NEWSLETTER JANUARY 2013

TABLE OF CONTENTS HEALTHCARE MARKET REVIEW AND OUTLOOK .... 1

HEPATITIS C: UPDATE ON AN EVOLVING THERAPEUTIC AREA ................................... 5

RECENT PUBLICATIONS BY MEMBERS OF THE SECTORAL SCIENTIFIC ADVISORY NETWORK ..... 18

ABOUT SECTORAL ASSET MANAGEMENT ......... 21

HEALTHCARE MARKET REVIEW AND OUTLOOK Healthcare stocks underperformed the overall markets during the last quarter as big pharma and medtechs lagged. Of note, emerging market healthcare stocks closed out the year on a strong note, rising 5.0% in the quarter. Nonetheless, 2012 was a good year for healthcare, with the MSCI World Healthcare Index advancing 17.5%, outpacing the MSCI World Index (+16.1%). Biotech stocks drove this performance, benefiting from a successful year with several new product approvals, solid product launches, and continued M&A activity. This overall strong performance will be tough to repeat in 2013. On the one hand, expectations are clearly higher for biotechs, and positive surprises will be tougher to achieve; on the other, the defensive character of healthcare, which played out well among the economic woes of 2012, may be less of an asset. Indeed, the pick-up of housing in the US points to a strengthening economy, and the European financial and economic crisis appears to have hit a (temporary) bottom. One caveat: the US budget discussions, which

now will drag on for another two months at least, may favor less cyclical names in the immediate future, such as big pharma and biotech.

The recent biotech regulatory news flow was positive, although it did not exceed expectations. The only controversial filing, United Therapeutics’ oral Remodulin, ended up being rejected. Otherwise, the US FDA approved Abraxane in NSCLC (Celgene), Jetrea for symptomatic vitreomacular adhesion (Thrombogenics), Cometriq in medullary thyroid cancer (Exelixis), Iclusig for CML and Ph+ ALL (Ariad), Gattex for short bowel syndrome (NPS Pharmaceuticals), and Juxtapid for homozygous familial hypercholesterolemia (Aegerion). The clinical news flow was far more positive, leading with the positive outcome of the GALNS phase III trial for Morquio Syndrome (Biomarin). Celgene’s pomalidomide also succeeded in phase III trials, as did Abraxane in pancreatic cancer, a greater surprise. Among other major trials, Biogen-Idec’s hemophilia

ANNUALIZED VOLATILITY

1 MONTH 3 MONTH 6 MONTH 9 MONTH 12 MONTH 3 MONTH 6 MONTH

MSCI World Index 147.4 2.3% 2.9% 9.9% 3.8% 16.1% 11% 10%

MSCI World Healthcare Index 157.5 0.4% 0.7% 8.0% 9.3% 17.5% 10% 10%

MSCI World Pharma 133.8 0.2% 0.5% 7.7% 10.3% 14.5% 10% 10%

MSCI World Biotech 577.9 -0.9% 2.5% 20.2% 25.8% 44.0% 16% 17%

MSCI World Equip and Suppl 211.1 1.0% 0.6% 7.2% 4.9% 18.4% 12% 12%

MSCI Emerging Market Healthcare 426.3 5.0% 5.0% 16.6% 16.0% 33.3% 9% 10%

CLOSE

12/31/2012INDEX

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NEWSLETTER FOURTH QUARTER 2012

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products also had positive phase III trials, and Gilead’s all-oral hepatitis C regimen scored a total success in phase II tests. The main disappointments were the modest clinical benefit of Vertex’ VX-809 in cystic fibrosis and the failures of ibrutinib in multiple myeloma (Pharmacyclics) and fostamatinib in rheumatoid arthritis (Rigel). On the commercial front, Regeneron’s Eylea once again surpassed expectations, while most other products met or modestly beat expectations. Finally, on the M&A front, we note Amgen’s acquisition of Decode Genetics and Gilead’s bid for YMI.

After last year’s strong stock run up, biotech companies will have a harder time beating expectations. We still see significant upside for some of the majors, such as Gilead, Celgene, Biogen-Idec, or Novo-Nordisk, as we believe their new product cycles will help these companies sustain their historic high growth rates. However, we also note that current valuations partially anticipate these positive developments. We also are cautious on some of the recent high flyers, especially Regeneron, where we think new patient accrual will be significantly more difficult in 2013. Hence, while we still maintain a positive stance on companies entering new product launches, we now advocate a more selective approach than we did 12 months ago.

Generics stocks had a tougher fourth quarter, as jitters were created by the Indian government’s decision to slash prices on drugs appearing on a newly created 348 Essential Drug List. Also, Japanese generic manufacturer stocks reacted negatively to slightly disappointing quarterly results. Finally, Teva, the industry’s flagship company, disappointed with subdued guidance for 2013 and an underwhelming analyst day. There were a series of notable M&A announcements, mostly from Indian companies: Sun Pharma bought Dusa and URL’s generics business,

Cipla bid for a majority stake in Cipla Medpro, and Dr Reddy’s announced the acquisition of Dutch injectables developer OctoPlus. Also Watson closed its acquisition of Actavis and announced a name change (to Actavis, effective in January).

Despite a generally tough pricing (in Europe) and regulatory (in the US) environment, generic stocks outperformed big pharma and the overall healthcare indices in 2012. We expect the same to hold true in 2013. While pricing will remain challenging in Europe and price cuts will be implemented in India, volumes should generally continue to benefit from accelerating genericization of developed markets with current low generic penetration (eg, Japan and Southern Europe) and the increasing spending power of the middle classes in emerging markets. As for biotechs, selectivity is essential to continued investment success, as the environment remains challenging, particularly in developed markets. Among global majors, we favor such players as Mylan and Watson

COMPANY PRODUCT INDICATION TIMELINE

ISIS Kynamro Homozygous familial hypercholesterolemia Q1/13

NuPathe Zelrix Acute migraine Q1/13

Raptor RP103 Nephropathic cystinosis Q1/13

Celgene Pomalidomide Relapsed and refractory multiple myeloma Q1/13

Dynavax Heplisav Hepatitis B Virus vaccine Q1/13

Biogen-IDEC BG12 Multiple sclerosis Q1/13

Immunogen TDM-1 Breast cancer Q1/13

Hyperion Ravicti Urea cycle disorders Q1/13

MAP Levadex Acute migraine Q2/13

Theravance Breo/Relvar (LABA/ICS) COPD (US/EU) and asthma (EU) Q2/13

Dendreon Provenge Prostate cancer (EU) Q2/13

Aveo Tivozanib Renal cell carcinoma Q3/13

Halozyme SC Herceptin Breast Cancer (EU) H2/13

Algeta Alpharadin Prostate cancer H2/13

Actelion Macitentan Pulmonary arterial hypertension H2/13

Biomarin GALNS (Vimizim) Morquio H2/13

Biogen rhFVIII-Fc Hemophilia A H2/13

Biogen rhFIX-Fc Hemophilia B H2/13

Celgene Abraxane Pancreatic cancer H2/13

Auxilium Xiaflex Peyronie's H2/13

Vectura QVA149 COPD (EU) H2/13

Medivir Simeprevir (with interferon) Hepatitis C H2/13

Gilead Sofusbuvir (with interferon) Hepatitis C H2/13

Theravance Anoro (LAMA/LABA) COPD H2/13

Alexion Soliris STEC-HUS H2/13

Potential biotech drug approvals in 2013. Source: Company reports, Sectoral estimates.

NEWSLETTER FOURTH QUARTER 2012

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over Teva, which still has to qualm investor concerns about how to replace Copaxone. In addition, we focus on selected regional opportunities, particularly in emerging markets and in Japan.

While the news flow in medical technology picked up after a quiet third quarter, there were both positive surprises and disappointments. In the end, medtech stocks ended the quarter virtually flat and underperformed the broader healthcare indices for the full year. The underperformance was driven primarily by difficult economic conditions in Europe and several product-specific issues that arose during the year. Last quarter saw several US approvals: Insulet’s Gen2 insulin pump, Heartware’s HVAD (approval for bridge to transplant), Dexcom’s GenIV continuous blood glucose monitoring system, and Edwards Sapien transcatheter heart valve, while Given Imaging’s PillCam Colon II was filed in Japan and the US. There also was dense M&A activity, with Wright Medical’s acquisition of BioMimetic for USD190m in cash and stock (plus USD190m contingent on milestones), Smith & Nephew’s bid for HealthPoint for USD782m in cash, and Merit Medical’s acquisition of Thomas Medical for USD167m in cash. Finally, Given Imaging announced that they are exploring strategic alternatives. The mixed news came mostly from disappointing quarterly results. Edwards disappointed, due to the timing of the Sapien launch and logistic challenges, Align due to a slow economy, and St Jude due to Riata/Durata ICD-lead problems. Of note, both Varian and Elekta beat expectations on strong demand for radiotherapy equipment, and Insulet was a positive surprise, thanks to good execution.

