This article is excerpted from a letter by MOI Global instructor Jim Roumell, portfolio manager of Roumell Asset Management, based in Chevy Chase, Maryland.

RAM investors know our long history with PRTK, a small biotech company focused on developing novel antibiotics in a world desperately in need of them. We originally invested in PRTK in 2014 when its lead drug—omadacycline—was ready to enter its first, of what would ultimately be three, Phase 3 trials. RAM exited two-thirds of its position roughly one year ago at about $27/share (the stock currently trades at about $6/share). At the time of our exit, while FDA approval appeared increasingly likely (and priced-in to the stock), dilutive, albeit necessary, capital raises materially reduced our estimate of the company’s per share intrinsic value.

Recently, we’ve been rebuilding our position in reaction to: 1) Omadacycline (now renamed NUZYRA for commercial purposes) receiving FDA approval with an exceptionally “clean” label and 2) PRTK’s stock price dropping to a value that we find exceptionally compelling. In contrast to our original investment thesis that hinged on FDA approval, today our PRTK investment is predicated on commercialization success. NUZYRA is the first FDA-approved once-daily, IV to oral antibiotic to treat both pneumonia (CABP) and skin infections (ABSSSI) in nearly twenty years. We do not believe PRTK’s drug is another “me-too” antibiotic.

The company’s vision for NUZYRA is clear. From its 12/31/18 10K, “We believe that NUZYRA has the potential to become the primary choice of physicians for use as a broad-spectrum monotherapy antibiotic for ABSSSI, CABP, UTI and other serious community-acquired bacterial infections, where resistance is of concern. We believe NUZYRA will be used in the emergency room, hospital and com- munity care settings. We have designed NUZYRA to provide potential advantages over existing anti- biotics, including activity against resistant bacteria, broad-spectrum antibacterial activity, oral and IV formulations with once-daily dosing, no dosing adjustments for patients on concomitant medications and a generally safe and well tolerated profile.”

To recap the problem: Some twenty-five years ago, pharmaceutical companies pursued a business model of cheap and abundant antibiotics with the intent to “make it up in volume.” Antibiotic usage skyrocketed. Branded drugs eventually went off patent and drug prices dropped even further as generic versions became widely adopted. Pharmaceutical companies pulled back on antibiotic development because the return on investment was no longer economical. Over time, as bug resistance grew, and antibiotic development fell-off, we entered a period of antimicrobial resistance that leading health organizations around the world now regularly describe as being a “crisis.”

Governments, showing increased alarm in recent years, have entered the fray to help spur antibiotic drug development. For example, in 2012, the U.S. Congress passed the Generating Antibiotic Incentives Now (GAIN) Act as part of the Food and Drug Administration Safety and Innovation Act (FDASIA) to encourage the development of new antibiotics. Effectively, the government, on a bipartisan basis, endorsed a price increase for antibiotics, even while fighting to decrease the cost of many other drugs. GAIN was embedded in the FDA Safety and Innovative Act (FDASIA) and passed the House with a vote of 387 to 5 and the Senate by a vote of 92 to 4.

The Pew Foundation’s Antibiotic Resistance Project’s team is credited with providing the leadership to getting the GAIN Act passed. In our discussion with members of Pew’s project team, they indicated that they view GAIN as a “first step” in a broader set of solutions to address the economics of antibiotic development. They shared with us their current efforts working with all stakeholders to create a unified legislative “ask” that they hope to propose to Congress in the near future.

Lord Jim O’Neil, Chair of the Chatham House think tank and former Goldman Sachs chief economist, headed up a British government global review of antimicrobial resistance in 2016. He believes the problem is so severe that he’s recommended government bonus payments of between $1 billion and $1.5 billion for any successful new antibiotic drug. In the book “Super-Bugs—An Arms Race Against Bacteria,” published in 2018, the authors highlighted a variety of market-oriented ideas percolating to reward antibiotic development or warn that it will need to switch to a publicly-financed system.

If the macro industry dynamics aren’t bad enough with plentiful cheap generics and payor pressures, the micro factors are daunting as well. The antibiotic market is very complex. No two antibiotics are the same, patients respond differently, and doctors have to make choices involving these issues as well as considering ease-of-use. Two years ago, two of PRTK’s would-be competitors, Cempra, which was acquired by Melinta (MLNT), and Tetraphase (TTPH), were each valued at $2 billion in the public market. Both companies have been big disappointments, with Cempra failing to get its drug approved by the FDA. Recent “failure to launch” events have cast a pall over the entire antibiotic industry, i.e., when the cops show up, sometimes the innocents get rounded up, too.

Why invest in an emerging antibiotic company with the uphill challenge of differentiating one’s product in a crowded space with pricing pressures? First, for the reasons cited above, there is tremendous disdain for the entire antibiotic space. Achaogen’s (ACHO) announcement to file for bankruptcy protection on April 14th has further cast a dark cloud over the industry. Second, we believe PRTK has the right stuff— a differentiated product designed for a niche market in instances where generics are not appropriate and a AAA-rated management team that knows how to execute.

