Synageva’s Upside is Limited by an Outsized Valuation

Synageva (NASDAQ:GEVA) announced its third stock offering in twelve months on Thursday, which after a pricing update, should raise approximately $90M for pipeline development, particularly for its lead - and only - candidate in the clinic, SBC-102 (sebelipase alfa). The drug is intended for a minuscule and underserved patient population, a strategy that proved vastly successful for Alexion Pharmaceuticals (NASDAQ:ALXN) and its shareholders in the last few years, and one that’s spurring considerable interest in Synageva. Shares of the company went on a tear in 2012, climbing 100% into October, even through two large and dilutive stock offerings. This week’s financing brings Synageva’s proceeds from the issuance of common stock in the trailing twelve months to a whopping $280M, and for a company with zero debt that expects to have burned only $45M in 2012, there’s a lot of capital on the balance sheet (~$300M). While we note the strong financial position of this orphan drug developer, GEVA remains a Phase II company, and its $1.25B market capitalization and impressive 2012 performance are indicative of an equity that’s gotten a little too big for its britches. Synageva’s only clinical product, SBC-102, is still in mid-stage development, and investors aren’t likely to see commercialization of the Lysosomal Acid Lipase (LAL) Deficiency treatment for another three years, time in which the company will be doing little more than burning through cash. Synageva is far from validating its outsized valuation, and while SBC-102 may play out as a quality treatment in the long-run, GEVA has little room for upside from current levels, particularly with no value driving events expected in the new year and a number of risks overhanging the stock.

Synageva’s lead candidate is still far from proven, and patent concerns create long-term risk. SBC-102 is being evaluated as a treatment for two disorders, early onset and late onset LAL deficiencies known as Wolman disease and Cholesteryl Ester Storage Disease (CESD). The drug received Orphan Drug designation from FDA and EMA due to its minute patient population, and has fast-track status in the U.S. SBC-102 has been evaluated in Phase I and II trials, demonstrating good safety and tolerability, but Synageva is relatively vague about further trials, which will be pivotal to proof of efficacy and regulatory approval. Clinicaltrials.org lists a Phase III study for SBC-102 set to begin in January of 2013 (updated at the end of December) of which the company has made no mention and recruitment has yet to start. Nevertheless, this and the other studies listed on the website (primarily natural history) aren’t set to release data until late in 2014. Synageva is looking at almost two years before more value driving events related to SBC-102, and commercialization isn’t likely until 2015 or 2016. And considering that the rest of the company’s pipeline is preclinical, we see little reason for GEVA to continue climbing in 2013. In addition, Synageva recognizes that SBC-102 carries some risk of patent infringement issues: “While we believe that the [U.K.] patent is invalid due to the substantial body of prior art, we are unable to predict the outcome of this proceeding.” In November, a preliminary hearing at the European Patent Office upheld the existing patent, which Synageva intends to appeal, and a trial is scheduled for May. While the outcome is uncertain and Synageva will continue development in the interim, patent infringement adds an element of risk to Synageva’s only drug candidate.

Macro forces may affect Synageva’s profitability with SBC-102. Interestingly, orphan drugs like SBC-102 have been the topic of much discussion this week in the biotech community. A number of recent publications (HuffPost, TheStreet, Forbes) suggest that the increasing prices for orphan drugs are reaching a breaking point, and payers may begin to push back against outlandish pricing demands, or regulators may step in. NPS Pharmaceuticals (NASDAQ:NPSP) announced this week that it will be pricing Gattex, a drug for short bowel syndrome, at $295K per patient per year, a staggering cost made necessary (according to proponents) by the small patient population. Pricing concerns and a poorly defined patient population (CESD is often mistaken for other liver diseases and diagnosis is difficult) for SBC-102 make its true market opportunity difficult to pin down.

Synageva is one of those rare companies that, despite repeated dilution, continues to gain, largely riding on momentum from analyst updates. Some have even suggested that high price targets from the sell-side are attempts to leverage banking agreements for gains. Regardless, the company built a strong financial position throughout 2012, and we don’t expect more stock offerings in the near-term. With all that cash, Synageva may even pursue a product licensing or acquisition, a boon to the company that would diversify its product portfolio and decrease its “eggs-in-one-basket” risk. Management hasn’t made indication, however, and with few other catalysts this year, an outsized valuation for a Phase II company, and a number of long-term risks affecting its lead candidate, we see upside in GEVA as severely limited in the new year. It will take further validation of SBC-102 and a more defined market opportunity in the long-term (2014) before we see a compelling reason to own the stock.