Top-line phase 3 data results for Ziopharm Oncology's (NASDAQ:ZIOP) anti-cancer drug Palifosfamide will be announced in the last week of March. Ahead of the data, we review herein the bull and bear arguments, and present results from our fair-value model and discuss approaches to trade the event. We view the trial as having a 60% chance of success but investors need to pay careful attention to ZIOP's balance sheet in order to make the right trade.
The Bull Thesis
The bull thesis on ZIOP ahead of the data centers around 3 main points as outlined below:
Palifosfamide is the Active Metabolite of Ifosfamide
Palifosfamide (PALI) is the active metabolite of the anti-cancer drug Ifosfamide (IFOS). IFOS is actually a prodrug that must be metabolized in the body to produce the DNA alkylator isophosphoramide mustard. Along with this desired active drug, IFOS metabolism produces inactive metabolites acrolein (which is urotoxic) and chloroacetaldehyde (neuro- and nephro-toxic). Palifosfamide is a tris-stabilized version of isophosphoramide mustard. Because the drug contains only the active metabolite of IFOS, it cannot be metabolized into acrolein or chloroacetaldehyde leading to a higher maximum tolerated dose. In clinical studies, the maximum tolerated dose of single-agent PALI was reported to be equivalant to an IFOS dose of 15 - 30 g/m2/day, an IFOS dose that cannot be achieved in practice. Furthermore, since PALI does not require metabolic activation, more uniform performance across patients is expected compared to IFOS which relies upon a patient's metabolism to be converted into it's active compound.
Phase 2 PICASSO Trial Succeeded
In the phase 2 PICASSO trial of Palifosfamide in advanced unresectable or metastatic Soft Tissue Sarcoma (STS), the combination of PALI and doxorubicin (DOX) demonstrated a 3.4 month progression free survival (PFS) benefit compared to DOX alone. According to data presented at ASCO in 2010, patients on PALI+DOX had PFS of 7.8 months while patients on DOX alone had PFS of 4.4 months (hazard ratio 0.43 p=0.019).
The current phase 3 trial, PICASSO III, is designed to detect a PFS hazard ratio of .6 with 85% confidence - equivalent to a 3 month median PFS difference between the PALI+DOX arm vs the DOX+Placebo arm. Since the phase 2 trial showed a 3.4 month PFS, bulls argue that a similar result should be seen in this trial. However, the optimism is not simply due to the phase 2 trial, read on.
EORTC 62012 Trial Results Point to Success in PICASSO III
The third major point in the bull thesis is that the EORTC 62012 trial of IFOS+DOX vs DOX in advanced unresectable or metastatic STS (the same population as the phase 2 PICASSO trial), showed a control arm (DOX mono-therapy) median PFS of 4.6 months and a DOX+IFOS arm PFS of 7.4 months. Bulls argue that the 4.6 month median PFS for the DOX arm in this trial, being very closely matched to the 4.4 month median PFS from the PICASSO trial suggest that the current phase 3 trial's modeled control arm median PFS of 4.3 months is a good design and likely to succeed.
The Bear Thesis
The bear thesis on ZIOP is partly about the trial result but also partly about the overall approval prospects of Palifosfamide.
PICASSO III Trial is Different than PICASSO and EORTC 62012
Both the PICASSO phase 2 trial and the EORTC 62012 trial addressed the patient population of advanced unresectable STS as well as front-line metastatic STS. In contrast, the PICASSO III trial is strictly in front-line metastatic STS. This means that some patients in PICASSO and EORTC 62012 were second line (specifically for PICASSO 1/3rd of the patients were second line), and therefore we can assume they were sicker. If the "healthier" patients in PICASSO III, on average, respond more favorably to the single agent DOX treatment, the hazard ratio for PALI+DOX might be much higher than seen in previous trials. We view this argument as having little merit since differences in patient populations are likely to affect both treatment arms equally.
