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Price and Expectation Reset Creates Buying Opportunity

Last week, a small biotech stock Theravance Biosciences (Nasdaq: TBPH) had a 20 percent one-day plummet in reaction to disappointing quarterly revenues and earnings. It’s part of a larger decline that saw the share price crater from an all-time closing high of $42.56 on June 22 to $23.96 as of close on Thursday.

Theravance Biopharma was spun off from Innoviva (Nasdaq: INVA) (then known as “Theravance, Inc.”) in 2014. Innoviva became strictly a royalty-management company while Theravance Biopharma retained the product pipeline—the classic split of a company into income and growth components.

As several of Theravance’s products advanced in the pipeline, excitement built and exuberant buyers pushed the share price above $40. But after Theravance reported strong enough late-stage clinical data to file for FDA approval for revefenacin, its most advanced drug in the pipeline, some shareholders sold their holdings in what appears to be a case of “buy the rumor, sell the news” profit taking.

Revefenacin has shown very good efficacy and safety profiles during testing and will likely become the first once-daily nebulized treatment (delivered via a machine called a “nebulizer”) for chronic obstructive pulmonary disease (COPD), which includes a number of progressive lung diseases characterized by increasing breathlessness. Theravance will receive 35 percent of profits from its Mylan (Nasdaq: MYL)—its partner on the revefenacin program—for U.S. sales.

A nebulizer differs from an inhaler in that the machine is electric- or battery-powered and the patient only has to place a mouthpiece in his/her mouth or a mask over his/her mouth and nose in order to consume the medicine in mist form. This results in a more efficient delivery than inhalers, which require a little more work and sometimes—especially true for children and the elderly—inhaling the medicine properly can be difficult.

Two other programs that Theravance is particularly excited about are gastroenterologic.

During the earnings conference call, the company reported top-line results from Phase 2b trial of velusetrag, being evaluated as treatment for gastroparesis, partial paralysis of the stomach which prevents the emptying of food, a condition of unmet medical need. Different dosages of velusetrag were tested, and only the lowest dose (5mg) exhibited symptomatic benefits, probably due to higher doses causing other problems.

The 5mg data showed sufficient efficacy to move the drug to Phase 3 development, expected to consist of two separate trials lasting one year.

The other drug management reported on was TD-1473, a JAK inhibitor, a class of medication that has therapeutic application in the treatment of inflammatory diseases and cancer. In the case of TD-1473, Theravance is first targeting patients with moderate to severe ulcerative colitis (inflammation of the colon lining). Early-stage tests on a small number of patients over four weeks suggested that the drug was able to locally target the affected areas without affecting the patients systematically, which can lead to undesired side effects. Patients showed good tolerance of the drug. The early results supports continued development of the drug. Theravance is now enrolling two larger groups of patients for further Phase 1b testing.

The market, however, seemed to want more data from TD-1473, and along with a revenue and earnings miss, punished the shares severely. The fact that expectations had previously run too high likely contributed to the selloff.

The early data on both early-stage drugs, however, suggest good efficacy and tolerability that support further development.

Besides the aforementioned products in the pipeline, Theravance has 7 other potential drug candidates in the pipeline.

Additionally, Theravance has an 85 percent interest in the royalties due Innoviva from GlaxoSmithKline (NYSE: GSK) (upward tiering of 6.5 percent to 10 percent of annual net global sales) for the upcoming closed triple COPD therapy, which consists of three classes of drugs combined and delivered via an inhaler. GSK has already filed for FDA approval and a decision is expected before the end of this year. This means Theravance could begin receiving cash royalties in early 2018. Peak sales for the closed-triple therapy is estimated to be a $1 billion or more per year.

Theravance also has VIBATIV, its only marketed drug, a treatment for staph infection that has showed superior efficacy to competing drugs. This drug currently contributes only about $17 million a year, and essentially functions as cash generator to fund the development of the pipeline.

The company ended the first half with nearly $500 million in cash and cash equivalents online, and projects a net operating loss of about $210 million for 2017, excluding share-based compensation. This is about $10 million higher than its previous guidance, driven by accelerated spending associated with the JAK inhibitor program.

We note that the “Oracle of Boston” Seth Klarman’s highly successful Baupost Group hedge fund owns 9.27 million shares of the stock (or 17.2 percent of the company). Even after the price drop, that position is worth more than $220 million. Considering the average daily trading volume over the past three months is less than 265,000 shares, a huge position like that makes it extremely difficult for Baupost to exit without taking a major haircut. In other words, in order to buy a high-conviction stake in a tiny company like that, Klarman better be very sure of the investment.

With biotech companies in their early stages, volatile stock price movement is common. We often caution our readers not to chase a rally after big upward moves because expectations have become too high, but after a price reset, as TBPH has just experienced, provided no fundamental changes have occurred with the company, it’s time to consider buying.

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