Evan Loh, MD, PRTK’s President and Chief Operating Officer, and Adam Woodrow, Chief Commercial Officer, launched Tygacil in 2006 while working at Wyeth. Wyeth was subsequently purchased by Pfizer where Evan served as Senior Vice President of Development and Strategic Operations, Worldwide Research and Development from October 2009 to January 2012. Tygacil reached over $400 million in peak sales despite being IV-only and possessing a black-box warning noting increased risk of death such that its use is restricted for situations in which alternative treatments are not suitable. Evan was recently named the new Chairman of the Antimicrobials Working Group (AWG). AWG was founded in 2012 in order to improve the regulatory, investment and commercial environment for emerging infectious disease companies. On April 1, 2019, the American Chemical Society awarded a Heroes of Chemistry Award to the scientific team that worked on NUZYRA (omadacycline) and Seysara (sarecycline). Evan received the same award in 2006 for the development of Tygacil.

One antibiotic industry analysis succinctly summed up the environment’s risks and opportunities: “One of the major areas of debate has centered around the reimbursement for antibiotics in the hospital set- ting. Hospitals face the challenge of a fixed payment system in the diagnosis-related group (DRG) world. Convincing hospitals to put a premium priced drug on their formularies in a fixed-payment environment is a challenge, even if backed by the most solid clinical data. Hospitals, already operating on tight margins, are responsible for any expenses incurred beyond the flat reimbursement rate they currently receive under the longstanding DRG system. Therefore, an oral antibiotic that can shorten the length of hospital stay should have a significant pharmacoeconomic value.” We’re well aware of the fact that PRTK undoubtedly faces reimbursement risk.

In December 2018, Senators Hatch and Casey introduced S. 3787, the Developing an Innovative Strategy for Antimicrobial Resistant Microorganisms (DISARM) Act of 2018. To encourage antibiotic development, DISARM would allow Medicare to offer an add-on payment to inpatient hospitals that use qualifying antibiotics to treat serious or life-threatening infections, effectively by-passing the DRG system. Senator Hatch noted, “Senator Casey and I want to encourage the development of novel drug and biological products that treat these serious and life-threatening infections. Working together with researchers, physicians, hospitals and other healthcare providers, we will find solutions that ensure good stewardship and help overcome economic obstacles to innovate in this area.” Hatch called the situation a health emergency and Casey compared the dearth of antibiotic development to cancer, natural disasters and nuclear threats.

However, policy solutions like the one introduced by Hatch and Casey may be slow in coming. One industry report recently noted, “A sense of urgency within the U.S. government, foundations, the academic and medical community, as well as industry is evident. We detect a greater degree of collaboration among various stakeholders, but we do not yet have conviction that anything meaningful will be implemented in 2019.”

NUZYRA possesses an IV to oral switch mechanism for its pneumonia and skin indications, allowing the patient to go home after only three days. There is also an oral-only dosing schedule for serious skin infections. PRTK strongly believes that its drug will send patients home from the hospital sooner (while lowering the chance of recidivism because of its broad-spectrum capability), thereby saving payors money. NUZYRA received an exceptionally “clean” FDA label (no black box warning and no heightened- risk labeling in the doctor instruction package). NUZYRA, a tetracycline, has a high tolerability profile and an attractive once-daily dosing regimen. It was our clear sense from attending the FDA’s Advisory Committee hearing on NUZYRA in October 2018 that the FDA’s scientists and doctors thought highly of the drug.

We ask ourselves: What’s the probability that a team with as much antibiotic domain knowledge as exists at PRTK would embark on a multi-year journey without having thoroughly thought through all of the industry dynamics and challenges to successfully bring this specific drug—NUZYRA—to market? We think the probability is low; but most importantly, it’s low in relation to the hurdle-rate embedded in today’s share price.

We’ve spoken with many industry experts. One of the most valuable of these experts is an antibiotic clinical investigator and emergency physician who has worked with most of the leading novel antibiotic biotech firms. This investigator told us, “It is a tough road and it’s a crowded space.” Nonetheless, he believes that PRTK’s NUZYRA is a likely winner. According to this individual, “The drug’s IV to oral switch along with being broad-spectrum lends itself to being a popular drug. I do think it’s well priced and with hospitals running out of beds, if they can get a patient out of the hospital a day or two early that’s big. It comes down to having faith in the management team’s ability to execute on its plan. Evan and his team are the strongest team I’ve worked with.” This management team has earned our full respect. Dating back five years, they have met or exceeded every developmental milestone and been savvy capital raisers as well (despite requiring significantly more capital than we originally anticipated).

