SECTORAL ASSET MANAGEMENT Newsletter

THE S.A.M. NEWSLETTER Healthcare Market Review April 2005 Volume 4.3 and Outlook

Biotech stocks decline on global factors and In This Issue uncertain regulatory environment

Biotech stocks have had a tough first quarter. At the close on March Healthcare Market Review & Outlook 31, 2005, the Nasdaq Biotech Index was down –15.3% year‐to‐date Page One. vs –8.1% for the Nasdaq Composite Index and a marginal drop of –2.6% in the S&P500. This poor performance comes somewhat as a surprise – though not entirely (vide infra) – inasmuch as we expect Antibodies – Past, Present and Future the biotechnology industry’s strong 2004 financial performance, Page Six. with sales and earnings comfortably above 20%, to continue over the next few years. It also fails to reflect the relatively strong per‐ formances of Genentech (+4.0%) and Serono (15.9% in CHF and About Sectoral Asset Management 11.2% in USD), two of the sectors largest capitalizations, though Page Twelve. not part of the Nasdaq Biotech Index. Two sets of factors – global and sector specific – have been influential since the beginning of the year.

The S.A.M. Newsletter is published Global factors force technology stocks down quarterly by Sectoral Asset Manage‐ ment (Montreal, Canada). Opinions Through February 25, the last trading day prior to Biogen‐Idec and expressed herein are those of the au‐ Elan’s announcement of the voluntary withdrawal from the market thors and do not necessarily reflect of multiple sclerosis (MS) drug Tysabri, the declines of the Nasdaq those of Sectoral Asset Management. Biotech Index and the Nasdaq Composite Index were similar ‐5.6% This information is provided solely for and ‐5.1%, respectively. Their poor performance is largely attribut‐ purposes of evaluating S.A.M.ʹs advi‐ able to the increase in oil prices and the sharp rise in long‐term US sory services. It is not an offer of any interest rates, factors, which have weighed on equity markets in fundʹs securities. Past performance is general and high‐beta stocks in particular. Risk‐averse investors no guarantee of future results. The have migrated to less volatile, i.e. « safer », asset classes or market performance achieved by Mr. Sjöström segments. They have preferred blue‐chip stocks to technology and others at Sectoral Asset Manage‐ stocks, as illustrated by the modest decline in the S&P500 (‐2.6%) ment may not match his performance vs the –8.1% decline in the Nasdaq Composite Index during the while employed by another organiza‐ first quarter. Similarly, they have also showed a preference for tion. Investing in healthcare and bio‐ large caps over small caps. In the biotech sector, this translated in a technology companies involves a high pre‐Tysabri‐withdrawal year‐to‐date performance of –4%, ‐6% and degree of risk, and prices of these –12% performance for large, mid and small caps, respectively companiesʹ stocks may be very vola‐ (source: Sectoral Asset Management). This mirrors what happened tile. in the summer of 2004, and is not a reflection of any deterioration in industry fundamentals.

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Overall Market Results Return Annualized Volatility Average Volume (m) To Tysabri Index Close 3/31 Withdrawal 3 Month 6 Month 9 Month 12 Month 3 Month 6 Month 3 Month 6 Month (02/25/05) MSCI World Index 1151.3 0.7% -1.5% 9.9% 8.4% 8.7% 8% 8% 6280 6058 S&P 500 1180.6 0.0% -2.6% 5.9% 3.5% 4.8% 10% 11% 1323 1273 Nasdaq Composite 1999.2 -5.1% -8.1% 5.4% -2.4% 0.3% 13% 15% 1054 1054 Nasdaq Biotech Index 650.6 -5.6% -15.3% -9.0% -14.3% -16.4% 20% 23% 74 72 Philadelphia Drug Index 183.41 0.6% -1.1% 2.3% -1.9% 0.6% 13% 13% 62 70 S&P Pharmaceutical Index 312.64 -0.4% -1.1% 0.0% -8.7% -6.8% 16% 16% 61 69 Table 1: Overall Market Results

