This week, Arrowhead Research Corp. (NASDAQ:ARWR) reported data from a phase IIa clinical trial for its lead pipeline candidate ARC-520 in a hepatitis B indication. The company picked up a bit of strength on the announcement, but has since discounted to trade low single digit percentage points below its last Friday close. The data demonstrated efficacy, and so a decline seems counterintuitive. Is this, then, an opportunity to grab an exposure at a discount, or have markets picked up on a counterweight to the expected upside? To try and answer, let’s take a look at the science behind ARC-520, and decipher the trial results and their implications. Here goes.

So, the science. To understand how ARC-520 works, we’ve first got to look at how hep B is treated currently. Basically, there are two types of treatment – interferons and nucleotide analogues (NUCs). The former are naturally occurring signaling proteins that tell cells that surround virally infected cells to heighten their anti viral response. These can be effective therapies, but have some pretty bad side effects. The more commonly used therapies are NUCs, which attack virally infected cells by breaking down reproduced cells. This reduces replication and inhibits or slows increased levels of infection, but isn’t really an effective cure. ARC-520 is what’s called a simple interfering RNA (siRNA). It attacks hepatocytes (just another word for the cells that make up liver tissue) at the mRNA level. mRNA is the stuff responsible for the translation process in cells, which to simplify considerably, is the process through which amino acids that perform cell functions are created. By interfering with the mRNA, translation doesn’t happen and the virally infected hepatocyte breaks down, rather than replicate. In other words, ARC-520 attacks the core process through which a cell creates its own functionality; in doing so it can hypothetically be an effective cure for hep B.

Did the trial results support this hypothesis? In a word, yes. When a physician diagnoses hep B, he or she takes a blood test and looks for what’s called HBV surface antigens. These are expressed on the surface of infected cells, and are a sign that a patient is infected. In its trial, Arrowhead measured the reduction of these antigens as a primary endpoint. At 57 days’ post treatment, the drug presented a 99% maximum reduction in HBV surface antigens and a mean reduction (across 58 patients) of 96.8%. On top of this, Arrowhead reported safety and tolerability, reporting no serious adverse events, no discontinuations, and modest occurrence rate of 23%.

So why the decline? Well, it looks as though the decline has come from a couple of recent sell ratings issued by other publications.  Mainstream publications will often induce near term volatility as they affect public sentiment, and without any real adverse events, its looks as though that’s what has happened here. The next question, why the sell ratings? They look to be based on weak earnings and revenue growth. In development stage biotech, however, especially at this stage of development, financials can be misleading. It costs a lot to bring a drug through the FDA trial process, and small caps generally run at a loss and debt finance through share issue to fund trials. As such, judging a company like this on its trailing revenues can give an inaccurate representation of its potential future financial position. Of course, this is the risk we take when investing in biotech. Many companies like Arrowhead fail because they debt finance and don’t achieve approval for their pipeline.

So what’s the verdict and takeaway on this one? Well, first up, we’ll say Arrowhead is a risky allocation. The company is relying on two early stage candidates to justify its market cap (currently circa $330 million), and has only demonstrated efficacy across a small patient sample. Up to 1 million people die each year in the US from hep B (it is the leading cause of liver cancer by a long, long way, and such proliferation will certainly translate to the FDA requiring a far bigger trial before it thinks about accepting an NDA. However, risk aside, there is also potential. ARC-520 has performed well in an albeit small trial, and as we just said, there is a potentially huge market for the therapy if it can replicate this performance going forward. A discounted exposure at current rates? Perhaps.