Investment Thesis

Kaleido Biosciences’ (KLDO) stock was one of the top gainers in the biotech industry last week, as its share price rose by 54% to $8.9, and the upward momentum has continued into this week.

The company’s announcement that it had dosed its first patient in an unregistered study of its Microbiome Metabolic Therapy (“MMT”) candidate KB295 in Ulcerative Colitis (“UC”) lifted the stock price by a further 13% yesterday, to $11.75 at the time of writing.

This represents a 47% discount to the company’s February 2019 $15 per share IPO, however, which raised $75m, with 5m shares sold, and a 77% discount to Kaleido stock’s peak trading price of $18, achieved shortly after IPO, in May 2019. As such, I believe this is an interesting time to be considering purchasing some Kaleido stock.

Kaleido Biosciences share price performance since IPO. Source: TradingView.

The company has a unique and differentiated approach focused on the human microbiome, the health of which a growing body of scientific evidence suggests could have a profound effect on overall human health – addressing diseases from immuno-oncology, metabolic, liver and kidney conditions, and multiple sclerosis, to diabetes, irritable bowel syndrome, UC, and Parkinson’s disease.

Kaleido is using advances in chemistry to create novel synthetic targeted glycans – collections of complex carbohydrates that modulate the microbial metabolism to drive a specific biological response.

Kaleido BioSciences: Current Pipeline. Source: company website.

The company’s current pipeline is focused on 4 main assets (as we can see above) with KB195 – targeting Urea Cycle Disorders (“UCD”) – and KB174 – targeting hepatic encephalopathy (“HE”) – both conditions caused by high levels of ammonia in the blood, with both treatments demonstrating efficacy in early stage trials.

More recently, however, it is KB109 – the company’s COVID-19 pathogen-targeting candidate, and KB295 – its UC treatment, that are exciting investors and potentially turning around the fortunes of the company – whose share price had traded stubbornly in a range between $9 and $4 for the past 12 months.

Kaleido’s management team and Board of Directors have plenty of biotech and big pharma experience – notably, the company’s Chair of the Board of Directors and acting CEO Michael Bonney was CEO and Director of Cubist Pharmaceuticals – an antibiotics specialist acquired by Merck (MRK) for $9.5bn in 2015.

Like Cubist, Kaleido is pioneering R&D into an unfashionable and overlooked sector of the biotech industry, and if Kaleido is able to match its success, shareholders will realise significant upside. There is a long way to go of course, but Kaleido shares are finally starting to show signs of life and the company’s near-term catalysts look attractive.

Results from the first COVID study of KB109 in outpatients with mild-to-moderate symptoms are due in Q420, with results from the second due in Q121. The KB295 UC study will post top-line data in mid-2021, and the phase 2 study results of KB195 are due in H221, whilst Kaleido has new candidates ready for the clinic in 2020 and early 2021 in cardiometabolic/liver disease, immuno-oncology and immune mediated disease.

Microbiome treatments address a market that is estimated to be worth $942m by 2024 and to grow at a CAGR of 22.5% until 2027, reaching $1.7bn in size. Seres Therapeutics (MCRB), another microbiome developer that was seeded from the same venture capital biotech incubator as Kaleido – Flagship Pioneering – recently saw its share price catapult from $4 in August to $29 at the time of writing, after posting positive results from a phase 3 trial for treatment of recurrent Clostridium difficile infection.

Hence, I feel bullish about Kaleido’s short and long-term progress – although investors may have to act quickly to get in before the price rises too high. The microbiome sector is potentially undervalued and coming to the boil at the right time, whilst the company may also generate significant momentum from its COVID trials. Management has executed strongly under similar circumstances at other companies, and although it is tricky to recommend a price target for a company that is unlikely to launch a commercial candidate in the next 12-18 months, analysts have suggested a 12-month target price of $13.5.

I would go a little higher. Based on Seres’ current market cap of $2.5bn, and Kaleido’s $362.2m valuation, I think that could double within 6-12 months on positive news flow, so am looking at a share price of ~$20.

