DBTX - Decibel Therapeutics' CVR Appears Around Fair Value

2023-09-15 18:32:23 ET

Summary

• Decibel Therapeutics is being acquired by Regeneron for a cash consideration of $4/share and a CVR linked to DB-OTO.
• DB-OTO is a gene therapy for hearing loss, with a phase 1/2 trial underway.
• The CVR broadly pays out with the early stages of the Phase III trial and subsequently the filing of a BLA application (or European equivalent).
• Decibel's shares appear around fair value at current levels, given the estimated probabilities of CVR payout.

As announced August 9 2023, Decibel Therapeutics (DBTX) will very likely be acquired by Regeneron ( REGN ) for a combination of cash and a Contingent Value Right or CVR. Here's the breakdown on the potential payments. Note this is a broad summary and specific terms can be referenced in the 8-K and subsequent updates:

Source: Decibel 8-K filing, August 9, 2023

So that's a total potential payment of $7.50/share before any discounting of future payments and payment risk, as compared to a $5.17 share price today.

About DB-OTO

This is how the company described the DB-OTO program (the therapy which the CVR payments depend on), and note that the program is in partnership with the acquirer, Regeneron.

The DB-OTO is a gene therapy product candidate designed to provide durable restoration of hearing to individuals born with profound hearing loss due to mutation of the OTOF gene. DB-OTO is the first program developed in partnership with Regeneron Pharmaceuticals under the terms of our collaboration agreement.

Timeline

The DB-OTO phase 1/2 CHORD clinical trail began in May 2023 . The FDA's data suggests Phase 2 trials take "several months to 2 years" with a 33% success rates.

A Rare Disease

About 3 in 1,000 babies have congenital hearing loss, and then of that cohort, it's estimated that somewhere between 1.4%-4.0% have OTOF mutations . Therefore, for about 7 million births in the U.S. and Europe per year, there will be 300-900 babies born with the OTOF condition per year, or 0.00009% of births. This may make trials relatively hard to recruit for, especially when there are competing trials targeting a similar population .

Market Expectation

At the current price of $5.17/share vs. a $4/share cash acquisition price DBTX is pricing in a 33% chance of a full CVR payout (both milestones) or a 59% chance of the first milestone payout (clinical trial enrollment before year-end 2024).

Probabilities

In order for the CVR to payout we need the CHORD Phase 1/2 trial to complete before December 2024. Given the Phase 1/2 trial began in May 2023, that's 18 months, against a typical phase 2 timeline of roughly 3 to 24 months. It would seem there's about a 71% chance of that occurring, using broad base rates without any specific knowledge of the trial in question. However, to progress to phase 3 the trial must also be successful, and the base rates for that are 33% there are risks from immune response, a need for targeted delivery and potential side-effects from modifying the genome.

Therefore for the trial to happen by late 2024 and successful the base rate probabilities are perhaps (71% x 33%) or 23%. Then the chance of a BLA application if there is a Phase 3 trial is perhaps 80% (again using base rates).

That gives us a fair CVA value of:

That gives a discounted CVR fair value of $0.70/share, plus the expected cash payment on closing that's $4.70/share. When compared to the current price of $5.17/share I believe the DBTX current price is offering risk without reward at these levels. Of course, we should beware excessive precision here, so rather than say that the CVR is overvalued, I'm more comfortable saying it's around fair value at $5.17/share.

Risks

• These are broad estimated based on clinical trial timings and base rates, unique aspects of DB-OTO may chance the assessment.
• There is some agency risk in that Regeneron might be tempted to move a little slower on the clinical trial if the December 31, 2024 date is looming as that would save a material cash payout (potentially almost halving the realized acquisition cost). Though these are important therapies if successful with clear economic and societal benefits, so Regeneron may be more interested in bringing the therapy to market than optimizing for the CVR.
• Of course, there is some small risk that the acquisition does not close, not included in this analysis.
• CVRs are generally highly illiquid and non-tradable.

Conclusion

The Decibel Therapeutics CVR appears relatively uninteresting at current levels. Starting a phase III trial next year and enrolling 5 patients from a very small population when the phase 1/2 trial is not yet complete and competing therapies may also be running similar trials for similar patients is quite possible, but not a cakewalk. That's especially true when the Phase 1/2 trial must also show sufficient success to move to phase III which is not a given. Also, not meeting the first milestone eliminates the chance of the second milestone paying out, which is a less favorable setup for investors. Plus at current interest rates, the potential payment value from a few years out become less valuable. Should DBTX dip materially from here before closing it may become interesting, but for now it appears around fair value, without any compensation for the illiquidity of the CVR.

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