I was recently in Houston. Solt DB is based in Pittsburgh. There are many differences between the two cities, but one subtle distinction is in how natives treat strangers. People in the South are nice, but not necessarily kind. People in Pittsburgh are kind, but not necessarily nice. You'd rather encounter the latter – blunt, but authentically helpful.

For example, there's a saying in the South, "bless your heart." It sounds nice, but it translates to "go f@ck yourself." In Pittsburgh we just cut to the chase.

Well, in recent weeks Coherus BioSciences has taken Wall Street's revenue targets and misunderstandings of the clinical pipeline and politely responded with "bless your heart." The opportunity resides in understanding the translation.

Financial Details of the Acquisition

Coherus BioSciences agreed to acquire Surface Oncology for up to $65 million in stock. The acquisition will add two clinical-stage assets to the pipeline, as well as partial financial rights to two outlicensed clinical-stage assets. The transaction will occur at $5.2831 per share of Coherus BioSciences' stock. The total transaction price includes two components:

• $40 million in base value (representing 7.571 million shares of common stock)
• $20 million to $25 million to acquire the cash balance of Surface Oncology (representing up to 4.732 million shares of common stock)

There's some inaccurate and confusing reporting about the net acquisition cost. Investors should be aware Coherus BioSciences must acquire the cash balance of Surface Oncology by issuing shares (this component of the acquisition is akin to a stock offering to raise cash), so the dilution will be greater than the $40 million net acquisition cost.

That's the immediate financial impact of the acquisition. The mid- and long-term details are more complex.

Surface Oncology outlicensed an anti-CD73 drug candidate to Novartis and an anti-CD112R drug candidate to GlaxoSmithKline. Coherus BioSciences will acquire partial interests in the potential development, regulatory, and sales milestone payments and royalty streams from these assets. It will earn 30% of the following, if achieved:

• The CD73 asset (formerly SRF373, now called NZV930) can earn development milestones of up to $325 million, sales milestones of up to $200 million, and royalties.
• The CD112R asset (formerly SRF813, now called GSK4381562) can earn development milestones of $60 million, regulatory milestones of up to $155 million, sales milestones of up to $485 million, and royalties.

Novartis has terminated development of NZV930 as a monotherapy due to low efficacy, but is evaluating its potential as a combination therapy with its own PD-1 asset. Multiple CD73 and PD-1 combinations in the global industry pipeline have demonstrated encouraging results and advanced into later stage studies.

• AstraZeneca is evaluating a pairing between its CD73 asset oleclumab and PD-1 asset Imfinzi in pancreatic cancer (phase 2) and lung cancer (phase 3).
• I-Mab is evaluating a pairing between its CD73 asset uliledlimab and Junshi Biosciences' PD-1 asset toripalimab in multiple tumor types (phase 2).

Coherus BioSciences has also structured the acquisition to allow Surface Oncology shareholders to benefit from potential international licensing agreements for the two wholly-owned assets at the center of the deal.

• Surface Oncology will earn 25% of upfront payments from potential international licenses granted for SRF114.
• Surface Oncology will earn 50% of upfront payments from potential international licenses granted for SRF388.

Expanding the I-O Pipeline

Assuming the acquisition closes, Coherus BioSciences will have five immuno-oncology assets in its pipeline. That includes the two clinical-stage assets from Surface Oncology:

• SRF388 is an anti-IL-27 drug candidate being developed as a monotherapy in liver (phase 2) and lung cancers (phase 1). It's the most advanced IL-27 asset in the global industry. The largest initial market for the drug candidate is second-line non-small cell lung cancer (2L NSCLC). Importantly, the synergistic mechanism of action creates an opportunity to explore triple-combination cancer treatments by combining PD-1, TIGIT, and IL-27 targeting.
• SRF114 is an anti-CCR8 drug candidate being developed across multiple tumor types, although the greatest potential resides in head and neck cancers, cervical cancers, and gastric cancers. The largest initial market for the drug candidate is cervical cancer. Importantly, toripalimab's first approval will be in nasopharyngeal carcinoma (NPC), which is a type of head and neck cancer.