Tysabri recall rekindles regulatory worries

The sector‐specific factors are largely due to perceptions of the regulatory environment in the United States. Re‐ call that investor reaction to Vioxx’s market withdrawal last September prompted fears of a toughening of the US Food and Drug Administration’s (FDA) policies and decision‐making. The lack of permanent leadership at the FDA had also been a source of lingering worries for healthcare investors in general and biotechnology inves‐ tors in particular. During the first half of February the horizon seemed to clear on this front as (1) US President George W. Bush announced the nomination of Acting FDA Commissioner Lester Crawford to the position; and (2) an FDA panel surprisingly supported the reintroduction of Merck’s arthritis drug Vioxx to the market and endorsed the benefit/risk profile of the COX‐2 class of drugs in general (albeit for a smaller patient population). On February 28th, however, investors’ regulatory worries were rekindled when Biogen‐Idec and Elan an‐ nounced the voluntary – some would argue premature ‐ withdrawal of their MS drug Tysabri following the ap‐ pearance of a rare, deadly and totally unforeseen side‐effect. Tysabri had been hailed as a significant (and up to that time, safe) advance in the pharmacopoeia against multiple sclerosis and was forecast to become first‐line treatment of MS, with peak sales estimated to exceed USD3bn. As a result, biotechnology equities plunged, dropping –10.3% since the announcement. While about a quarter of this drop is attributable to Biogen‐Idec stock alone, there is no denying that investors have, again, started to discount an industry unfriendly turn in the regu‐ latory environment.

Specifically, investors are worried that due to public, media or political pressure, the FDA might deemphasize Priority Review and Accelerated Approvals, which have been applied to numerous drugs in the last few years. Indeed, Tysabri was approved under Priority Review status and granted Accelerated Approval on November 23, 2004, six months after filing. The FDA grants Priority Review status to products that are considered to be potentially significant therapeutic advancements over existing therapies or that address an unmet medical need. The agency granted Accelerated Approval for Tysabri following Priority Review based on one‐year data from two Phase III studies. Normally, two‐year data would have been needed but the FDA agreed with the sponsors in February of last year that the strength of the data (both efficacy and safety) warranted a filing based on one‐ year data only. This comes on the heels of another clinical disappointment, the lung cancer drug called Iressa, which had also been approved expeditiously based on summary data and which later failed to deliver on its early clinical promise.

FDA critics have recently been fairly vocal and have accused the Agency of being too cozy with the healthcare industry. In response, the FDA has announced the creation of a Drug Safety Monitoring Board, which we don’t view as necessarily negative for industry since such a body will exclusively be in charge of monitoring post‐ approval drugs, with the aim of detecting unexpected side‐effects as early as possible. As mentioned earlier, a detailed inquiry into the risk/reward profile of COX‐2 inhibitors was conducted last month by two consolidated FDA Advisory Committees; the FDA has not yet responded to the committees’ recommendations. It is too soon to judge whether recent events will have any effect on the FDA’s tendency toward risk‐aversion and defensive‐ ness in decision‐making. As events unfold, it will be useful to follow some of factors discussed below.

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The new Commissioner, Lester Crawford. Should he be confirmed as the permanent FDA Commissioner, what would be his impact on drug review times, data requirements, the use of Priority Reviews and Accelerated Approvals, etc? Most FDA observers would agree that he lacks the vision, dynamism and gravitas of his prede‐ cessor Mark McClellan and that he is unlikely to foster any positive change. In investors’ minds, no or little change might be a rather positive outcome as the FDA had embarked on a more aggressive use of Priority Re‐ views and Accelerated Approvals under the short tenure of Mark McClellan. Most notably these resulted in the early approvals of Velcade, Avastin, Erbitux and Vidaza, all of which have significantly benefited patients. On the other hand, the FDA also showed its conservative side under McClellan’s tenure, notably with respect to gene therapy. In a more negative scenario, his lack of clout might suggest he is likely to cave in to the demands of critics calling for more restrictions and conservatism toward new drug approvals, but recent developments have been encouraging. Recently, Sepracor’s Xoponex (acute asthma) was approved in first cycle review, whereas only an Approvable Letter had been expected. Bristol Myers’ Entacavir for Hepatitis B won the unani‐ mous support of an FDA Advisory Committee and, shortly thereafter, formal FDA approval. Amylin Pharma‐ ceuticals’ Symlin for type I and type II diabetes won FDA approval, although most observers had predicted only about a 50% chance of being approved. On the other hand, the precipitous interdiction by FDA of GlaxoSmith‐ Kline’s clinical trial of an MS drug using the same mechanism of action as Tysabri appears to be a worrying ex‐ ception.

The level of medical need. This is already a key determinant in granting Priority Review status and in con‐ sidering Accelerated Approval. We would expect the sensitivity of the FDA to these issues to be heightened as a consequence of the Tysabri withdrawal. While medicines for chronic diseases, especially if neither deadly nor debilitating, might be subject to more debate prior to granting any preferred status, we think products address‐ ing debilitating and/or deadly diseases will continue to benefit from more rapid review times and lighter re‐ quirements in terms of data, at least prior to approval.

