sustaining rare disease pharmaceutical business. The cash runway extends to mid-2020; management will likely seek to optimise the funding requirements through a combination of deals and equity financing. While not without risks, we believe the current valuation fails to reflect the strength of the underlying assets. Our valuation is now £442m or $574m, equivalent to 412p/share or $20.60/ADS.

Mereo BioPharma is currently a clinical development company that has built up an interesting portfolio of late-stage compounds through acquisition and in-licensing. No discovery work or preclinical development is undertaken in-house. The focus is on the treatment of rare diseases or specialist indications, with programmes then either partnered or, in selected cases, retained for self-commercialisation. The ideal candidate profile would be a compound that addresses an orphan disease for a respiratory, bone/musculo-skeletal, or endocrine indication. The longer-term aim is to create a specialty company that in-licenses, develops, and then selectively commercialise a suite of products themselves.

The product portfolio is well-diversified and currently consists of six clinical assets, three from the original deal with Novartis, the fourth licensed in from AstraZeneca, and two more from the OncoMed acquisition. All of these programmes had already generated positive clinical data for the target, or a closely related, indications. In-house development has centred on generating supportive clinical data that will increase a programme’s partnering potential. Several of the programmes have reached an attractive partnering point and negotiations are thought to be underway for certain, unspecified, assets. The proceeds from the partnering efforts will be used to support the development of the rare disease products, including sourcing additional programmes.

Mereo BioPharma has been hampered by its previous shareholder structure. What was once seen as a supportive cornerstone investor, notably Woodford’s original 41.9% stake, turned out in fact to be a major concern as the well-publicised, yet not company specific, issues unfolded. Although Woodford no longer owns those shares, the damage to the share price was done and investor confidence dented. The result has been a valuation that, in our view, fails to reflect the inherent value of the portfolio. With the cash runway extending to mid-2020, further funding is clearly required. We expect this to arise from a combination of additional equity funding and partnering transactions for one or more of the clinical assets.

Strong news flow is expected from Mereo BioPharma in the foreseeable future, with the first item being the outcome of the meeting with the FDA in early 2020 to discuss the further development of setrusumab in osteogenesis imperfecta (OI). Positive outcomes should result in the better recognition of the company’s worth.

Healthy portfolio in need of appreciation

Mereo BioPharma was created to exploit the opportunities to source late-stage clinical assets that regularly present themselves; and has since refined its focus to products with potential in rare diseases that can be self-commercialised. These typically arise as discrete development programmes within an originator company are de-emphasised. The reason could be product related, for instance a failure to demonstrate the desired clinical profile in a commercially large and competitive therapeutic area, or it could merely be a change in research priorities as management (often new) refines its visions, goals, and objectives.

Typically, such clinical assets have had significant effort expended and investment made, resulting in extensive supporting data packages and robust intellectual property; yet they now languish aimlessly within the originator’s development pipeline. Mereo BioPharma screens for appropriate programmes that fit its criteria and actively explores potential re-purposing of the compound, particularly if an orphan or rare indication is clinically feasible.

Exhibit 1: Mereo BioPharma’s approach in a nutshell

Source: Mereo BioPharma, Trinity Delta

The five stages of this approach are summarised in Exhibit 1. In all cases, Mereo BioPharma only selects products with a straightforward clinical trial pathway, with the proof-of-concept and pivotal trials being achievable with small, and relatively inexpensive, studies. The specialty products currently in its portfolio, which address larger markets, will be partnered for pivotal Phase III development and/or marketing, and the proceeds used to support the development of a broader portfolio of rare disease assets.

The maiden deal was struck with Novartis in 2015 and covers three clinical assets that had fallen victim as Novartis reviewed its strategic direction. The programmes are: setrusumab (BPS-804), in Phase IIb for osteogenesis imperfecta; leflutrozole (BGS-649), is Phase III ready for hypogonadism in obese men; and acumapimod (BCT-197), which has completed Phase II to reduce acute exacerbations in COPD. In 2017 alvelestat (MPH-966) was licenced-in from AstraZeneca; it is in Phase II for countering the damage caused by excess neutrophil elastase in α₁-antitrypsin deficiency.

In April 2019 Mereo BioPharma completed a combination with OncoMed Pharmaceuticals (effectively an acquisition) for a number of strategic corporate reasons. This brought two oncology programmes: navicixizumab, an anti-DLL4/VEGF bispecific antibody; and etigilimab, an anti-TIGIT monoclonal antibody. The aim is to out-license these compounds.

