Essex Biotech – Why I am bullish

Recently some of you readers have contacted me either through the blog or on twitter to discuss Essex Biotechnology. Since I also recently increased this to a high conviction position, I thought I would share my thoughts on why I did so and some very recent development.

This post will not make sense if you are not familiar with the company, so please check out my full write-up from last April: Essex Biotechnology (1061 HK) – Core products fund investment portfolio.

Terrible investment

To start with I want to say so far Essex has been a terrible investment, I allocated significant capital to Essex on 5th of April, very close to the market bottom. And the stock is trading flat since then, whereas my portfolio is up 54%, a pretty remarkable underperformance. Why am I then adding to this holding which obviously the market doesn’t really see any value in? Well the (maybe obvious) answer is that I believe that the market is wrong and that there is significant upside in Essex to hopefully be unlocked. The most exiting trigger is that Essex today posted what I have been waiting for for some time now.

The Board is pleased to announce that, as informed by Mitotech, the topline data of VISTA-2 will be released and presented on 24 February 2021 after trading hours, and an announcement will be made by the Company accordingly

This post won’t be very structured but I would just comment on different aspects of the company. Let’s jump in

SKQ1

Let’s start with the exciting news that we finally tomorrow might have a trigger to take us away from value trap land. If you need a refresher on what this is about, this article is good: Mitotech: a Dry Eye treatment aimed at mitochondria. Essex has so far spent ~37m USD to fund this research and Essex MCAP is 300m USD so this is really significant for the company.

Just as the article mentions it is very hard to get a product approved for dry eyes by FDA. I can imagine partly because dry eyes is not a very clearly defined symptom/disease. That said, if we allow ourselves to dream away a bit here, the potential is really good if the VISTA-2 results are promising enough. Restasis is best seller of three FDA approved eye-drops for dry eyes and has annual sales of 1.2bn USD, Xiidra second has 400m USD and newly launched Cequa from an Sun Pharma does not seem to have taken off in a major way yet. The sales potential is in other words mind-boggling if they can take some 10-20% market share over time. Obviously Essex/Mitotech would need a partner to distribute the product (outside of China) but if the results are good enough I can’t see any larger problem with securing a good deal for this. Essex would potentially have very good sales of this product in China (and the sales network they already have).

If we try to land on the ground again, we should not forget that the VISTA-1 study was not a home-run: “not meeting co-primary endpoints (Central Corneal Fluorescein Staining and Grittiness)”. I think what was very positive from the VISTA-1 study was how well tolerated the SKQ1 formula was for the patients. “Drug tolerability comparable to that of an artificial tear”, the reason why this is so important is that the three above named FDA approved drugs all come with quite common side-effects. Potentially Essex’s product doesn’t need to be better, just a very good alternative for the once that can’t tolerate the Restasis drug. We should also not forget that this product is already approved in Russia and sold over 1 million eye drops. Anyway, there is no point for me to speculate too much, by tomorrow we will know much more.

Henlius

Next big one is the co-operation announced with Henlius, this is not something that will create value short term but has good potential long term. Again Essex is putting up some big bucks, up to 49m USD for getting Henlius help to develop a drug for wet-AMD from their biosimilar portfolio. Essex will get about 85% (deducting royalties and milestones) of future revenue on the products if launched successfully. Mind you here that Essex a 300m USD MCAP company is funding one of the developments for 2.8bn USD MCAP Henlius.

As a good comparison how the market values a biosimilar that replicates a existing wet-AMD product is Swedish listed Xbrane. They are in a phase 3 awaiting the patent to expire on the product they are creating a biosimilar off. Xbrane has a market cap of 250m USD today and they have given away more of the sales due to not having a sales network themselves to push out their product (they also needed the funding). In my view Xbrane is a weaker company financially launching one single promising product, whereas for Essex this is just one of many products they can fund off their cash flow from their already highly profitable products. But the market does not put much value on Essex cooperation but highly values Xbrane, again I don’t agree with how the market currently values Essex assets.

Essex core products

Two questions I got here on the blog:

1) Why don’t they sell some of their products outside of China? even if the drugs are less good than their more expensive counterparts (Regranex vs Beifuji) when you described them as “advanced generics” wouldn’t some other countries also be potentially interested?
2) What did you mean by advanced generic? was it that they developed a drug that does the same thing as another, but just charge significantly less for it?

Clearly when I wrote my Essex write-up I did not in detail understand this myself, so allow me to correct myself to the level of knowledge I have now. Recombinant Bovine Fibroblast Growth Factor, or rb-FGF as Essex calls it is the key ingredient for both their eye drops and wound care product. What is this rb-FGF then, some magic product? In some ways, yes. As I understand it FGF was discovered a very long time ago (1973) initially from cow brain extract. the “rb” part in the name is basically saying that its a synthesist version of the bovine (or in my plain English cattle) brain extract. Ok great, so we have a lab version of cow brain extract? What is the deal here? Without making too much of a funny story out of it, the deal is that it’s hard if not impossible to patent something that comes from a cow brain – except that it what Essex managed, in China. From my discussion with the company It seems Essex was lucky to be able to patent it’s rb-FGF products in China back in the late 90s. I understand that such a patent would probably not have been given in more modern days. So by a somewhat lucky stroke or call it mistake by China’s patent office this enabled Essex to invest in a sales network to sell their rb-FGF products without fear that someone would just copy their products. Over the years now they have established themselves with a strong presence in the market and even if the patent expires it will be hard for a competitor to just swoop in and take over the market. Perhaps somebody will try, but Essex is already selling their products fairly cheap. So the answer to why this product barely exists abroad and why Essex would struggle to launch it abroad is at least partly because you can’t patent the rb-FGF product elsewhere. From what I understand you can order some rb-FGF online: rb-FGF from webshop, so it’s not a unique product in that sense.

Something else I thought about was, what is the competition for Essex core products? Well there are some as mentioned earlier, depending on use case. But as I also was explained, in many cases the competition is to not use anything. Your skin will heal even without Essex products, perhaps slightly less nicely and less quick but still the product is a nice to have, not need to have in many cases. Again this then explains why Essex has spent so much of its money to build up the sales network. They just needed to educate doctors all around China to push the product and also ensure that the products are safe. Safety might be an area which explains why these products are not sold elsewhere in the world but this is something I haven’t got a clear answer to. Studies are being done on use cases of FGF. Two examples here:

Efficacy and safety of basic fibroblast growth factor in the treatment of burns

Effect of recombinant bovine basic fibroblast growth factor gel on repair of rosacea skin lesions: A randomized, single-blind and vehicle-controlled study

If you read the studies above it does seem to be a powerful product with strong use cases. So the company has a strong set of products, which just keeps growing on back of China’s growth. I confirmed that Essex products are not affected by the Central Procurement initiatives.

Finally I just want to end with this now quite old update on how the company is fairing in these Covid times:

The board of directors of the Company (the “Board”) wishes to update its shareholders and potential investors that as clinical operations of hospitals in the PRC have been largely resumed to normalcy, the Group’s revenue in the third quarter of 2020 has also been largely recovered to nearing the pre COVID-19 level

It should mean that looking forward the company on 2019 earnings should be back to generating 300m HKD net profit in 2021, not too bad when it has the above presented pipeline and trading at a Market Cap of 2.4bn HKD.

This summarizes why I felt it was time to make this a high conviction position: Strong rebound in results to be presented in the annual report within a months time. SKQ1 announced tomorrow and Henlius R&D will progress over the coming years.