Global economic conditions and budget constraints will remain the main challenges for the industry in 2013. However, several new product launches (eg, Accuray’s RT system, Sirona’s CAD/CAM, Heartware’s HVAD, Dexcom’s GenIV, Insulet’s EROS, Edwards’ Sapien) could generate momentum for selected stocks. Our favorites for 2013 remain companies with a clear focus on innovation, bringing disruptive technologies with clinical and economic value to the market.

The main event for large pharma during last quarter was the confirmation of clinical efficacy for Lilly’s solanezumab for Alzheimer’s disease in phase II trials. Nonetheless, after conversations with the FDA, the company decided not to file based on these data but to proceed with phase III trials instead. The stock’s negative reaction to this news leaves Lilly largely de-risked going into 2013. The other major news, which lay at the opposite end of the spectrum, was the failure of Rigel’s (and partner AstraZeneca’s) rheumatoid arthritis drug fostamatinib in a phase II trial, casting doubt on the outcome of the phase III program and the commercial potential of the drug. This failure leaves AstraZeneca still searching desperately for new sources of revenue, as major patent expiries are looming. Overall, pharma stocks produced solid returns in 2012, generally in-line with the healthcare sector. From the point of view of fundamentals, disappointments and positive surprises more or less balanced each other out. Going forward, we stick to our focus on companies with long-tailed assets, emerging markets exposure, and limited soft (patent and competitive) exposure. Generally speaking, the European majors − with the exceptions of the two UK-based companies − appear to offer the best value, although Lilly now looks more attractive on a risk/reward basis and joins Merck as our preferred US-based pharma stocks.

For the coming year, we maintain our focus on companies with strong innovative content, as well as on those with significant exposure to emerging markets. These two factors remain the main sources of growth in a pricing and reimbursement environment that will remain challenging for the foreseeable future, particularly in developed markets. Thus, we focus on biotechnology, generics, and medical technology stocks, at the expense of big

Based on Sectoral estimates / median numbers

SALES EPS PE13E EV/SALES13E COGS

Pharmaceuticals 2-4% 4-6% 12x 2.8x 15-20%

Generics 10-15% 10-15% 12x 2.6x 25-55%

Biotechs 15-20% 20-25% 17x 5.3x 10-20%

Medtechs 10-15% 15-20% 14x 2.5x 20-40%

GROWTH P.A. 2012-2015E

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pharma. We are more cautious on biotechs after their strong run in 2012 and have tightened our selectivity. Preferred investments remain those companies entering a new product cycle. Among generic drug makers, emerging market companies and Japanese generic players should be emphasized. In medtech, an improvement in the economy in Europe could be a significant upside, but in the absence of further evidence, the focus should remain on companies with innovative products and upcoming approvals and/or

launches. Finally, although less evident than last year, big pharma’s defensive character could once again prove to be attractive. However, due to the multiple expansions witnessed since the beginning of 2011, we would exclusively focus on companies with long-tailed assets, exposure to emerging markets, and limited exposure to upcoming patent expirations.

Michael Sjöström, CFA Chief Investment Officer

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HEPATITIS C: UPDATE ON AN EVOLVING THERAPEUTIC AREA Since we last discussed this topic in July 2010, the development of drugs to treat the hepatitis C virus (HCV) has remained a very high profile area for biopharma companies and investors alike. Since then, two novel direct-acting antiviral (DAA) agents were approved to treat genotype 1 HCV in combination with pegylated-interferon-α (IFN) and ribavirin (RBV): Merck’s Victrelis (boceprevir) and Vertex’s Incivek (telaprevir, marketed by JNJ outside the US as Incivo). Within a few months of the US launch of both agents in May 2011, sales of these products reached over USD600m globally in Q4’ 2011 alone. However, as expected, sales of these DAAs have since declined, as the backlog of patients most urgently needing treatment has been addressed, and physicians and patients await the availability of more effective and better-tolerated all-oral regimens that do not include IFN – the so-called “holy grail” of HCV drug development.

Data presented at recent medical meetings, including the American Association for the Study of Liver Diseases (AASLD) in November 2012, have shown very promising results with several IFN-free regimens containing combinations of DAAs with or without RBV. These include drugs from Gilead and Abbott, for which phase III trials have recently been initiated. Many additional DAA regimens are in earlier stages of development, supported by well-funded research and development efforts by companies ranging from small-cap biotech to large pharmaceutical companies. Indeed, the attractiveness of the HCV space is reflected in some of the largest acquisitions and the highest premiums in the healthcare sector, most notably Gilead’s acquisition of Pharmasset for USD11bn.

In addition to identifying the companies with the ‘winning’ regimens, the most pressing questions for investors in the space are the potential size and duration of the HCV opportunity, with key levers including the proportion of patients diagnosed and treated over the next 5-10 years and beyond. This

article provides an update of developments in the HCV market and our expectations for key compounds and the overall commercial opportunity.

OVERVIEW OF HCV

The course of HCV infection is variable. Acute infection clears spontaneously in up to 15-25% of cases; however, viral infection is persistent or chronic in the majority of cases, and the resulting long-term inflammation can lead to complications including cirrhosis, liver failure and hepatocellular carcinoma (liver cancer). The disease usually progresses slowly, with a lengthy asymptomatic period. An estimated 20% of HCV-infected people will develop cirrhosis over a period of 20-30 years after infection, with substantial morbidity and mortality over time.

HCV is transmitted via blood-to-blood contact. In the developed world, the majority of people with HCV were infected prior to the introduction of sensitive screening tests in 1992, which curtailed transmission from blood transfusions or organ transplants. Currently, the annual infection rate in the US is estimated to be less than 20,000 (mainly due to high-risk intravenous [IV] drug use), down from 240,000 in the 1980s. Due to the high infection rates in the 1970s and ‘80s, HCV-related liver disease is expected to rise significantly over the next 10 years as the number of people who have been infected for over 30 years increases. The growing prevalence of HCV-related disease has become a significant global health problem; the World Health Organization estimates 170 million people worldwide are chronically infected with HCV, with 3-4 million in the US, 4-10 million in the EU, and a high prevalence in areas in the Far East, Africa, and Eastern Europe.

HCV is a heterogeneous virus, comprising 11 genotypes and several subtypes. In the US and Western Europe, about 75% of HCV is genotype 1 (GT-1), with about being 15% GT-2 and 3, and the remainder being GT4-6. HCV strains respond differently to therapy. About 80% of patients with GT2-3 HCV achieve treatment success with a 24-week regimen of IFN and RBV, with successful outcome

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defined as sustained virologic response (SVR) 24 weeks after the completion of therapy. In contrast, only about 45% of patients with GT-1 achieve SVR24 with IFN and RBV, despite extending treatment to 48 weeks. Given these outcomes and the poor tolerability of treatment, the majority of patients with GT-1 HCV traditionally did not initiate treatment in the absence of signs of disease progression. A backlog of treatment-naive GT-1 patients awaits better therapeutic options, as do the 300,000-400,000 patients in each the US and EU who failed prior treatment with IFN and RBV. Thus, GT-1 patients have the greatest unmet need and represent the largest commercial opportunity for DAAs.

Different classes of DAAs have varying coverage of HCV genotypes. In addition, the genetic barrier to resistance varies between classes, an important consideration in light of the virus’ high replication frequency and mutation rate. The first marketed class of DAAs, protease inhibitors, target GT-1 HCV and have a moderate barrier to resistance. Nucleoside polymerase inhibitors are active across HCV genotypes, and have a high genetic barrier to resistance: they bind to the active site of the polymerase, and mutations in this region generally have impaired fitness for viral replication. As such, in contrast to other classes of DAAs, baseline resistance to nucleoside polymerase inhibitors has not been detected, and essentially no viral rebounds or resistance-related breakthroughs have occurred in the clinic. Non-nucleoside polymerase inhibitors specific for GT-1 HCV have been developed; these DAAs do not bind to the active site of the enzyme, and have a poor barrier to resistance. NS5a inhibitors have variable genotypic coverage and barriers to resistance. While DAAs of this class are attractive in combination therapy because of their potency and low propensity for drug-drug interactions, NS5a inhibitors have relatively low strategic value because there are quite a few in clinical development.

HCV: A KEY THERAPEUTIC AREA FOR BIOPHARMA AND HEALTHCARE INVESTORS

The development of treatments for HCV has remained an area of intense focus for biopharma companies,

with the lure of multibillion-dollar revenues for the leading drugs to market. Numerous companies have developed rich portfolios of HCV DAAs and advanced them at a rapid pace; in a few cases this aggressive posture has precipitated some high-profile setbacks related to safety signals. Further, several companies lacking key classes of drugs have supplemented their pipelines with acquisitions, leading to competitive bidding and significant premiums. As a consequence, investors have keenly focused on HCV drug development, performing detailed analyses of early-stage trials in very small numbers of patients and generating oversized moves in shares of companies in the HCV space.