A diversified portfolio of clinical programmes

Mereo BioPharma’s current portfolio consists of six clinical assets, three from the original deal with Novartis, the fourth licensed in from AstraZeneca, and two more from the OncoMed deal (Exhibit 2). 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 for the target indication or for a related indication. Further risk mitigation is 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 2: Mereo BioPharma pipeline summary

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

All the product candidates acquired have already received sizeable investment from their originator companies, and have substantial existing preclinical, clinical, and manufacturing data packages. Aside from the risk reduction aspects mentioned, the ready availability and quality of this data helps with the regulatory processes and any partnering or out-licensing activities. There is also a solid intellectual property estate attached to each product, with additional defences added as appropriate (for instance Orphan Drug status). Mereo BioPharma has the global commercial rights to all the product candidates.

In the future, Mereo BioPharma aims to license-in product candidates for development in rare diseases, which it can self-commercialise. It will also focus its attention in the fields of musculo-skeletal, endocrine and respiratory indications, in which it has developed expertise and physician/KOL networks.

Setrusumab: Targeting brittle bone disease

Setrusumab, also known as BPS-804, is a fully humanised monoclonal antibody targeting sclerostin (SOST). Sclerostin is a protein secreted by the osteocyte cell (which is the cornerstone cell of bone structure) and that plays a pivotal role in bone homeostasis. The appeal of sclerostin inhibition lies in how it could not simply improve bone mass through reducing bone resorption (antiresorptive) but, importantly, through the activation of bone formation (osteoanabolic). This led to the inhibition of sclerostin being explored as a novel therapeutic target^[1] for a variety of bone disorders, including large commercial indications such as osteoporosis and rare diseases like osteogenesis imperfecta (OI).

A promising data package was transferred across

Mereo BioPharma acquired setrusumab as part of the original portfolio of three programmes from Novartis in 2015. It came with an extensive data package, including four Phase I and II clinical trials in OI, HPP (hypophosphatasia) and osteoporosis. A 44-patient Phase II study in post-menopausal women with low bone mineral density (BMD) was successfully completed in 2013 and showed improvements in bone mineral density, coupled with a clean safety profile. An encouraging 14-patient Phase II study examined the safety profile of setrusumab in adults with osteogenesis imperfecta, with improvements in BMD. A 9-patient Phase II study examined escalating doses in adults with HPP with positive results.

Mereo BioPharma is focussed on developing setrusumab for OI, which is better known as brittle bone disease, an orphan disease with different genotypes characterized by varying degrees of skeletal fragility. Most types (usually classified into eight categories) are caused by disruption or mutations of 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 bone fractures that happen with only minimal to moderate trauma. Type I is the least severe form of the disease and 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. Breaks can occur in any bone, but breakage of the lower limbs (often the femur) is the most common. In general, the earlier the fractures occur in life, the more severe the disease is.

Largest clinical programme conducted in OI

In May 2017 Mereo BioPharma initiated a c 112 adult OI patient, double-blind, placebo controlled Phase IIb clinical trial (ASTEROID) in the US, Europe and Canada. The patients are 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. Recruitment, despite the complex logistics (eg standardising transport for such delicate patients) to 27 specialist sites, completed on track, in October 2018. There three double-blinded, active arms, evaluated differing intravenous doses (low, mid, and high), and one open-label arm at the top dose, which was initially the placebo arm before the study was amended in August 2018 to assist recruitment into the study.

A novel primary endpoint, measured at 12 months, was selected (after specialist advice). 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 end-points 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 ASTEROID study results were announced in November 2019 and the data showed that the primary endpoint was missed yet the outcomes for the secondary endpoints were highly positive.

HRpQCT was selected as the primary endpoint, although it is a novel method of measuring BMD, as it was thought to be more predictive of fracture risk. However, there was exceptional heterogeneity in the Tb vBMD data and some OI patients had higher baseline vBMD than was recorded in normal individuals in the Kocijan study. This heterogeneity resulted in modest mean changes in Tb vBMD with very high standard deviations. In contrast, there were significant increases in Total vBMD at the radius using HRpQCT and in areal BMD (aBMD) measured using the widely-used DXA (dual-energy X-ray absorptiometry) at the lumbar spine, femoral neck and total hip with the medium and high doses of setrusumab (Exhibit 3).

Exhibit 3: Changes in total vBMD in the radius and aBMD at the lumbar spine, femoral head and total hip at 12 months

Source: Mereo BioPharma

The changes observed with the high dose of setrusumab compare very favourably with those seen in trials in adults with both teriparatide and bisphosphonates (Exhibit 4). Caution is needed with all meta-analyses, but it is reassuring that the analysis consistently suggests that setrusumab is better than teriparatide and bisphosphonates, regardless of OI subtype. Also, the benefit observed is similar to that seen with the anti-sclerostin antibody romosozumab in osteoporosis.

