Company Description
Incyte is a small biotechnology company primarily focused on developing novel small molecules for the treatment of HIV, inflammation, cancer and diabetes. Its lead drug candidate, Reverset, is poised to become a large revenue generator for the company.

Pipeline
Incyte has two drugs in clinical evaluation: Reverset and INCB3284. Reverset is the most clinically advanced compound currently in phase II studies.

Reverset
Incyte is developing Reverset, a nucleoside reverse transcriptase inhibitor (NRTI), for the treatment of HIV. Reverset is an oral, once-a-day drug with a favorable safety profile that has shown efficacy in early clinical studies.

The recommended treatment for HIV is a combination of three or more drugs in what is known as Highly Active Anti-Retroviral Therapy (HAART). Typical combinations include two nucleoside reverse transcriptase inhibitors (NRTI) used in combination with either a protease inhibitor or a non-nucleoside reverse transcriptase inhibitor (NNRTI). HAART typically results in a dramatic drop in the viral load within two weeks of treatment, however, it does not completely eradicate the virus. Since its introduction, HAART has led to a significant improvement in the survival of HIV patients.

Despite the success of HAART, resistance to these drugs often develops due to HIV’s high mutation rate, resulting in treatment failure. An estimated 90% of patients become resistant to one or more antiviral drugs. Upon showing drug resistance, treatment combinations must be altered in order to maintain viral suppression. Thus, there remains a need to develop newer HIV drugs, either for different HIV targets, such as with the viral entry inhibitors and integrase inhibitors in development, or by developing novel drugs within the existing drug classes.

Reverset Clinical Data
Preclinical studies have shown Reverset to inhibit replication of wild-type and mutant strains of HIV commonly seen after treatment with front-line NRTIs including Retrovir (Zidovudine; GalxoSmithKline) and Epivir (Lamivudine; GlaxoSmithKline). In fact, Reverset has demonstrated efficacy against two of the most common HIV drug-resistant strains: M184V and T215Y. In vitro studies have also shown Reverset efficacy against the K65R mutations associated with resistance to Viread (Tenofovir; Gilead).

Data from a small early Phase II trial, Study 202, which evaluated Reverset over a 10-day period in 30 treatment-naïve and 10 treatment-experienced patients, showed that Reverset was effective in reducing viral loads. In the treatment-naïve patients, Reverset reduced viral loads by 1.67 to 1.77 log10 copies/ml while in treatment-experienced patients an overall mean viral load reduction of 0.8 log10 copies/ml was achieved. Viral load reduction with Reverset was seen in patients resistant to Epivir (3TC) and Viread (Tenofovir). While this is encouraging, the patient sample was very small, necessitating a larger trial to determine Reverset’s efficacy.

Reverset is currently in a Phase IIb trial called Study 203, which is a double-blind, placebo controlled trial evaluating Reverset in 180 treatment-experienced patients over a 6 months period. Enrollment has already been completed and interim analyses released in February 2005 on 140 patients suggests that Reverset provided sustained anti-viral activity in patients with multiple resistance mutations including thymidine analog mutations (TAMS), M184V, and K65R mutations.

Study 203 is ongoing and all patients are expected to complete the 16 weeks of Reverset treatment by June. Interim data is expected at the International AIDS Society (IAS) meeting in July 2005. This study is expected to be completed by the summer of 2005, and a phase III study is expected to be initiated in the second half of 2005. Based on this timeline and assuming positive data, we estimate FDA approval of Reverset to occur in the second quarter of 2008.

We are optimistic of Reverset’s likelihood of approval at 7% above average. We believe that it will initially gain approval for the treatment-experienced patients and will become the treatment of choice for these patients. Reverset also has the potential to become a front-line agent.

Partnership with Pharmasset for Reverset Development
In September 2003, Incyte entered into a collaborative licensing agreement with Pharmasset to develop and commercialize Reverset. Incyte paid Pharmasset an upfront payment of $6.3 million and is required to pay future performance milestone payments and future royalties on net sales in exchange for exclusive rights in the United States, Europe and certain other markets to develop, manufacture and market Reverset. One of these milestones was met in the second quarter of 2004, resulting in $0.5 million of research and development expense. Under the terms of the agreement, Pharmasset will retain marketing and commercialization rights in certain territories including South America, Mexico, Africa, the Middle East, Korea and China.

Patent Expiration
Incyte exclusively licensed from Pharmasset three U.S. patents and their related filing directed to the use of Reverset, in Europe, Canada, Australia and Japan, which expire between 2015 and 2016.

INCB3284
INCB3284 is Incyte’s second compound in clinical development. It is an antagonist against the chemokine receptor CCR2. Chemokines are a family of small secreted proteins that promote inflammation by recruiting white blood cells, such as macrophages, neutrophils, and lymphocytes, to the site of injury. CCR2 is a chemokine receptor that is activated by the chemokine Monocyte Chemoattractant Protein 1 (MCP-1). As its name suggests, MCP-1 is involved in the recruitment of macrophages and monocytes to the site of inflammation. MCP-1 and CCR2 is thought to be important in a number of diseases in which macrophages and monocytes play an essential role, such as rheumatoid arthritis, multiple sclerosis, and atherosclerosis. Thus, the inhibition of CCR2 is a therapeutically exciting option that could potentially yield a blockbuster drug.