On the other hand, a clear difference between PICASSO III and both the EORTC trial and the phase 2 trial is that PICASSO III is a double blind placebo controlled trial whereas,the other trials were open label. Patients and clinical site investigators in the PICASSO phase 2 trial and the EORTC trial knew whether they were on the single-agent DOX arm or the combination therapy arm (note the independent radiology readers were still blinded in these trials making the PFS readings reliable). In the PICASSO III trial, the control arm receives DOX+saline in volume equivalent to the volume of PALI given to treatment arm subjects. This means that the phase 3 trial is more susceptible to the placebo effect than the previous trials. We note that a meta-analysis published in the Journal of the National Cancer Institute found that, while placebo controlled oncology trials tend to show better responses to pain and other symptoms, they rarely lead to objective tumor responses. The placebo effect is thus most likely to affect the secondary outcome measures of health related quality of life potnetially reducing any benefit of PALI+DOX campared to DOX alone.
While the phase 2 PICASSO trial involved 23 treatment sites with just 5 outside of the US, the PICASSO III study involves 162 sites with over 80 outside the US. While this is a requirement to enroll enough patients in this rare cancer type, enrollment in controlled clinical trials in certain countries may lead to better outcomes due to a generally increased level of care compared to patents not involved in a clinical trial. We do not expect this to be a factor in the timing of disease progression, but it could explain why observed PFS benefits might not translate into overall survival benefits.
EORTC Trial Actually Failed
Bears are correct to point out that the EORTC trial actually failed to show an overall survival benefit for IFOS+DOX compared to DOX alone. Given the severe side effects seen in the IFOS+DOX arm, the conclusions drawn from the study were that:
Doxorubicin remains the gold standard first line chemotherapy of patients with metastatic soft tissue sarcoma. Significantly improved overall survival was not demonstrated by combination therapy and routine use of ifosfamide/doxorubicin was not supported, although response rates suggest that ifosfamide/doxorubicin may be justified in selected patients younger than 60 years where tumor shrinkage is critical, bearing in mind the higher toxicity rate.
Bulls focus on just the 4.6 month DOX arm median PFS and the 2.8 month PFS benefit as the key takeaways from the EORTC trial; however, since full approval will depend on demonstrating an overall survival (OS) benefit, bears argue that the EORTC results reflect negatively on Palifosfamide's chances. Also of note, the PFS hazard ratio of 0.72 in the EORTC trial is larger than the designed hazard ratio of 0.6 for the PICASSO III trial.
PICASSO III Trial Had Problems Early On
When the PICASSO III trial was launched in Q3 2010, ZIOP expected full enrollment to complete by the end of 2011. However, just a few months later, in their 2010 form 10-K here is what ZIOP said about the trial enrollment:
We commenced the PICASSO 3 pivotal trial for IV palifosfamide early in the third quarter of 2010. The trial is in front-line metastatic soft tissue sarcoma, entitled PICASSO 3, and is an international, randomized, double-blinded, placebo-controlled trial with a targeted enrollment of 424 patients. To date, the Company has experienced slower than anticipated enrollment in the trial due in part to the timing of regulatory approvals for opening trials sites and unanticipated contractual delays attributable to international healthcare budgetary constraints. The Company has taken steps to accelerate patient enrollment in order to meet its previous forecasted timeline for full enrollment by the end of 2011
Later, in their 2011 Q1 form 10-Q the company adds to the above explanation:
Also affecting the enrollment and pace of the study is a recent limited supply of doxorubicin necessary for the trial. If the Company cannot accelerate enrollment in the PICASSO 3 study to meet its forecasted timeline, if limited supply of doxorubicin prevents treatment of patients in the trial, or the trial is delayed for other reasons, the delay will postpone our receipt of results from the trial and, consequently, our ability to submit a corresponding NDA with FDA for regulatory approval in accordance with our plans.
