Transition Therapeutics Still Undervalued: Good Trial Outcome Shifts Focus To Lilly Decision

Transition Therapeutics (TTHIannounced on Tuesday morning that its investigational GLP-1/glucagon agonist, TT-401, generated positive results in its first proof of concept human study (Phase I), sending shares up by as much as 65% in early trading. PropThink covered TTHI in January, and with the results our readers are up 43%. Most importantly now, however, is how partner Eli Lilly (LLY) decides to execute on its options to continue developing the product, which will be indicative of TT-401’s value to TTHI long and short term (we outlinedthese three scenarios in our previous article).

Transition will receive a $7 million milestone payment from LLY in relation to the trial completion, but future milestones and royalty rates hinge on Lilly’s chosen development path, which include TTHI funding a large Phase II trial, Eli Lilly taking over the asset for in-house development, or Lilly relinquishing its future optionality on TT-401 completely (unlikely given the favorable data and large market). We expect Eli Lilly to make a decision within the next month or two, so investors don’t have long to wait for clarity. Regardless, with data in hand for TT-401, two fully funded CNS treatment programs in TTHI’s pipeline, and strong proof of concept for each asset, TTHI’s $83 million valuation could still double and not exceed a valuation range that would be acceptable for a pipeline of this caliber.

Positive Results Support Further Development

Although a detailed analysis is forthcoming, Transition reported that: “…TT-401-treated patients in the three highest dose groups [of five doses] experienced statistically significant reductions in mean fasting plasma glucose relative to placebo. Statistically significant mean body weight reduction relative to baseline occurred in the three highest dose groups. A similar reduction in body weight was also observed in the obese non-diabetic cohort.” Tolerability and safety were acceptable, and the mos common adverse events was decreased appetite, with some nausea and vomiting.

The company said explicitly in Tuesday’s press release that the data supports a move into a larger Phase II study, but the question remains: Who will fund this study? Transition licensed TT-401 from Eli Lilly in 2010 for $1 million before the drug had entered the clinic. Lilly retained the option to reacquire rights to TT-401, and can take over development at two different time points: 1) following this proof of concept trial, or 2) following a Phase II trial. The economic contrasts are stark: In both scenarios, TTHI receives a $7 million payment upon completion of the current trial, but should Lilly take over development now, before TT-401 enters Phase II, Transition is entitled to milestone payments of up to $150 million and royalties on sales in the high single-digit range. Conversely, if Lilly waits until after a Phase II study, Transition will be entitled to another milestone payment for the Phase II results (undisclosed), total milestone payments of up to $250 million, and low double-digit royalties on sales of the drug.

Clearly the economics for Transition are advantageous under the second scenario. Given that large pharmaceutical companies are doing everything they can to bolster earnings and cash flow, LLY has incentive to continue allowing Transition to front the costs. We believe that Lilly will be more interested in keeping Phase II development off of its own P&L, even if it means paying up further down the road and that means a greater share of the long-term profits. The pharma company should make a decision within the next month or two, but we believe that Lilly will wait until TT-401 finishes a Phase II trial to opt in.

After Lilly’s Decision, Full Data Is the Next TT-401 Catalyst

Aside from an official Lilly decision, we expect that Transition will present the full data set from the trial at a medical meeting or publish in a peer-reviewed journal shortly. The company has not offered guidance on this event, but the next two major diabetes meetings will be in June at the 73rd Scientific Sessions of the American Diabetes Association, and in September at the 49th Annual Meeting of the European Association for the Study of Diabetes. We expect to receive clarity on this over the next month, and/or see publication in a medical journal.

What It Means for Investors

We estimate that with the $7 million payment from Eli Lilly, TTHI has north of $25 million in accessible capital, which may be sufficient to run a Phase II trial for TT-401 if Lilly elects to keep the development off of its own books (which we expect). That means Transition benefits significantly from the enhanced economics of the second scenario, which are almost doubly as beneficial in the long run. TTHI is worth more than it’s current sub-$100 million valuation implies, particularly if we’re correct in assuming that Lilly forgoes reacquiring the asset until after the Phase II trial. In fact, we believe that Transition remains undervalued either way. TT-401 has a proven mechanism of action (GLP-1/glucagon agonist), significantly de-risking a larger trial and further development.

Transition now has a Phase II diabetes asset and a fully funded Phase II asset for bipolar and Alzheimer’s agitation, ELND005 (partnered with Elan (ELN)). While the Alzheimer’s cognition indication remains in limbo (Phase III ready), Acadia Pharmaceuticals (ACAD) has demonstrated that supportive therapies for CNS disorders can be quite valuable; ACAD’s pimavanserin is indicated in Parkinson’s Disease Psychosis and the company carries a $978 million valuation. TTHI trades at less than $100 million, even with two mid-stage assets in three large-market indications. Even if the stock doubles from its current levels, we believe it remains within a fair valuation range considering the commercial prospects of its two lead assets.

With this data readout, Transition’s visibility should increase notably, thus we expect to see more investors entering this Canadian micro-cap. As we’ve said previously, TTHI’s sub-$100 million valuation is still low for a mid-stage company with the potential to enter three large markets. In our previous article, we outlined a number of highly valuable deals that included first-generation GLP-1 agonists, most of which occurred in the $500 million range. Bristol-Myers Squibbs (BMY)reported that Byetta, another GLP-1 agonist, had $580 million in revenue in 2011 and Novo Nordisk’s (NVO) Victoza generated sales of $1.7 billion last year. Overall, we don’t expect this low valuation to last.