Company Overview and markets

Kaleido is still ~55% owned by Flagship Ventures, with Fidelity Asset Management also owning a 7% stake in the company. Prior to its scaled down IPO, which had originally been intended to offer shares at $20-22, the company raised ~65m from private investors, with Mike Bonney – a former partner at another biotech incubator, Third Rock Ventures – who seeded Constellation Pharmaceuticals (CNST) and Relay Therapeutics (NASDAQ:RLAY) amongst others – appointed CEO in 2017. Bonney is also a Board member at mid-size biotech Alnylam (ALNY) and big-Pharma Celgene (CELG).

Using its proprietary technology, Kaleido says it has built a library of >1,500 MMTs, which, thanks to its in-house and outsourced manufacturing capabilities, it is able to deploy rapidly – targeting 12 new MMTs per year, and potentially double that number from 2020 onwards. The company believes its platform provides accelerated discovery and development timeframes, capable of moving from preclinical to phase 2 trials in 2-3 years, as compared to the industry standard of 5-7 years.

Kaleido anticipates submitting an IND for KB195 and commencing phase 3 trials imminently – possibly before the end of 2021. Urea Cycle Disorder (“UCD”) is a rare disease, affecting ~3k patients in the US and ~4.5k in Europe. Ravicti, marketed and sold by Horizon Therapeutics (HZNP), is the current standard of care and made sales of $228m in FY19, whilst competing against generics.

Hepatic Encephalopathy – which Kaleido hopes to treat with its candidate KB174 – affects ~500k patients in the US, and around 800k in Europe, according to a Kaleido corporate presentation quoting research from American Journal of Managed Care. The antibiotic Rifaximin is marketed and sold as Xifaxan by Bausch Health, earning the company ~$1.5bn of global sales in 2019, although there are other challengers in this market, such as Cosmo Pharmaceuticals’ Aemcolo. These lactulose formulations are known to have tolerability issues, however, plus there are no currently approved treatments for minimal HE. As with KB195, Kaleido says that the FDA would welcome an IND from the company ahead of a phase 3 trial.

The dosing in patients in the KB295 trial, meanwhile, appeared to take the market somewhat by surprise. Although it is a small, 30-person study, the trial will look at clinical colitis activity scores and biomarkers of inflammation as well as evaluating safety and tolerability. UC is a vast market (>1m+ patients) potentially worth up to $7.5bn by 2023, dominated by tumor necrosis factor (“TNF”) inhibitor treatments supplied by big pharma concerns including GlaxoSmithKline (GSK), Johnson & Johnson (JNJ) and Abbott Laboratories (ABT). KBT295 stimulates butyrate – a fatty acid that supports immune system functions – production, whilst suppressing pathobionts – disease causing organisms associated with inflammatory conditions.

Recently, Kaleido has secured a development agreement with Johnson & Johnson (JNJ) subsidiary Janssen’s World Without Disease Accelerator to explore microbiome pediatric treatments, with Janssen funding R&D and potentially making up to 3 milestone payments.

There is also a partnership in place with the Gustave Roussy cancer research campus in Europe related to Kaleido’s immuno-oncology pipeline, which I will not discuss in detail in this article since it is very early stage, but provides another significant development opportunity, based on potentially replacing antibiotic treatments in the oncology setting, the use of which has been shown to reduce survival in cancer patients. Kaleido is expected to select lead compounds based on the preclinical work done to date in Q420.

The COVID Opportunity

Whilst all the recent market speculation has focused on defeating the SARS-Cov 2 virus with vaccines, treatment of the disease is of comparable importance, and to date, many of the solutions developed by the pharmaceutical industry – e.g. Gilead’s (GILD) Remdesivir, Hydroxychloroquine, or convalescent blood plasma – have not proved to be successful, leaving the door open for enterprising biotechs like Kaleido to propose and develop alternative solutions.

Kaleido’s solution (KB109) is focused upon keeping patients out of the hospital and managing the cytokine storms – caused by an overreaction of the body’s immune system’s – which are a symptom of COVID-19 and can lead to respiratory failure. Additionally, most patients who are hospitalised with COVID-19 (91%) have an underlying medical condition e.g. metabolic or cardiovascular disease that can be treated with MMTs, Kaleido believes, through short chain fatty acids, which reduce inflammation and promote immune tolerance.