In other words, supply problems with DOX affected the trial enrollment and may have affected treatment of patients (the pace of the trial). These early problems were resolved before Q3 2011, but they clearly affected the trial's enrollment. Full trial enrollment was originally forecasted to complete by the end of 2011, later forecasted for Q1 2012 and finally achieved in late Q2 2012.
PFS Events Might Have Been Happening Slower Than Expected
As late as August of 2012, the company was predicting that the PICASSO III trial would reach it's targeted number of PFS events for unblinding by the end of 2012. However, in November 2012, the company announced that the Independent Data Safety Monitoring Committee projects that the triggering PFS event would occur sometime before the end of Q1 2013. One possible interpretation of this timeline slippage is that the control arm of the study may be responding better than anticipated to the treatment. If this were the case, the PFS benefit for the PALI+DOX arm might be much lower than anticipated. However, given that earlier projections by the company were confounded by slower than expected trial enrollment, bulls will argue that the delay in actual vs. projected event rate is not meaningful.
Accelerated Approval Based on PFS is Not a Sure Thing
Bears correctly point to the fact that ZIOP chose to forego a special protocol assessment (SPA) for the PICASSO III trial based on discussions with the FDA. At issue was that FDA wanted overall survival as the trial endpoint in order to issue an SPA. Instead, based on recent FDA approval actions of other oncology drugs ZIOP chose to commence the PICASSO III trial without an SPA seeking accelerated approval with PFS followed by full approval after demonstrating an overall survival benefit. This approach requires a robust PFS benefit with balanced safety profile. ZIOP management is confident that Palifosfamide will show balanced safety compared to DOX alone based on their earlier clinical trial work. But should the PFS benefit come in much below the 3-month target, an overall survival benefit may be elusive.
In a very recent development, at the Barcaly's Global Healthcare Conference on March 13, ZIOP CEO Jonathan Lewis suggested that the PICASSO III trial's primary efficacy endpoint has been changed to just PFS (it used to be PFS followed by OS), and that the company and FDA have agreed that PFS would suffice for FULL approval. Here is what Lewis said:
Notable and new is the following -- and that is in the study, as of now, PFS is the primary endpoint and for protocol, its primary endpoint, full approval. OS is a secondary endpoint. This modification has been done, incorporating changes with dialogue with FDA.
He later reiterated:
Again, consistent with FDA policy as articulated by them, and again, consistent with the amendment, as done now, to this protocol, with PFS as a primary endpoint, for full approval.
If these statements accurately reflect FDA's stance on the issue, this particular bear argument is no longer valid.
Fair Value Model
Having gone over the main points of the bull and bear thesis, the next step is to figure out the correct trade. For this we employ a very simple model to determine fair value ahead of the binary event. We described this simple model in an earlier Red Acre Insight ahead of the Celsion HEAT trial data. In essence, the model calculates a probability weighted fair-value using the extreme valuations for a firm based on positive or negative outcomes from the trial. This model requires estimated valuations for the company on trial success and failure as well as the estimated probability of trial success in order to yield a fair value.
Should the PICASSO III trial succeed, we value the company at 3 times expected peak revenues (for the STS indication). We estimate peak world-wide sales of Palifosfamide for STS at roughly $330 million which is in-line with company estimates for us-only sales (see slide 18 in this presentation). While the company based it's market sizing on prescription data from IntrinsicQ Data for first-line STS, we note that with 11,000 newly reported STS cases per year and 4,000 deaths due to the disease, these numbers may be an over estimate of US-only sales.
Based on our $330 million peak revenue estimate, a 3x revenue multiple (equivalent to peak revenues in year 5 discounted at 10%), we employ a positive outcome market cap of $990 million.