Shares in several HCV-related companies yielded tremendous outperformance since our last review of the field (see figure 1), with several prominent acquisitions at prices that exceeded our expectations (see figure 2). We had predicted that Pharmasset’s portfolio of nucleoside polymerase inhibitors would position the company well with respect to its strategic options, and indeed, Pharmasset shares appreciated 10-fold from July 2010 through to the company’s acquisition by Gilead in November 2011. At over

Figure 1: Returns of HCV-related stocks versus the Nasdaq Biotechnology Index (NBI) from July 1, 2010 to December 20, 2012 or to the close of the acquisition where relevant (return for Gilead since the announcement of the Pharmasset acquisition on November 21, 2011). Source: Bloomberg.

85%

85%

85%

27%

44%

16%

85%

49%

61%

-15%

5%

34%

97%

103%

142%

311%

958%

979%

MEDIVIR

IDENIX

VERTEX

GILEAD

ANADYS

ZYMOGENETICS

ACHILLION

PHARMASSET

INHIBITEX

BIOTECH NBI

NEWSLETTER FOURTH QUARTER 2012

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USD11bn, this purchase was the largest transaction in the HCV space. As we had outlined, this class of DAAs was thought to be critical in an all-oral HCV regimen, largely due to the high barrier to resistance, and bidding was intensely competitive for these scarce assets. Although not universally lauded at the time due to the high price tag and hefty premium (Gilead shares closed down 9.1% the day of the announcement), the acquisition of Pharmasset appears to be the only transaction to date that has added value for the acquirer, with Gilead shares since outperforming, in large part due to the continuing compelling profile of PSI-7977 (now sofosbuvir).

Inhibitex was acquired for USD2.5bn by BMS, after its nucleoside polymerase inhibitor INX-189 showed potent antiviral efficacy in a phase I trial. This transaction was a spectacular failure: in August 2012, less than 6 months after the close of the acquisition, BMS halted the phase II trial of INX-189 after one patient died and eight other patients were hospitalized with heart and kidney problems. Since then, the FDA appears to be proceeding cautiously on nucleoside polymerase inhibitors (although we note that currently available data suggest there is a low risk for new safety signals with sofosbuvir). However, multiple other nucleoside polymerase inhibitors have had challenges in development. The development of Pharmasset’s second wholly-owned compound PSI-938 was halted due to liver laboratory abnormalities just 1 month after the company’s acquisition by Gilead. Idenix’s shares have underperformed, as its lead compound IDX184 showed suboptimal efficacy in combination with IFN and is currently on clinical hold for a second time due to its similarities with INX-189 (see below). BioCryst had to withdraw the

Investigational New Drug application for its nucleoside polymerase inhibitor BCX5191 because of preclinical toxicity, scuttling plans for its merger with Presidio, a private company with an HCV NS5a inhibitor. The only other nucleoside polymerase inhibitor in clinical trials is Vertex’s VX-135 (formerly ALS-2200). As we predicted in 2010, Vertex needed to investigate additional DAA combinations. The company has since in-licensed two nucleoside polymerase inhibitors from Alios BioPharma in a deal with rich terms for preclinical stage compounds: USD60m upfront, USD715m in development and USD750m in sales milestones, in addition to tiered royalties. While VX-135 showed compelling antiviral effects, a second compound, ALS-2158, did not show sufficient efficacy to warrant further development. Vertex’s underperformance over the past two and a half years has largely been related to the outlook for its cystic fibrosis franchise, although more rapid-than-expected declines in Incivek sales have contributed as well.

In addition to the potential of nucleoside polymerase inhibitors, other classes of DAAs show promise as effective treatment regimens; these have affected the performance of some large-cap pharma players, notably Abbott and BMS. While the outlook for their HCV portfolios has impacted share performance, the effect was not as dramatic as that seen for the biotech companies listed in figure 1. Medivir and JNJ’s protease inhibitor simeprevir (TMC-435) recently showed compelling efficacy and safety in phase III trials with IFN and RBV. Still, Medivir shares have underperformed, as the market potential for an IFN-containing regimen is limited, and the compound has no clear commercial roadmap for an all-oral combination, despite several ongoing trials with DAAs

Figure 2. Acquisitions of HCV-related companies. Source: Company reports, Bloomberg.

ACQUIRER TARGET DATE

DEAL SIZE

(USD M) PREMIUM KEY ASSET(S)

Gilead Pharmasset Nov 2011 11000 89% Phase II and phase I nucleoside polymerase inhibitors

Bristol Myers Squibb Inhibitex Jan 2012 2500 163% Phase I nucleoside polymerase inhibitor

Bristol Myers Squibb Zymogenetics Sept 2010 885 84% Phase IIb pegylated interferon lambda

Vertex Virochem Mar 2009 375 n/a Two phase I non-nucleoside polymerase inhibitors

Roche Anadys Oct 2011 230 249% Phase II non-nucleoside polymerase inhibitor

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from other companies. Achillion shares have appreciated over 300% since July 2010, as the company has advanced its protease and NS5a inhibitors in clinical development. However, much of the outperformance (and volatility) has been a result of read-through from competitive regimens and M&A speculation. Vertex does not appear to be advancing development of the VX-222 non-nucleoside polymerase inhibitor from the ViroChem acquisition. While not expensive, the value of Roche’s acquisition of Anadys remains to be determined. The non-nucleoside polymerase inhibitor ANA598 showed modest efficacy and is currently being evaluated along with Roche’s two other modestly effective antivirals: danoprevir (RG7227/ITMN-191, for which Roche bought full rights from Intermune in October 2010 for USD175m) and Pharmasset’s first-generation nucleoside polymerase inhibitor R7128.

Finally, BMS acquired Zymogenetics, mainly for its pegylated-interferon lambda, a novel and much better-tolerated interferon. BMS is testing interferon lambda in combination with Incivek and with its protease and NS5a inhibitors daclatasvir and asunaprevir. However, the rapid pace of development of IFN-free regimens suggests this compound has a limited place, at best, in the treatment armamentarium in the Western world, although aggressive pricing may lead to appreciable value in emerging markets.

THE FIRST WAVE OF DAAs: COMBINATION WITH IFN AND RBV

The addition of the protease inhibitors telaprevir and boceprevir to IFN and RBV increased the rates of treatment success in patients with GT-1 from less than 50% to about 75%, and in many cases, shortened the duration of treatment from 48 to 24 weeks. As we expected, telaprevir gained the majority market share, particularly in the initial period following the launch of both agents in May 2011. However, treatment remains poorly tolerated due to the myriad adverse events associated with IFN and RBV; these include flu-like symptoms, anemia, rash, depression, and gastrointestinal disturbances. Further, these first-generation protease inhibitors themselves have

serious side effects, notably rash and anemia, which have been increasingly troublesome in the post-marketing experience. In fact, the US prescribing information for telaprevir was updated in December 2012 to include a black-box warning about serious skin reactions, including fatalities. Thus, while a significant improvement over IFN and RBV, telaprevir and boceprevir have seen a rapid decline in use (see figure 3), as the backlog of patients in most urgent need have been treated and other patients are increasingly “warehoused” in anticipation of more effective and better-tolerated all-oral regimens that do not include IFN.

Approval of two additional DAA combinations with IFN is expected in late 2013 or early 2014. On December 20, 2012, Medivir and JNJ released top-line data from three phase III trials of their once-daily protease inhibitor simeprevir (TMC-435) on an IFN/RBV background. With an SVR of around 80% in treatment-naïve and experienced patients, simeprevir’s efficacy is in-line with telaprevir’s. Simeprevir has a more favorable safety profile, however, particularly with respect to rash and anemia. In addition, Gilead expects to file the first in a series of marketing applications for its nucleoside polymerase inhibitor sofosbuvir combined with IFN and RBV for GT-1 HCV by mid-2013. The use of telaprevir and boceprevir is expected to decline even more rapidly when these agents are approved in late 2013 or early 2014.

Figure 3: US weekly total prescription numbers for Incivek and Victrelis, data to Dec 7, 2012. Source: IMS.

0

500

1000

1500

2000

2500

Victrelis Incivek

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The peak sales and subsequent decline of the first HCV protease inhibitors was more rapid than we had expected, in large part due to the speed of drug development which has been enabled by various initiatives from regulatory agencies. For example, the FDA and the European Medicines Agency have allowed trials to concurrently evaluate multiple investigational therapeutic agents, including some with limited clinical data. Development timelines have been greatly shortened by a new framework, in which SVR measured 4 weeks after treatment completion (SVR4) has been used to inform further clinical testing, while the primary endpoint of all trials, including registrational studies, was changed from SVR24 to SVR12. Finally, due to the toxicities associated with treatment regimens including IFN, regulatory bodies have allowed both early- and late-stage trials to be conducted without an active comparator. This allowance may not persist past the approval of the first all-oral regimen for HCV.

