2023-04-10 08:55:44 ET
Summary
- COMPASS Pathways is a market leader in the listed psychedelics space and the company has made significant advances over the last few years.
- COMPASS is burning through cash at a high rate relative to its balance sheet cash resources and investors should be mindful of the downside risk of a dilutive capital raise.
- The company has commenced the first ever Phase 3 trial using psilocybin combined with psychological support.
- COMPASS Pathways has genuine potential to deliver game-changing treatment options for sufferers of treatment resistant depression.
- Clinical trials are expensive and regulatory approval remains a somewhat distant and uncertain prospect.
Hype Unwind Proves Painful
Looking at the chart below, a reader unfamiliar with UK-based and Nasdaq-listed COMPASS Pathways plc ( CMPS ) would most probably assume that things have gone pretty terribly for the company since its September 2020 IPO. In stark contrast to the bleak picture painted by the share price chart, as discussed later in this note, from an operational perspective CMPS has actually made rather impressive advances in the last two and half years, built around COMP360 (which is a proprietary psilocybin formulation optimized for stability and purity).
Despite being a leader in the race to make psychedelic-assisted therapy ‘PAT’ a reality, believers in the CMPS story have had plenty of opportunities to incur heavy losses. Investors in the IPO felt pretty good when CMPS closed at $29 per share on its first day of Nasdaq trading; a gain of 70.6% relative to the IPO price of $17 was certainly not to be sneezed at. By December 2020, early CMPS shareholders must have been experiencing a natural high when the stock started to nudge $60. As Exhibit 1 shows, investors who bought in at that level (which corresponds with the peak of psychedelic sector hype) are currently sitting on losses of ~83%%.
November 2021 provided another good opportunity to purchase CMPS shares at a price that required a huge amount of optimism to justify. In late October 2021, CMPS published news regarding positive topline data from an open-label study of COMP360 psilocybin therapy for depression in cancer patients. Combined with anticipation of the imminent release of initial results from the Phase 2b clinical trial of COMP360 psilocybin therapy for treatment-resistant depression ‘TRD’, the October 2021 release regarding the cancer patient study attracted bullish commentary from sell-side analysts and helped to push the share price up to ~$50. This bounce proved to be very temporary. On 09 November 2021 , CMPS updated the market on its initial COMP360 Phase 2b trial data; the results were positive in terms of the treatment of TRD but a relatively high incidence of treatment-emergent adverse events put a major dampener on market sentiment and sent the stock back down into the low $30 range. Investors buying in to that November 2021 round of optimism are now looking at losses of ~79%.
Exhibit 1:
The above analysis highlights that investing in psychedelic stocks is a high-risk endeavor. It can be argued that CMPS is the leading player in the sector, and investors who backed the company might feel some positive reinforcement in that regard, but even for this sector ‘winner’, the share price performance reality has been very painful. Hype around the psychedelic sector hit extreme levels in late 2020 and early 2021 and the price corrections seen across the sector reflect an unwind of irrational optimism and the reversal of FOMO induced price gains. CMPS is far from alone in regard to woeful share price performance and stocks in the unlisted space have also struggled to access capital. If you are interested in exploring the sector further, a comprehensive and useful summary of listed stocks, ETFs and private companies in the space can be found here: Psychedelic Stocks & Companies - Psychedelic Alpha .
CMPS Has Made Genuine Progress
From an investment perspective, it’s hard to argue against the conclusion that CMPS has been something of a flop. Putting share price performance to one side, in the context of the group’s stated ambition to ‘find better ways to help and empower people suffering with mental health challenges who are not helped by existing therapies’ CMPS has made impressive progress. A quick summary of the group’s key achievements is set out below:
- The FDA granted Breakthrough Therapy designation for the use of COMP360 to treat TRD in 2018.
- Successful completion of a Phase 1 clinical trial combining COMP360 with psychological support in 2019. This trial was relatively small, involving 89 healthy volunteers, but laid the groundwork for continuation into Phase 2b trials. The double-blind, placebo-controlled trial was the largest randomized controlled trial of psilocybin at the time, and the first to simultaneously administer psilocybin, with one-to-one support from therapists in a clinical research setting. Following peer review, the Phase 1 trial results were published in The Journal of Psychopharmacology in January 2022.
- Successful completion of a Phase 2b clinical trial combining COMP360 with psychological support in 2021. The trial was conducted at 22 sites within Europe and North America and involved provision of COMP360 plus therapy to 233 patients who had been diagnosed with TRD. Following peer review, the Phase 2b trial results were published in The New England Journal of Medicine in November 2022. This was the largest, randomized, controlled, double-blind psilocybin therapy clinical trial completed to date.
- In 4Q22, CMPS commenced the first ever Phase 3 trials evaluating PAT with psilocybin. The trials are split into two programs. Pivotal trial 1 is designed to replicate the treatment response seen in the 2021 Phase 2b trial, with a slightly larger patient group (255 patients, as compared with 233 patients in the Phase 2b trial). Top-line data for the Pivotal 1 trial is targeted for summer 2024. Pivotal trial 2 involves a significantly larger group (568 patients) and will investigate whether a second dose of treatment can improve patient outcomes. Top-line data for the Pivotal 2 trial is targeted for mid-2025.