Incyte has a portfolio of CCR2 inhibitors, of which INCB3284 is furthest along in development. INCB3284 successfully completed phase I single and multiple-dose studies in the fourth quarter of 2004, which showed the drug to be well tolerated. Phase II studies of INCB3284 is expected to be initiated in the first half of 2005, with one study expected for rheumatoid arthritis and the second for type II diabetic patients.

While it is still too early to decipher INCB3284’s safety and efficacy, we feel that Incyte’s focus on CCR2 is scientifically sound and may give the company an important drug to add to its portfolio.

Revenue Potential
According to the Center for Disease Control (CDC), in 2003, prevalence of HIV in the U.S. was 127.8 cases per 100,000 people while AIDS afflicts 167.3 patients per 100,000 people. Thus, there are approximately 860,000 known cases of HIV/AIDS. Gilead has estimated that there are between 360,000 and 370,000 patients currently on anti-viral treatment for HIV/AIDS in the U.S. Based on the growth of the disease and the access to anti-viral drugs, we estimate the number of people on anti-viral drugs to grow to over 500,000 in the next ten years.

By capturing 25% market share and assuming similar pricing to Viread (a commonly used NRTI), we currently project Reverset to achieve peak U.S. revenue of $518.6 million in 2013, with peak worldwide revenue of $838.9 million in 2014. We estimate Incyte will pay Pharmasset a 20% royalty on all U.S. sales of Reverset. We expect Incyte to partner with another company in Europe and Japan and receive 35% and 20% of European and Japanese revenues, respectively. As such, we estimate Incyte’s peak revenue from Reverset to be $523.6 million in 2013. Please see our Reverset for HIV/AIDS revenue model for additional detail.

Valuation
We have chosen to only include Reverset’s revenue contribution for Incyte’s valuation since its other product candidates are still very early in development. Based on Incyte’s 5 and 10-year pipeline values of $5.41/share and $6.07/share, respectively, we currently feel the company is slightly overvalued as of the March 31th closing price of $6.83/share. Our valuation is based on Incyte’s projected 5 and 10-year probability adjusted EBITDA using a 25x EV/EBITDA multiple to determine a stock price that is then discounted at a rate of 16%. For more information on our valuation process, please see the Explanation section of our company pages.

Upcoming Catalysts and Valuation
Our valuation is heavily based on the likelihood of Reverset gaining regulatory approval. While we currently feel the drug has an above average likelihood of approval (LOA), it is still only in Phase II studies conducted in a relatively small patient population.

There are two upcoming catalysts for Reverset in 2005 that could drive Reverset’s LOA and therefore Incyte’s pipeline values. The first is the presentation of interim data from Study 203 at the International AIDS Society (IAS) meeting in Rio de Janeiro on July 24-27, 2005. Should this data be positive and the LOA move to 42%, we value Incyte’s 5 and 10-year pipeline at $6.15/share and $6.57/share respectively.

The second catalyst is the initiation of the phase III clinical trial. Study 203 is scheduled to conclude by the summer of 2005. Incyte is expected to hold an end-of-Phase II meeting with the FDA in mid-2005 to discuss the 16-weeks interim analysis of Study 203 and to discuss the design of the pivotal phase III study. The phase III study is expected to be initiated in the second half of 2005. By moving into phase III, the LOA will jump to an average of 67%, but with positive phase II data, Reverset’s initial phase III LOA is expected to be 5% above average. This would value the 5 and 10-year pipeline at $10.50/share and $9.50/share, respectively.

Incyte Convertible Debt
Incyte currently has two sets of convertible subordinated notes outstanding. Most recently, in February 2004, the Company issued $250 million, after the exercise of a $50 million over-allotment option, of 3.5% notes due in February 2011. These notes have a conversion price of $11.22/share, and were priced with an initial conversion premium of 35%.

In February 2000, the Company issued $200 million in 5.5% convertible subordinated notes due in February 2007. The notes were issued with an initial conversion price of $134.84 but then were restructured in September 2000 with a conversion price of $67.42/share, at a 27% conversion premium, due to a 2 for 1 split in the company’s stock. Since the notes have been issued, the Company has repurchased approximately $71.9 million of the debt in the open market. (Source: Bloomberg) The soft-call feature of these bonds has expired and the next hard call is due April 25th, 2005 at face value. Due to the relatively high interest payments and the unrealistic conversion price, we estimate that the company will continue to repurchase these notes.

Biotech Converts Overview
Year to date, there have been seven new 144a convertible offerings by biotech and pharmaceutical companies totaling $980 million in total principal. Issue size has ranged between $50 million and $200 million. Terms have ranged from 7-10 years. Interest rates have ranged from 1.375% to 6.5%, and have been priced with an initial premium ranging from 15% to 35%.

During the same period in 2004 there were eight new 144a convertible offerings by biotech and pharmaceutical companies, totaling approximately $1.8B in total principal. Issue size ranged between $10 million and $400 million. Terms ranged from 2-20 years. Interest rates ranged from 0.25% to 4%, and were priced with an initial premium that ranged between 17.5% to 35%. (Source: PlacementTracker)