ASTEROID also showed that setrusumab was safe and well tolerated, with few serious adverse events (AE) seen across the three treatment arms and none that were classed as treatment related. A total of nine events were investigated as potentially being cardiac related, but none were deemed to represent a cardiovascular safety concern.

Exhibit 4: Comparison between the increases in areal BMD observed in the ASTEROID Phase IIb with high dose setrusumab with those seen with teriparatide and bisphosphonates at 12 months, measured using DXA

Source: Mereo BioPharma, Trinity Delta

A pivotal Phase IIb/III trial to support paediatric approval in Europe has been agreed and, pending suitable financing being in place, is expected to start in 2020. This European and Canadian study will treat c 160 children aged 5 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.

If the data from this paediatric trial is 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 and Canada using data from the ASTEROID study and the proposed Phase IIb/III trial, with the requirement for a Phase IV study to confirm the efficacy and safety profile.

The requirements for US approval are not yet known. However, management intends to have discussions with the FDA in early 2020, and we expect the FDA will require a similar trial design to that agreed with the EMA. So, it should be possible essentially to use the same study for the approval of setrusumab in both Europe and the US by adding US sites to the existing trial design, together inevitably with a few additional modifications.

Rare and debilitating disease with few treatment options

Osteogenesis imperfecta (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 striving to strengthen bones and the supporting 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, such as alendronate and risedronate, to ameliorate bone mass. These have been shown to ameliorate bone mass; however, as the 2016 Cochrane review concluded from a meta-analysis of 14 trials, it is not clear that they reduce fracture rates. Denosumab (Amgen’s Prolia, RANK-L antibody) and teriparatide (Lilly’s Forteo, PTH analogue) have also been investigated, but both have severe limitations. Other treatments used in osteoporosis have been evaluated clinically, but with limited reported results.

It is estimated that OI affects between 20,000 and 50,000 people in the US and between 32,000 and 51,000 people in the EU. The overall prevalence for all types of OI is estimated at between 5 to 7 per 100,000 individuals in the US and between 7 to 11 per 100,000 in Europe.

OI is seen in both genders and all races. It ranges from severe (Type II) to mild (Type I); individuals with the most severe type may die at birth, whilst those with the mildest form may achieve a normal stature and life span. Types I and IV are the most common forms and are typically less severe; these tend to affect 4 to 5 per 100,000 people in the US and Europe. The majority have a degree of physical impairment such as bowed arms and legs, short stature, curvature of the spine (scoliosis), and may be unable to walk unaided.

The commercial potential reflects the clinical need

In 2016 setrusumab was granted Orphan Drug designation for OI in both the US (March) and Europe (June). Such designations offer a number of valuable benefits, such as assistance with filings and reduced fees, but the main incentive is a period of market exclusivity – 7 years in the US and 10 years in Europe. Setrusumab was accepted into the EMA’s adaptive pathways programme in February 2017 and admitted to the PRIME scheme in November 2017; these reflect the desire to expedite approvals for novel drugs that address clear and pressing clinical needs.

Setrusumab could achieve rapid commercial success

In our modelling we have assumed that an approval submission could be made to the EMA in early 2023, based on the results generated by pivotal Phase IIb/III European and Canadian trial, with possible approval in late-2023 and the first sales in 2024. We presume US approval around a similar time, with the Phase IIb/III study expanded to include US centres. The actual route to market in the US will become clearer once there is greater visibility on the FDA’s views.

In terms of marketing assumptions, we forecast peak sales of $735m (£566m) with only modest penetration of the adult market. We estimate that setrusumab will be used to treat c 50% of the children with OI in the US and c 40% in Europe, but only c 20% of adults in both markets. This is because the clinical need for treatment is greater for children. We also estimate that the cost of treatment will be $90,000 per annum in the US and $60,000 in Europe; in line with our policy, this is conservative pricing for an orphan drug. The final pricing will depend on the clinical benefit observed in the clinical trials, but we note that Kyowa Kirin / Ultragenyx’s Crysvita (burosumab-twza), approved for the rare bone disease X-linked hypophosphatemia has been priced at $160,000 per annum in children and $200,000 per annum in adults, i.e. approximately double our pricing assumption.

