There's no such thing as a slam dunk in gene therapy, but investors should be feeling pretty confident in Krystal Biotech's upcoming U.S. Food and Drug Administration (FDA) approval decision on February 17, 2022.

Vyjuvek delivered a no-doubter phase 3 clinical trial in dystrophic epidermolysis bullosa (DEB). The rare skin disease is caused by mutations in the COL7 protein, which anchors the outermost layer of skin (epidermis) to the middle layer of skin (dermis). It's characterized by fragile skin, chronic and recurring wounds from simple touch, and the inability to do normal everyday things such as wearing a shirt or taking a shower. There are no approved treatments and management of symptoms typically costs $200,000 to $400,000 per year.

Krystal Biotech stands tall above the competitive landscape, ranking ahead of Amryt Pharma (rejected by the FDA), Abeona Therapeutics (seeking FDA approval), and Castle Creek Biosciences (phase 3 ongoing) in patient outcomes and convenience. The manufacturing facility being used for initial production volumes of Vyjuvek supplied product during clinical trials, which reduces regulatory risk for manufacturing data and inspections.

But hey, this is gene therapy. The FDA sets a very high bar. Investors can never be too sure approval will occur on time – or at all.

Therefore, although I expect Vyjuvek to earn FDA approval, I'm keeping the existing margin of safety range in place. The uncertainty of the upcoming approval decision for Vyjuvek and steady stream of delays across all other programs creates just enough doubt to subdue the definition of "attractive valuation."

However, if the DEB drug candidate earns regulatory approval in mid-February 2023, then Solt DB Invest will significantly increase the margin of safety range. Let's walk through the nuances of the competitive landscape and forecast.

What Makes HSV Gene Therapy an Ideal Modality in Skin?

Vyjuvek is a herpes simplex virus (HSV) gene therapy, which has multiple advantages:

• Large capacity: HSV gene therapy can carry at least 30,000 bases of genetic material, allowing full-length human genes (sometimes multiple copies) to be delivered to patient cells. Lentiviral (LV) gene therapy can only carry 8,000 bases, adeno-associated virus (AAV) gene therapy can only carry 10,000 bases or so, and lipid nanoparticles can only carry 12,000 bases. This is why many other gene therapies use microgenes, such as microdystrophin in Duchenne muscular dystrophy; they're too small to hold full-length human genes.
• Low immunogenicity: HSV gene therapy doesn't trigger an immune response in patients, allowing continuous dosing. LV, retrovirus (RV), and AAV gene therapies trigger strong immune reactions, which is why they're one-and-done treatments. They cannot be dosed a second time.
• No integration risk: HSV vectors don't integrate in human genomes. Integration can increase the risk of cancer for LV, RV, and AAV gene therapies. This is one reason LV and RV gene therapies are administered to cells in the lab (ex vivo) and not directly inside patients (in vivo).

On paper, HSV gene therapy is the perfect therapeutic modality for treating skin and lung diseases. These are tissues that regenerate frequently, which requires redosing capabilities to constantly resupply genetic fixes. Skin and lung tissues are also constantly exposed to the environment, which means they shoot first and ask questions later when it comes to immune responses (see: asthma, skin allergies). Low immunogenicity treatment options are crucial.

In a real-world setting, the characteristics of HSV gene therapy translate into additional advantages. A large capacity, low-immunogenicity gene therapy can be formulated into a topical gel and applied directly onto the skin as many times as needed. A topical gel can also be administered in a patient's own home, which is significantly more convenient than traveling hundreds of miles to be treated in the office of a rare disease specialist.

These advantages have handed Vyjuvek the best data and most convenient drug candidate in the competitive landscape. At a high level, the ideal DEB treatment would lead to complete wound healing and be used for long-term maintenance when wounds reopen.

• Amryt Pharma is developing a topical gel named Oleogel-S10 (birch extract). In a phase 3 study, the drug candidate helped 41.3% of wounds achieve complete healing at Day 45, compared to 28.9% for placebo. The responses worsened by Day 90. The FDA rejected the drug candidate. Although it was approved in Europe, the company had to cut pricing by half after a strong backlash over the ineffectiveness of the treatment.
• Abeona Therapeutics is developing an RV gene therapy named EB-101. Treatment requires harvesting skin cells from patients, administering the gene therapy to the cells ex vivo, growing the engineered skin cells in sheets, and the surgically transplanting them onto patients. In a phase 3 study, EB-101 helped 81.4% of wounds achieve at least 50% healing at six months, compared to 16.3% for untreated wounds. The gene therapy candidate also reduced pain in treated wounds. The company plans to submit a BLA in the second quarter of 2023.
• Castle Creek Biosciences is developing a LV gene therapy named D-Fi (formerly FCX-007). Treatment requires harvesting skin cells from patients, administering the gene therapy to the cells ex vivo, and then injecting the cells below the epidermis. The phase 3 clinical trial now underway has the same primary endpoint as Vyjuvek's pivotal study.

