Monday, 9 September 2013

Fund Manager Hugh Cleland Comments On Recent Neptune & Acasti Stock Volatility, Price Expectations

Neptune Technologies and Bioressources
Basic Shares: 60.0 million
Fully Diluted: 67.5 million

Acasti Pharma
Shares Outstanding: 79.4 million
Fully Diluted: 91.4 million

Late Friday, long time proponent of Neptune & Acasti, Hugh Cleland, Portfolio Manager Blumont Capital, circulated his thoughts on the recent share price volatility experienced by the krill oil producers and what he views as reasonable share price targets in the coming years. The following is a full copy of his report.

NEPTUNE: Acasti reported excellent Phase II open label results, Neptune has a new 10%+ shareholder, and there are at least a couple of major Neptune-specific catalysts ahead in the coming weeks and months.

The tragic explosion of November 8, 2012 has cast a long shadow, but we got some great news from Neptune in the May 22 press release and the May 23 conference call: the class action lawsuits are dead, once and for all, and Neptune has received all necessary permits to restart construction on the new production plant in Sherbrooke. (This new plant will be a modified version of the facility which was only 2-3 months from completion at the time of the November 8th explosion, and which was largely undamaged by the explosion.) We also learned that 3 production-outsourcing options are under consideration, and management originally guided that they expect to make a decision on how to proceed with respect to outsourcing by the end of August. (I am now expecting an announcement on this by the end of September.)

What the market doesn’t seem to have figured out from these developments is that, by the end of 2013, we should have visibility on Neptune’s production capacity getting into the 600,000kg to 1million kg/year range1. I expect that the announcement of a significant outsourcing deal, plus more confidence in the completion of Neptune’s own production facilities, will add $2/share or more to Neptune’s share price by the end of the year, meaning we will probably break to new 5-year highs, just on the basis of Neptune-specific events. The developments at Acasti (discussed in detail below) should provide a springboard for another dramatic step-up in value in Neptune’s stock by the end of the year, and during 2014. On a 3-year basis, I would expect to see this stock somewhere in the $15-$30 range.

For those who are interested, I have provided a link to the initiation report from the latest US analyst to pick-up coverage: 

Eye-opening addition to the Neptune and Acasti shareholder base: George Haywood
George Haywood now owns 6,857,762 shares, or 11.39% of Neptune. These shares were accumulated for his personal account, and were accumulated in the open market between December of 2012 and now. He has also accumulated about 1.5million shares of Acasti, and I am guessing he will buy more in the weeks and months ahead.

George Haywood is a remarkable individual. He was the head of corporate bond trading for
Lehman Brothers from 1987-1994, then headed up corporate and high yield bond investing at hedge fund Moore Capital Management from 1994-1998. Since 1998, he has been managing his own money—very successfully I might add. I will dig more into his history when I have time, but from the conversations I have had with him about his past, and how he came to be an investor in Neptune, it is clear he likes to get deeply involved with companies, establishing big positions, and then helping the companies in a variety of ways—on a few occasions, going as far as joining the Board. Of the many big wins he has had, the two that have the most relevance to Neptune are Martek (formerly MATK on NASDSAQ; acquired by DSM in 2011), and Sarepta Therapeutics (SRPT on NASDAQ).

Sarepta is a biotech stock that—based at least in part on the additions that George helped make to the Board and management—was one of the top-performing NASDAQ stocks in 2012, as it traded in the $3-$6 range for much of the year, before hitting a high of $45; in 2013, it  has traded in a range of $24 to $47.

Martek is particularly relevant because it was the first publicly traded Omega-3 stock.

(Martek’s marine algae-derived DHA is now in almost 90% of DHA-enriched baby formula sold in North America.) George was an early investor in Martek, and became close to the founders before declaring a 5%+ stake in May of 1999 when the stock traded in a range of $6-$12. He exited in the $40-$60 range in 2003. George even used Martek’s founders as part of his due diligence on Neptune, and he has commented to me more than once that he considers Neptune to be his “next Martek”. If George is right about that, it will make my 3-year target range of $15-$30 look conservative.