THE NEXT WAVE OF DAAs: ALL-ORAL TREATMENT REGIMENS

As mentioned above, the real promise in HCV lies with the development of all-oral regimens, which are expected to reach the market as soon as 2015. Two important sets of data presented at AASLD in November 2012 framed expectations for Gilead to capture a significant portion of the HCV market with regimens containing sofosbuvir. In the first data read-out for its proprietary all-oral combination regimen, Gilead reported 100% SVR4 rates for sofosbuvir in combination with its NS5a inhibitor GS-5885 and RBV in 25 GT1 treatment-naive patients . Importantly, the safety profile for sofosbuvir and GS-5885 was clean for either drug alone or in combination, and the only adverse events of note were laboratory abnormalities in hemoglobin, which were likely due to RBV. While this was a small study conducted at a single-site in New Zealand, the promising early data were supported by a trial with a different combination: BMS presented data for sofosbuvir combined with its own NS5a inhibitor daclatasvir that showed 95-100% SVR rates for 12-week regimens. Of note, RBV was not required for these responses. A potential RBV-free

regimen has advantages in convenience/compliance and tolerability because RBV requires 5-6 pills dosed twice daily, as well as individual dose titration to avoid significant anemia. Although Gilead declined to pursue further development of a sofosbuvir-daclatasvir combination, likely because of an unwillingness to share the economics with BMS after the costly Pharmasset acquisition, the data substantiate the opportunity for Gilead to develop an ideal HCV treatment regimen − a single, once-daily tablet that is well-tolerated, safe, and highly efficacious, at least in naïve patients.

Gilead has initiated its first phase II/III trial of sofosbuvir and GS-5885, with and without RBV, over a course of 12- and 24-weeks in treatment-naïve patients. An interim analysis in the first half of 2013 will trigger full enrolment, and the data will inform the second, confirmatory phase III trial. We expect approval in 2015, and anticipate that the pivotal program will largely replicate early findings and result in SVRs of 90% or higher. It is important to point out that results will likely be lower than 100%, as these trials will include harder-to-treat patients (eg, individuals with fibrosis or cirrhosis).

Upcoming data could address outstanding questions regarding the efficacy of Gilead’s regimen in hard-to-treat patient populations. For example, it is difficult to draw conclusions regarding the efficacy of sofosbuvir and GS-5885 in patients with a prior null response to IFN/RBV, as too few patients have been studied to date. Data in 9 such patients will be presented at EASL in April 2013 (SVR4 was reported in 3/3 patients at AASLD). Further, patients with cirrhosis have been excluded from most early-stage trials because of the risk of safety signals or lower efficacy. This is a particular concern with nucleoside polymerase inhibitors, which need to be converted to the active tri-phosphate form by functioning hepatocytes. Cirrhotics currently represents up to 20% of patients with HCV infection and have the greatest need for effective treatments. The efficacy of sofosbuvir and GS-5885 in patients with cirrhosis will be determined in phase III trials, and expectations are for lower efficacy. While sofusbuvir and RBV in GT-1

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and GT-2/3 patients showed lower SVR rates and trends towards higher relapse than in patients will milder disease, the addition of another potent DAA may improve outcomes. A recent announcement from JNJ/Medivir has been viewed with optimism: the ongoing trial of sofosbuvir and simeprevir will be expanded to a second cohort of moderate/severe cirrhotics (F3-4), suggesting the combination was effective in the initial cohort of mild/moderate null cirrhotics (F0-2). Gilead also recently reported positive phase III results of sofosbuvir and RBV in patients ineligible for or intolerant of IFN, with SVR12 rates of 93%, 61%, and 61% in patients with GT2, GT3, and cirrhosis, respectively. Gilead should be able to improve SVR rates in these populations in future studies incorporating GS-5885. Approval of sofosbuvir and RBV for patients with GT2/3 is expected by late 2013 or early 2014; while this cohort represents an appreciable population of patients, it has less of an unmet need compared with the GT-1 group. More specifically, IFN-RBV has higher rates of treatment success and shorter treatment duration in GT-2/3. Thus, a greater proportion of diagnosed patients had initiated treatment, and the backlog of patients who failed prior treatment is lower. Finally, GILD has additional DAAs in development, including a non-nucleoside polymerase inhibitor GS-9669 and a back-up, potentially pan-genotypic NS5a inhibitor.

While Gilead appears to be well positioned, other companies have also reported impressive efficacy with all-oral DAA regimens in HCV. Abbott has the most advanced regimen, containing 3 DAAs, ritonavir and RBV: ABT-450/r (ritonavir-boosted protease inhibitor), ABT-267 (NS5A), and ABT-333 (non-nucleoside). Abbott showed 98% SVR12 in treatment naïve patients and a particularly striking 93% SVR in prior null patients following 12-weeks of treatment. The safety profile of this complex regimen appeared acceptable, with low rates of serious adverse events or patient discontinuations. Low rates of anemia also were observed in regimens containing RBV. Abbott’s regimen is more effective in GT1b patients, who might be able to use simplified regimens without RBV

or for 8 weeks duration, whereas GT1a patients will likely require all 5 drugs for 12-week treatment duration. Abbott has initiated a broad phase III program targeting 2500 patients across various sub-populations, including patients with cirrhosis, HIV co-infection, and treatment naïve/experienced. The company anticipates approval in 2015, likely about 6 months ahead of Gilead.

Overall, Abbott appears to have a viable regimen, albeit one likely to have multiple disadvantages, compared with Gilead’s sofosbuvir and GS-5885. First, there may be complex drug interactions due to the ritonavir boosting. Second, the pill burden is greater (~3-8 pills/day with twice daily dosing for Abbott versus one pill daily for Gilead). Third, the side-effect profile is expected to be inferior (particularly with RBV). In addition, concerns about resistance to multiple drug classes in patients failing treatment with Abbott’s regimen may be a factor in the choice of a first-line regimen. Patients failing Gilead’s regimen are likely to retain susceptibility to several regimens, as no drug resistance or viral breakthroughs have been observed. That said, we also expect efficacy in harder-to-treat patient populations and commercial considerations to play a role in determining market share.

BMS also presented strong early data for a multiple DAA regimen at AASLD, and the company is not out of the HCV race, despite the high-profile failure of the nucleoside polymerase inhibitor acquired from Inhibitex. BMS showed 94% SVR in GT-1 naïve patients after 12 or 24 weeks with the combination of daclatasvir (NS5a inhibitor), asunaprevir (protease inhibitor) and ‘325 (non-nucleoside polymerase inhibitor). These data may be critical in informing HCV drug development: while daclatasvir and asunaprevir had poor efficacy due to high rates of virological failure, the addition of another DAA resulted in strong efficacy. Thus, high SVRs may be achievable by combining multiple agents, even in the absence of any drug with a high barrier to resistance. Phase III studies could begin in 2014, meaning that BMS could be only 18 months to two years behind Abbott and Gilead. However, with twice daily dosing

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and the potential for issues with resistance, BMS may compete more with Abbott than Gilead, and has the advantage of not containing ritonavir or RBV. BMS is also developing daclatasvir and asunaprevir in GT-1b; the dual combination regimen showed good efficacy in these easier to treat patients.

Other companies with promising drugs or regimens in HCV include JNJ-Medivir, Vertex, and Achillion. (Ongoing or soon-to-be initiated all-oral combination trials are depicted in figure 4.) As described above, JNJ-Medivir’s simeprevir has shown robust efficacy and good safety in combination with IFN and RBV, with particularly compelling data in hard-to-treat patients including those with fibrosis and cirrhosis. Data from four trials in 2013 could inform the further development of an all-oral combination regimen.

Vertex recently reported promising phase I antiviral efficacy for VX-135, which may now be the second most advanced nucleoside polymerase inhibitor (behind sofosbuvir). 2013 will see significant news flow regarding the safety and efficacy of VX-135 in a variety of combinations, including with RBV, Incivek, an NS5a inhibitor from GSK, and simeprevir.

Achillion is developing a potent, pan-genotypic NS5A inhibitor ACH-3102 which appears differentiated based on a superior resistance profile. ACH-3102 retains activity against the common variants conferring resistance to daclatasvir and other NS5a inhibitors. The strong resistance data led the FDA to allow a 12-week study of ACH-3102 and RBV in GT-1b CC patients (those with the best chance for potential rescue treatment). Achillion wants to expand the trial to non-CC patients, which suggests that breakthroughs

Figure 4: All-oral combination regimens currently being studied for the treatment of HCV. Source: Company reports, Sectoral estimates.