Should the trial fail, we value ZIOP at twice cash value. As of Q3 2012, the company reported $95.3 million in cash. We note that, in all of it's recent presentations, ZIOP continues to use the 9/30/2012 cash position number of $95.3 million and guides "cash to last into 2H2013." Furthermore, the company has yet to release it's year-end 2012 results. Our view is that the company may delay release of the 2012 10-K until after the top-line results are announced in order to minimize focus on their cash position. While the company burned $57.3 million in cash during the first 9 months of 2012 indicating a monthly cash utilization of $6.3 million, this likely under-estimates their cash usage going forward. In their Q3 2012 report the company states that:
Our current plans involve using our principal internal financial resources to develop palifosfamide and to extend the synthetic biology program, with the intention of ultimately partnering or otherwise raising additional resources to support further development activities for all of our product candidates. Based on these plans, we expect to incur the following expenses during the next twelve months: approximately $91.5 million on research and development expenses and approximately $22.9 million on general corporate and administrative expenses.
Adding up the R&D and G&A projected expenses, the company expected to use $114.4 million over 12 months - a burn rate of $9.5 million/month. By the end of March, the company will have burned 6 months worth of cash since their Q3 report - or nearly $57.2 million; therefore, when the trial data are announced we estimate the company should have approximately $38.1 million on-hand. For our model we use 2X cash as the downside value or a market cap of $76.2 million. The excess over cash value is attributed to a fire-sale valuation on ZIOP's pipeline. In actuality, the rest of the pipeline is likely worth considerably more than $38.1 million.
Next we need to calculate the true share count. The company reports 83.2 million shares currently outstanding; however, this does not count 13.18 million shares issuable due to warrants, and 4.98 million shares issuable due to options. Thus, for our purposes, we use a fully diluted share count of 83.2 + 18.16 = 101.36 million. In our simple model we use the fully diluted share counts because it yields more conservative estimates than using the as-reported shares outstanding. Using these numbers, on a positive outcome, our fair-value model assumes a share price of $9.77 and on a negative outcome the model assumes a price of $0.76.
At Red Acre, our view is that, on balance, ZIOP's PICASSO III trial has a 60% chance of success. We find the bear arguments regarding the difference in trial populations and the delay early on in the trial rather weak when weighed against the fact that Palifosfamide should deliver the benefits of Ifosfamide without it's attendant toxicity. Furthermore, the phase 2 PICASSO trial results are promising; although extrapolating from a 66 patient trial to a 424 patient trial is risky and the observed hazard ratios will most assuredly be higher than those seen in the phase 2 trial. The regulatory pathway argument, based on recent developments, may be invalid and in any event it has no bearing of the outcome of the trial itself in our view.
Using our 60% probability of success, our model yields a fair value of $6.17. Note that if we gave the bulls and bears equal weight, our model indicates risk-adjusted fair value of $5.27.
How to Trade the Event
For investors on the sidelines, our fair value model indicates that the stock is either at fair value, or quite close to it depending upon the probability of success one assigns to the event. In this scenario, an options straddle may be the best way to trade the event. The April $5 options straddle (long both calls and puts) currently trades for $2.70. This straddle trade is likely to be profitable as long as the trial either meets it's target 3-month PFS endpoint, or if the trial fails miserably. What is uncertain is how the trade would work out if the results are positive, but fall short of the 3 month PFS benefit. For example, if the PALI+DOX combination shows a 2 month PFS benefit, there would be major doubt regarding whether or not FDA would grant the drug accelerated approval. In this scenario, we see the company's weak cash position relative to projected needs as the determinative factor in which way the stock trades.
For investors already long the stock, protection with puts, or further reduction of cost basis with a July covered call strategy should be considered. Based on our cash position calculations above, we estimate that the company has enough cash to last just through July; therefore, they will raise cash between now and then.
Investors should also keep in mind that this Friday is the last trading day for March Options. Furthermore, many biotech traders who play the run up but do not hold through a binary event will be selling next week. This may blunt the recent upward momentum of the stock in the week prior to the data release.