There are three important implications to acquiring clinical-stage assets.

• First, these assets can be studied in combination with toripalimab several years sooner than assets developed in house. A drug candidate generally cannot be used in a combination until it has been studied in a phase 1 clinical trial by itself. SRF114 has already entered its first phase 2 study, while SRF388 will begin a phase 1 study in combination with toripalimab soon.
• Second, clinical-stage assets can make meaningful contributions to the company's valuation. Only 5.8% of oncology assets that begin a phase 1 clinical trial earn FDA approval, but investors must account for a portion of their future potential value throughout clinical development. The current value of SRF388 in our risk-adjusted net present value (rNPV) model already exceeds the total acquisition cost.
• Third, the international rights for clinical-stage assets can be outlicensed for meaningful upfront payments. SRF388 has promising data in multiple tumor types, including a 27% objective response rate in first-line liver cancer as part of a triple-combination. An upfront payment for SRF388 could be worth more than the total acquisition cost, although Coherus BioSciences will only recognize half.

Cementing a Low PD-L1 Strategy

The most valuable aspect of the acquisition isn't the most obvious to pin down in 2023. Coherus BioSciences is cementing a low PD-L1 strategy by acquiring SRF388 and SRF114. What the heck does that mean?

There are over 15 anti-PD-1 drug products and drug candidates dotting the global competitive landscape, including the world's bestselling drug Keytruda. The proliferation of the drug class is no fluke. PD-1 proteins on the surface of immune cells bind to PD-L1 proteins on the surface of cancer cells like a lock and key. The binding suppresses the immune system, so blocking the interaction can improve responses across a broad range of solid tumor types. Although PD-1 inhibitors generally aren't very effective as monotherapies, they can be combined with numerous other inhibitors to greatly improve responses.

However, the proliferation of the drug class comes with one major drawback. Patients who don't respond to treatment with a PD-1 inhibitor or relapse after treatment generally cannot be treated with similar drugs again. That's led to an arms race to develop drugs with activity in low PD-L1 tumor types – and Coherus BioSciences is impressively positioned.

The company's entire immuno-oncology pipeline has activity in no and low PD-L1 tumors. Ironically, that includes the anti-PD-1 asset toripalimab, which is the foundation of the pipeline. Toripalimab has a unique binding mechanism to PD-1 receptors. As a result, it has 12x the binding strength of Keytruda and 23x that of Opdivo, which makes it significantly more effective in low PD-L1 tumors. These two assets combined for full-year 2022 revenue of $29 billion.

Will toripalimab have $10 billion in peak annual sales? Almost certainly not. But if the company's low PD-L1 strategy pays off, then the total immuno-oncology pipeline could reach $5 billion in peak annual sales. It's early, but results to date are promising.

• Toripalimab (PD-1) recently became the first PD-1 inhibitor to demonstrate meaningful activity in small cell lung cancer (SCLC) – a low PD-L1 tumor type. Both Keytruda and Opdivo were granted accelerated approvals in SCLC, but had to be withdrawn from the market due to a lack of benefit. In esophageal cancer, toripalimab reduced the risk of death by 39% regardless of PD-L1 status. Keytruda reduced the risk of death by 38% in high PD-L1 patients, but by only 14% in low PD-L1 patients.
• An exploratory phase 1 clinical trial of SRF388 (IL-27) in NSCLC demonstrated two partial responses and one disease stabilization in no or low PD-L1 patients, all of which were previously treated with PD-1 inhibitors.
• CHS-006 (TIGIT) will have initial data from a U.S. clinical trial in early 2024. After initially being hyped as the next blockbuster target, TIGIT assets have largely disappointed in the clinic, even when combined with PD-1 inhibitors. The primary reason is a lack of activity in low PD-L1 tumors. It's too soon to suggest combinations of CHS-006 and toripalimab will buck the trend, but investors shouldn't rule out the possibility either.

