Oncothyreon (ONTY) Research Note

Oncothyreon: Price: $1.21; Market Cap (MM): $23.6 -- Market Outperform; Target Price: $4.00 

Transferring Coverage. We are assuming coverage of Oncothyreon, a biotechnology company focused on oncology, with a Market Outperform rating and a 12-month price target of $4. Our target price is based on a comparables analysis of companies in the oncology and therapeutic vaccines space. We consider ONTY shares undervalued at current levels and believe they offer an attractive risk-reward ratio, with significantly more upside than downside, especially long-term.

We would like to draw investors" attention to the 4 following points:

1) Stimuvax is in one large Phase III trial in lung cancer and soon to be in a second one, in a second indication. Stimuvax is a therapeutic vaccine that is partnered with Merck KGaA (FWB:MRK, Not Rated) and is currently in the 1300-patient Phase III START trial in NSCLC, which we expect will complete enrollment later this year with data anticipated in 2011.

In the upcoming months, we expect the announcement of the initiation of a second Phase III trial in a second oncology setting, probably prostate, breast or colorectal cancer. We believe that this move would further demonstrate Merck KGaA's confidence in the Stimuvax program, especially given that it will not wait to see the results from the NSCLC trial before investing in a second Phase III trial.

2) Two early-but promising molecules going after important targets. With the development of Stimuvax being paid for by Merck KGaA, Oncothyreon is currently focusing its efforts on their two most promising early stage compounds that are targeting two of the most exciting and validated targets in cancer: PX-478, which is an irreversible inhibitor of HIF-1a and PX-866, which an irreversible inhibitor of PI3K. Both compounds have promising preclinical profiles and are both in Phase I trials, with data readouts in '09.

We believe these two compounds, albeit early, hold a lot of promise, and should the Phase I trials demonstrate safety (and possibly hints of efficacy), we expect them to be partnership candidates, given the importance of, and big pharma interest in, these targets. We also expect that with positive data from the Phase I trials both molecules will enter Phase II testing this year.

3) The '09 catalysts that can move the stock: 1) Proof of concept data from the PX-478 and PX-866 Phase I trials can A) provide evidence of the compounds' promise and B) attract partners (or even acquirers), providing both validation and non-dilutive capital. 2) Initiation of a second large Phase III trial with Stimuvax in a second cancer indication will further demonstrate Merck's confidence in the program and provide an additional shot on goal for Stimuvax by testing it in another setting.

4) Limited downside with shares trading at cash value. With ONTY shares trading at around cash, we view current price levels as depressed and not accounting for the fact that the company will soon be in two large Phase III trials, with an experienced large pharma partner with strong expertise and focus in oncology, is run by an experienced management and board and is developing two promising compounds that are going after two very important pathways and will have POC data this year.

Finally, we view the renegotiation of the Stimuvax agreement as a savvy management decision. Oncothyreon recently renegotiated their Stimuvax deal, with Merck KGaA now solely responsible for the clinical development and manufacturing of Stimuvax. This new deal provided Oncothyreon with $13M in non-dilutive capital, which was sorely needed, in a time when the financial markets were closed, without giving up much-if any-of the upside that can come if Stimuvax is successful.

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