Kaleido depiction of the “gut-lung axis”. Source: corporate presentation.

Early trials have shown that KB109 is active in patient microbiomes and is able to reduce the presence of pathogens, hence Kaleido has launched 2 studies to compare ~400 patients’ supportive-self-care (“SSC”) capabilities with and without the treatment.

There is certainly a gap in the market presently for such a treatment, although Kaleido’s studies are early stage and results will not be available until Q420. Still, patient enrolment should be relatively straightforward and positive results would provide significant encouragement – not only in COVID but for a range of acute respiratory diseases – and a strong upside price catalyst for any Kaleido investors.

Financials

Kaleido says it has sufficient funds to support its activities until the end of 2021, although it would not be a surprise to see the company follow up positive news flow with a share offering to capitalise on a spike in the share price.

The company reported $71m of cash as at Q220 and $77m of current assets, vs. total liabilities of $36m. The only income Kaleido generated in H120 was $250k of collaboration revenues (from Janssen), and its cash burn in H120 of $37.2m was in fact a substantial drop from the $45m losses recorded in H119.

Kaleido does appear to have an ugly financing agreement in place with Hercules Capital – borrowing $22.5m which will be paid back over a 4-year period paying ~9% interest. Given that Kaleido recently filed for a mixed shelf arrangement worth $150m, however, going forward the company ought to be able to secure more favourable financing terms – although investors should be aware of potential dilution.

Risks

Until very recently, I do think that Kaleido has been operating under the radar since its scaled down IPO, without attracting the market’s attention, causing its shares to be somewhat undervalued, in my view, but there are naturally risks to consider.

Kaleido seems to operate numerous trials quite independently of the FDA; i.e., the UC and COVID studies which are a non-IND/non-CTA open label trials, which is unusual, and may cause problems or delays when it comes to pushing for phase 3 trials, slowing down the development process – one area in which Kaleido considers itself to have a significant competitive advantage.

This may also increase the risk of late-stage trial failures in my view, as Kaleido may not operate as compliantly with the FDA as it could do, although an experienced management team may offset this particular risk. Even so, it is worth noting that nothing is guaranteed approval-wise for a sector of the biotech industry that is slightly off the beaten path – Seres Pharmaceuticals suffered a blow in 2016 when its candidate for C-diff failed a mid-stage study and the company’s share price collapsed from $35 to $9.

Additionally, Kaleido could raise – and spend – significant funds developing candidates that may not prove to be big-sellers even if they are successfully brought to market. The UCD opportunity – probably the company’s best chance of an approval at present – is not a large market, and stagnant sales will not find favour with analysts or investors.

The COVID trials may not prove to stand the test of time if the pandemic eases; and in general, although Kaleido’s candidates hint at efficacy, it will still require a leap in progress and some strong faith in its methods to deliver results that qualify its candidates to be competitive in a real-world setting. My fear is that the treatments could fall somewhere between a nutrition/dietary type product and a genuine pharmaceutical drug.

Conclusion

These doubts aside, personally I like the look of Kaleido and I am expecting the company’s shares to keep building on their significant recent momentum. The fact that the company is led by Michael Bonney – who turned Cubist Pharmaceuticals from an unfashionable biotech into a $9bn acquisition target – would seem to be great news for shareholders, and the recent success of Seres Pharmaceuticals might suggest that MMTs could be one of the next big biotech trends.

I don’t think the downside case is severe either, given that Kaleido appears to be capable of developing multiple candidates with a robust manufacturing operation in place, is not overly indebted, and is part of a network of venture capital investors who are patiently backing a host of early-stage biotechs and giving the company every chance to succeed long term.

With numerous short-term price catalysts also on the horizon, and based on the 104% gains the company has made in the past week on just a single trial initiation announcement, I think Kaleido presents a strong bull case at this time.

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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in KLDO over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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