Forecast & Modeling Insights

(Increased 2023 model, introducing preliminary 2024 model)

Solt DB Invest's expectations for full-year 2023 revenue haven't changed from previous communications. However, our updated 2023 model increases the valuation attributed to commercial-stage assets across the portfolio and includes new contributions from SRF338 and SRF114.

• Full-year 2023 revenue of $338 million.
• Udenyca franchise contributes at least $125 million, including roughly $100 million from Udenyca PFS and at least $25 million from Udenyca AI. Solt DB Invest does not expect Udenyca OBI to generate revenue in 2023.
• Cimerli contributes at least $100 million, mirroring management's guidance. Solt DB Invest expects Q2 2023 revenue of at least $18 million.
• Yusimry contributes $108 million in full-year 2023 revenue reflecting 2% market share at average selling prices required to win over payers and pharmacies.
• Toripalimab contributes $15 million, although this may be an overestimate depending on the specific launch date. Coherus BioSciences will have a wide open opportunity in NPC, but it's a relatively rare cancer that's often misdiagnosed as head and neck cancer. Slower-than-modeled patient discovery could shift revenue generation into 2024.

It's important to note three caveats to our 2023 model.

• First, Udenyca AI might generate significantly more revenue than the $18.5 million expected.
• Second, Yusimry will have enough units available at launch to generate more revenue than our model, especially if Coherus BioSciences' pricing strategy lands government supply contracts or preferred status from government payers.
• Third, toripalimab could generate significantly less revenue that our model as it may not launch until late 2023.

Solt DB Invest is introducing its preliminary 2024 model.

• Full-year 2024 net product revenue of $604 million. This does not include expectations for an upfront payment (licensing revenue) for international rights to SRF388 of $25 million to $50 million.
• Udenyca franchise contributes at least $160 million, including roughly $80 million each from Udenyca PFS and Udenyca AI. Solt DB Invest does not expect Udenyca OBI to generate revenue in 2024.
• Cimerli contributes at least $125 million.
• Yusimry contributes at least $274 million.
• Toripalimab contributes at least $45 million.

We will refine our 2024 model as more data become available and expect to tighten the Margin of Safety range for 2024, which currently prices in a relatively broad swath of valuation probabilities.

Margin of Safety & Allocation

(Increased 2023 model, introducing 2024 model.)

Coherus BioSciences is considered a Growth (Speculative) position. The current Margin of Safety range for the company based on our 2023 model is below:

• Current Price (market close June 16):  $4.13 per share
• Likely Undervalued:         <$10.15 per share
• Midpoint:                            $13.31 per share
• Likely Overvalued:            >$16.47 per share
• Allocation Range:              Up to 15%

The current Margin of Safety range for the company based on our preliminary 2024 model is below:

• Current Price (market close June 16):  $4.13 per share
• Likely Undervalued:          <$13.29 per share
• Midpoint:                            $17.05 per share
• Likely Overvalued:            >$20.81 per share
• Allocation Range:              Up to 15%

Coherus BioSciences reported 80.554 million shares outstanding as of April 30, 2023. The business subsequently completed a public offering of common stock and plans to acquire Surface Oncology in an all-stock acquisition. The Margin of Safety range above assumes 111.713 million shares outstanding, which prices in 5% dilution from the estimated share count after the acquisition of Surface Oncology.

Further Reading

• June 2023 research note with preliminary analysis on the acquisition of Surface Oncology
• June 2023 press release announcing intention to acquire Surface Oncology
• June 2023 research note analyzing toripalimab's successful FDA inspection and Yusimry list price announcement
• May 2023 research note analyzing the public offering of common stock
• May 2023 research note analyzing the first-quarter 2023 operating results

‍