Arrowhead Pharmaceuticals, Inc.

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 4/5

Arrowhead Pharmaceuticals is a biotechnology company focused on developing RNA interference (RNAi) therapeutics for a range of diseases.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview:

Arrowhead Pharmaceuticals is a clinical-stage biopharmaceutical company that develops therapies to treat diseases by silencing the genes that cause them using its proprietary Targeted RNAi Molecule (TRiMTM) platform. This core competency in RNAi technology forms the basis of its potential competitive edge. This is primarily within the pharmaceutical and medical devices industry.

They focus on a diverse range of therapeutic areas including cardiovascular, pulmonary, liver, and a few central nervous system conditions.

Their business model is to discover and develop new drug candidates, conduct clinical trials, and then partner with larger pharmaceutical companies to commercialize and sell the drugs on the market.

Arrowhead’s revenue stream is primarily through collaboration agreements, licensing fees, and milestone payments.

  • Revenue Distribution: Currently, Arrowhead’s revenue is not driven by product sales, they are a clinical stage company. Instead it is largely dependent on:
    • Collaboration & Licensing Agreements: This is their biggest revenue source, and it is driven from milestone payments and licensing fees associated with new development stages of their drugs and licensing partnerships.
    • Government and Other Grants: They also receive revenue from state and federal grants, that may be used to supplement operational funding.
  • Industry Trends:
    • The pharmaceutical industry is seeing a shift towards targeted therapies, often driven by cutting-edge technologies, which is a favorable trend for RNAi technologies like Arrowhead is developing.
    • RNAi is seeing increased interest due to its potential for treating diseases that were previously considered to be untreatable. This technology allows them to target disease on a genetic level.
    • However, the industry is also seeing a rising tide of competition, with many companies working on gene-editing therapies.

Margins:

As a clinical-stage company, Arrowhead has negative margins, which are going to remain such until its drugs come onto the market. Their main expenses are R&D, clinical trials, and operating costs of the company. While their gross margins will be significant with approved products, until then they will be reliant on external funding and licensing agreements to keep them afloat.

Competitive Landscape:

The competitive landscape in the biotech industry is extremely difficult, they are competing with companies that might have many more sources of capital, bigger brand names and wider access to talent than they. They have to compete with:

  • Large Pharmaceutical Companies: With vast research and development resources, they have the ability to develop innovative products and the ability to take their products through regulatory process.
  • Specialized Biotech Firms: There are some that work within the RNAi space, some with other gene-editing platforms and some on other methods. Companies within RNAi might have better technologies than they or a faster development track.
  • Small Biotech Firms: This is a rapidly evolving field so it is impossible to know what new companies will arise.

What Makes Arrowhead Different

What sets Arrowhead apart is its unique TRiMTM platform. This next-generation technology is designed to enable highly targeted and potent RNAi therapeutics. This allows them to make multiple shots at a disease by having multiple different drug candidates for the same disease, which they can then decide which to put into full scale development.

  • They are not just working on one drug, they have a large pipeline of products across several diseases. Diversifying its R&D pipeline and the companies they partner with will help stabilize their risk and their growth.
  • They use an extremely collaborative business model, partnering with larger and more established companies (such as Amgen and GSK) to help with funding and the often arduous commercialization process of their products. This model also means that other more established companies could be pushing their drugs more than they.

Financials:

The company’s financial statements shows a typical picture of a pre-commercial biotech company.

  • Liquidity: The Company has significant amount of cash, cash equivalents, and investments. This provides funding for operations over the foreseeable future, for clinical trial, manufacturing and for any other purposes.
  • Cash Flow: They have consistent negative free cash flow, primarily due to investment and clinical research. They are heavily dependent on collaboration and licensing agreements as a result.
  • Capital Structure: The company has some minor debt and obligations, primarily in the form of lease liabilities. They utilize no other forms of debt, which keeps the risk to the business at a lower level.
  • Research and Development: R&D expenses are a very large expense due to ongoing research and development projects of their technology. This accounts for the majority of the company’s operational expenses. However, we have to keep in mind they also get funding through licensing agreements for these costs, so their total R&D costs are less than what the raw numbers might seem like.