COMPANY NUCLEOSIDE PROTEASE NS5A NON-NUCLEOSIDE RIBAVIRIN STAGE COMMENTS

ABT-450/ritonavir ABT-267 ABT-333 + Phase III

ABT-450/ritonavir ABT-267 Phase II Japan and US GT-1b

ACH-3102 + Phase II GT1b IL-28B CC

sovaprevir (ACH-1625) ACH-3102 +/- Phase II Start early 2013, data H2'13

faldaprevir (BI-335) BI-127 + Phase IISOUND C2 trial showed SVR of 43% in

GT-1a, 71% in GT1b

faldaprevir (BI-335) BI-127 + Phase III Study planned in GT-1a CC and GT-1b

asunaprevir daclatasvir (BMS-790052) Phase III GT1b, up to 91% SVR in phase II

asunaprevir daclatasvir (BMS-790052) BMS-791325 Phase IIUp to 94% SVR, potential phase III

start in 2013

sofosbuvir (GS-7977) GS-5885 +/- Phase II/III

sofosbuvir (GS-7977) Phase IIIGT2-3, first phase III trial showed 93%

SVR in GT-2 and 61% SVR in GT-3

sofosbuvir (GS-7977) GS-9669 + Phase II

Gilead/BMS sofosbuvir (GS-7977) daclatasvir (BMS-790052) +/- Phase II Up to 100% SVR +/- RBV

Gilead/JNJ-Medivir sofosbuvir (GS-7977) simeprevir (TMC-435) +/- Phase II Data Q1'13

JNJ-Medivir simeprevir (TMC-435) TMC647055/ritonavir +/- Phase II Data H2'13

JNJ-Medivir/BMS simeprevir (TMC-435) daclatasvir (BMS-790052) +/- Phase II Data mid-2013

MK-5172 + Phase II GT-1 IL-28B CC, start early 2013, MK-

MK-5172 MK-8742 + Phase II Start early 2013

mericitabine

(RG7128)

danoprevir/ritonavir

(RG7227/ITMN-191)+ Phase II

INFORM and MATTERHORN showed 41-

67% SVRs, with 100% SVR in GT1b

mericitabine

(RG7128)

danoprevir/ritonavir

(RG7227/ITMN-191)

setrobuvir

(RG7790/ANA598)+ Phase II

VX-135 (ALS-2200) + Phase II

VX-135 (ALS-2200) telaprevir Phase II Start early 2013, data H2'13

Vertex/JNJ-Medivir VX-135 (ALS-2200) simeprevir (TMC-435) +/- Phase II Start early 2013, data H2'13

Vertex/GSK VX-135 (ALS-2200) GSK2336805 +/- Phase II Start early 2013, data H2'13

Merck

Vertex

Roche

ALL-ORAL COMBINATION TRIALS IN HCV

Abbott

Achillion

Boehringer Ingelheim

BMS

Gilead

NEWSLETTER FOURTH QUARTER 2012

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or the development of resistance have not been observed. Initial data for ACH-3102 and RBV are expected in early 2013 and may yield interesting proof-of-principle results, even if the regimen is not commercially viable. Achillion will subsequently initiate combination trials with its protease inhibitor sovaprevir.

The GT-1b population may emerge as a distinct and highly competitive sub-market, with the potential for more treatment options than for those with GT-1a. Interestingly, Achillion has already discussed a potential commercial strategy of competing on price in GT-1b patients. In addition to BMS and Achillion, Abbott may have a simplified regimen for these patients and is evaluating a potentially once-daily combination of ABT-450/ritonavir and ABT-267.

Other companies have less promising HCV pipelines. Dosing of Merck’s protease inhibitor MK-5172 is limited by liver toxicity, which may compromise the efficacy of its ongoing all-oral combination trials. The company does have a number of phase I compounds in the pipeline, however. Boehringer Ingelheim’s regimen does not look compelling, and Roche has shown suboptimal results for its ritonavir-boosted protease inhibitor danoprevir and the nucleoside polymerase inhibitor mericitabine, which is only modestly effective. The ongoing trial incorporating the non-nucleoside inhibitor setrobuvir may improve efficacy, but is unlikely to be competitive with Abbott’s 3-DAA regimen.

Finally, Idenix has had the unique misfortune of having its lead nucleoside polymerase inhibitor program IDX184 twice put on clinical hold by the FDA for safety reasons related to other compounds. The latest setback occurred earlier this year, following the discovery of toxicities with INX-189 since both drugs have the same active metabolite. In February 2012, the FDA lifted a partial clinical hold on IDX184 which was issued in 2010 after three cases of elevated liver-function tests were reported in combination trials with the protease inhibitor IDX320. Idenix is performing detailed cardiovascular analyses of patients treated with IDX184 in combination with IFN and RBV. However, as it may be difficult to disprove a

cardiac safety signal, it also is hard to predict whether the FDA will lift the clinical hold. In any event, recruitment for trials with IDX184 would likely be challenging due to the perceived risk, and other companies may be reluctant to engage in combination trials for fear of further delays should safety signals emerge. (The suboptimal efficacy of IDX184 in combination with IFN/RBV must also be taken into account). The nucleoside polymerase inhibitor IDX368 may suffer a similar fate. Idenix also has a phase I NS5a inhibitor (IDX719) and a uridine-based nucleoside polymerase inhibitor, which could enter the clinic in mid-2013. These compounds may represent Idenix’ best options for a DAA regimen, in which case the company will be several years behind Gilead, Abbott, and other competitors, with an increasingly high hurdle for a competitive profile with respect to efficacy and safety.

SIZING THE HCV MARKET OPPORTUNITY

With expectations for the availability of multiple all-oral regimens for HCV in 2015 and beyond, investors have shifted focus to commercial considerations, particularly to the peak size of the HCV market and how rapidly peak sales may decline. Overall, the opportunity is relatively finite, as HCV treatment is curative and the rates of new infections are low.

The first 2-4 years of sales of all-oral treatments are widely expected to be very strong, driven by the backlog of patients awaiting treatment: patients who previously failed treatment (300,000-400,000 in the US) and treatment-naïve patients who are currently “warehoused” and awaiting better options (estimated at 70% of new diagnoses and about 400,000 patients overall in the US). Subsequently, sales may decline in the absence of newly diagnosed HCV-infected individuals and increasing rates of treatment. The discussion below considers these variables, focusing on the US market because of greater visibility on disease prevalence, public-policy and payer initiatives, and market trends. However, the overall picture is broadly similar in the EU, albeit with larger patient numbers and greater sensitivity to costs. Cost and access-to-care limit diagnosis and treatment rates in other markets.

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PATIENT NUMBERS: PREVALENCE OF HCV AND DIAGNOSIS RATES

In the US, it is estimated that about 3 million people are chronically infected with HCV, based on the National Health and Nutrition Examination Survey (NHANES) data. This figure may actually underestimate the prevalence of HCV in the US because the surveys do not include incarcerated or homeless people; adding these high-risk populations could increase estimates by 500,000–1,000,000 people. However, because the disease is asymptomatic for a long period of time, the majority of HCV-infected people do not know they are infected. Only about 30% of HCV-infected people or 1 million individuals in the US have been diagnosed, many as a result of blood-donation screening or from elevated liver enzymes detected during routine examinations. The number of diagnosed HCV infections is expected to increase through public health policy initiatives, with a growing consensus for a broader screening and diagnosis strategy in HCV.

In August 2012, the US Centers for Disease Control and Prevention (CDC) issued guidelines recommending one-time screening for HCV for everyone born between 1945-1965, ie, the baby boomers. This birth-cohort screening supplements testing of individuals with known risk factors: having had a transfusion or organ-transplant before 1992, current or past IV drug use, hemodialysis, or occupational exposure as a healthcare worker. The CDC estimates that birth-cohort screening could identify more than 800,000 additional HCV-infected people and potentially lead to 200,000 fewer cases of cirrhosis, 46,000 fewer cases of hepatocellular carcinoma, 10,000 fewer liver transplants, and 78,000 fewer HCV-related deaths. In contrast, the US Preventive Services Task Force (USPSTF) issued its own guidelines three months later. Based on the risk-benefit profile of currently available treatment options, the USPSTF took a more cautious stance on birth-cohort screening. These guidelines are widely expected to be revised as all-oral regimens become available and the risk-benefit dynamic changes. Incorporation of birth-cohort screening into the USPSTF guidelines should lead to broader use of

HCV testing and better coverage (without co-pays in many medical settings). Moreover, the revisions will likely contribute to increasing rates of HCV diagnosis beginning in 2015. For comparison, the rate of diagnosis among HIV-infected individuals in the US is over 80%, a figure that has been significantly impacted by various public-health initiatives.

In addition to policy changes, we expect better treatment options and education initiatives targeting both physicians and consumers to increase rates of diagnosis and expand the addressable market. Such initiatives are likely to be strongly supported by companies marketing treatments for HCV. Finally, the rate of diagnosis should rise as the proportion of people who have been infected for 20 or more years increases, as these patients are at higher risk of developing HCV-related clinical manifestations. Of note, a rapid test for the detection of HCV was approved in 2011. The test is marketed by Orasure and generates results in 20 minutes from finger-stick blood (or oral fluid outside of the US), providing an alternative to laboratory-based testing that may be useful in public health settings, physician offices, and emergency rooms. Orasure had a marketing collaboration with Merck that targeted physician-office laboratories. However, Orasure recently let the agreement lapse in order to maximize flexibility for potential future collaborations with leading HCV therapeutics companies. Such marketing collaborations could help Orasure gain a significant share of the growing HCV testing market, currently in excess of 12 million tests per year in the US.