The risk acceptance level of drug reviewers and users. This is an emotional as well as a rational issue in a political context. Clearly, cases such as Vioxx and Tysabri tend to make people more cautious. Scientifically (as well as intuitively), however, it is understood that rare side‐effects are not always detectable in clinical trials which, by definition, have less patient‐year exposure than the market. They are an unavoidable cost of medical progress. The question is how one deals with them. Increasing the data requirements prior to approval might in many cases prove practically unrealistic and economically impossible (and which would likely be perceived negatively by investors). The decision here would, we believe, hinge (again) on the level of medical need. A more practicable approach might be to more systematically track new products and their side‐effects as they are used in a broader population and in an uncontrolled setting. The market clearly fears the former (increased data requirements). Interestingly, a recent article in the New England Journal of Medicine1 points out that FDA offi‐ cials, observers and critics generally appear satisfied with the current pre‐approval requirements (primarily di‐ rected at determining efficacy) and point to post‐approval safety monitoring as the area to reinforce. The debate seems to be centered on the form such a monitoring body should take – that is, whether it should be part of or independent from the FDA. The Data Safety Monitoring Board proposed by Crawford is a hybrid, in the sense that although it is organizationally within FDA, its membership includes representatives from other federal agencies. Finally, a great deal also hinges on the public’s perception of how responsibly companies behave, which in many cases is admirable. Most dramatically, recall that an FDA Advisory Committee of medical ex‐ perts offered an opposing opinion to Merck regarding the risk/benefit of Vioxx – in this case the company acted more aggressively by removing Vioxx from the market than experts and regulators deemed appropriate (al‐ though at the time of withdrawal Merck did not know of the similar side‐effects of other members of the COX‐2 class).

1 Susan Okie, M.D., Safety in Numbers – Monitoring Risk in Approved Drugs, New England Journal of Medicine 352;12, p. 1173-1176

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SECTORAL ASSET MANAGEMENT Newsletter Deterioration in regulatory environment less dramatic than stock prices suggest

The Tysabri withdrawal has had clear short‐term negative implications on investors’ perception of the regula‐ tory environment. However, we believe the most likely route FDA reform will take, is that of post‐marketing safety monitoring. This will have a cost, primarily for products targeting the (mass) primary care market. Such cost will come in two forms: the cost of the post‐marketing studies themselves and the (possible) opportunity costs of less off‐label prescribing. We see relatively little risk of systematic higher pre‐approval requirements. The previously cited NEJM article notes that 50% of drugs approved in the U.S.A. have been shown to have un‐ expected post‐approval side‐effects that have led to label changes, including black box warnings, and rarely withdrawals. Moreover, most drug companies routinely conduct post‐marketing studies, both for commercial and safety purposes. As is often the case with investors, the fear is greater than the threat, and time will likely assuage many of their concerns.

We expect the next set of quarterly results and the expected approvals of drugs such as Exanatide for type II diabetes in April (Amylin Pharmaceuticals), Revlimid for vascular cancers in June (Celgene) and Ranexa for chronic angina later this year (CV Therapeutics) to help investors regain confidence. Also, the way FDA re‐ sponds to the Advisory Committees’ recommendations on COX‐2 inhibitors will be very revealing.

Let us not forget that the biotech industry’s strong fundamentals remain intact: Biotech drug sales are on track to increase by more than 20% p.a. (even without Tysabri), 50% of New Drug Applications originate directly or indirectly in the biotech industry and this quarter also had its set of significant good news including Chiron’s speedy return to flu‐vaccine manufacturing and Genentech’s Avastin positive data in Non Small Cell Lung Cancer. Last but not least, valuations are now close to historical bottoms with EV / Sales ratios for large cap bio‐ techs of less than 5x (2006E) and of less than 4x for emerging biotech companies. On a Price / Earnings basis, large caps are now at 22x 2006E for a PEG of 1.0x. This data suggests that this might be a propitious time to pick up biotech stocks in general and those of confirmed sustainable growers and emerging product companies with drugs in areas of high unmet medical need in particular. Names that come to mind are (in order of increasing risk and expected return) Amgen, Genzyme, Celgene, Amylin, Onyx and Alexion.