Those aren't even in the same ballpark as Vyjuvek. In a phase 3 study, the HSV gene therapy candidate helped 67.4% of wounds achieve complete healing at six months, compared to 21.6% for placebo. A low-immunogenicity profile enables the gene therapy to be formulated as a topical gel and administered on-demand, forgoing the multi-week waiting period for ex vivo gene therapies.

That suggests Vyjuvek is poised to dominate the competitive landscape. So, what's the value of the opportunity and how much can Krystal Biotech capture?

Forecast & Modeling Insights

The value of a clinical-stage asset is estimated by developing a risk-adjusted net present value (rNPV) model. This is influenced by factors including the stage of development, disease prevalence, percent of the population diagnosed and treated, efficacy, safety, average selling price of the treatment, and traditional financial metrics used for discounted cash flow calculations.

The stage of development is one of the most important metrics in determining the probability of success, which can be thought of as the percent chance the rNPV is fully realized. An asset in phase 1 clinical trials may only contribute 8% of its rNPV to a company's valuation, whereas one under regulatory review typically contributes 90% of its rNPV valuation.

This is the mathematical reason late-stage drug candidates are more valuable than early-stage drug candidates, and what drives the misconception that drug development is binary. An asset being evaluated in a phase 2 study has a 15% chance of reaching market, but an asset being evaluated in a phase 3 study has a 52% chance of earning approval. Large swings in share prices due to data readouts are the result of changing how much of an rNPV model is being priced into a company's shares – and it cuts both ways.

Vyjuvek is right on the finish line, but Wall Street is still being cautious.

Evaluate Pharma has developed global revenue forecasts for combined DEB treatments in 2026 (published April 2021) and 2028 (published November 2022). My modeling has historically conflicted with Evaluate Pharma on both the size of the market (I think it's smaller) and the relative share among treatment options (I think Vyjuvek's will be higher). Their latest forecast for 2028 reduced the size of the market and increased Vyjuvek's share of the opportunity – both bending closer to Solt DB Invest modeling (there's still some disagreement but the gaps are shrinking).

‍Note: Evaluate Pharma's 2028 revenue forecast is the most current and replaces the 2026 revenue forecast. Data Source: Evaluate Pharma.

There are nuances from the competitive landscape that must be acknowledged to create the most accurate model for Vyjuvek.

First, the size of the market could be smaller than $1 billion per year for DEB treatments.

• There are an estimated 6,000 individuals affected by DEB in the United States and Europe combined. Evaluate Pharma's combined full-year 2028 revenue estimate assumes roughly 50% of American and European patients are treated at an average selling price of about $331,000 per year.
• Due to the regeneration of skin cells, DEB treatments will need to be repeated relatively frequently. That means the average selling price (ASP) per year is likely to be near the current cost of treating symptoms, or $200,000 to $400,000 per year. This is different than gene therapies aimed at the liver that offer symptom relief for many years and can be priced in the millions of dollars.
• As is true for many rare diseases, prevalence rates can sharply overestimate the size of the patient population. Similarly, many individuals with DEB aren't diagnosed or have been incorrectly diagnosed. Therefore, treating 50% of the estimated patient population by 2028 isn't a slam dunk.

Second, Evaluate Pharma is overestimating the relative share of Amryt Pharma.

• The company's topical gel is only approved in Europe and has an average selling price of about $62,000 per year after the price cut. That means the drug product would need to treat 3,790 patients per year to reach $235 million in annual revenue in 2028.
• Filsuvez / Oleogel-S10 is approved in Europe to treat all forms of epidermolysis bullosa, but only outperformed placebo on wound healing in DEB, and only through 45 days. It provided no benefit through 90 days. Treatments need to provide durable outcomes for patients measured in months and years. The drug product may not even be on the market in 2028.

Third, the phase 3 data from Abeona Therapeutics suggests it may only play a niche role in the market.

• The inferior complete healing rate and inconvenience of EB-101 are partially offset by pain reduction data – something Vyjuvek doesn't have.
• Abeona Therapeutics could focus on the niche of larger surface area, harder-to-treat wounds and set the highest average selling price in the market. The business could achieve $122 million (or more) in annual revenue by 2028, but it could be significantly lower if Vyjuvek becomes the first-line treatment due to convenience. Patients who don't respond to Vyjuvek may turn to EB-101 as a second option.

