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Wednesday, March 14, 2012

Avoid Osiris Therapeutics

By Jason Napodano, CFA

I recommend avoiding shares of Osiris Therapeutics (OSIR). I believe the stock is meaningfully over-valued at this price, and I see potential clinical failures, the dissolution of the development partnership with Sanofi Aventis, and subsequent dilutive cash raises as catalysts to drive the shares significantly lower.

Osiris Therapeutics is a stem cell company focused on developing and marketing products to treat medical conditions in the inflammatory, autoimmune, orthopedic and cardiovascular areas. The company’s lead product, Prochymal, is produced from the expansion of human mesenchymal stem cells (MSCs) derived from adult bone marrow. Osiris has developed a manufacturing process that allows the harvest and expansion of MSCs without immuno-matching complications that can lead to rejection.

This type of allogeneic stem cell potentially allows for an “off-the-shelf” dosing model, in contrast to autologous stem cell products in which a patient donates his/her own stem cells to create a personalized medicine approach. I am skeptical of allogenic stem cells. I believe the regulatory pathway for approval of an allogenic product will be far more stringent than an autologous product. I do not believe the FDA will approve a stem cell product that involves seeking commercial supply from unrelated healthy donors. The approval pathway for stem cells products is difficult enough. The FDA noted its efforts to assure safety and efficacy of these products in December 2011. The added risk of an allogeneic product adds further risk to the story.

...Too Many Past Failures...

But steep regulatory hurdles are only a concern for a company seeking approval. And as of yet, I do not see an indication for which Osiris has proven utility with Prochymal. Management has conducted clinical studies with Prochymal in graft-verse-host disease (GvHD), Crohn’s disease, chronic obstructive pulmonary disease (COPD), Type-1 diabetes, and acute heart attack. The data are uninspiring.

In September 2009, Osiris announced that Prochymal had failed both pivotal phase 3 studies in patients with GvHD. In the first trial, Osiris tested Prochymal in 260 patients with steroid-refractory GvHD. The Prochymal response rate was 35%, compared to a 30% response rate for placebo. Sounds good, but results were not statistically significant. In the second study, Osiris tested Prochymal as a first-line therapy for 192 patients with GvHD. Results show a 45% response rate for Prochymal versus a 46% response rate for the control. The company is running a confirmatory program in GvHD now. Confirming what, I wonder? That the drug does not work? Expect the results to be clouded with statistically mumbo-jumbo, dating mining, and suspect interpretation – all of which the U.S. FDA and Health Canada will shoot down. 

Speaking of Health Canada, Osiris filed for approval of Prochymal to treat GvHD in Canada during the summer of 2010. Health Canada actually granted the new drug submission (NDS) a priority review. This was supposed to shortern the review period to 180 days. Instead, Health Canada came back with questions, to which Osiris has filed a complete response during the third quarter 2011. A decision out of Canada is expected during the second quarter 2012. I think approval gets held up again, and that will send the shares lower.

Earlier, in March 2009, Osiris announced that they were discontinuing a phase 3 trial with Prochymal in 210 patients with Crohn’s disease because of “a design flaw”. I believe the design flaw is simply that the drug does not work. Osiris only tested Prochymal in nine patients with Crohn’s disease prior to initiating the phase 3 study. Starting the phase 3 trial was a clear waste of shareholder money. Management has since reinitiated a phase 3 program in Crohn’s disease. I believe the trial will fail, and that will send shares lower.

In September 2008, Osiris moved Prochymal into a phase 2 study to treat 62 patients with chronic obstructive pulmonary disease (COPD). Interim data, released in June 2009, showed no statistically significant improvement in patients compared to the placebo. From the press release, "Pulmonary function tests such as FEV1 and DLCO or carbon monoxide diffusing capacity of the lung were not improved over placebo following treatment with Prochymal at six months." There has been little update on the status of the COPD program since then.

In January 2012, Osiris announced results from a phase 2 study with Prochymal in 63 patients with Type-1 diabetes that management called “groundbreaking”. I’ve read the press release several times, and I am yet to stumble across anything that was remotely “groundbreaking”. The data showed no significant differences in the rates of disease progression, as measured by stimulated C-peptide levels at the one year time point. That’s a failure. Management did note a trend towards fewer hypoglycemic events for patients treated with Prochymal as compared to the control, but lots of already approved drugs do this. Plus, that's not an endpoint the U.S. FDA will allow for a pivotal program.