Sales, earnings and M&A support exposure to generics/specialty pharma

Our generics/specialty pharma universe declined by –10.5% year‐to‐date. Excluding Elan (a specialty pharma company thus part of this group), the decline still amounts to –4.7%. Here, the global factors mentioned earlier are the main culprits because most of the companies in the generic universe rely on abbreviated, low‐risk regu‐ latory pathways for well‐characterized molecules whose side effects are well understood. As such, they should have remained unaffected by the deterioration in the regulatory environment. During the quarter, the acquisi‐ tion of Hexal and Eon Labs by Sandoz confirms our thesis of increasing momentum in consolidation in the ge‐ nerics industry. Adding to the good news are the generally solid 2004 results posted by companies in the indus‐ try and the promising 2005 outlook, with sales and earnings expected to rise by more than 20%. At 16x 2006E EPS, the group remains attractively valued. Our favourites include sector leader Teva as well as KV Pharmaceu‐ ticals and Endo Pharmaceuticals.

Pharma temporarily regains some of its safe haven status

Finally, stocks of large cap pharmaceuticals have remained remarkably unaffected by the FDA turmoil, the Philadelphia Drug Index losing a mere –1.1% over the quarter. These companies are however the most suscepti‐ ble to suffer economic consequences of an increase in post‐marketing safety monitoring, inasmuch as they are large promoters of primary care products and substantial beneficiaries of off‐label sales in broad populations. The pharmaceutical rebound had more to do with their already depressed levels and the dissipation of the mar‐ ket’s worst fears with the positive outcomes of the FDA Advisory Panels on COX‐2 inhibitors (see our previous

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Newsletter) than with a significant change in fundamentals. Also, their traditional safe‐haven appeal has tem‐ porarily resurfaced in this environment of rising oil prices and interest rates. At 16x 2006E EPS their downside remains limited, but we see this rebound, and the steep decline in biotech and generics/specialty pharma stocks as a good buying opportunity for investors who haven’t yet diversified their holdings within the healthcare space.

Michael Sjöström, CFA Chief Investment Officer

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SECTORAL ASSET MANAGEMENT Newsletter Antibodies: Past, Present and Future

Antibodies have become an integral part of the armamentarium for oncology, hematological malignancies and autoimmune diseases. Since the FDA approval of the first antibody therapy in 1986, 15 additional antibodies have reached the market (see Table 1). Rituxan (Genentech / Biogen Idec / Roche), approved in 1997, is cur‐ rently the leading brand with worldwide sales of USD2.7bn in 2004. Total sales of antibody therapies in 2004 were over USD7bn. The recent approvals of Avastin (Genentech) and Erbitux (ImClone / Bristol Myers Squibb) provided new sources of growth in antibody sales. US peak sales for Avastin and Erbitux are estimated to ex‐ ceed USD4bn and USD1bn respectively. Despite the rise of other new technologies, the biotech and pharmaceu‐ tical industries continue to view antibodies as an important class of therapeutics. Engineered antibodies cur‐ rently represent more than 30% of the product candidates in the clinical pipeline.

Product Name Antibody Type Indication Launch Year Orthoclone OKT3 Mouse Transplant rejection 1986 ReoPro Chimeric Fab Cardiovascular disease 1994 Rituxan Chimeric Non‐Hodgkin lymphoma 1997 Zenapax Humanized Transplant rejection 1997 Remicade Chimeric Crohns disease, rheumatoid arthritis 1998, 1999 Simulect Chimeric Transplant rejection 1998 Synagis Humanized Respiratory syncytial virus 1998 Herceptin Humanized Metastatic breast cancer 1998 Mylotarg Humanized Acute myeloid leukemia 2000 CroFab Ovine Fab Rattlesnake antidote 2000 DigiFab Ovine Fab Digoxin overdose 2001 Campath Humanized Chronic lymphocytic leukemia 2001 Zevalin Mouse Non‐Hodgkin lymphoma 2002 Bexxar Mouse Non‐Hodgkin lymphoma 2003 Avastin Humanized Colorectal cancer 2004 Erbitux Chimeric Colorectal cancer 2004 Table 1. FDA‐approved therapeutic antibodies. (Source: Nature Biotechnology – Monoclonal An‐ tibodies and Therapies and Sectoral Asset Management.)

Industrialization and evolution of antibodies

Antibodies have exquisite specificity and affinity. They were recognized early on as potential “magic bullets” for fighting invaders (germs, viruses), aberrant host cells (autoreactive immune cells, cancer cells), and unregu‐ lated signaling molecules (growth and chemotactic factors). A key milestone in the industrialization of thera‐ peutic antibodies was the generation of the hybridoma technique by Köhler and Milstein in 1975. The fusion of antibody‐producing B cells with immortal tumor cells enabled unlimited production of a specific antibody against a single antigen. While the technique for generating mouse monoclonal antibodies has been long estab‐ lished, the delivery of therapeutic promise requires further technological advancements.

