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Morningstar | Initiating Coverage of Immuno-Oncology Player Nektar Therapeutics with $39 FVE; Shares Overvalued. See Updated Analyst Note from 10 Aug 2018

We are initiating coverage of Nektar Therapeutics with a no-moat rating and stable moat trend. The San-Francisco-based emerging biotech is most known for its leading immuno-oncology candidate, NKTR-214, a PEGylated variation of interleukin-2 that has blockbuster potential in many oncology indications. Our fair value estimate of $39 per share and very high uncertainty rating puts the stock in 2-star territory as of Aug. 9. We believe the overvalued shares are an indication of the market's excessive exuberance for NKTR-214, failing to account for the highly competitive and dynamic landscape in immuno-oncology.

Nektar has made waves in biotech headlines this year, from a massive multi-billion-dollar collaboration agreement with Bristol-Myers Squibb announced in February for NKTR-214 to the precipitous 40% drop in stock price after a questionable data readout less than four months later. The agreement with Bristol Myers provided the cash-burning biotech with an upfront payment of $1 billion in cash and an additional $850 million in equity. The significant cash buffer, shared profits, and agreed-upon $125 million cap on research and development spending for NKTR-214 comprise a lucrative deal that will allow Nektar to develop its pipeline in immuno-oncology, immunology, and pain and have greater bargaining power in future collaborations.

NKTR-214's story is closely tied to the PD-1/PD-L1 market, which we estimate will reach $33 billion by 2022. It is currently dominated by Bristol's Opdivo, Merck's Keytruda, Roche's Tecentriq, and AstraZeneca's Imfinzi. While these drugs have shown remarkable efficacy in a myriad of cancer indications, the therapies are (sometimes inexplicably) not as effective in some patients, usually those with low expression of biomarker PD-L1 (programmed death ligand), a crucial yet not fully understood component for the immune response. NKTR-214 stimulates the proliferation of T-cells in the tumor microenvironment, and when paired with PD-1/PD-L1 inhibitors, NKTR-214 studies show promising results, including partial and complete responses in advanced stages of melanoma, renal cell carcinoma, non-small cell lung cancer, and bladder cancer, regardless of the patient's PD-L1 expression. Further, the side effect profile in early studies was much more attractive than current standards of care, many of which include chemotherapy. With Big Pharma and big biotech players in a heady race for immuno-oncology market share, studies of combination therapies continue emerging left and right as these players scour for combinations to improve the efficacy and side effects of their immuno-oncology therapies to ultimately win share.

The agreement between Bristol and Nektar legitimized the excitement for NKTR-214's potential, but we believe the current stock price underestimates the competing combination therapies that will vie for share at a rapid pace. Further, the early promising data from NKTR-214 and Opdivo were from a small number of patients, and the most recent data (still from a relatively small subset) showed signs of flat/slightly lower efficacy and a less-pristine safety profile. Lastly, the early trial designs, although common in immuno-oncology, make it difficult to compare results to monotherapies, other combinations, and current standards of care in different patient populations, and we hope management will improve upon this with the Phase 3 trial designs to be revealed in the second half of this year. Given these factors, we believe the current market price assumes much higher market share and probability of approval than is warranted by the data we have from NKTR-214. We model a less than 40% chance of approval for the NKTR-214 and Opdivo combo with moderate market share, mostly in PD-L1-low patients. We model much lower probabilities for NKTR-214's other opportunities due to the lack of data presented at this point, and Nektar's other pipeline and marketed drugs do not have a significant effect on valuation given NKTR-214's blockbuster potential. This pegs probability-weighted sales at over $2 billion by 2027. We expect further data readouts this fall, with positive results positioned to provide upside to our current fair value.