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Actionable news in ARWR: Arrowhead Research Corporation,

Unlocking Deep Value With Arrowhead Research

Summary

Arrowhead Research Corporation's share price is tied to the progress of its hepatitis B pipeline.

In 2015, Arrowhead's stock has reacted with stark volatility in both directions following updates on its drug candidate ARC-520.

Smaller biotechnology companies have recently suffered. Success stories especially in the CAR-T space like BLUE or AGIO have seen their share prices shrink by over 50%.

As a result, ARWR's share price has been depressed in a $5-6.50 range despite impressive progress in its quest to cure hepatitis B, a multi-billion-dollar opportunity.

I see an investment opportunity with a highly asymmetric reward/risk profile of at least 100% upside in 2016 and limited downside from the current depressed valuation.

Investment Thesis

Small biotech companies have been painful to watch for investors in recent months. 2015 can roughly be divided into three periods. The first half of 2015 brought outsized gains to speculative biotech companies with cancer immunotherapy leading the way. Then, China tumbled and the US stock market with it, which did not fare well for speculative holdings. This was the first blow. The second blow for biotech was the controversy about predatory pricing practices, which temporarily became a political issue, and the Valeant (NYSE:VRX) scandal. The CAR-T euphoria has noticeably cooled off after many companies reporting trouble at ASH, as detailed in this article.

Who Is Arrowhead?

Who is Arrowhead and what does this mean for it? Arrowhead is a clinical-stage biotechnology company that went public in 2000 and has since then tried to commercialise RNAi therapeutics. In short, RNA interference is a process that enables the selective silencing of genes. RNAi technology was heralded as a once-in-a-decade breakthrough and, around 2005, sparked a euphoria similar to CAR-T therapy this year. The hype soon cooled off when clinical trials showed major obstacles in realizing the therapeutic potential. A more detailed story of RNAi with references to Arrowhead can be found in a 2014 article about the second coming of RNAi. The takeaway from the article is that after many initial setbacks, researchers are now making steady progress in moving RNAi technology from plants and animals to clinical treatments.

The core of my investment thesis is this: Arrowhead has made promising progress and is clearing hurdle after hurdle towards curing hepatitis B. Arrowhead's share price does not reflect adequately this progress or the expected value of its lead product candidate. In part, this is the company's own fault, as I will elaborate. In part, this is due to a more general capital outflow from speculative biotech holdings. In the remainder of this article, I will look at the company's lead product candidate, the hepatitis B market, the competitive landscape and possible outcomes for Arrowhead next year. I will then conclude with a specific recommendation and outline the risk of this position.

Hepatitis B

Hepatitis B (HBV) is an infectious disease affecting the liver caused by the hepatitis B virus. It can occur both in an acute and a chronic form.

It is transmitted through blood and other infectious bodily fluids. Vaccination has been available since 1981 and can safely prevent infections. Acute hepatitis B infections initially do not cause symptoms and may only require supportive treatment.

On contrast, 750,000 people die each year due to chronic hepatitis B infection. Chronic hepatitis B infections are a primary source of liver cancer, which has a five-year survival rate of about 10%. Currently, there is no cure for hepatitis B, but there are seven approved drugs that help patients manage the disease and keep viral load at low levels. Yearly treatment costs range between $5,000 and $35,000. The total hepatitis B market was $3B in 2014 and is projected to grow modestly due to considerable migration into the US/EU from high-prevalence countries. The main issue with the current treatments is their side-effects. For instance, Gilead's (NASDAQ:GILD) Viread carries a black box warning. In a way, the hepatitis B space is similar to the hepatitis C space prior to the once-a-day cure Sovaldi. There are some treatment options to make the disease manageable, but clearly a full cure would provide a billion-dollar opportunity.

The investment thesis on Arrowhead is based on the conviction that after its latest updates, there is a good chance of producing a full cure in the foreseeable...


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