Moat Assessment:

I’m going to put a focus on economic moats, which are the characteristics of the company that allow it to fend off competitors and generate excess profits over a long period. Moat Rating: 2/5

Here’s a detailed assessment on why I gave this rating:

  • Intangible Assets: Arrowhead’s patents relating to their TRiM technology can be a source of moat and give them the ability to protect their drug development from competition. However, patents in biotech, especially if the technology is successful, are often intensely attacked and subject to ongoing legal challenges, which puts the durability of their moat at risk.
  • Their experience in the RNAi space also gives them a small intangible advantage over new companies trying to break into this area, but that doesn’t necessarily constitute an “economic moat”, as it doesn’t limit others from innovating or using similar technologies.
  • Switching Costs: From a customer perspective (the healthcare companies they are partnering with), switching costs are low, since there are many companies offering similar services to them. However, from the perspective of patients, if their drug proves effective, switching costs may be higher since there would be few competitors with a similar product. These would be similar to “brand” costs, and are also uncertain until further product development.
  • Network Effects: There are no network effects with the TRiM platform. There are not direct nor indirect network effects. The product is not dependent on a user base, it is just something a company provides a product.
  • Cost Advantages: They have a cost advantage in the discovery process of the drug development, since their TRiM platform uses a similar approach to target different genes, but this is hard to quantify how much of an advantage this gives them compared to competitors. Moreover, there is no real barriers to entry in this space. A new company could use the same methods to enter into the space and have a very similar cost structure.

Overall: Arrowhead has some potential to build a moat, but their current competitive advantages do not demonstrate the durability that an economic moat has. The main area for their moat to be successful is through patents and first mover advantages. They would have to dominate this space in the coming years to grow this moat and solidify its competitive position.

Risks to the Moat and Business Resilience

These are the main risks to the company’s moat and to the business in general:

  • Competition: The most prominent threat is competition in the biotech space. The technological landscape for gene-therapies is constantly evolving, and there is no guarantee that their drugs will be better than a competitor, which can quickly erode their lead in the market and any potential moat they might be building.
  • Technological Disruption: Their TRiMTM platform has been a major innovation and gave them an edge in the market. However, a new technology or methodology could take over the market and render their platform obsolete.
  • Clinical Trial Failures: There is always the risk that a drug could fail during clinical trials and therefore erode the company’s value and diminish the viability of their projects and the value for the companies that want to acquire them.
  • Commercialization Failure: Even if a drug passes regulatory trials, there is no guarantee that the company and its commercialization partners will be able to market and sell it successfully or at a profitable enough rate.
  • Regulatory Hurdles: Any drug has to get approval through extensive regulatory filings. This is always risky and is subject to unexpected decisions from the different regulatory bodies.
  • Partnership Risks: As they are heavily dependent on partnerships to monetize their drugs, there is a risk if other larger players decide not to acquire them or leave their current agreements.
  • Management: As an early-stage firm, any instability in management or decision making may hurt the company and lead them to miss deadlines or make bad decision.

Business Resilience: Based on the points above, there is a large possibility of the company failing, but they seem to have reasonable business structure that can support them over a prolonged period of time. They have high cash, they have a number of partnerships and a number of drug programs. This gives them a reasonably stable base which would enable them to survive potential problems.

Understandability:

Understandability: 4/5 This is a biotechnology company and that alone makes it hard to understand for laypeople. The core technology of RNAi and the underlying science and mechanism will be hard for the average investor to understand. However, their business model of partnering with other companies to bring their drugs to market is relatively simple to understand, making it have a slightly better rating. Their financial statements, until they are commercially selling drugs are also rather straightforward and relatively easy to understand. The company structure is complex, but it is not a core factor into understanding their financial position. Overall, there is high understandability but the science can be tough for anyone not in the sector.

Balance Sheet Health:

Balance Sheet Health: 4/5

  • They have significant cash and investment balances, which is a very positive sign and shows they can sustain operations through to 2025 and beyond.
  • They are not using much debt, which lowers the risk to their business.
  • However, their equity is consistently shrinking due to losses from operating costs, they will need to become profitable at some point to maintain good equity structure, rather than relying solely on external funding.

Based on the analysis, the company has a pretty healthy balance sheet, but needs to focus on getting profitable in the future to retain this rating.

Recent Concerns and Management Response:

In a recent conference call, the company noted that they are working to improve the enrollment for trials that they are having a difficult time enrolling the correct number of patients. For example, for ARO-MUC5AC, they are actively working to improve the speed of enrollment to the Phase II study. For ARO-ANG3 they have achieved higher enrollment than expected. The management acknowledges that this is part of the process, especially as the company is getting into the later development phases. Also the CEO, Mr. Anzalone states that they are now entering into a period of increasing data readouts and should see many updates coming in the coming months.

Other than that they had a significant jump in prices recently, which they think is due to the news around clinical trials, the fact that their drugs have been moving forward in development. The management doesn’t give any guidance on the stock price, but does think that it is due to their advancements in their drug pipeline.

Also during their financial report, it was noted that their expenses have increased significantly due to investment in their pipeline development and manufacturing costs. This is something to keep in mind in the future for the company’s operating costs. They also mentioned increased costs from personnel as they are having rapid growth.