To be clear, NUZYRA is not a first-line antibiotic. It is designed for particular situations when generics are not appropriate. There are roughly 6.7 million people hospitalized in the United States each year for serious skin and pneumonia infections. PRTK estimates that roughly 13% of these cases are “high-risk” situations that could be well-served by NUZYRA. These patients are often high risk for Clostridium Difficile Infection (C. diff). Importantly, tetracyclines have long been associated with being neutral to protective against the C. diff infection. Not a single case of C. diff was observed in NUZYRA’s Phase 3 pneumonia trial. Other high-risk situations include patients that are allergic to penicillin, taking an SSRI (which often interact badly with traditional antibiotics), or possessing co-morbidity issues like diabetes or vascular disease. High-risk individuals cannot gamble with being mistreated with a failed first-line antibiotic and often must be treated empirically with a broad-spectrum drug like NUZYRA (covering gram positive and negative bugs) because the pathogen is unknown to the prescribing doctor.

PRTK now has 40 salespeople targeting “Early Adopter” healthcare providers in 400 high-value institutions. By the end of 2019, the company expects to have 80 salespeople targeting 800 hospitals. There are an estimated 6,000 hospitals in the United States. The company is projecting a slow revenue ramp with projected sales of $10 to $13 million in 2019. The company strongly believes that the slower “hospital to community” strategy pays off in the long-run by first building brand value inside leading institutions that ultimately leads to acceptance in community settings.

PRTK hopes to capture about 15% of the high-risk population. For example, of the 6.7 million total skin/ pneumonia hospitalizations, roughly 890K (13%) are estimated to be high-risk situations. If PRTK captures 15% of 890K prescriptions, or 133K annual scripts, at $3K for a 10-day course, that equates to $400 million in annual revenue. NUZYRA’s price is in-line with newer branded antibiotics. For example, Melinta’s Vabomere is priced at roughly $5K for a 5-day course, Achaogen’s Zemdri is priced at roughly $4K to $13K for a 4 to 14-day treatment, and Merck’s Dificid costs about $4K for a 10-day course.

Big pharma typically pays 3x+ peak revenue to purchase branded drugs. This equates to about $1.2 billion for PRTK’s NUZYRA, or roughly $24/share on a fully-diluted basis before accounting for additional possible indications. In light of our view of the potential take-out value for PRTK, we find its shares exceptionally compelling at today’s $6/share price. Based on 32 million shares, the company’s market cap is roughly $200 million. The company has approximately 17 million additional shares of potentially dilutive securities if all were converted to common stock. However, most would only be converted at significantly higher prices. The company has about $290 million in cash/investments and $230 million in debt. PRTK smartly issued a 4% coupon, $16/share convert in April 2018. PRTK recently indicated that it is capitalized “beyond the 1st quarter of 2021.” Potential sources of non-dilutive funding options include selling non-U.S. commercial rights for NUZYRA or the non-U.S. rights for Seysera, if needed. Unlike many of its peers, PRTK’s management team opportunistically raised capital and has not been caught flat-footed.

After subtracting out what we believe is a conservative $50 million value for its 10% royalty interest for U.S. Seysera sales, which is now owned by Spanish Almirall, the implied value for NUZYRA is around $100 million. Note, it’s taken roughly $400 million to bring NUZYRA to market and over 10 years of development time. What’s the probability that NUZYRA is not worth 25% of its sunk capital costs after the elimination of 10-plus years of development time in a world desperately in need of new antibiotics?

The above analysis ascribes no potential revenue value to the current Phase 2 trial for a third indication, urinary tract infection, UTI (topline data expected in in the second half of 2019), or the soon-to-be announced Phase 3 trial for an oral-only pneumonia dosing option. One of the biggest unmet needs is an oral antibiotic to treat UTI. PRTK is currently running one oral-only dosing trial for uncomplicated UTI and a separate IV-to-oral dosing schedule for complicated UTI. In fact, the company presented new data in Amsterdam, The Netherlands, on April 15, 2019 at the 29th European Congress of Clinical Microbiology & Infectious Diseases that shows NUZYRA is “highly potent in vitro activity against” urinary tract infections (UTI). Evan Loh, M.D., said, “These data expand the understanding of NUZYRA’s in vitro activity against pathogens responsible for urinary tract infections, where there is a significant unmet need for new oral, broad-spectrum antibiotic agents.”

Moreover, PRTK’s soon-to-be announced oral-only pneumonia Phase 3 trial is a well-positioned option to treat community pneumonia given FDA guidelines that discourages the use of fluoroquinolones, as well as dramatically rising macrolide resistance.

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The specific securities identified and described do not represent all of the securities purchased, sold, or recommended for advisory clients, and the reader should not assume that investments in the securities identified and discussed were or will be profitable. The top three securities purchased in the quarter are based on the largest absolute dollar purchases made in the quarter.

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