Introduction

Editas Medicine (NASDAQ:EDIT) is a genome editing company focused on adapting CRISPR techniques for correcting human diseases. Although it just had its IPO in February of last year, it was founded in 2013 and is the oldest of the four major companies currently working to develop CRISPR-based medicines (their rivals being CRISPR Therapeutics, Intellia Therapeutics, and Caribou Biosciences).

On February 15, Editas, by way of their licensor Broad Institute, received a favorable ruling from the U.S. Patent Trial and Appeal Board (PTAB) regarding the crucial Cas9 CRISPR patent. Rocketing to the high 20's soon after, the stock has since fallen close to 50% over the past four months.

This article examines the factors which have lead to the slide since the PTAB ruling and argues that the selloff was overdone. But first, some background regarding Editas and its technology for context.

Science and IP Wars

CRISPR (short for Clustered Regularly Interspaced Short Palindromic Repeats) are actually DNA segments from bacterial cells functioning as part of the cell's immune system. However, they have been adapted with great success by scientists around the world for quickly and easily editing eukaryotic cell DNA, which is why they have received billing from the press as the "Holy Grail" of modern medicine. Many summaries have been written about the science behind CRISPR here and on other platforms, so that will not be the focus of this article (Editas' website gives a nice summary here).

Naturally, with such a powerful technology which could command billions of dollars, there will be battles concerning who owns the intellectual property rights. The two front runners right now are the Broad Institute (a biomedical research center composed of members Harvard and MIT) and another group consisting of the Regents of the University of California, Emmanuelle Charpentier, and the University of Vienna. Jennifer Doudna of the University of California Berkeley (UCB) was the first to use Cas9 to edit prokaryotic cells and filed a patent soon after. However, Feng Zheng of the Broad Institute worked quickly to apply the work to eukaryotic cells and paid extra to have his patent expedited. Initially, Doudna was one of the founders of Editas alongside Zheng, but bad blood caused her to leave and found her own company Caribou Biosciences. This boiled over into the aforementioned patent dispute, with the Broad Institute and their licensee Editas scoring a major victory. However, the battle wasn't quite over, which leaves us with enough background information to get started dissecting Editas' drop.

The Negative News Stream Surrounding Editas

"Ultimately, we expect to establish definitively that the team led by Jennifer Doudna and Emmanuelle Charpentier was the first to engineer CRISPR-Cas9 for use in all types of environments, including in non-cellular settings and within plant, animal and even human cells."

Were the Federal Circuit to rule against Broad in the appeal, this would be a significant blow for Editas since their flagship LCA10 program is currently using the Cas9 CRISPR variant. Their exclusive Cas9 agreement with Broad would be worthless, and they would be forced to scramble to work out some sort of agreement with UCB, the terms of which would undoubtedly be unfavorable for Editas. However, it appears the odds are stacked against UCB in undertaking the appeal. In 2016, the Federal Circuit upheld 75% of the decisions made by the PTAB. The Broad Institute has countered the announcement with their own press release. One passage notes an important consideration:

"The Federal Circuit does not independently weigh the facts determined by the PTAB. To overturn the PTAB decision, the Court would need to decide that the PTAB committed an error of law or lacked substantial evidence to reach its decision. Given the careful and extensive factual findings in the PTAB's decision, this seems unlikely."

The PTAB sided with Broad because they determined the jump from prokaryote to eukaryote using Cas9 was not obvious or trivial. This is a matter of fact and not of law, meaning that the Federal Circuit cannot rule on it. From this it appears that Editas and Broad are still in the driver's seat concerning Cas9 patent ownership (here is a source which goes into further detail regarding the case).

Given that the cash burn over the past two quarters has been around $80M total, one would expect at minimum the market penalizing the company for this amount since there will be two more quarters before the product timeline is set into motion. However, the drop since then came out to around $400M, which is significantly more. Additionally, there still may be some positives given that management is now working with Allergan in filing the IND and moving forward on the LCA10 clinical trials. Make no mistake, the slip-up is a strike against management, but the amount of the selloff is greater than what is justified by the two quarter delay.

Additionally, while most research effort is currently being focused on Cas9, Editas has also licensed the exclusive rights to Cpf1 from the Broad Institute. Here there is no legal dispute like with Cas9 and Editas' exclusive access to the patents remains safe. (source: company website)

Important to note is that Cpf1 is known for being particularly selective in its determination of targets for editing. On top of that, Editas has developed a proprietary platform called "UDiTaS" with the goal of detecting and monitoring both on-site and off-site edits. This will help them in assessing and preventing any unintended consequences of Cas9-based editing.

It's Not All Bad News Being Released...

This was excellent news for several reasons. It showed management's ability to negotiate deals with big pharma, which will be necessary to get products to market without significantly diluting shareholders. It also demonstrated the confidence of companies like Allergan in the ability of Editas to execute on its project timelines. Editas is already leveraging Allergan's help in filing the IND and setting up the clinical trials for LCA10. The input from an experienced team like Allergan's will surely be invaluable moving forward. And finally, the upfront payment from the deal comes at a time when Editas desperately needs cash to get the clinical trials for LCA10 off the ground.

"For animals treated with the higher dose, the projected productive editing rate may be as high as 50 percent in photoreceptor cells, based on directly measured editing of 15 percent in total genomic DNA and an estimate for the proportion of cells represented by photoreceptors. Achieving 50 percent of all alleles would be well above the editing rate hypothesized to have a therapeutic effect in patients."

This provides a great deal of confidence in the LCA10 program going forward since the editing level was deemed high enough to have a therapeutic effect. Additionally, Editas released pre-clinical data from their program to treat blood diseases like Sickle Cell and Beta-Thalassemia. The experiment involved editing human stem cells outside of the body and infusing them in mice. Editas' analysis of the editing frequency and hemoglobin data showed that this approach may be more effective than others currently reported.

The excitement behind SHERLOCK is due to its potential to rapidly and cheaply detect many different afflictions, such as Zika, cancer, and even the risk of heart disease from saliva. Broad's researchers have said they are looking for ways to commercialize the technology, and given their history of licensing tech to Editas, it's definitely not out of the question that Editas may be involved with this technology in the future.

Risks

As Editas is an early stage biotech company with any potential products many years away from release, the risks are self-evident. On top of the current lack of products, the patent licensed for Editas' lead development program is under heated legal dispute, which is expected to be an overhang for the next few years. Editas' cash burn is significant, and despite having $352M currently on the balance sheet, their funding stockpile is only expected to last around two years.

(source: generated from company 8-K's)

In the worst case scenario, Editas is never able to achieve a viable product and is forced to dilute shareholders into oblivion. However, Editas has an alternative method for raising capital: R&D alliances that come with upfront payments and milestone awards. Potential milestone payments from Allergan and Juno Therapeutics could soften the need for issuing equity in the future. Additionally, Editas can negotiate deals with other companies on new programs which are not currently covered by the Allergan and Juno ones.

Conclusion

Editas has seen a significant amount of downward pressure recently due to a stream of negative news which has surfaced. In this article, I have addressed why many of these issues are overblown, as well as presented other positive news pieces which are important to consider. Given the infancy of the technology and the risks involved, I would not recommend Editas as a core holding. But for investors looking for a small speculative position which has the potential for a 10x gain if everything goes right, this looks like a good entry point.

Rating: Speculative Buy

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in EDIT 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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Editas Medicine: Addressing The Negatives - Seeking Alpha