Hawaii-Born Pill: The Next Wonder Drug?

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New Paradigm

At Big Pharma companies, the response to the laggard pace of drug development has been to slash their own R&D departments. In the last five years, the industry has laid off more than 100,000 of the chemists, bio-engineers and medical doctors that it takes to run a modern drug-research program. Instead, Big Pharma is betting it can do better by buying companies that already have promising drugs in the pipeline. But, like the VC community, Big Pharma is mostly interested in products far down the development road. In effect, they’ve decided to pay more for their new drugs, but shift the risk of R&D to the small biotech companies.

Deepak Bhatt points out that this has major implications for how drugs are developed. “I think, in some respects, this is good for small companies like Cardax,” he says, “because it creates an opportunity that really wasn’t there before. That’s a plus. But these small companies now also have to take things a lot further than they had to in the past. In the past, many times they would just do very basic work on a compound, and Big Pharma would take over the R&D. Now, those larger companies really want data from further along in the research continuum before they decide to invest in a compound. For small companies, that requires you to have a different set of skills. You have to be able to build things.”

That’s the convoluted Catch-22 Cardax is in. It needs investors to pay for clinical trials, but it needs clinical trials to attract Big Pharma investment. It has what it feels is a low-risk product, but it still doesn’t match Big Pharma’s risk profile.

One Big Pharma executive, speaking on background, tried to explain why a company like Cardax still looks risky to Big Pharma:

“You can’t always tell if a product is going to take off or not. It’s not simply a matter of being ‘first to market.’ Being first sometimes just means that your R&D costs are tremendous. While you’re blazing a trail through the regulatory and approval process, the FDA may get worried and say, ‘Increase the size of your study.’ If it’s a new target, they don’t know what the risks are, so they may make you the guinea pig. But a company that’s second or third or fourth to the market already knows the approval path. They can say, ‘We don’t have to do it the way Pfizer did it or the way Merck did. If the FDA made them start over and use a bigger study group, we can just start out that way.’ Similarly, if the bigger study group turned out not to be necessary, the FDA may not require it for the new company. That means their costs can be lower. For example, if you look at the statin market, Lipitor wasn’t first to the market; it was like fifth or sixth.”

But Watumull sees the risk/reward equation differently. “We’ve done a significant amount of animal studies that give us confidence that the clinical studies will be successful,” he says. “With target-based drug study, the risk is much higher. But the active drug in our compound is the same as in astaxanthin, so the probability of success is much higher than if the drug was coming in de novo. Certainly, using one or another of our compounds with animals, the efficacy has been very strong. That’s what gives everybody here confidence. But you don’t go from theory to human clinical trials without money, and the last few years it’s certainly been challenging finding enough capital coming in. That’s the main thing.”

Finding a Path

Despite all those problems, over the last year or so, Cardax seems to have found a path to success. The key is probably its contract with BASF. Although the German chemical and Big Pharma company hasn’t exactly invested in the company, it has played a key role in Cardax’s development. It was BASF that figured out how to synthesize astaxanthin on an industrial scale, which means Cardax products are inexpensive to mass-produce. They’re even cheaper than natural astaxanthin – cheap enough, for instance, to use as an inexpensive additive in health food products. Indeed, at one point, Cardax was in discussion with Nestle. That was only possible because of the company’s relationship with BASF.

Another important development has been Cardax’s decision to start with a nutraceutical, and use the income from that to develop a pharmaceutical down the road. Watumull points out that BASF wasn’t always interested in expanding its relationship with Cardax. “Their change of heart came about because of the recent explosion in the global astaxanthin market,” he says. “They’ve seen the retail market in astaxanthin go from $5 million or $10 million a year to $100 million a year. That makes somebody like BASF say, ‘I’ve got to pay attention to astaxanthin.’ ”

Of course, BASF has to also be paying attention to wider anti-inflammatory market. “It’s a very, very large potential market,” Watumull says. “A multibillion market for osteoarthritis alone. There are probably 150 million osteoarthritis patients globally in the middle class. That’s $55 billion annually, even at just a dollar a pill.”