THE CASE FOR TREATING HCV: IMPROVING PATIENT OUTCOMES

The burden of HCV is growing. The peak of infections occurred in the 1970’s and 80’s, and the complications of disease typically take 20-40 years to develop. Thus, HCV-related illness and deaths have been increasing and are projected to continue to grow significantly in coming years. The prevalence of HCV-related cirrhosis in the US is expected to peak at 1 million individuals from the mid-2020s through the mid-2030s (see figure 5). Further, the CDC cites

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studies estimating that if their HCV infection remains untreated, 1.8 million people will develop cirrhosis, and 400,000 will develop liver cancer over the next 40–50 years.

A key question for investors is whether effective and well-tolerated treatment regimens will lead more individuals with HCV infection to begin therapy. Currently, many asymptomatic patients do not get treatment because of poor safety, tolerability, and low success rates. While all-oral regimens will remove these barriers to initiating treatment, it is uncertain whether a significant portion or even the majority of asymptomatic people will receive treatment for HCV. We do, however, expect patients with evidence of early liver disease to seek treatment, and as described above, an increasing proportion of those infected will have manifestations of disease.

Increasing evidence demonstrates that treatment of HCV infection improves patient outcomes. Multiple studies have shown that HCV infection results in significantly higher rates of death from liver-related diseases, as well as increased mortality from other causes, including cardiovascular and renal disease, which may be due to persistent inflammation and immune-complex deposition. Overall, HCV infection reduces life expectancy by 8-12 years. Key data include matched control studies in over 80,000 HCV-infected patients in a Veterans Administration (VA) cohort, and a 2008 report in more than 10,000 HCV-seropositive blood donors in the US (see figure 6). The REVEAL-HCV study in Taiwan prospectively evaluated almost 24,000 subjects for an average duration of over 16 years and showed an 89% increase in all-cause mortality. A 12.5-fold increase in death due to liver-related disease was observed, as well as a 35% higher incidence of death from other causes, including cardiovascular and renal disease, and an increased rate of cancer in organs other than the liver. Importantly, seropositive individuals who did not have

detectable levels of HCV RNA had mortality rates comparable with uninfected individuals. This finding suggests that active rather than prior HCV infection is the important factor in determining the risk of death. This critical point was addressed in a 2011 VA study, which demonstrated that achieving an SVR after HCV treatment was associated with a substantial reduction in the rates of decompensated cirrhosis, liver-related deaths and all-cause mortality (see figure 7). The study provided a clear demonstration that successful treatment of HCV infection improves patient outcomes.

Figure 5: The prevalence of HCV-related cirrhosis will peak in 2020. Source: Checkforhepc.com.

Figure 6. Age-specific survival by HCV-status, all causes of death – hazard ratio 3.13, P<0.00001. Source: Guiltinan et al, Am J Epidemiol. 2008;167;743.

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Another consideration, which was debated prior to the launches of telaprevir and boceprevir, is capacity constraint among healthcare providers. We do not think capacity will be a significant factor in the utilization of all-oral regimens; these regimens have a

vastly improved tolerability profile and will require far less time for the management of symptoms and monitoring of treatment responses. They also have a much shorter treatment duration. Further, the prescriber base may expand from specialized gastroenterologists to infectious-disease doctors, which may further alleviate any potential capacity issues. However, we do not expect HCV to be broadly treated by primary care physicians.

COSTS OF HCV TREATMENT

In addition to the clinical benefits, pharmaco-economic analyses support treatment of HCV. Infected patients incur higher healthcare costs, compared with a non-infected population matched by sex, age, and healthcare enrollment (see figure 8). Predictably, costs are driven largely by end-stage liver disease, liver transplants, and cancer, so total HCV-related healthcare expenditures are likely to increase significantly over time as patients progress to more severe disease. The stringent technology assessment by the UK’s National Institute for Health and Clinical Excellence (NICE) showed robust cost effectiveness for treating HCV with either telaprevir or boceprevir. This analysis supported treatment of various patient sub-populations, including treatment-naïve patients with mild disease. Depending on the price points, the higher cure rates and reduced incidence of adverse events associated with oral DAA regimens may lead to even greater cost effectiveness. Further, two US studies found that birth-cohort screening and

Figure 8: All-cause healthcare costs in non-HCV-infected population vs HCV-related costs by disease severity. Source: Allabouthepc.com.

Figure 7. Cumulative mortality for non-responders (no SVR) and responders (SVR) with number at risk: GT-1 hazard ratio, 0.70; P < 0.0001; GT-2 hazard ratio, 0.64; P = 0.006; GT-3 hazard ratio, 0.51; P = 0.0002. Source: Backus et al. Clinical Gastroenterology and Hepatology. 2011:9;509.

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treatment for HCV were cost-effective because of reductions in morbidity and mortality.

While cost-effective, new HCV treatments will have high overall costs, and the price of the various all-oral regimens for HCV may play a role in determining market share. Payers also are likely to have a significant influence on market dynamics. In the US, in addition to requiring prior authorizations, payers are likely to aggressively manage costs by selecting a preferred regimen and negotiating favorable pricing. The key considerations in selecting a preferred regimen will be efficacy, safety, and cost, and SVR rates within 5-10% will likely be deemed comparable. Anticipated real-world outcomes will probably be the focus. Thus, material differences in adherence and compliance will factor into the decision, including such considerations as tolerability, significant differences in duration of treatment, and once versus twice daily dosing (although overall pill burden probably will not be a factor). Feedback from commercial payers suggests disease severity probably will not limit access to treatment, largely due to ethical considerations. However, in some cost-sensitive markets in the US and other countries, treatment may be restricted to patients with signs of fibrosis. For example, the prevalence of HCV infection is particularly high in US prisons, with various estimates ranging from 12-31%. Although the treatment of HCV has been shown to be cost-effective in the prison population, even when considering treatment with IFN-RBV, the high cost may nonetheless lead to some patient segmentation. Treatment rates may also be substantially lower in populations with limited access to care and/or high risk of re-infection, such as homeless people and IV drug users.

Selection of a preferred regimen may result in a significant first-mover advantage for Gilead and Abbott, as substantial differentiation may be needed to drive uptake of later market entrants. Given the high barrier that late entrants will surely face over their efficacy, safety, resistance profiles, and drug interactions, pricing discounts in excess of 20% may be play a key role in driving uptake of other regimens.

The GT-1b market may be particularly cost-driven, given that more treatment options for these easier-to-treat patients will likely be available.

If the more efficacious all-oral regimens are priced at a comparable level to current treatments on a per-cure basis, the cost of treatment could exceed USD100,000. However, we believe companies in the space are sensitive to pricing in a competitive market, and we expect the cost of new oral drugs like sofosbuvir to be more in line with Incivek’s (net pricing of about USD47,000 per course of treatment), while the price of combination regimens such as sofosbuvir and GS-5885 may be comparable with the total cost of treatment of Incivek, IFN, and RBV (around USD60,000 net price).

CONCLUSIONS

The commercial opportunity for new all-oral drugs to treat HCV is very large, irrespective of outstanding questions regarding price and rates of diagnosis and treatment. While expectations for the HCV market will be refined over time and as pricing strategies become clear, many estimates predict a total market opportunity in excess of USD10-12bn by 2020 (see figure 9).

Recent data for regimens containing sofosbuvir suggest that Gilead is likely to capture a significant share of the HCV market, with estimates for peak

Figure 9. Hepatitis C estimated worldwide market sales. Source: Firstword.

CAGR (2006-2011)=9.4% CAGR (2011-2020)=11.1%

ROW US Market growth

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NEWSLETTER FOURTH QUARTER 2012

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sales ranging from USD4bn-7bn. Several other regimens have also shown compelling efficacy, including a 5-drug treatment from Abbott that is likely to be the first all-oral regimen for HCV with approval expected in 2015; street estimates for Abbott’s HCV franchise range up to USD3bn in sales. Other companies, including BMS, JNJ, Achillion and Vertex, are racing to develop fast-follower treatments. Ultimately, market share will be determined by each regimen’s relative competitive profile, particularly in harder-to-treat populations, such as patients with fibrosis and cirrhosis. Initial data for sofosbuvir in combination with simeprevir or with GS-5885 in these patient populations will be important in gauging the peak sales potential, with moderate downside to revenue estimates (eg, 20-30%) should sofosbuvir-containing regimens be effective mainly in treatment-naïve patients with limited fibrosis. Estimates for Abbott will be revised with clinical data for competitive regimens, with potential for material downside to numbers, and revenue estimates for other regimens will similarly be defined by emerging clinical data. Commercial considerations, including price, will also play a role in determining market share, especially in cost-sensitive environments. However, regimens competing on cost

must show comparable efficacy and safety − an increasingly difficult challenge.

Rich clinical news flow in 2013 and beyond, followed by regulatory approvals and sales, should ensure that the HCV space will continue to be of interest for investors. However, the flurry of M&A activity in the HCV space may be largely complete, barring a new wave of drug development. Achillion may be the last remaining HCV takeover candidate, particularly after data in 2013 is released, which could materially reduce the risk of key programs.

