Epistem: Novartis collaboration puts therapeutic and biomarker cancer specialist on the map

It is no secret that the pharmaceutical sector is one of most profitable industries around, but usually the lion’s share of those profits are made by very big beasts indeed – a couple of which reside on the FTSE100.

However, it is possible to make substantial gains by investing in small cap life science businesses. The trick is to find a firm that is either targeting niche markets that the big companies feel are too small for themselves to partake in or one that has specialised, proprietary knowhow that can be sold to large organisations. AIM biotech business EpiStem, which specialises in epithelial stem cells, is the latter type.

Epithelial stem cells are cells found in the tissue of adult humans. They regulate the process of new cell creation and regeneration in particular tissues (e.g. skin, breast, prostate, lung and intestinal tissues). According to EpiStem, epithelial cancers account for more than 80% of adult cancers, so there is a well-defined market for the company’s therapeutic products and diagnostic biomarkers in this area.

The firm is divided into three divisions: Contract Research Services, Biomarker and Novel Therapies.

Contract Research Services provides specialised preclinical efficacy testing, primarily for drug development companies, on a fee-for-service basis. The division is cash generative and profitable, and has a seven-year track record of providing testing services to more than 90 corporate clients that are mainly based in Europe and the United States.

The Biomarker business is a relatively-new division that is focused on developing and selling the company’s emerging biomarker products. EpiStem’s biomarker technology uses the company’s knowledge of the behavior of epithelial cells, and drug-induced gene expression change to measure drug effects during treatment. Changes in gene expression can be detected within hours and at low levels of chemotherapy or radiation.

The division recently launched GenetRx, a gene expression profiling technology that has the ability to analyse individual plucked hairs, blood and other tissue samples that are traditionally too small to be analysed by other methods. The technology is used by clinicians and research scientists to study target engagement and the ‘pharmacodynamic’ effects of a drug to establish dose scheduling, drug effect and patient response.

The Novel Therapies division develops its own therapeutics and diagnostic biomarkers. Through its discovery platform, says EpiStem, the division has identified more than 250 potential drug candidates, of which a subset is undergoing further evaluation as stem cell regulators for the company’s emerging drug development pipeline. Novel Therapies is also conducting feasibility studies with two drug development firms, using its clinical diagnostic biomarker technology.

EpiStem’s business model exploits synergies between its divisions. The company integrates the discovery efforts of Novel Therapies with the efficacy testing assays of its Contract Research Services Division, to identify and characterise new drug candidates. Additionally, revenues generated by Contract Research Services and the Biomarker business are being used to assist in offsetting Novel Therapies’ investment requirements for the discovery and development of therapeutics.

Contract Research Services has performed reasonably well during the past year in spite of some disruption caused by the global financial crisis. The division’s revenues during the 12 months to 30 June increased by 20% to £2.3m, driven in part by the continuing expansion of EpiStem’s bio-defence contract with the US government and the launch of new services by the company.
The bio-defence contract with the US National Institutes of Health was in place before EpiStem came to AIM in April 2007. EpiStem is a main provider of tests for agents that may treat radiation sickness following a nuclear incident.

The Contract Research Services division also benefited recently from an increase in revenues from large pharmaceutical groups that use EpiStem for preclinical and discovery research services.

EpiStem’s Novel Therapies division announced its first research and development collaboration in March this year. This ‘Regenerative Medicine’ collaboration is with Swiss firm Novartis, a leading pharmaceuticals business, and is aimed at identifying new drug targets and therapeutics across of variety of epithelial disease areas.

Under the terms of its agreement with EpiStem, Novartis has made an upfront cash payment of $4m to the company and is providing research funding for two years. If the collaboration is successful, EpiStem is eligible to receive tiered royalties on any new drugs and therapies developed. In the meantime, the company is eligible to receive up to $45m in milestone payments for each drug developed from these targets.

Away from the Novartis collaboration, EpiStem says there is a growing interest in its drug discovery platform and the role that epithelial stem cells play in the mechanisms of tissue renewal and cell generation.

Despite its relative youth, EpiStem’s Biomarker division enjoyed strong growth during its first year of business to produce a small maiden operating profit. The company expects demand for its biomarker technology is being helped by a trend where new drug development is increasingly targeting specific oncology genes in molecular pathways. EpiStem says that demand is being driven specifically by regulatory authority requirements to show that development drugs are effectively targeting these ‘oncogenes’ and molecular pathways.

The company is opening a US office, based in Boston that is aimed at increasing the awareness of the company’s technology in that country, as well as supporting the commercialisation of the Biomarker division’s GenetRx platform. EpiStem’s biomarker collaborations in North America will focus on preclinical and clinical oncology drug development for providing a means of translating drug effect in specific oncology pathways.

During the first six months of the year, EpiStem’s total revenues almost doubled from £2.1m to £4m, with the company’s first-half loss before tax falling by half to £669,000 (H1 2008: £1.3m). However, the firm saw its first ever after-tax profit of £0.1m (H1 2008: £1.2m loss) thanks to a tax credit on the prior year’s losses. At the end of June, cash reserves were £3.7m (2008: £2.1m).

EpiStem reported in October that it had seen the second half of the year returning to a more settled trading position, with a further increase in demand for its services.

A recent research note from Daniel Stewart forecasts turnover for the current year to 30 June 2010 will reach £5.5m, with pre-tax profit coming in at £0.5m. For 2011, the investment bank predicts turnover of £6.2m and pre-tax profit unchanged at £0.5m. These profits translate to earnings per share of 4.6 pence and 4.7 pence. However, the earnings forecast from Daniel Stewart does not take into consideration any milestone payments from the Novartis, which if achieved, would mark a material change in the company’s revenues.

EpiStem is still on the early leg of its journey to join the big beasts in the pharma jungle, but it appears to be on the right path.