(ZIOP 1-year daily stock chart - click to enlarge)
Don't Forget About Bear Raids
ZIOP's chart created a perfect pennant formation from mid to late February (see chart above). Since the beginning of March, the clear breakout from the pennant indicates the runup trade ahead of the data. Whenever a stock makes such a sharp upward move, momentum traders are piling into the stock and will generally use stop-loss orders to minimize their potential downside risk. After a strong run, a "bear raid" is something to watch for. Dumping several tens of thousands of shares on the market when volume is relatively light can trigger a cascade of stop loss orders which results in a sharp drop in share price to below recent support levels. Being caught in a bear raid when you are long the stock is not fun. However, if you are prepared, bear raids can offer shares at a steep discount. Generally speaking, the dip in share price is short lived, and the stock may recover to within 10% - 20% of it's previous highs.
One of the factors that seems to correlate well with the possibility of a bear raid is a high short interest in the stock. As of the latest short interest reporting date, ZIOP had 12.34 million sahres short, representing 21.8% of the public float. This is not a particularly high short interest, and given the company's need to raise cash, buy-side investors who are short are not likely to be too worried about covering ahead of the data event. Nevertheless, a standing order to purchase shares at a price well below market just might get filled if a bear raid occurs. For ZIOP we see levels from $4.10 - $3.50 as attractive ranges to have standing bids in place to catch a bear raid in progress. Investors should remember to set these bids to automatically cancel before 3/25 to avoid being filled on the order if bad trial data is announced.
How to Play the Event Without The Drama
Given the uncertainties surrounding both the trial data and the volatility in trading, Threshold Pharmaceuticals (NASDAQ:THLD) may be a drama free way to play the binary event. THLD is a derivative trade on ZIOP's data because THLD's compound TH-302 is a pro-drug of palifosfamide with the chlorine atoms replaced by bromine. In the tumor environment, TH-302 is thought to be activated in the hypoxic areas of the tumor but is generally not activated in the normoxic regions. TH-302 is undergoing a phase 3 trial in combination with doxorubicin and, unlike ZIOP, Threshold obtained a special protocol assessment (SPA) for their trial. The company has a collaboration with Merck and due to milestones under this partnership they have over $100 million in cash on hand.
Our view is that THLD potentially benefits no matter which way ZIOP's data goes. If the data are positive the inference is that since TH-302 is a prodrug of isophosphoramide mustard - TH-302's STS trial should also work. On the other hand, if ZIOP's trial fails - the differentiated nature of TH-302 (targeting hypoxic regions of the tumors) means that there is still reason to believe TH-302 could work and with Palifosfamide being out of the running TH-302's addressable market increases.
TH-302 had some disappointing results in a poorly designed phase 2 pancreatic cancer trial last year and shares got taken down 50% because of it. However, the drug did show promise in an earlier phase 2 trial for STS and the current phase 3 STS trial will not read out until sometime next year. As we've described in the past, derivative trades on binary events are an excellent way to participate in the upside without taking on undue downside risk.
As we outline above, both bulls and bears have their reasons for thinking that they are right about the upcoming Palifosfamide trial results. At Red Acre we view the trial as having a 60% chance of success, and we see risk-weighted fair value ahead of the data at $6.17. We expect ZIOP's stock price momentum to pause in the coming week as momentum traders begin exiting ahead of the data event. We view a positive data outcome as pivotal for ZIOP since it validates their oncology program and potentially enables them to begin generating revenues sometime next year if FDA allows the company to file for accelerated approval. Given the company's cash position ($38.1 million cash on hand at the end of March) equivocal or negative trial data will result in an 80% or greater cut to the stock price. Later this year we expect a readout from the AD-RTS-IL-12 phase 1/2 trial in melanoma; however we expect ZIOP to raise cash via sale of equity soon after this binary event and regardless of the outcome of the trial. Given the expected volatility in ZIOP's share price, options straddles, which are essentially non-directional bets on a binary event, and long biased trades in THLD are attractive ways to potentially profit from the data event without taking on unwarranted risk.