Of Mice And Men. Clinical success with the first treated human patients was modest as it turned out that their immune system was recognizing the therapeutic mAbs as foreign (non‐self), leading to a human anti‐murine antibody reaction (HAMA). This misfortune happened to OKT3, the first mAb approved in the US. Moreover, mouse mAbs do not generate adequate antibody‐dependent cell cytotoxicity (ADCC) and complement‐ dependent cytotoxicity (CDC) effector functions that are crucial to biological efficacy (see below). Successive rounds of “humanization” followed, where larger and larger parts of the murine scaffold were swapped for human counterparts (see Figure 1). Scientists first left about a third of the rodent framework, producing mosaic

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SECTORAL ASSET MANAGEMENT Newsletter mAbs. Several such chimeric mAbs are commercialized, such as the multi‐billion dollar lymphoma drug Ri‐ tuxan. After a period of time, however, treated patients also mount an immune response against the murine portion of the mosaic mAb, leading to human anti‐chimera antibody reaction (HACA). It was subsequently rea‐ soned that only the regions contacting the antigen should be left untouched while the rest of the mAb, about 98 percent, could be of human origin. This concept led to the humanized mAbs, which constitute the bulk of the approved mAbs and of those in clinical development. In the industry, Protein Design Lab has been at the fore‐ front of humanization and still reaps the fruits from its pioneer role in the form of multiple royalty streams. The ultimate step was the generation of fully human mAbs, where every bit is human. This is achieved through two techniques, each with advantages and drawbacks. The first consists in using transgenic mice where large parts of the genetic loci coding for immunoglobulins have been deleted and replaced by their human complements. Companies like Medarex, Abgenix and Genmab follow this road. The alternative technique employs in vitro se‐ lection of human mAbs displayed at the surface of bacteriophages, which has been the foundation of a set of companies like Cambridge Antibody Technolgy, Morphosys and Dyax. Cambridge Antibody Technolgy has developed Humira, the first fully human mAb approved for commercialization and prescribed for rheumatoid arthritis. Despite their theoretical advantage the jury is still out on whether fully human antibodies are actually better than humanized ones. Indeed even fully human mAbs can elicit immune responses, due to suboptimal manufacturing. This leads to incorrect polypeptide folding, protein aggregation and aberrant glycosylation pat‐ terns, all of them potentially immunogenic. From our own survey, it appears that humanized mAbs are just as reliable as the fully humans.

Figure 1. Diagrammatic illustration of mouse, chimeric, human‐ ized and fully human monoclonal antibody. (Source: Nature Re‐ views. Drug Discovery.)

Smart bombs. Because of their high target specificity, several groups strive to use antibodies as “smart bombs” by linking them to toxic payloads. The rational is that the cytotoxic agent is targeted and concentrated near the cells to be eliminated, thereby minimizing unwanted side effects (off‐target effects). It should allow for lower dosing thereby widening the therapeutic window. By far the largest application for smart bombs is cancer, where aberrant tumor cells are to be wiped out. Radioisotopes and toxins are the two types of warheads, which we will discuss next.

Nuclear warheads. Here a radioactive isotope is chemically conjugated. Once injected the mAbs bind the cells to be killed, and the radioactive moiety can exert its cytotoxic effect. Two radioactive mAbs targeting CD20 have been approved for the treatment of non‐Hodgkin lymphoma, Zevalin (Biogen Idec) and Bexxar (Corixa in part‐ nership with GlaxoSmithKline). Radioisotopes have the advantages over chemical payloads to have a small mass, their conjugation to mAbs is simple, and their toxicity is well characterized and predictable. On the other hand, radioactivity in general is inconvenient, as it must be used in specialized units. Finally, there are logistic issues including handling, waste disposal and short half‐lives of radioisotopes. Because of their shortcomings

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SECTORAL ASSET MANAGEMENT Newsletter and the relatively modest marginal improvement over their naked counterparts, the two radioactive anti‐CD20 mAbs have had limited commercial success so far. Indeed, most current efforts in this area came from the aca‐ demia.