So, in a sense, the new BASF contract is just an innovative way for Cardax to adjust to Big Pharma’s wary investment strategy. “We got a very attractive royalty rate on all BASF sales,” Watumull says. “That’s what’s new. They would be responsible for all manufacturing, which we were going to pay them for, and for distribution, which we would have had to arrange for with someone else. They’re also going to help with the pathway to pharmaceutical, which could have cost us $200 million.” Because BASF is assuming so much of the cost of marketing and development, it will also get an exclusive license to market the Cardax product.

Reverse Merger

But the recent development that’s drawn the most attention to Cardax has been its decision to go public using an uncommon technique called a reverse IPO or reverse merger.

Basically, the reverse merger is a way to take a company public without having to go through the costly and time-consuming SEC procedures. In principle, it’s simple: you find a publicly traded shell company – either an existing company that’s no longer in operation, or a purposely created shell –and merge your company into that one in exchange for shares in the new  company. In this case, Cardax merged with Koffee Korner, a troubled Houston-based chain of coffee shops. After the merger, the new company will simply sell off its Koffee Korner assets and change its name back to Cardax. Later, it can petition the SEC to change its stock ticker symbol and it will likely be traded over the counter.

A reverse merger is one of the few ways a small company can go public. Ted Kalem, a partner with Highline Research Advisors, the investment bank handling the Cardax IPO, points out, “The classic IPO is really only possible for companies that are going to have a market capitalization of $500 million or more.” That’s largely constrained by rules on the various stock exchanges. For smaller companies that will be traded over the counter, a traditional IPO just isn’t cost-effective. In contrast, Kalem says, the reverse IPO is probably only viable for companies that need to raise less than $15 million.

But that’s the central advantage of being publicly traded: It makes your company more attractive to investors. In advance of the Cardax merger with Koffee Korner, Kalem and HRA were able to raise nearly $11 million in capital; and the mere fact of being publicly traded means it will be easier for the company to raise money in the future. “When we go public,” Watumull says, “we’re going to be a $100-million company. That sounds big, but it’s still small for institutional investors.”

Watumull also notes that the timing of the fundraising in a reverse merger is important. “What was key for me was the financing prior to the merger. With a regular IPO, all the money comes in after going public. That makes it risky. If you go through all that trouble, and something happens in the market so you can’t get financing, you’ve wasted all that time and money. But in the case of the reverse merger, you separate the fundraising from the IPO. In this case, the company is using the imminent IPO as a way to attract investors.”

But the reverse IPO isn’t appropriate for all companies, Kalem says. “I think, first of all, all the companies that we work with we believe have outstanding management teams. That’s especially important with the reverse merger, because it requires a lot of effort on the part of the management team to pull it off successfully. The company also has to be ready and want to be a public company, because being a public company carries certain responsibilities that being a private company doesn’t.”

As an investment banker, Kalem also wants to make sure investors – who are clients, too – get a good deal. “A lot of the reverse mergers that we’ve done, we’ve taken to a retail audience. Cardax is one of them. For those, we need to make sure that the risk profile is appropriate for the retail market. There has to be a very, very low likelihood that there could be a complete disaggregation of company value. A high-risk, high-reward profile isn’t appropriate for the retail investor. In our judgment, if you look at the risk profile of Cardax – given its ability to produce a nutraceutical and its contract with BASF, and the high potential on the pharmaceutical side – the risk of complete failure is fairly low.”

That’s an investment banker’s way of saying, “This is a good deal.”

But, as Watumull will readily point out, not all good ideas make it. “Not even close,” he says. However, Cardax seems on the verge of a level of success that could affect not just this little biotech company and its investors, but the whole state. Watumull is one of those idealistic biotech guys who believes Hawaii can become a center for this kind of research. In that sense, he views Ivor Royce and what he did for the San Diego biotech community as a model for what Cardax could do for Hawaii.

It might seem strange to think that a modest company housed in the Manoa Innovation Center could have that big of an impact – could, in fact, have figured out problems that have stumped some of the biggest and most profitable companies in the world. Watumull, though, takes a historical view:

“Did Wang ever figure it out? Did Dell or IBM? Sometimes someone else has to come along and figure it out and supplant them. I think we can be one of those companies.”


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