What about Vyjuvek? Solt DB Invest modeled the market opportunity by considering:

• low, medium, and high selling price scenarios
• low, medium, and high penetration of the patient population scenarios
• combined patient population of 6,000 in the United States and European Union

If Vyjuvek treats 20% of American and European patients at an average selling price of $150,000 per year, then it would generate roughly $180 million in annual revenue. That's considered the lowest value scenario, but accounts for potential challenges in identifying patients.

The selling price will most likely be higher to account for the expectation patients use fewer applications over longer periods of time. If Vyjuvek treats the same share of the patient population at $350,000 per year, then the annual revenue potential climbs to $360 million. List prices are likely to be higher in the United States compared to Europe, but the geographic pricing gap isn't as large in rare diseases and gene therapies as it is for other indications and modalities.

There's some uncertainty in long-term treatment dynamics. All companies are collecting multi-year data to better understand how product usage changes from Year 1 to Year 2 and so on. New patients will require more product, but hopefully long-term maintenance treatment includes less frequent dosing and lower product volumes.

It's a little easier for Krystal Biotech to collect these data with its convenient topical gel formulation. In fact, the FDA insisted the company include at-home dosing in the open-label extension (OLE) study, which is essentially an extension of the phase 3 study. New patients can enroll. This is an important advantage within the competitive landscape.

Considering the totality of factors, Solt DB Invest expects Vyjuvek to reach peak annual global revenue of at least $540 million. At this time, modeling the revenue ramp by year is more difficult considering the rarity of the disease, uncertainty in pricing dynamics, and uncertainty in product usage over time. Nonetheless, Vyjuvek could reach at least $400 million in annual revenue by 2026 (Year 4).

Vyjuvek peak annual revenue of at least $540 million would contribute roughly $2.7 billion to the company's valuation. The trajectory of the launch and sales performance in the first 24 months will determine how much of this valuation is priced into shares in 2023 and 2024. A significant share can be priced in earlier due to ownership of multiple manufacturing facilities, which offer considerable value, too.

However, this all goes out the window in a potential acquisition, which would likely account for 100% of peak annual revenue. The sluggish activity and constant delays throughout the pipeline could be a sign Krystal Biotech is looking for a suitor, especially given the unusually large ownership stake of the cofounders.

If Vyjuvek earns FDA approval on February 17, 2023, then Solt DB Invest will increase the margin of safety range as follows:

• Likely Undervalued would be set to the full value of Vyjuvek's peak annual revenue while valuing the rest of the technology platform at $0. This market valuation would be $2.7 billion, equivalent to $91.19 per share.
• Midpoint would be set to a market valuation of $3.2 billion, equivalent to $108.07 per share.
• Likely Overvalued would be increased to a market valuation of $3.7 billion, equivalent to $124.96 per share. A potential acquisition could exceed this level.

All share prices account for an additional 15% in dilution, or 29.610 million shares outstanding. A public offering of common stock is expected immediately following approval.

The rest of Krystal Biotech's pipeline is not very valuable because most programs have yet to begin phase 1 clinical trials. Solt DB Invest values the aesthetics pipeline at $0 based on data published to date, which are not competitive within the landscape. The assets with the most potential value reside in the lung pipeline, especially KB407 in cystic fibrosis. If KB407 succeeds in phase 1 and phase 2 clinical trials in the next few years, then Krystal Biotech could be worth over $10 billion.

Margin of Safety & Allocation

(No change.)

Krystal Biotech is considered a Growth (Quality) position. The current margin of safety range for the company is below:

• Current Price (market close December 16):  $79.84 per share
• Likely Undervalued:         <$50.66 per share
• Midpoint:                            $67.55 per share
• Likely Overvalued:           >$84.43 per share
• Allocation Range:              Up to 10%

Krystal Biotech reported 25.748 million shares outstanding as of October 31, 2022. The margin of safety range above assumes 29.610 million shares outstanding, which accounts for an additional 15% of dilution.

Further Reading

• November 2022 company update discussing development delays across Krystal Biotech's pipeline
• November 2022 article from Evaluate Pharma discussing competitive landscape with 2028 revenue forecast
• November 2022 press release from Abeona Therapeutics announcing phase 3 results for EB-101
• July 2022 company update discussing potential for Krystal Biotech to sell priority review vouchers for at least $100 million in cash.
• April 2021 article from Evaluate Pharma discussing competitive landscape with 2026 revenue forecast

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