Does Achillion Have a Place in the HCV Market of the Future?

The biotechnology sector is one where growth is, for the most part, fueled by a single factor: new drugs. Companies that develop the next generation of drugs for a market stand to gain billions over the life cycle of that drug. And no health market embodies that more than the hepatitis C (HCV) market. Multiple companies, including Gilead Sciences (NASDAQ:GILD), Vertex Pharmaceuticals (NASDAQ:VRTX), and Abbot Labs (NYSE:ABT) are vying to gain a piece of a market estimated to be worth up to $20 billion. However, there is one company that investors seem to have forgotten: Achillion Pharmaceuticals (NASDAQ:ACHN), and it is one that I feel cannot be overlooked.

Achillion rallied sharply in 2011 and early 2012 as merger mania gripped the HCV sector. With Pharmasset bought out for an 84% premium by Gilead, and Inhibitex bought for $2.5 billion by Bristol-Myers (NYSE:BMY), investors assumed that Achillion and Idenix Pharmaceuticals (NASDAQ:IDIX) were next. But so far, no deal has materialized, and that has pressured the stock prices of these two companies. But what has pressured Achillion more is the perceived weakness of its competitive position. Achillion’s protease inhibitors, led by lead candidate ACH-1625 (now known as sovaprevir), are seen as being inferior to the nucleotide’s under development across the sector, led by Gilead’s GS-7977. Most drug companies with HCV compounds under development presented their latest data at the American Association for the Study of Liver Disease’s annual meeting in Boston (from November 9-13), and although Achillion sold of sharply as the conference progressed, falling from around $9 to under $8, I believe that this should to be seen as a buying opportunity.

Protease Inhibitors: Not as Weak as They Seem

The largest contributing factor to Achillion’s slide was data from Abbot Labs’ AVIATOR trial, which was a Phase IIb trial of a combination of three of its HCV compounds. However, these were not NS5A nucleotides. Rather, Abbot’s drugs were protease inhibitors, which are generally seen as being weaker. How can this be? The answer lies in the complexity of the science behind this new generation of HCV treatments. As Bristol-Myers (which released its own non nucleotide HCV data at the conference) noted, “The nuc [nucleotide] may not be as sacrosanct as we thought it may have been…It was a big ’a-ha!’ moment with our internal triple combination.” And as Achillion’s own chief scientific officer stated at the conference, “A few years ago, no one thought you could develop a regimen without interferon.” The science of HCV treatment is rapidly evolving, and investors should not discount Achillion so quickly.  Wells Fargo, in its latest note on Achillion, said that the market is likely misinterpreting this latest round of clinical results. The firm believes that Abbot’s data, rather than weakening Achillion’s competitive position, instead affirms it. Abbot’s data demonstrates that a treatment that combines protease inhibitors with nucleotides can produce high cure and sustained virologic response rates. And a combination of Achillion’s two leading HCV candidates, ACH-1625 and ACH-3102, could produce cure rates as good, or even better than what Abbot has posted. Furthermore, ACH-3102 has, in genotype 1a patients, higher resistance to mutation than other nucleotides, which could give Achillion an advantage relative to its peers.

Achillion is also working on ACH-2684, a second-generation protease inhibitor whose unique pharmacological profile gives it some distinct advantages in the HCV space. Phase Ib studies have shown that ACH-2684 does not require active uptake into the liver, and has shown to be well tolerated by patients with minimal safety effects. As Wells Fargo notes, “the market is not fully recognizing the reward/risk of Achillion's all-oral HCV portfolio.” I agree with their assessment. While biotechnology is certainly a risky sector, every investor who chooses to invest in the sector is hopefully aware of the increased risks (and increase in reward) that come from investing in this sector. Achillion, however, has been sold off excessively as the market is ignoring the company’s potential in the HCV market. Will Achillion be the market leader when the FDA approves the next generation of HCV drugs? It is highly unlikely, but with a market capitalization of under $600 million (compared to over $55 billion for Gilead), Achillion does not need to make the same amount of “waves” in the market to be successful and deliver profits to investors. The company’s clinical data is not as weak as the market believes, and I fully agree with Wells Fargo that for risk-tolerant investors, recent weakness presents a buying opportunity.