Mina Marmor, Ph.D., CFA Financial Analyst

Sources - Centers for Disease Control and Prevention, at: http://www.cdc.gov/hepatitis/hcv/index.htm - Lee et al. J Infect Dis. 2012;206:469. - Leerink Swann - McGarry LJ, Hepatology. 2012;55:1344. - Rein D. Ann Intern Med 2011;155: 263. - Tan et al. Hepatology. 2008;48:1387. - Wells Fargo

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RECENT PUBLICATIONS BY MEMBERS OF THE SECTORAL SCIENTIFIC ADVISORY NETWORK AMANDA ADLER, MD, PH.D.

Stratton IM, Aldington SJ, Taylor DJ, Adler AI, Scanlon PH. A simple risk stratification for time to development of sight-threatening diabetic retinopathy. Diabetes Care. 2012 Nov 12. [Epub ahead of print].

Erqou S, Lee CT, Suffoletto M, Echouffo-Tcheugui JB, de Boer RA, van Melle JP, Adler AI. Association between glycated haemoglobin and the risk of congestive heart failure in diabetes mellitus: systematic review and meta-analysis. Eur J Heart Fail. 2012 Oct 25. [Epub ahead of print].

Jilani A, George E, Adler AI. NICE guidance on cabazitaxel for hormone-refractory metastatic prostate cancer previously treated with a docetaxel-containing regimen. Lancet Oncology. 2012;3:573.

Nagrebetsky A, Jin J, Stevens R, James T, Adler A, Park P, Craven A, Shine B, Farmer A. Diagnostic accuracy of urine dipstick testing in screening for microalbuminuria in type 2 diabetes: a cohort study in primary care. Fam Pract. 2012 Sep 17. [Epub ahead of print].

Lee CC, Adler AI. Recent findings on the effects of marine-derived n-3 polyunsaturated fatty acids on urinary albumin excretion and renal function. Curr Atheroscler Rep. 2012 Dec;14:535.

Erqou S, Lee CT, Adler A. Intensive glycemic control and the risk of heart failure in patients with type 2 diabetes. Am Heart J. 2012;163:e35.

Waugh N, Royle P, Craigie I, Ho V, Pandit L, Ewings P, Adler A, Helms P, Sheldon C. Screening for cystic fibrosis-related diabetes: a systematic review. Health Technol Assess. 2012;16:1.

Kandasamy N, Lennox G, Annamalai AK, Maguire G, Adler AI. Sitagliptin in glutamic acid decarboxylase antibody-positive diabetes mellitus. Endocr Pract. 2012;18:e65.

Rinaldi F, George E, Adler A. Cetuximab, bevacizumab and panitumumab for the treatment of metastatic colorectal cancer after first-line chemotherapy. Lancet Oncology. 2012;13:233.

Salem W, Adler A, Lee C, Smith G. Maternal waist to hip ratio is a risk factor for macrosomia. BJOG. 2012;119:291.

Pilacinski S, Adler AI, Zozulinska-Ziolkiewicz DA, Gawrecki A, Wierusz-Wysocka B. Smoking and other factors associated with short-term partial remission of Type 1 diabetes in adults. Diabet Med. 2012;29:464.

Lee CC, Howard BV, Mete M, Wang H, Jolly S, Adler AI. Association between fish consumption and

nephropathy in American Indians--the Strong Heart Study. J Ren Nutr. 2012;22:221.

AURELIO BALSALOBRE, PH.D.

Budry L, Balsalobre A, Gauthier Y, Khetchoumian K, L'honoré A, Vallette S, Brue T, Figarella-Branger D, Meij B, Drouin J. The selector gene Pax7 dictates alternate pituitary cell fates through its pioneer action on chromatin remodeling. Genes Dev. 2012;26:2299.

Langlais D, Couture C, Balsalobre A, Drouin J. The Stat3/GR interaction code: predictive value of direct/indirect DNA recruitment for transcription outcome. Mol Cell. 2012;47:38.

SUI HUANG, MD, PH.D.

Zhou JX, Aliyu MD, Aurell E, Huang S. Quasi-potential landscape in complex multi-stable systems. J R Soc Interface. 2012;9:3539.

Huang S. Tumor progression: chance and necessity in Darwinian and Lamarckian somatic (mutationless) evolution. Prog Biophys Mol Biol. 2012;110:69.

Huang S. The molecular and mathematical basis of Waddington's epigenetic landscape: a framework for post-Darwinian biology? Bioessays. 2012;34:149.

HENRY I. MILLER, MS, MD

Miller HI. ObamaCare's medical device tax will cost innovation and jobs. Forbes.com. December 17, 2012.

Miller HI. Politicians' meddling with regulation does not serve society well. Forbes.com. December 5, 2012.

Miller HI. Letter: Food radicals will fail in court. Wall Street Journal. November 26, 2012.

Miller HI. A supremely important decision about America's logging industry. Forbes.com. November 29, 2012.

Miller HI. India's GM food hypocrisy. Wall Street Journal Asia. November 27, 2012.

Miller HI, Kershen DL. Is opposition to genetic engineering moral? National Review Online. November 26, 2012.

Miller HI. Beware Obama's regulatory cliff. OCregister.com. November 16, 2012.

Miller HI. Free speech for big pharma. Defining Ideas (Hoover Institution). November 14, 2012.

Miller HI. A David and Goliath parable. Daily Caller (DC). November 12, 2012.

Miller HI, Cornett R. Is organic agriculture "affluent narcissism?" Forbes.com. November 7, 2012.

Miller HI. Eureka: Prop 37: An initiative in need of its own warning label. Advancing a Free Society. October 31, 2012.

Miller HI. Save the whales, forget the children. Wall Street Journal. October 30, 2012.

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Miller HI. When genetic engineering came of age. Forbes.com. October 29, 2012.

Miller HI, Stier J. A lack of government transparency: the devil in the detailing. Forbes.com. October 24, 2012.

Byrne J, Miller HI. The roots of the anti-genetic engineering movement? Follow the money! Forbes.com. October 22, 2012.

Miller HI, Kershen DL. Europe versus scientific consensus. American Magazine (American Enterprise Institute). October 18, 2012.

Miller HI. Dr. Carmona's condition. Forbes.com. October 17, 2012.

Miller HI. Poison-proofing China. Project Syndicate. October 12, 2012.

Conko G, Miller HI. A losing proposition on food labeling. Orange County Register Online. October 11, 2012.

Miller HI. The controversy around BPA: bad reporting on bad science. Forbes. October 10, 2012.

Miller HI. Obama's death by jobs. Defining Ideas (Hoover Institution). October 10, 2012.

Conko G, Miller HI. "Genetically Engineered" in California: a food label we don't need. Forbes.com. October 8, 2012.

Carter CA, Miller HI. Feds could lessen drought impacts but don't bet the farm on it. Forbes.com. October 3, 2012.

Miller HI, Wager R. Technophobia equals poisoned fruit. Genetic Engineering and Biotechnology News (NY). October 1, 2012.

Miller HI. Regulation, the Democrats, and the parallel universe. Forbes.com. September 26, 2012.

Miller HI, Chassy B. Scientists smell a rat in fraudulent genetic engineering study. Forbes. September 25, 2012.

Conko G, Miller HI. Labeling of genetically engineered foods is a losing Proposition. Forbes.com. September 12, 2012.

Miller HI, Conko G. Rachel Carson's deadly fantasies. Forbes.com. September 5, 2012.

Miller HI. A (genetically-modified) apple a day... Defining Ideas (Hoover Institution). September 6, 2012.

Miller HI, Kershen DL. Will overregulation in Europe stymie synthetic biology? Forbes. August 29, 2012.

Miller HI. Prop. 37: GE labels mean higher costs. San Francisco Chronicle. August 21, 2012.

Miller HI, Stier J. There are a thousand ways to do an experiment wrong. Forbes. August 22, 2012.

Miller HI. Biden's unhinged, and worse, history. Orange County Register. August 17, 2012.

Miller HI. Joe Biden's gaffes call for a thorough neurological examination. Forbes. August 20, 2012.

Miller HI. Obama's shallow farm rhetoric compounds plight of midwest drought. Forbes. August 15, 2012.

Swogger G, Miller HI. Obama's radical agenda ruined his chance to be leader. Investor's Business Daily. August 6, 2012.

Miller HI. Good riddance to Obama's regulatory czar. Forbes.com. August 8, 2012

Miller HI. The nuking of Japan was a tactical and moral imperative. Forbes.com. August 1, 2012.

Carter CA, Miller HI. Corn for food, not fuel. New York Times. July 31, 2012.

Miller HI. Fake and flawed medicines threaten us all. Forbes.com. July 25, 2012.

Miller HI. Organic is overrated. Defining Ideas (Hoover Institution). July 26, 2012.

Miller HI. FDA Has Device Makers Looking Outside U.S. Orange County Register. July 19, 2012.