TRD remains the main focus for CMPS. However, the group is also conducting Phase 2 trials for the use of COMP360 in conjunction with psychological support for the treatment of anorexia nervosa and PTSD. These are relatively small trials (60 patients for the anorexia nervosa trial, 20 patients for the PTSD trial). Patient recruitment has been a challenge for the anorexia nervosa trial, and trial data is now expected in 2024. The PTSD trial data should be available in 2023. The CMPS strategy to investigate the use of psilocybin across a range of mental health conditions is not particularly novel; many other companies and organizations are also going down this path. CMPS also provides COMP360 to external research groups (mostly academic and medical institutions) who are investigating the use of psilocybin to address multiple different mental health conditions.
Exhibit 2 provides a summary of the current clinical trials being run by CMPS. Exhibit 3 sets out the external institutions that have completed studies using COMP360 or are currently doing so, along with the conditions targeted.
Exhibit 2:
Source: COMPASS Pathways Presentation – February 2023, slide 13. CMPS Investor Relations website.
Exhibit 3:
Source: COMPASS Pathways Presentation – February 2023, slide 14. CMPS Investor Relations website.
So Why Is The Share Price So Weak?
As highlighted above, CMPS is the clear market leader in the race to bring PAT for the treatment of depression to market. The company has made a lot of progress since its September 2020 IPO. It’s therefore not immediately clear why CMPS stock has performed so badly. In my view, there are several factors contributing to weakness in the CMPS share price:
- Uncertainty regarding the outcome of the Phase 3 trials (effectiveness).
- Uncertainty regarding regulatory approval for PAT and the timeline for this to be achieved (regulatory support).
- Assuming that regulatory approval is granted, there remains a great deal of uncertainty around the scalability of PAT and the potential revenue streams that CMPS will be able to participate in (commercialization).
- Balance sheet and cash flow.
At the peak of psychedelic hype, many investors were willing to ignore or down-weight the uncertainties for factors 1, 2 and 3. The general view seemed to be that psychedelics work, that regulators would eventually get on board and that the size of the potential addressable market was so vast that most participants would be able to enjoy large profit streams (I’m over-simplifying of course, but hopefully you get the picture). For me, a coherent bullish investment case for CMPS cannot be constructed without forming a robust view on effectiveness, regulatory support and commercialization. Unfortunately, as things stand at the time of writing, the number and range of uncertainties is such that I feel unable to arrive at a confident conclusion regarding the outlook for these three key factors.
The fourth factor – balance sheet and cash flow – was rarely considered during the hype phase, but this is surely the most significant issue for investors today. Let’s take a quick look at the balance sheet and cash flow position for CMPS. Exhibit 4 tracks operating cash flows over the last three years and provides a quarterly breakdown for FY22.
Exhibit 4:
Source: author’s calculations based on CMPS quarterly reports.
At FY22, the company provided operating cash flow guidance for FY23E as follows:
- 1Q23E = -$24m to -$32m
- FY23E = -$85m to -$110m
Referring to Exhibit 4, the increase in operating cash outflows over time is consistent with the company’s ongoing investment in clinical trials and organizational expansion. I am concerned that the operating cashflow guidance for FY23E is too low given the (expensive) large Phase 3 trial program that is currently underway. I will give management the benefit of the doubt in terms of the guided range, but will assume that FY23E operating cash flow will be at the upper end of the stated range, thus -$110m.
As at 31 December 2022, CMPS balance sheet cash and equivalents stood at $143.1m. Assuming an ongoing cash outflow rate of -$110m pa, CMPS only has sufficient cash to make it through to the end of 1Q24. If I were to be very optimistic and assume an ongoing cash outflow rate of -$85m pa, CMPS has sufficient cash to make it through to the end of 2Q24. With results from the Phase 3 Pivotal 1 trial not expected before summer 2024 and the more important Phase 3 Pivotal 2 trial not expected to report results until mid-2025, it is extremely likely that CMPS will run out of cash before being able to advise the market of its critical Phase 3 results.
It therefore appears to be a question of when, not if, CMPS comes to market to raise capital. My expectation is that the company will move on this issue sooner rather than later, as further cash outflows will likely contribute to continued share price decline (as the market becomes increasingly focused on the likelihood of material dilutive share issuance). The CMPS management team and board may well be hoping for some positive psychedelic sector news to improve market sentiment in the coming months, which might allow a capital raise to be triggered from a slightly higher share price level.
Conclusion & Rating
CMPS is a market leader in the listed psychedelics space and the company has made significant advances over the last few years. There is a realistic chance that CMPS will succeeds in its ambition to bring psychedelic-assisted therapy using its COMP360 proprietary psilocybin to market. However, consistent with many other companies in this space, CMPS has a high cash burn rate and a balance sheet cash position that is rapidly approaching a point at which a large capital raise is likely. I therefore land at a SELL rating for CMPS.
For further details see:
COMPASS Pathways: Cash Burn Rate Overshadows Positive Trial Progress