Chemical and toxin-based warheads. Instead of killing cells with radiation, a highly toxic chemical entity is grafted onto the mAb of interest. The poisonous part can either be a genetically engineered toxin, a prodrug, or a small synthetic molecule. Mylotarg (Wyeth) that targets CD33 for the treatment of relapsed acute myeloid leu‐ kemia (AML) is the only approved drug of this category. Mylotarg is bound to calicheamicin, an extremely cyto‐ toxic chemical entity. Several biotech companies are working in this space, Seattle Genetics and Immonugen being the most advanced ones. Chemotoxic mAbs are easy to handle and do not have the decay issue of their radioactive peers, but also suffer from limitations. In particular, fusing of the toxic portion to the mAb can be challenging, and only minor leakiness often results in severe off‐target toxicities. Furthermore the transformed mAb is usually antigenic and bulkier than the original one, altering pharmacokinetics, pharmacodynamics, and efficacy. At this point, we are less enthusiastic about this class of modified mAbs. The marginal improvements that they offer are small and they are plagued with serious practical and clinical problems. We favor mAbs without payloads where the effector functions have been enhanced (see section below). In the future, new chemical warheads strategies, such as use of small synthetic cytotoxic molecules and improved chemical linkers, may overcome current limitations. Should these progresses materialize, such mAbs would become very potent therapeutic modalities. An application where loaded mAbs may have a clear advantage over their naked coun‐ terparts is the treatment of immune compromised patients, since their natural effector functions are diminished. Future developments

Enhanced effector functions. Until recently, most efforts in the development of therapeutic mAbs where de‐ voted to enhancements of target specificity and affinity. While these are clearly crucial, it is now recognized that other parameters also contribute significantly to clinical efficacy. Monoclonal antibodies exert their therapeutic benefits by either neutralizing a macromolecule (naked mAbs eliminate targeted cells through their effector functions, for instance a cytokine circulating in the bloodstream) or by eliminating undesirable cells (loaded mAbs achieve this with the help of some payload). The antibody‐dependent cell cytotoxicity (ADCC) and com‐ plement‐dependent cytotoxicity (CDC) constitute the two natural effector functions. Both work through the re‐ cruitment of immune cells to the Fc region of the mAb (Figure 2). Indeed it has been documented that the mag‐ nitude of effector functions often correlates with the extent of biological and clinical response. A number of aca‐ demic laboratories and companies have logically embarqued in the quest of enhanced effector functions. One way to achieve it is to ensure that the Fc region binds the right subtype of FcγR receptors on effector cells (natu‐ ral‐killer cells, neutrophils, macrophages, and dendritic cells). The affinity of the Fc regions for the FcγR recep‐ tors can also be tailored for optimal efficacy. A telling illustration of effector functions improvment is the mAbs targeting CD20. This antigen is the target of Rituxan, and because of its phenomenal commercial success, a number of companies are developing second generation anti‐CD20 mAbs, including Macrogenics, Applied Mo‐ lecular Evolution (AME, now part of Lilly), Genentech, Xencor, and Genmab. In each case, the ADCC and/or CDC effector functions have been tinkered and improved. An alternate for improving effector function is to en‐ gineer bispecific mAbs where one half of the molecule targets the cells to be eradicated and the other recruits effector cells. Although theoretically appealing, the bispecific approach poses manufacturing challenges, it re‐ mains to be seen whether the pharmacokinetic, pharmacodynamic, and distribution parameters of bispecific mAbs are compatible with clinical efficacy. Finally, “troybodies” have been developed where the Fc region car‐ ries an antigenic region that recruits effector cells, however by definition this approach renders the mAb anti‐ genic, which normally is undesirable.

Optimized distribution. Antibodies are large macromolecules of about 150 kilodaltons, i.e 300 times the mo‐ lecular weight of the largest orally available drugs. This explains why antibodies have to be injected, and yet tissue distribution challenges still remain. This issue is well exemplified in solid tumors. Their high inner inter‐ stitial pressure prevents the full distribution of large proteins, they are sometimes poorly vascularized, and the

