A rewrite of my first investment letter...
At a June 1st closing share price of $0.88 and market capitalization of $99 million, Provectus Pharmaceuticals is an exceptional long idea.
I began due diligence on the Company in 2006, and started accumulating shares in 2007. My historical and ongoing diligence comprises thousands of interactions with Provectus management. As a result, my view of the Company’s prospects has evolved over time. If our portfolio was one hundred percent cash and I was investing from scratch, would I establish this position in Provectus and, if so, how big would it be? The answer is I would have the same position I have today.
In writing this investment letter to and sharing my investment thesis with you, I borrowed from Whitney Tilson’s Why We’re Short Netflix letter as well as OneMedPlace Research’s December 2011 report, which is a well-written primer on the Company.
Provectus Pharmaceuticals (PVCT)
Provectus is a Knoxville, Tennessee-based biotechnology company with two lead compounds in early- to mid-stage clinical trials: PV-10 for oncology (metastatic melanoma, hepatocellular carcinoma, recurrent breast cancer, other solid tumors) and PH-10 for dermatology (atopic dermatitis, psoriasis, other inflammatory skin disorders). Rose Bengal, the active pharmaceutical ingredient (“API”), has an established safety profile with the Food and Drug Administration (the “FDA” or “Agency”) for prior human use as an intravenous hepatic diagnostic (Robengatope) and topical ophthalmic diagnostic (Rosettes and Minims), and has been used in liver function studies for more than 90 years.
Investors often underestimate or overestimate risk in the context of the return they should expect. Just because a so-called safe asset or security could provide a safe return does not mean the expected return is commensurate (i.e., high enough) for that level of risk. Conversely, just because a so-called risky security could generate a robust return does not mean the expected risk is commensurate (too high) for that amount of return. Provectus’ stock is a situation where the risk-reward profile is clearly and visibly out of whack. The return opportunity is much more than commensurate for the potential risk.
The Company’s share price has trended downward over the last five years however, losing nearly 50% of its value along the way, despite clinical, regulatory and business value propositions that have increased over time.
Clinical: PV-10 is very efficacious and safe, and produces very beneficial local-regional and systemic effects on cancerous tissue. Pre-clinical and clinical results have been repeated and reproduced. Further efficacy, particularly when tumor burden is high, is achieved by combining PV-10 with other therapies, such as radiotherapy and Bristol Myers Squibb’s Yervoy, because PV-10 facilitates the efficacious action of these treatments.
Regulatory: The path to drug approval in the U.S. and Australia for metastatic melanoma (“MM”) is clear, but not yet completed. The path for hepatocellular carcinoma (“HCC”) is in process. Orphan drug status has been received for both MM and HCC. The path for recurrent breast cancer has been started. The FDA has been very constructive. Interactions with the Agency have been unusual in a good way.
Business: PV-10 is very easily administered and should be easily reimbursed. Provectus has significant treatment pricing flexibility (as currently contemplated, gross margins are very high), incurs very low manufacturing costs to produce the drug and requires very low costs to scale manufacturing to meet domestic and international demand for the drug when it is approved. The Company has a large, well-protected intellectual property portfolio of U.S. and international patents.
Stock: Provectus recently formed an independent board of directors. The corporate advisory board has been tactically and strategically populated. The stock, however, does not trade on a major exchange and has limited equity research coverage. No license deal in either oncology or dermatology has been struck, as managed has turned down or resisted license interest because of valuations below their acceptable minimum at the time. There has been no historical insider selling and plenty of insider buying. The Company’s balance sheet is solid, with committed and structural access to capital.
So, why am I risking my professional reputation, a large portion of net worth and my sanity on this company, its management team and the stock, when most institutional investors, including biotechnology-focused investors, have mostly or completely ignored Provectus? Healthcare fund manager OrbiMed Advisors, a firm with whom the Company has an association through a corporate advisory board member for several years owns no shares as of a March 31st 13F filing (David Darst, the advisor, is a member of OrbiMed’s private equity team and not their public equity one). Hardcore biotech investors understand the situation and opportunity. There are two practical and pragmatic reasons for their lack of participation in the stock: a yet-to-be-received Special Protocol Assessment (“SPA”) from the FDA for the Company’s pivotal MM Phase 3 trial and a security that trades over-the-counter.