ACASTI: the Phase II open label clinical data support my long-standing contention that Acasti could ultimately have a value in the $1billion to $5billion range.

On August 13, Acasti released “best in class” data from their Phase II open label trial, which
tested the effect of CaPre (Acasti’s phospholipid Omega-3 drug candidate) on triglycerides, and other blood lipid components, including LDL (bad cholesterol) and HDL (good cholesterol). In a population for which 88% of the patients started the trial with "mild-to-moderate" hypertriglyceridemia (“HIGH triglycerides”; TG 200-499mg/dL), a 4g/day dose of CaPre caused three primary effects after two months:

1) A decline of 21.6% in triglycerides;

2) A decline of 8.3% in LDL (and, more importantly, a decrease in non-HDL cholesterol of

14.3%); and

3) An increase of 11.1% in HDL.

On the back of this data, Doug Loe, PhD, the biotech analyst at US-based EuroPacific Securities, raised his 1-year target on Acasti from $4.75 to $6.75—because he saw the data as a significant risk-reduction event for Acasti, and therefore lowered the discount rate he uses to calculate Acasti’s NPV from 30% to 20%. (It’s worth noting that a reduction in the discount rate to 15% boosts Acasti’s NPV to $10.78/share; I would expect events that will allow Doug to reduce his discount rate to 15% to occur in the next 4-6 months.)

Statements from the report that bear highlighting include:
1) “magnitude of triglyceride reductions from baseline were strong for this patient population”. 
2) “relative magnitude of triglyceride reductions compared to alternative lipid-lowering

therapies was equally strong”.

3) “LDL/HDL data is industry-leading for any Omega-3 formulation we have reviewed”.

A link to the report in its entirety is here:

In my view (and more importantly in the view of Dr. Harlan Waksal), we have the best in class Omega-3 drug, and—based on the LDL and HDL effects—we may even have something quite special. Based on a variety of industry benchmarks (including the $1.65billion acquisition of Reliant by GSK to obtain fish oil drug Lovaza), the best in class Omega-3 drug should be worth over $1billion, and potentially a lot more. Dr. Waksal believes that if the data from the Phase III pivotal trial looks as good as the open label data, then it means CaPre should be a billion dollar drug, and that—once positive clinical outcome data is out for the Omega-3 drugs—we have a drug that could sell upwards of $5billion per year.

So, why did the stock decline after the data came out?
The lack of a statistically significant number of subjects with a starting point of VERY HIGH
triglycerides (TG >= 500mg/dL) created more confusion and uncertainty than I would have expected. In my view, that effect is significantly overdone now, and as the confusion and uncertainty are lifted, the stock should begin lifting again. This really was the only frustrating aspect to the open label data we saw—it didn't have a statistically significant number of VERY HIGH triglycerides patients so that investors could easily do an apples-to-apples comparison with the other Omega-3 drugs. The data that investors are most familiar with from the other Omega-3 drugs are from VERY HIGH triglycerides populations, where declines in triglycerides levels are always higher on average than those seen in HIGH triglycerides populations; in HIGH triglycerides populations, across all 3 of the main lipid components (triglycerides, LDL and HDL), the data from Acasti’s CaPre is better than the data from Amarin’s Vascepa, and Omthera’s Epanova, and is infinitely superior to GSK’s Lovaza in the HDL and LDL readings.
(Lovaza actually increases bad cholesterol, and has no impact whatsoever on HDL.)
Here is the extrapolation that the market has so far been unwilling to make: based on what we know about Omega-3, an Omega-3 drug that is superior in HIGH triglycerides populations will be superior in VERY HIGH triglycerides populations. I have been immersed in Omega-3 science and data since 2005 when I first purchased shares of NTB, so I don’t really even look at this as an extrapolation—I see it almost as fact. Some agree; others need more time to get there.
Another factor in the decline since the results came out was uncertainty created by purchase
warrants that were scheduled to expire on October 8th. They have now been exercised: my
understanding is that insiders sold just enough stock to cover the exercise price of the warrants, and to cover the cash tax liability resulting from the exercise, but net added to their position in the stock substantially. Great news: George Haywood was among the buyers of the stock from the warrant exercise. This source of pressure and uncertainty is now behind us.