Alvelestat: Addressing a respiratory rare disease

Alvelestat, previously AZD-9668 and also known as MPH-966, is an oral small molecule that selectively and reversibly inhibits neutrophil elastase (NE). Mereo BioPharma is exploring alvelestat for the treatment of severe AATD (α₁-anti-trypsin deficiency), a rare and potentially life-threatening genetic condition. A Phase II proof of concept study was initiated in November 2018, with top line results expected in mid-2020. If developed successfully, alvelestat would be one of the rare disease compounds that Mereo BioPharma would commercialise itself.

AATD is relatively common but under-diagnosed

NE is an aggressive and cytotoxic protease enzyme that is associated with the destruction of lung tissue. It has long been known to be implicated in the signs, symptoms, and disease progression in 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. AstraZeneca initially developed alvelestat for the treatment of COPD, cystic fibrosis (CF) and bronchiectasis, where these NE pathways are known to be disrupted.

Alvelestat’s mechanism of action appears particularly well suited to negating the impacts of α₁-antitrypsin deficiency (AATD). 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 current therapy options limited to symptomatic treatments, such as inhaled steroids and bronchodilators, and prompt antibiotic treatment of chest infections.

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. Screening studies suggest one in every 1,700 to 5,000 people has an AATD genetic disposition (equivalent to a population of 145,000 to 425,000 in Europe); however, the number with severe AATD is estimated at around 60,000 in Europe and 50,000 in the US.

The appeal is in countering NE over-activity in AATD

Mereo BioPharma is developing alvelestat for the treatment of severe AATD, where the inhibition of NE has the potential to protect AATD patients from further lung damage. Mereo BioPharma initiated a proof-of-concept Phase II study, dosing the first patient in November 2018, although it took longer than hoped to initiate certain trial centres. The study examines around 165 severe AATD patients with the PiZZ or NULL genetic mutations.

The trial lasts 12 weeks and consist of three arms (placebo and two alvelestat doses); examining elastin breakdown and biomarkers of NE inhibition. Desmosine, a breakdown product of elastin that can be reliably and reproducibly measured 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. Study results, expected mid-2020, will guide the design of the pivotal Phase III trial.

The alvelestat programme is also supported by a collaboration with The Alpha-1 Project (TAP), the venture philanthropy arm of the Alpha-1 Foundation. Subject to meeting agreed development milestones (the first being the dosing of the first patient in Phase II last November), Mereo BioPharma will receive investment from TAP; and subject to these investments being made, Mereo BioPharma has also agreed to issue warrants to TAP on future unspecified dates.

Additionally, Mereo BioPharma is supporting a number of investigator-led studies evaluating alvelestat in treating AATD. An example is the team at University of Alabama (Birmingham, USA) which has been awarded a NCATS (National Center for Advancing Translational Sciences) grant, expected to total $10m, to study the efficacy and safety of alvelestat in treating patients with AATD. The study aims to enrol c 66 patients and should post top line data in H221. Mereo BioPharma provides clinical trial material and regulatory support for the study. Another investigator-led study is exploring alvelestat in bronchiolitis obliterans syndrome (BOS), a progressive loss of pulmonary function following lung transplantation.

The licensing/acquisition deal is structured to limit risks

The deal with AstraZeneca is structured as a licensing agreement with an option for the outright acquisition of alvelestat. This allows Mereo BioPharma to complete the initial proof-concept Phase II study using existing financial resources, and only if the outcome is positive would it be acquired at the already agreed price. The initial licence fee cost was $5m, of which $3m was paid in cash and the balance through the issuance of 490,798 new ordinary shares.

Assuming all the development and regulatory milestones are achieved in a timely manner, the maximum payment to AstraZeneca would be $115.5m, payable through a combination of cash and new shares issued. No further details on the timings of the potential payments have been disclosed, but we believe that a material payment will have to be paid to AstraZeneca in FY21, if Mereo BioPharma decides to take MPH-966 into Phase III development.

Unspecified payments would also arise on reaching undisclosed commercial milestones. Royalties, ranging from high-single digit to low-double digit, would also be payable on a country by country basis for 10 years after launch or until patent expiry (whichever happens first). If alvelestat were to be sub-licensed to a third party then a specified, but also undisclosed, percentage of the value would be payable to AstraZeneca.

Alvelestat is a clear candidate for self-commercialisation

The nature of the AATD market means that alvelestat is well suited to being commercialised through a small, targeted sales team. Management intends to establish a marketing infrastructure in the US and Europe addressing the rare disease therapeutic segments. We have assumed that a pivotal Phase III trial could start in 2021, with results in 2023 and a typical 12-month approval process, could lead to first marketing in 2024. We have modelled peak annual sales at $420m (£323m), and a modest adoption profile.