At just under $100 million, Provectus’ valuation is extremely low. Fair value is at least $200-300 million. Once the Company receives an SPA for its pivotal MM Phase 3 trial and more information on the drug’s mechanisms of action and immune response are further elucidated, followed by the out-licensing of Provectus’ dermatology drug PH-10 for inflammatory skin disorders, institutional and retail investors should become much more aware of the stock and its risk-reward proposition. There is substantial cash and contingent upside above fair value in excess of $2-3 billion.
Rose Bengal and PV-10: A tremendous clinical value proposition
Through early- to mid-stage trials and a compassionate use program, Provectus’ clinical results have been impressive. The Company has completed Phase 1 and 2 trials for MM, for which Provectus received orphan drug status; a Phase 1 trial for HCC, for which it received orphan drug status; a Phase 1 trial for recurrent breast cancer, for which the Company demonstrated efficacy; and Phase 1 and 2 trials for atopic dermatitis and psoriasis, for which Provectus demonstrated efficacy given limitations of trial designs. These trial results show, suggest and infer much better overall survival benefit, much higher levels of tumor destruction and disease reduction, beneficial local-regional and systemic effects on cancerous tissues, multi-indication viability, and repeated reproducibility of outcome in and across pre-clinical and clinical trials.
PV-10 is very efficacious: Clinical results indicate, for MM and HCC, and more than likely suggest, for recurrent breast cancer and several other indications treated in the compassionate use program, materially superior results for objective response, complete response and progression free survival (taken alone and when compared with the results achieved by standards of care and competing drugs). Results infer such for durable response. Understanding the caveats of comparing clinical trial results, PV-10's response rates for injected lesions, non-injected lesions and non-injected systemic lesions exceeded other intralesional therapies like Vical's Allovectin-7 and Amgen's talimogene laherparepvec (formerly BioVex’s OncoVEX GM-CSF). Substantial unmet needs exist for melanoma treatment despite the approvals of Yervoy and Zelboraf, whose efficacy outcomes and safety profiles pale in comparison to PV-10.
Two fair criticisms of PV-10 are the small number of trials completed (oncology: 4, dermatology: 4) and the small number of patients treated (oncology: >200, dermatology: >225). Efficacy, however, has been repeatedly superlative in pre-clinical work (from bench research, in murine models and on animals), clinical trials (MM, HCC, recurrent breast) and the compassionate use program. Further, Provectus, its principal investigators and H. Lee Moffitt Cancer Center & Research Institute (“Moffitt”) have reproduced superlative efficacy in pre-clinical work, clinical trials and murine models (and human studies), respectively.
PV-10 is very safe: Rose Bengal is an FDA-approved API, with a century of safe and successful use in humans as an intravenous hepatic diagnostic and topical ophthalmic diagnostic. Patients treated with PV-10 predominantly suffer only mild to moderate adverse events. There have been neither NCI CTCAE Grade 4 or 5 events nor clinical trial insurance claims. Paraphrasing: “Rose Bengal has a 30-minute “half-life,” which is the amount of time the compound is in the patient’s bloodstream before it is excreted in the bile. It is very stable in the human biological system, and although the portion remaining in the bloodstream is excreted rapidly, the portion that has been absorbed by the cancer tissue actually remains in its parent form for weeks until the dying cancer tissue is absorbed by the body and the remaining Rose Bengal is excreted.” (Amy Baldwin’s Investment Choices For Melanoma Awareness Month). Such historical and ongoing safety means no surprises in future clinical trials or, once approved, from patient use.
PV-10 has both local-regional and systemic beneficial effects on diseased tissue: PV-10 has an autophagic mechanism of action and an autophagy-induced, system-wide anti-tumor mechanism of immune response. Rose Bengal partitions into diseased cells. Entering the cells’ lysosomes, it causes them to leak or rupture. Autophagy cascade subsequently occurs. Moffitt independently confirmed PV-10’s local and systemic response benefits in murine models, and also identified the quintessential immune-mediated response: Splenocytes from PV-10-treated mice produced interferon-γ in response to B16-F10 melanoma cells. Shortly, Moffitt should confirm the same in human studies.
PV-10 has demonstrated multi-indication viability: PV-10 has been used to treat MM, HCC, recurrent breast cancer, squamous cell carcinoma, scalp sarcomas and colorectal cancer (mets to the liver). Moffitt conducted further murine model work on other cancers besides metastatic melanoma to successfully demonstrate multi-indication efficacy and immune response.