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Figure 2. Antigen‐binding sites are located on the variable region (Fab region). The constant region (Fc region) is responsible for recruitment of immune cells. (Source: http://www.symphogen.com/) antigen may reside in a confined compartment. For these reasons, investigators have devised strategies to re‐ duce mAbs size to the smallest fragments retaining biological activity. These midget mAbs come in various fla‐ vors such monovalent fragments (Fab, Fv, and scFv fragments, many companies), single‐domain camelid anti‐ bodies (Ablynx), dia‐ tria‐ and tetrabodies, domain antibodies (Domantis), and novel molecular recognition scaffolds (Affibody, Biorexis, Borean Pharma, Compound Therapeutics, Pieris Proteolab, Scil Proteins, and Sele‐ core). Since most of these developments are at pre‐clinical stages, it is impossible to predict whether they will actually translate to improved clinical efficacy. For certain applications minimizing mAb size is clearly a theo‐ retical advantage, and the fact that Genentech, a highly successful mAb pioneer, is using this approach is in it‐ self a testimony. Indeed for the treatment of age‐related macular degeneration the San Francisco firm chopped its already approved mAb Avastin into a Fab fragment, which is currently in clinical development under the name of Lucentis. Another way to optimize tissue distribution is to play with the mAb affinity. For some targets one may want to enhance it, contraintuitively however, others targets are best reached with medium affinity mAbs. In some solid tumors for instance, mAbs of too high affinity tend to bind their target at as soon as they reach the tumor mass, and may get stuck at the periphery without reaching the tumor center.

Antigen selection. Up to this point we have discussed proprieties inherent to the mAbs themselves. Equally important, if not more, is the choice of the right target. No matter how good a mAb is, if the target or indication selection is wrong, no clinical benefit can be achieved. An ideal target fulfills a number of criteria. First, it must be differentially expressed in healthy versus pathological condition, and ideally its level should correlate with disease severity and clinical outcome. The function of the target must be crucial to the etiology of the disease. Targets should be accessible to the mAb, hence, circulating or displayed at the cell surface, and not be hidden or down regulated once bound. Only few antigens stringently fulfill these conditions. In oncology, for instance, high‐quality targets include EGFR, Her‐2, EpCAM, PSMA, and VEGFR for solid tumors, VEGFR and PSMA for tumor vasculature, and CD20, CD22, CD25, CD33, and CD52 for hematological tumors. Not surprisingly, most of these low hanging fruits are already targets of approved and highly successful mAbs. There is no doubt that many other excellent antigens are yet to be discovered, but their full validation and efficient use will demand time and capital investment. Investigator and investor checklist Based on the arguments detailed above, we conclude this part with a checklist that ourselves and investors should apply when assessing a particular mAb. The following points should be satisfactorily met:

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• What is the target? How good is it (see above)? • What type of mAb is it (chimeric, humanized, fully human)? Which one is best suited for the indi‐ cation pursued? • To what class and subtype does the antibody belong? Which ones are best suited for the indication pursued? • What is its mechanism of action (ADCC, CDC, other)? • How is it manufactured (are there aggregates? are glycosylation patterns human?)? • Is it antigenic? If yes, are the mounted antibodies neutralizing? • What are its pharmacokinetics and pharmacodynamics? Is the distribution optimal? • What are its efficacy and therapeutic window? • How is it delivered? What are the clinical, practical and economical implications of the delivery mode? • Does it make pharmacoeconomic sense to develop a mAb for the pursed indication? • What is the competitive landscape? What is the risk of obsolescence (better mAb, small molecule, prevention)? • What are the chances of approval, and commercial success? Investment highlights

Medarex (Nasdaq: MEDX) and Abgenix (Nasdsaq: ABGX). Among the few biotech companies with capa‐ bilities for generating fully human antibodies, Medarex and Abgenix have the most extensive collaborations with development partners and the deepest antibody pipeline in human testing. Both companies have collabo‐ rative agreements with large pharmaceutical companies for developing antibodies to new targets. These part‐ nerships have not only provided Abgenix and Medarex with funding, but also opportunities for long‐term growth as the companies are eligible for royalty payment if any of the candidates are approved. Medarex and Abgenix currently have 22 and 10 antibodies, respectively, in the clinics with the majority in early phase devel‐ opment. Nonetheless, current valuations of these companies are largely based on the sales prospects of their lead product, as the probabilities of success for the early stage candidates are difficult to estimate. The lead product in Medarex’s pipeline, MDX‐010, is in phase III development for previously treated metastatic melanoma. Since there is a large unmet medical need in melanoma, the commercial potential in this indication could exceed USD 300M. Additional market opportunities may come from successes in other types of malig‐ nancies. In November 2004, Medarex signed a worldwide collaborative agreement with Bristol Myers Squibb to develop and commercialize MDX‐010. The partnership not only provided Medarex with additional resources to develop MDX‐010, but also a well established oncology sales force to effectively market the drug. While we view that Medarex is one of the few small cap companies with solid fundamentals and a promising lead prod‐ uct, we expect Medarex shares to trade roughly in‐line with the biotech sector in the next 12 months until data from the phase III study become available in H1/06.