Leflutrozole: Holistic testosterone deficiency therapy

Leflutrozole, also known as BGS-649, is an aromatase inhibitor being developed as a once-weekly oral treatment for hypogonadotropic hypogonadism (HH) in obese men. 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. Novartis has a strong background in this area, having developed the blockbuster Femara (letrozole, now generic), and explored the follow-on compound, leflutrozole, in a variety of indications. Novartis’s review of its future therapeutic focus resulted in this programme, among several others, being de-emphasised.

Aromatase inhibition to normalise testosterone levels

The hypothalamic-pituitary-testicular axis (HPT) is a complex and essential endocrine pathway that plays a critical role in the regulation and activation of many bodily functions, notably the reproductive and immune systems. Within this, oestradiol has an important effect on the regulation of testosterone biosynthesis and spermatogenesis. Among a number of physiological actions, the enzyme aromatase converts testosterone to oestradiol. This, in turn, inhibits gonadotropin secretion and exerts a lowering effect on intratesticular testosterone production.

Inhibiting aromatase activity reduces the conversion of testosterone to oestradiol, so increasing testosterone levels endogenously. In addition, aromatase inhibitors block the inhibitory feedback of testosterone on the HPT axis and also improve, rather than reduce, the levels of the hormones LH (luteinizing hormone) and FSH (follicle stimulating hormone). Leflutrozole is a highly selective non-steroidal reversible inhibitor and the attraction of the approach is that the re-balancing is achieved without an increase in circulating oestrogens. Obese male patients suffering from infertility would seem ideal targets for aromatase inhibitor therapy as many of them have decreased testosterone-to-oestradiol ratio.

Encouraging safety and efficacy data from early trials

Novartis carried out a total of eight clinical trials, which showed lefrutrozole had a clean safety profile and encouraging signs of efficacy. A Phase IIb study was performed in the US and Europe and saw a total of 271 patients allocated into a four-arm (low-, intermediate-, high-dose, and placebo) double-blind protocol over 24 weeks with a 12-week follow-up.

Top-line results were published in March 2018. The primary endpoint of normalising testosterone levels in over 75% of patients was met at all dose levels, with the secondary endpoint of achieving this normalisation in over 90% of patients met at the two higher levels (the lower dose was trending towards but failed to achieve statistical significance). All three doses also met the other secondary endpoints, including significant improvement in FSH and LH levels. Total sperm motility and levels of fatigue also improved. There was no overshoot in testosterone levels at any dose; confirming that the normal feedback mechanisms remained undisturbed.

A six-month extension study, involving 143 men, presented results in December 2018. This aimed to provide additional safety and efficacy data and showed a clean safety profile with no unexplained side-effects. Neither primary nor secondary safety endpoints were breached (including no significant reduction in BMD at the pre-determined level of 3% on lumbar spine BMD), with this data corroborating the result from the original trial. Importantly, all three doses achieved both primary and secondary efficacy endpoints (normalisation of total testosterone levels in 75% and 90% of patients respectively). Similarly, all three doses achieved all other secondary endpoints. These positive outcomes formed the basis of an advisory board meeting and it was concluded that future product development should focus on male fertility.

Leflutrozole is not a programme that Mereo BioPharma would commercialise itself. The question now is whether it undertakes the first pivotal Phase III trial and then seeks a partner, or whether the partner is brought in earlier and shares in the last stages of development too.

For our modelling we have assumed that leflutrozole would start the Phase III registration studies in 2021, regulatory submission in 2024, with a probable first approval, and launch, in 2025. The commercial potential would depend largely on how a partner would position leflutrozole, with its fertility profile potentially helping it to be differentiated in what is a fragmented and competitive market. Thus, we have forecast relatively modest peak sales of $483m (£372m).

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. Early development p38 MAPK programmes failed due to poor efficacy and unacceptable side-effects; but a greater understanding of the complexities, and subtleties, of the p38 MAPK signalling mechanisms has allowed better targeting and more specific compounds to be developed. The challenge has been to inhibit the desired cytokines in the inflammatory cascade sufficiently to exhibit the necessary activity, but with the appropriate selectivity so as not to cause unwanted off-target effects.