Osiris is currently studying Prochymal in a phase 2b trial in 220 patients following acute myocardial infarction (AMI). Results are expected out in the next few months. The phase 2a trial, conducted in 53 patients following AMI showed encouraging results, with statistical significance in things like improvement in  left-ventricle ejection fraction, arrhythmia, and chest pain. However, all-cause hospitalization, the key endpoint from an economic standpoint, was not statistically significant. The reason I am not more optimistic with respect to this indications, is that use of stem cells to treat AMI has been done before. The list is long, and Osiris is competing with Cytori, Athersys, Mesoblast, Cytomedix,  and Neostem. I think results from the phase 2b program have to really impress, hitting on endpoints from left ventricular end systolic volume (ESV), ejection fraction, infarct size, and major adverse cardiovascular events (MACE). Osiris has yet to show it can run a randomized, well-controlled trial meeting all endpoints.

...Chondrogen On Hold...

Osiris has also placed development of Chondrogen, a preparation of adult stem cells formulated for direct injection into the knee, for regeneration of meniscus and prevention of knee osteoarthritis on hold. Data on Chondrogen to date has been mixed. Results for a study in February 2007, touted by management as a success, actually did little to help patients regenerate the volume of meniscus in the knee. Management called the trial a success because the primary endpoint was safety. 

...Sanofi Walks...

In February 2012, Sanofi-Aventis, Osiris development partner for Prochymal, provided an update on its R&D pipeline, noting it was discontinuing development of Prochymal for GvHD. This update was put out without speaking to Osiris, it was simply listed in Sanofi's press release. That’s the equivalent of getting dumped via a Facebook status update. 

Osiris fired back with spin, claiming that they now have full rights to Prochymal back and will be seeking other collaboration partners. Sanofi got the rights to Prochymal when it acquired Genzyme back in February 2011. The product is an after-thought for Sanofi. My guess is that management at Sanofi saw Prochymal as a failed drug, not worthy of any further clinical testing in GvHD. If Sanofi does not want Prochymal, why should investors?

I think this is bigger news than the market has factored in. From Osiris' own filings, "We are dependent upon Genzyme's continued performance under these collaborations, and any determination by Genzyme not to proceed or perform, or any material adverse event that affects Genzyme's ability or desire to perform, under either of these collaborations may have a material adverse effect on our business." Osiris is telling you, if Genzyme (now Sanofi) walks, it bad news.

...Need For Cash...

The final area of concern for Osiris is its cash position. Osiris exited 2011 with $48 million in cash and investments – a nice number, but not nearly enough to fund operations to cash flow positive. I expect operating burn to approach $25 million in 2012. And, with Sanofi no longer helping to foot the bill for Prochymal, we expect cash to run out sometime in 2013. Therefore, I expect that management will look to raise cash during the second half of 2012. The current market capitalization is $175 million. Should Osiris seek to raise $35+ million, a fair estimate for what they would need to raise to keep development of Prochymal and its biosurgery efforts on track, it would be 20% dilutive to current stockholders.

I view Prochymal as a failed product. I expect management will continue to spend on clinical trials testing the drug in things like Type-1 diabetes, Crohn’s disease, and GvHD where it has failed in the past. I expect Chondrogen will remain on the shelf. Without Chondrogen, without Sanofi, and with expected rejections from Health Canada on the horizon, I think the shares have meaningful downside over the next few quarters.

There's no way to support the current market capitalization of $175 million given my belief that Prochymal has near zero commercial use. The biosurgery business generated revenues of $1.3 million for all of 2011. Grafix and Ovation are expensive, and lacking broad-scale reimbursement. Until we see formulary coverage, Biosurgery is a non-factor in the valuation.

I recommend avoiding the stock. Shorting biotech stocks is ultra-risky. If one were to short Osiris at today's price of $5.15 per share, I'd put a stop at $5.40 (+5%). I would not cover until the stock failed the current range, below $4.40 per share. If that happens, it could see $2.

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