Abgenix and partner Amgen are currently conducting phase III studies for Panitumomab in colorectal cancer patients. Although Panitumomab and ImClone’s Erbitux (2004 sales USD 260M) are antibodies against the same target, the two products differ in their registration path and timing of approval. Erbitux was tested in combination with chemotherapy, whereas Panitumomab is being developed as a single agent. Because the combination regimen is more powerful than the antibody alone, duration of treatment with Erbitux and iri‐ notecan would be longer than that with Panitumomab alone. Furthermore, the Erbitux registration trials were done in second and third line patients whereas the Panitumomab studies are being conducted in third line pa‐ tients only. Thus, more patients are eligible for Erbitux treatment than for Panitumomab. Hence, we anticipate Panitumomab to have a much lower market potential than Erbitux and experience slower adoption since Erbi‐ tux has already gained substantial penetration in the third‐line market. We do not believe Abgenix shares will outperform the biotech sector unless Panitumomab demonstrates efficacy in a larger market.

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SECTORAL ASSET MANAGEMENT Newsletter

Genmab (Copenhagen: GEN). Genmab, a spin‐off from Medarex, has a different business model than the pre‐ vious two antibody companies. Genmab does not have large antibody development collaborations and does not view these deals as value adding to the company. Its dual prone focus is on development of proprietary products and of antibodies against validated targets. While the introduction of another antibody against a known target would not have the first‐to‐market advantage, these projects also carry little development risk. The value driver behind Genmab is HuMax‐CD4, which is about to enter a pivotal study in advanced cutaneous T‐cell lymphoma patients. We estimate the market opportunity for Humax‐CD4 to exceed USD 200M. Since advanced cutaneous T‐cell lymphoma is an orphan indication, we anticipate that the HuMax‐CD4 pivotal trial would involve relatively small number of patients and could be completed within a year. We expect Genmab shares to have solid performance in the next 12 months. Vincent Ossipow, PhD Chief Scientific Officer

Carmen Tang, M.Sc., MBA Financial Analyst

First Quarter 2005 Page 11

SECTORAL ASSET MANAGEMENT Newsletter Sectoral Asset Management

Sectoral Asset Management (S.A.M.) is an SEC‐registered investment advisor based in Montreal whose focus is on managing global equity portfolios by industry. S.A.M. has one of the world’s longest track records in manag‐ ing biotech equities and is a sub‐advisor of numerous healthcare and biotech funds offered by partners in Europe, USA, Japan, and Taiwan. S.A.M. has also launched an alternative investment fund that offers an attrac‐ tive exposure to the growing healthcare/biotech sector through both long and short positions. The firm’s assets are USD2.0 billion as of March 31, 2005. Investment Professionals

Jérôme Pfund, CFA Chief Executive Officer Michael Sjöström, CFA Chief Investment Officer Vincent Ossipow, Ph.D. Chief Scientific Officer Laurent Payer, CFA Senior Portfolio Manager Stephan Patten, CFA Portfolio Manager Sanjay S. Patel, B.Sc. Financial Analyst Carmen Tang, M.Sc., MBA Financial Analyst Pierre Gauthier, CFA Trader Bandhna Mamak, MBA Risk and Operations Manager

Scientific Advisory Network

Under the supervision of Dr. Vincent Ossipow, S.A.M. has established a proprietary network of motivated and talented researchers and clinicians in complementary disciplines worldwide. The Scientific Advisory Network (SAN) is designed to support S.A.M. with scientific due‐diligence in its investment process. SAN’s members include:

Amanda Adler, MD, Ph.D. Epidemiology/Diabetes The Radcliffe Infirmary, Oxford, UK Aurelio Balsalobre, Ph.D. Molecular biology IRCM, Montreal, Canada Pao‐Hsien Chu, MD Cardiology Chang Gung Memorial Hospital, Taipei, Taiwan R.O.C. Sui Huang, MD, Ph.D. Oncology Harvard Medical School, Childrenʹs Hospital, Boston, USA Henry I. Miller, MS, MD Health Policy / Regulation Hoover Institution, Stanford CA, USA Olivier Schaad, Ph.D. DNA chips University of Geneva, Geneva, Switzerland Adam Smith, D.Phil. Drug Discovery Nature Publishing Group, London, UK

Contact information

Sectoral Asset Management Inc. Phone: +1 514 849 8777 ext. 235 1000 Sherbrooke St. West, Suite 2120 Fax: +1 514 849 6777 Montreal QC H3A 3G4 www.sectoral.com Canada [email protected]

You may request performance updates by emailing Martin Noël at [email protected].

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