Acumapimod being studied in Phase II trial

The rationale for p38 MAPK inhibition in reducing acute exacerbations in COPD is well understood, with eight compounds^[3] having been evaluated clinically; its utility has been explored in sizeable programmes by AstraZeneca (AZD-7624), GlaxoSmithKline (GSK-610677), Pfizer (PF-03715455), and Janssen (RV-568). The approaches were encouraging; however, most of the programmes have been discontinued or have stalled for a variety of reasons. Novartis undertook a comprehensive early clinical evaluation, with acumapimod the subject of three Phase I and two Phase II studies, involving a total of 498 treated patients, that showed a clean side-effect profile and promising anti-inflammatory activity. Dose-dependent improvements in markers for AECOPD were seen, as was a reduction in hospital stay, but statistical significance was not reached.

Positive outcomes from Phase II trial

The results and experience were used to design a larger Phase IIb study (AETHER) that Mereo BioPharma undertook. This involved 282 patients with two different dosing regimens (high and low dose) of three doses over five days versus placebo, on top of standard of care (including steroids, antibiotics, and bronchodilators). Patients were then followed for 26 weeks. The primary endpoint was FEV1 (forced expiratory volume in one second), with several additional endpoints including hospital stay times, patient reported outcomes, recurrence rates of AECOPD and hospitalisations. It should be noted that these patients tend to already be on maximal bronchodilator therapy.

The results were reported in May 2018. The data showed a statistically significant improvement in FEV1 for both the low and high dose groups from baseline (p=0.012), although the difference over placebo was not significant. There was also a significant reduction of more than 50% in clinical treatment failures (as defined by the number of re-hospitalisations for treatment of COPD) at days 90 through 150 in patients treated with the high dose of acumapimod compared to the low dose or placebo (p≤0.027 to 0.05). Interestingly, the greatest impact with both low and high doses was seen in the severe exacerbation group (more than two exacerbations per annum), suggesting that the patient group with the greatest clinical need may benefit the most from acumapimod treatment.

A potent anti-inflammatory effect was evident, with sustained reductions (through to 180 days) in inflammatory markers, fibrinogen and hsCRP (high-sensitivity C-reactive protein), seen in a dose-dependent manner. A significant reduction in the use of antibiotics and corticosteroids was seen in the follow-up phase of the study. There are currently two theories to explain acumapimod’s prolonged effect after such a short administration: the first is that it causes sensitisation to steroids; and the second is that a re-balancing of the neutrophil to lymphocyte ratio occurs.

Although the primary endpoint was FEV1, the more important data from a clinical and economic perspective is the statistically significant reduction of more than 50% in the endpoint of re-hospitalizations at days 90 through 150 in the high dose group. Interestingly, this effect was more pronounced in patients with more than two exacerbations per year. Each exacerbation that a COPD patient suffers is generally associated with a long-term deterioration in their lung function and prognosis. Additionally, there is a clear material economic cost linked with hospitalising a patient.

Mereo BioPharma has engaged with the FDA and has obtained clarity on the format and structure of the Phase III studies that would be required for approval. We believe the equivalent conversations with the European regulator (EMA) are similarly encouraging. Management has indicated that partnering discussions are underway but has not given detailed guidance as to progress. The nature of the COPD market, notably the size and duration of the clinical programme required for approvals in the US and Europe coupled with the marketing resources required for successful commercialisation, means selecting the right partner is important.

Product positioning will determine commercial success

For our financial estimates, we have assumed that the remaining clinical programme for acumapimod would be undertaken by a commercial partner. We have not factored any upfront element of the likely licensing deal, except in our valuation, in which we conservatively estimate the upfront payment will be $10m (£7.7m); we have forecast royalties of 10% of sales, net of the royalties due to Novartis, over the period of marketing exclusivity. The total milestone payments are estimated at c$100m (£77.0m).

The first marketing approval would depend on the nature and duration of the pivotal trial programme selected by the partner, but we have, cautiously, assumed the first launch would happen in 2025. Maintaining a cautious stance, we have forecast peak sales of $768m (£591m).

Navicixizumab: bi-specific oncology antibody

Navicixizumab, also known as OMP-305B83, is one of the two clinical assets from the OncoMed deal. It is an anti-DLL4/VEGF bispecific monoclonal antibody that targets and inhibits both Delta-like ligand 4 (DLL4) in the Notch stem cell signalling pathway and vascular endothelial growth factor (VEGF). Navicixizumab offers the potential of anti-angiogenic, anti-cancer stem cell, and immune-modulatory activity, with a Phase 1a clinical trial showing encouraging activity and manageable toxicities.

A Phase Ib study in combination with paclitaxel in heavily pre-treated patients with platinum-resistant ovarian cancer is underway. These patients had received a median of four previous therapies; all of whom had received prior paclitaxel and 69% had received prior bevacizumab. Interim results showed 22 of the 26 patients (85%) treated with the navicixizumab regimen experienced clinical benefit, with 11 (42%) achieving a partial response, and the median progression-free survival was 5.4 months (95% Cl: 3.5–8 months).