Catalysts & Financials

Achillion has several catalysts coming up that have the potential to move the company’s share price. Achillion is developing its Phase II study of a combination of ACH-1625 and ACH-3102 now that the compounds have passed their drug-drug interaction study. The company hopes to report data from this trial within the first half of 2013. In addition, Achillion recently announced positive results from a Phase I proof-of-concept study of ACH-3102 in genotype 1b patients, and has moved ACH-3102 into Phase II development. Data from that trial is estimated to be released by the end of 2012. ACH-3102’s half-life of 250 hours stands out in the HCV industry, and as I noted above, its resistance to mutation is also greater than that of competitors. As Merrill Lynch noted in its latest report on Achillion, the company has been “unable to generate a resistant HCV virus to 3102 in vitro, which suggests a high barrier to resistance that could make 3102 more like a “nuc”, while other NS5a inhibitors have demonstrated rapid emergence of resistance. These characteristics could prove useful as part of an oral HCV regimen, particularly in a real world setting where patient compliance is not robust.”

Achillion ended Q3 2012 with $90.648 million in cash & investments, $781,000 in debt, and with operating cash burn of $33.347 million in the first 9 months of 2012, the company is in decent financial shape. While future equity sales are likely, that is a “fact of life” when it comes to investing in the biotechnology sector. Development-stage companies will continue to raise equity (or in some cases debt) to fund the development of their drug candidates until they are either approved, or the company files for bankruptcy. We think that such an outcome is unlikely for Achillion. The company’s clinical data has been solid, and supports the continued development of its drug candidates. As Abbot’s recent clinical data has shown, there is room for protease inhibitors in the next generation of HCV treatments, and Achillion will almost certainly have a key role to play in this market over the next several years.

An Options Strategy for Mitigating Risk

For some investors, there is simply too much risk in holding biotechnology stocks on their own, with no hedge against negative clinical trial data. However, put options can provide investors with downside protection while still allowing them to participate in some upside. While put options do limit profits, they also limit risk, a tradeoff many investors deem worthwhile. For the purposes of this article, I would like to focus on March 16, 2013 puts, because I believe that this date will encompass a good deal of Achillion’s upcoming trial data, as well as its Q4 2012 earnings, which could be a potential catalyst for the stock, depending on what the company says (or does not say) on its Q4 conference call. In the table below, I present several different options strategies for mitigating the risk of investing in Achillion. Prices are accurate as of the close of trading on November 13, 2012.

Achillion Options Strategies
































































$7.50 Put & $10 Call



$7.50 Put & $12.50 Call



$5 Put and $10 Call



$10 Put



Share Cost



$7.92



$7.92



$7.92



$7.92



Cost of Protective Put



$1.45



$1.45



$0.40



$3.10



Proceeds from Sale of Covered Call



$0.90



$0.50



$0.90



N/A



Net Cost per share



$8.47



$8.87



$7.42



$11.02



Maximum Loss



-11.45%



-15.45%



-32.61%



-9.26%



Maximum Profit



+18.06%



+40.92%



+34.77%



N/A



% Change Needed to Break Even



+6.94%



+11.99%



N/A



+39.14%




From the options strategies we have included, the best one, in my view, is the use of a $7.50 put and a $12.50 covered call. The maximum loss is just over 15%, which is a fairly conservative maximum loss for the biotechnology sector. And with maximum profits of almost 41%, the risk/reward balance is favorable. While the $5 put and $10 call trade does not require a move for the trade to be profitable (the breakeven price is below the current market price), it is meant for more bullish investors, as the maximum loss of almost 33% is quite high relative to other available strategies. And the $10 put, while having no cap on potential profits, and a relatively low maximum loss of just over 9%, requires an almost 40% rally just to break even. Only investors who are fully confident in Achillion’s future should choose this fourth strategy. It makes no sense to buy a $10 put and see the stock move “only” 25% or 30%. At those levels, you would still see a loss, as ACHN needs to rise past $11.02 for the trade to be profitable.

Conclusions

It is too early to count Achillion out as an important player in the HCV market. The company’s clinical trial data is more robust than what its share price would have you believe, and the risk/reward profile is favorable. Protease inhibitors do have a role to play in the treatment of hepatitis C, and with a market capitalization of under $600 million and several upcoming catalysts, Achillion’s shares are well positioned for a rally. With several different options strategies to mitigate risk, investors can customize their positions to meet their own levels of risk-tolerance. Achillion’s best days are ahead of it, and risk-tolerant investors who add to or initiate positions in Achillion at this point in time are likely to be rewarded for their conviction.