An upcoming FDA advisory committee meeting regarding Amarin’s HIGH triglycerides
indication has also caused uncertainty in some investors’ minds.

GSK’s Lovaza and Amarin’s Vascepa have already been approved for use in patients with VERY HIGH triglycerides. But Amarin has applied for, and is still awaiting final FDA approval for the HIGH triglycerides indication. The expectation is that approval of the HIGH triglycerides indication will expand the market for Vascepa (and Acasti’s CaPre) dramatically, because there are about 7 times more patients with HIGH triglycerides in the USA than with VERY HIGH triglycerides (13% of the population, versus less than 2% of the population). Some investors think that if the FDA does not approve HIGH triglycerides as an indication, that it will be a hit to Acasti’s stock. I don’t think this would necessarily be the case, for at least 4 reasons:

1) I would argue that any hit we might have taken from that decision has already been more-than-accounted-for by the move in Acasti’s stock from its recent high of $4.32 to the current level.
2) GSK’s Lovaza was able to attain sales of $1.2billion/year while only having approval for the VERY HIGH indication. In fact, most of the prescriptions written for Lovaza are “offlabel” i.e., most of the Lovaza prescriptions are written for people with HIGH triglycerides, as opposed to people with VERY HIGH triglycerides. (The point being that
an Omega-3 drug does NOT need to have HIGH triglycerides approved as an indication
to have lots of HIGH triglycerides patients use it, and end up with sales over $1billion.)

3) As I have thought about Acasti’s future in the past (and now), I actually never assumed
that HIGH triglycerides would be approved as an indication, because I have always known that it was not a slam-dunk that the FDA would approve HIGH triglycerides as an indication. 

I have always believed that being the “best in class” Omega-3 drug would result in having sales of over $1billion, even based upon CaPre “only” having FDA approval for the VERY HIGH triglycerides indication—because “off label” prescriptions would get us to that level. Now that this Phase II data has shown that we (with a very high probability) have the best Omega-3 drug in the HIGH triglycerides area, we know that Acasti—with the right pharma marketing partner—should be able to sell over $1billion of CaPre, even if the VERY HIGH triglycerides label is all that we end up having.

4) Simply put: if the FDA decides that the only indication that any company can get is for
VERY HIGH triglycerides, then it is a slam-dunk that the company with the best HIGH
triglycerides data will—with the right pharma partner—get the most sales. The great thing is that Acasti has the best data in the HIGH triglycerides population.

The bottom line is that Acasti wins, regardless of whether the FDA advisory committee approves the HIGH triglycerides indication or not.

It may take a while for investors to grapple with the nuances around these issues—therein lies the current opportunity for investors willing to step in now. Nonetheless, we have now seen clinical data which reaffirms my belief that CaPre will be, at least, the “best-in-class” Omega-3 drug, and may even be something truly special. Remembering that GSK acquired Reliant (to acquire Lovaza) for $1.65billion in 2008, and then ramped sales of Lovaza to over $1billion within 2 years, I expect that pivotal Phase III results which once and for all confer “best-inclass” Omega-3 drug status upon CaPre should result in a takeout of Acasti for somewhere over $1billion (over $10/share), and perhaps somewhere in the multi-billion area. It is this logic and these facts which underpin my expectation that Acasti will be trading somewhere in the $10- $30 range within 1-2 years.

1 Getting to the stated objective of 600,000kg/year will occur through a combination of the stated 150,000kg/year of “internal” capacity, and an outsourcing deal, which will be decided upon soon. If they decide to enter into a second outsourcing deal of a similar size, that would give visibility to capacity closer to 1million kg/year.