A meeting with the FDA in July 2019 resulted in agreement for the design of a Phase II trial to potentially support the accelerated approval of navicixizumab in patients with ovarian cancer (including peritoneal or fallopian tube cancer) who have become resistant to prior therapies. Subsequently, the FDA granted Fast Track Designation to navicixizumab in October, which should facilitate the regulatory pathway for the product. Management is exploring partnering or out-licensing options for this programme.

Etigilimab: Holistic testosterone deficiency therapy

Etigilimab, also known as OMP-313M32, is an antibody that targets the TIGIT (T-cell immunoreceptor with immunoglobulin and ITIM) domains. TIGIT is an inhibitory receptor that is thought to stop T-cells from attacking tumour cells in a similar manner to the PD-1 inhibitory protein. Etigilimab is intended to activate the immune system through multiple mechanisms and enable anti-tumour activity to become effective for advanced solid tumours.

Preclinical models showed potent anti-tumour effects. A Phase Ia open label dose escalation study in locally advanced and metastatic solid tumours treating 18 patients, with doses up to 20mg/kg every two weeks, was completed successfully. Tumour types included colorectal cancer (six), endometrial cancer (two), pancreatic cancer (one) and eight other tumour types. No dose limiting toxicities were observed and the recommended Phase II dose was the top dose of 20mg/kg biweekly. A related Phase Ib dose escalation study in selected tumour types in combination with nivolumab has also been completed successfully.

Management is also exploring a number of partnering or out-licensing options for this programme.

Sensitivities

In common with most innovative healthcare companies the three main sensitivities relate to the clinical and regulatory aspects, the execution of the 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 four clinical programmes:

• Setrusumab showed compelling results across most parameters in the ASTEROID study, despite failing to reach significance in the primary endpoint. A similarly pivotal paediatric Phase IIb/III study in Europe and Canada is planned, and subject to financing, should initiate in 2020. Mereo BioPharma is seeking to extend this study into the US. 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 MPH-966’s activity. Additionally, we believe a material milestone is due to AstraZeneca upon entry into Phase III.
• Leflutrozole has produced promising results in both the Phase IIb study in HH, and the follow-on 6-month safety study. The next stage will be to refine its positioning in treating male fertility as management seeks a commercialisation and/or development partner. The potential market for BGS-649 is material, given the level of obesity in many countries. However, it is a challenging and competitive market and finding suitable partners may not be straightforward.
• Acumapimod has impressive data in AECOPD, however, in our view, there is still a risk that Mereo BioPharma may not be able to find a partner. Over the past decade the p38 MAPK inhibitors have been one of the most heralded classes of therapies for treating inflammation. So far there has been limited success, albeit in chronic and not acute settings; for instance, in Q316 AstraZeneca stopped development of its p38 programmes (AZD-7624) in COPD and related inflammatory conditions.

Further out, the sensitivities centre on the execution of the commercial strategy for programmes that will be marketed directly. Whilst this is an eminently 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. To date only three deals, that have brought in six programmes, have been closed. 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 four clinical programmes, with no value currently assigned to the OncoMed assets, which are 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 carries. These are summed and netted against the costs of running the operation and net cash. 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.

As always, we seek to 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 £541m or $704m, equivalent to 506p/share or $25.59/ADS on a fully diluted basis. We have updated our model (Exhibit 5) to reflect a number of assumptions and the new valuation is £442m or $574m, equivalent to 412p/share or $20.60/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 50% and 40%, respectively.

Looking at the elements of our prior valuation in greater detail, notably the changes that underpin our updated valuation:

Setrusumab remains the largest component of the valuation; amounting to £389m or $299m, equivalent to 305p per share or $15.26/ADS, from our prior £331m or $431m. We have assumed first material sales will occur in 2024 (previously 2023, updated to reflect the likely timing of the Phase III studies), with peak sales of $735m (£566m) occurring some 6 years later with an operating margin of 60%. We employed a 50.0% probability that it will successfully complete its clinical trials and reach the market. We view setrusumab as being well suited to self-commercialisation by Mereo BioPharma, so have factored in appropriate costs for marketing, offset obviously by a greater retention of the revenues. 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 was valued at £63m, or $82m. There has been slower than expected patient recruitment in the Phase II trial, but we still estimate that the first market launch will be in 2024, with peak sales of $420m, an operating margin of 65% being achieved, and a clinical success probability of 25.0%. We have valued alvelestat as a product well suited to self-commercialisation, hence we use similar financial assumptions to setrusumab, with a royalty equivalent rate of c10% of revenues payable to AstraZeneca^[5]. We had a higher gross margin assumption with alvelestat, compared to setrusumab, because it is a small molecule and not a monoclonal antibody. The increase in valuation of the asset is because of the impact of rolling the model forward a year with changes to discount rates. The new valuation is £80m or $105m, equivalent to 82p a share or $4.11 per ADS.