Two fair criticisms of PV-10, again, are the small number of trials completed and small number of patients treated. Yet, multi-indication success has been repeatedly shown in pre-clinical work, clinical trials and the compassionate use program. Further, Provectus, its principal investigators and H. Lee Moffitt have reproduced multi-indication success in pre-clinical work, clinical trials and murine models, respectively.
PV-10’s regulatory path is becoming clearer
Management's interaction with the FDA has been unusual in a good way. This month or next, I expect the FDA will grant an SPA to Provectus for it’s pivotal MM Phase 3 trial. Australia’s Therapeutic Goods Administration already has agreed to a data analysis and review process that allows early evaluation for MM marketing approval. Accelerated approval, at a later date, is a very real possibility, based on Moffitt’s historical and ongoing murine model and human study work. Provectus is pursuing a very focused label for PV-10, the supporting proof of which already has been demonstrated: loco-regional treatment of Stage III and early-Stage IV MM.
The company may finalize designs for a pivotal HCC Phase 2/Phase 3 randomized control trial using Sorafenib later this year. Drug orthogonality between PV-10 and sorafenib has been shown.
A very profitable business value proposition
PV-10 has the potential to be a very profitable drug. It is easily administered and should be easily reimbursed. Because of a relatively low amount of capital spent and required to bring the drug to market, Provectus and its eventual acquirer will have significant treatment pricing flexibility. PV-10 has a very low manufacturing cost. The cost to scale manufacturing is very low. The Company has a large, well-protected intellectual property portfolio.
Ease of drug administration: A medical or surgical oncologist makes treatment decisions. PV-10 is injected into target lesions by interventional oncologists in outpatient settings. An appropriately trained nurse practitioner or nurse can provide the same service. Injections into tumors on organs inside the body require an imaging assist. In either case, effective administration of the drug does not require a meaningful change to a physician’s current practice and practice behavior. There is no pre- or post-treatment care, nor is co-treatment needed. In the future, PV-10 could be ingested or deployed intravenously. For dermatology, patients apply PH-10 as a topical gel to the targeted area of skin.
Low treatment price: For the purposes of their valuation models, equity research analysts who follow Provectus assumed a treatment price of $20,000 to $30,000, which is not necessarily what the Company and its eventual acquirer could or would charge. At these prices, however, PV-10’s gross margin is more than 80% (in excess of 99% when not including a sales return-type allowance). Given PV-10’s equivalent to dramatically better efficacy and safety profile, predatory pricing (as it relates strictly to competitors’ treatment pricings) could be very lucrative. Pricing flexibility, resulting directly from the very low cost to produce the drug is a sustainable competitive advantage.
Physicians should be very easily reimbursed for PV-10 treatments. It is anticipated treatment would be reimbursed as chemotherapy or a procedure, and a potential crosswalk to other reimbursed interventional oncology procedures, such as image-guided therapy. Treatment price and reimbursability should be key drivers of adoption.
Low manufacturing cost: Provectus’ $110 million deficit accumulated during the development stage as of March 31st, combined with nearing the end of the regulatory approval process, means the eventual amortization of development expenses will not materially influence pricing.
It costs very little to manufacture PV-10. Synthesis of the API to modern pharmaceutical standards is well defined. Rose Bengal has a well-behaved, fully characterized impurity profile. Provectus owns the only formulation that meets the FDA's International Conference on Harmonization (“ICH”) guidelines. The cost to scale the production of PV-10 is very low. Critical process parameters and best practices are complete. PV-10’s formulation utilizes standard equipment.
Broad and deep intellectual property: The Company has more than 50 global patents issued and pending, with numerous applications filed and in process, covering the drug and subsequent (additional) family of compounds, and synthesis of the active pharmaceutical ingredient to modern pharmaceutical standards. Provectus’ family of compounds extends oncology applications far beyond traditional patent cliff.
Paraphrasing: “Rose Bengal is an old agent; the composition of matter patent has expired but Provectus filed a synthesis patent that spells a method to manufacture this agent that is devoid of any impurities and is the only formulation that meets the FDA's ICH guidelines. This patent maybe as robust as a composition of matter patent because without using this synthesis protocol, medicinal grade Rose Bengal can never be synthesized. Additional picket-fence is provided by use, indication, formulation and mechanism of action patents.” (OneMedPlace Research’s December 2011 report)
The key opinion leader community wants to use an emerging therapy like PV-10 with other agents like Yervoy, Allovectin-7, talimogene laherparepvec (formerly OncoVEX), and other anti-CTLA-4 and anti-PD-1 compounds.