Acumapimod has significant uncertainty within our model as the drug class is currently out of favour. The sales potential is large, and the economic benefit is clear, yet we lower the success probability of a suitable deal taking place to 50% (previously 70%) in 2020, which sees the valuation drop from £93m or $122m to £52m or $68m, equivalent to 53p per share or $2.65 per ADS. The assumptions that Novartis receives 20% of any upfront or milestone payments and Mereo BioPharma achieves net royalties of 10% (after royalties payable to Novartis) remain unchanged. We estimate that Mereo BioPharma receives a $10m upfront, a $30m milestone payment on filing and $50m on approval.

Leflutrozole was valued at £22m or $28m with the new valuation £17m or $22m, equivalent to 17p a share or $0.87 per ADS. The main change reflects the risks associated with timely partnering of the asset; we now assign a success probability of 40% (previously 50%) that this happens in 2021. We estimate that Mereo BioPharma will receive a $10m upfront, a $15m milestone payment on filing and $30m on approval, and thereafter net royalties of 10% (after royalty payments to Novartis).

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 6 to 24 months.

Financials

At H119 (June 2019) cash resources were £36.1m, which compared to H118 £36.9m and FY18 £27.5m. The figure was boosted by the $50.4m of cash that came with the acquisition of OncoMed, which was completed in April 2019. Total debt at H119 was £19.7m, against H118 £20.9m and FY18 £21.5m. Following the adoption of IFRS 16 (leases) in January 2019, there was a maiden lease liability of £13.1m at H119.

During the period, R&D expenditure rose by £1.0m to £11.9m, from £10.9m at H118, as a result of the planned expenditure on clinical studies, primarily for setrusumab and alvelestat. Administrative expenses fell by £0.6m to £8.5m, from £7.1m at H118, but these include a number of one-offs and non-cash items. Excluding these, the underlying administrative expenses were up £1.1m to £4.9m, from £3.8m at H118, of which the newly acquired OncoMed accounted for £1.3m. The operating loss at H119 was £18.4, against £18.0m at H118 and £35.2m at FY18. The equivalent net loss at H119 was £16.2m, against £17.0m at H118 and £32.0m at FY18.

In FY17 a credit facility of £20m with Silicon Valley Bank and Kreos Capital was established, with a £10m tranche drawn down in August 2017 and a second £10m tranche in December 2017. In April 2019 this was amended and the interest only period extended to December 2019, with interest and capital then being 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 9.0% annually, with an additional amount equivalent to 7.5% of the principal (£1.5m) due on repayment. Warrants, exercisable through to August 2027, are attached to the loan; 363,156 are with the first loan tranche with an exercise price of £3.03, and 333,334 are with the second loan tranche with an exercise price of £3.30. The total of 696,490 warrants is equivalent to 0.98% of the existing issued share capital.

In June 2019 the balance of the Novartis Loan Notes, together with accumulated interest plus the balance of bonus shares due under the Loan Note agreement were converted into ordinary shares in Mereo BioPharma.

Looking at the planned expenditures, Mereo BioPharma has cash resources sufficient to end-H120. Further funding is expected to arise from a combination of additional equity funding and partnering transactions for one or more of the clinical assets. Management is believed to be in discussions with a range of potential partners for a number of these assets.

There are no changes to our estimates.

Exhibit 6: Summary of financials

Source: Company, Trinity Delta; Notes: Our estimates exclude the costs associated with the pivotal Phase III paediatric study with BPS-804, because the timing of the trial is yet to be decided. We include in FY20 long-term debt (other financing cash flow) of £25m, which is indicative of our estimate of the company’s capital requirement; this could be achieved through an equity raise, debt of proceeds from partnering non-rare disease assets.

[1] Role of sclerostin in bone and cartilage and its potential as a therapeutic target in bone diseases. Lewiecki EM Ther Adv Musculoskelet Dis. 2014 Apr; 6(2): 48–57.

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

[3] Investigational p38 inhibitors for the treatment of chronic obstructive pulmonary disease. Norman Peter Expert Opin Investig Drugs 2015 Mar; Vol 24(3):383-92

[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.

Company information

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