The stock has a weak to modest value proposition at the moment
Provectus has an independent board of directors that includes Alfred E. Smith IV. The Company’s corporate advisory board includes Dr. Craig Eagle, Vice President of Strategic Alliances and Partnerships for the Oncology unit at Pfizer, and Doug Ulman, President and Chief Executive Officer of LIVESTRONG.
Provectus’s stock does not trade on a major exchange. Reduced requirements to list on the NASDAQ (e.g., market value of listed securities standard, net tangible asset minimum, minimum $2 bid for five consecutive days), however, present a lower bar to clear.
Although equity research analysts that cover the stock are highly-ranked or thoughtful, coverage is by firms with historical investment banking relationships or niche/boutique businesses and clienteles: Maxim Group, Rodman & Renshaw, Roth Capital, and Stonegate Securities. Firms with no promised or implied relationship could initiate coverage post-SPA.
Provectus has not yet entered into a license deal. Lack of a deal (or deals) does not mean no deal can be had. Management is seeking valuations commensurate with their view of value, turning down or resisting several opportunities in the process.
There has been no insider selling and plenty of insider buying. Insider exercising of options and purchasing of underlying common stock totals several million dollars to date. Most of these exercises have been done by one of the four principals. The other three principals have made small to moderate purchases.
The Company has a solid balance sheet, and committed and structural access to capital. As of March 31st, cash and cash equivalents totaled $5 million. Provectus owes no debt. The Company has a $30 million equity line of credit committed by a Chicago-based investment firm, and two $50 million shelf filings.
A management team in which I believe and support
Provectus is the story of an old molecule, a business scientist (Craig Dees), two scientists (Tim Scott and Eric Wachter), a businessman (Peter Culpepper), a decade of clinical development and a journey that began in the 1990s. This four-man team has been together for eight years, and should remain together through the acquisition of the company.
Management is intelligent, repurposing an old diagnostic compound as an anti-cancer agent and understanding the value of the molecule’s safety history in working through the regulatory process. Management is competent, getting this far in clinical development while accumulating a $110 million deficit during the development stage. Management is hardworking; while creating near composition of matter patents and scooping other companies requires intelligence and creativity, hard work increases the probability of execution and implementation.
I believe management is ethical and possesses a good moral compass.
While not having sold a single share of stock, management has made in-kind contributions (at the Company’s inception) and exercised options at an expense of $20 million.
But what if I’m wrong?
What if I am wrong? What would that scenario look like?
Could there be poor clinical results in the future? Given the repeatability, reproducibility and veracity of pre-clinical and clinical results, likely no.
Could there be unexpected adverse events in the future? Given Rose Bengal’s multi-decade, historical safety, likely no.
Could more time be required to confirm the regulatory path for MM? This is the likely scenario if I am wrong. I am prepared for more time to elapse for regulatory clarity to be achieved. Management may have to raise additional capital to fund operations until such time as this ambiguity is resolved to their satisfaction. This, however, is finite and can be bounded by several millions of dollars or several percentage points of potential dilution. This downside risk, however, is more than commensurate with the vast upside return opportunity when the regulatory ambiguity is indeed resolved.
Shareholders would incur further dilution if management elects to conduct the pivotal MM Phase 3 trial itself. I am prepared for this outcome because the dilution caused by raising capital to carryout the trial should be made up by a higher valuation resulting from Phase 3 trial results that are projected to exceed Phase 2 results.
And in conclusion…
Provectus is an extremely undervalued stock whose current share price ignores unambiguous pre-clinical, clinical, safety and multi-indication viability data for oncology therapies; ease of drug administration and low drug production costs; a large intellectual property portfolio; and, an intelligent, hard working, ethical management team.
Once the unknown of the regulatory path begins to be known, Provectus’ valuation should increase. The share price will display substantial upside when acquisitive pharmaceutical companies fully accept Rose Bengal’s value proposition.
This letter is for informational and educational purposes only and should not be construed to constitute investment advice. Nothing contained herein should constitute a solicitation, recommendation or endorsement to buy or sell any security by the author. The author owns shares of stock of Provectus Pharmaceuticals. He has no obligation to update the information contained herein and may make investment decisions in the future that are inconsistent with the views expressed in this letter. The author makes no representation or warranties as to the accuracy, completeness or timeliness of the information, text or other items contained in this presentation. The author expressly disclaims all liability for errors or omissions in, or the misuse or misinterpretation of, any information contained in this letter.