Miller HI. Overzealous and interventionist Feds come up short on drug shortages. Forbes.com. July 18, 2012.

Miller HI. Crime and non-punishment: when cops and DA's are the problem rather than the solution. Forbes.com. July 5, 2012.

Miller HI. The brewing crisis in science. Defining Ideas (Hoover Institution). July 2, 2012.

Miller HI. The use and abuse of science in policymaking regulation. (Cato Institute). June 27, 2012.

Miller H, Longtin D. Dangerous stowaways at the summer Olympics. Forbes.com. June 20, 2012.

Miller HI. Sour grapes over BPA. American Spectator. June 19, 2012.

Miller HI. Waste and abuse in federal research funding. Genetic Engineering and Biotechnology News. June 15, 2012.

Miller HI. Obama's disdain for the private sector. Forbes.com. June 13, 2012.

Miller HI. Rep. Joe Wilson was right: Obama has deceived us. Investor's Business Daily. June 8, 2012.

Stier J, Miller HI. "Oasis" film is an intellectual desert. Forbes.com. June 6, 2012.

Miller HI. Silicon Valley Cop Noir. Forbes.com. May 30, 2012. Miller HI. FDA user fees use consumers badly. Forbes.com.

May 23, 2012. Miller HI. Don't sour on idea of ‘corn sugar'. Orange County

Register. May 22, 2012. Miller HI. Romney's alleged lapses dwarfed by those of

Obama's minions. Forbes.com. May 16, 2012. Miller HI. ObamaCare's killer device tax. Wall Street

Journal. May 11, 2012. Miller HI, Brookes G. Opinions on genetic engineering that

aren't worth a bean. Forbes.com. May 9, 2012. Miller HI. Politicians worthy of respect are a rare

commodity. Forbes.com. May 2, 2012. Miller HI. Bill Clinton’s hypocrisy on Osama. Orange County

Register. May 2, 2012. Miller HI, Stier J. Anti-technology activists are the real

slime. Forbes. April 25, 2012. Miller HI. The dirt on Earth Day. Forbes.com. April 18, 2012. Miller HI. Bad faith and bad science from NRDC. Daily Caller

(DC). April 12, 2012. Miller HI. White House interference with regulators is

hazardous to your health. Forbes. April 11, 2012.

NEWSLETTER FOURTH QUARTER 2012

Page 20

Miller HI. The real dope on medical marijuana. Forbes.com. March 28, 2012.

Miller HI, Stier J. Avastin should be re-approved for breast cancer. Forbes.com. March 14, 2012.

Miller HI. The data on drugs' side effects must be reliable. Forbes.com. March 7, 2012.

Miller HI. Wrong Rx for the FDA. Los Angeles Times. March 5, 2012.

Miller HI. Regulation by litigation may be hazardous to your health. Forbes.com. February 29, 2012.

Miller HI. When technophobia becomes toxic. Project Syndicate. February 29, 2012.

Chassy B, Miller H. The science of things that aren't so. Forbes.com. February 22, 2012.

Miller HI. Fake drugs - all at a pharmacy near you! Forbes.com. February 16, 2012.

Miller HI. How is the FDA really doing? Genetic Engineering and Biotechnology News. February 15, 2012.

Miller HI. The National Science Foundation's fleecing of American taxpayers. Forbes.com. February 14, 2012.

Stier J, Miller HI. Don't put down polystyrene. Orange County Register. February 7, 2012

Miller HI. Red tape and pink slips: Obama’s imaginary regulatory reform. American. February 2, 2012.

Miller HI. NPR's bias against genetic engineering. Forbes.com. February 1, 2012.

Miller HI. Norman Borlaug: The genius behind the green revolution. Forbes.com. January 18, 2012.

Miller HI. California bureaucrats' bad chemistry. Orange County Register. January 6, 2012.

Miller HI. David Brooks: The conscience of a pseudo-conservative. Forbes.com. January 3, 2012.

PAO-HSIEN CHU, MD

Yang CH, Shen SC, Hui RC, Huang YH, Chu PH, Ho WJ. Association between peripheral vascular endothelial dysfunction and livedoid vasculopathy. J Am Acad Dermatol. 2012;67:107.

Chan YH, Liew KP, Sun CC, Hsueh C, Li BC, Tsai FC, Lin JL, Chu PH. Hyperacute rejection from a donor who died of carbamate intoxication-a case report. Am J Emerg Med. 2012;30:1661.e1.

Chen SW, Chu PH, Shih LG, Lu MS, Shen WC, Huang YK. Right atrial angiosarcoma: rupture and tamponade. Texas Heart Institute J 2012;39:153.

Lin HC, Chu PH, Jung SM, Yang ML, Ma DH. MUC5AC in juvenile conjunctival nevus. Jpn J Ophthalmol. 2012;56:107.

Hsiao PG, Hsieh CA, Yeh CF, Wu HH, Shiu TF, Chen YC, Chu PH. Early prediction of acute kidney injury in

patients with acute myocardial injury. J Crit Care. 2012;27:525.e1.

Tsai HS, Tsai FC, Chen YC, Wu LS, Chen SW, Chu JJ, Lin PJ, Chu PH. Impact of acute kidney injury on one-year survival after surgery for aortic dissection. Ann Thorac Surg. 2012;94:1407.

Wu LS, Tang CH, Lin YS, Lin CP, Hung ST, Hwa HL, Luo SF, Chu PH. Major adverse cardiaovascular events and mortality systemic lupus erythematous patients after successful delivery: a population-based study. Am J Med Sci 2012 Dec 18. [Epub ahead of print]

Li LF, Chu PH, Hung CY, Kao WWY, Lin MC, Liu YY, Yang CT. Lumican regulates ventilation-induced epithelial-mesenchymal transition through extracellular signal-regulated kinase pathway. Chest 2012 [Epub ahead of print].

Liew NC, Yang YH, Chio G, Chu PH, Gao X, Gibbs H, Ho CO, Ibrahim H, Kim TK, Kritpracha B, Lee LH, Lee L, Lee SY, Li YJ, Nicolaides AN, Oh D, Pratama D, Ramakrishnan R, Robless PA, Villarama-Alemany G, Wong R. Asia venous thromboembolism guidelines: prevention of venous thromboembolism. Int Angiol 2012;31:501.

Yen TH, Yang HY, Yeh YH, Chu PH, Wen CJ, Fu JF, Wang IK, Liang CC, Chang CT, Chen KH, Tian YC, Hung CC, Lin JL, Yang CW. Aliskiren attenuates proteinuria in mice with lupus nephritis by a blood pressure-independent mechanism. Lupus 2012 Dec 20. [Epub ahead of print].

OLIVIER SCHAAD, PH.D.

Fernandez P, Solenthaler M, Spertini O, Quarroz S, Rovo A, Lovey PY, Leoncini L, Ruault-Jungblut S, D'Asaro M, Schaad O, Docquier M, Descombes P, Matthes T; Swiss Cytometry Society. Using digital RNA counting and flow cytometry to compare mRNA with protein expression in acute leukemias. PLoS One. 2012;7:e49010.

Brankatschk B, Wichert SP, Johnson SD, Schaad O, Rossner MJ, Gruenberg J. Regulation of the EGF transcriptional response by endocytic sorting. Sci Signal. 2012;5:ra21.

Saurat JH, Kaya G, Saxer-Sekulic N, Pardo B, Becker M, Fontao L, Mottu F, Carraux P, Pham XC, Barde C, Fontao F, Zennegg M, Schmid P, Schaad O, Descombes P, Sorg O. The cutaneous lesions of dioxin exposure: lessons from the poisoning of Victor Yushchenko. Toxicol Sci. 2012;125:310.

NEWSLETTER FOURTH QUARTER 2012

ABOUT SECTORAL ASSET MANAGEMENT Sectoral Asset Management is an SEC-registered investment advisor based in Montreal whose focus is managing global healthcare equity portfolios. Sectoral has one of the world’s longest track records in managing biotech equities and is a sub-advisor of numerous healthcare and biotech funds offered by

partners in Europe, USA, Canada, Japan, Taiwan and Korea. Sectoral has also launched an alternative investment fund that offers an attractive exposure to the growing healthcare/biotech sector through both long and short positions. The firm’s assets are USD4.0 billion as of December 31, 2012.

Investment Professionals Jérôme Pfund, CFA - Chief Executive Officer Mina Marmor, Ph.D., CFA - Financial Analyst

Michael Sjöström, CFA - Chief Investment Officer Michal Marszal, MD – Financial Analyst

Pierre Gauthier, CFA - Senior Trader Paulina Niewiadomska, CFA – Portfolio Manager

Jeffery Elliott, Ph.D. – Financial Analyst Vincent Ossipow, Ph.D. - Partner, Private Equity

Maha Katabi, Ph.D., CFA – Partner, Private Equity Stephan Patten, CFA – Senior Portfolio Manager

Marc-André Marcotte, CFA – Senior Financial Analyst Vasilios Tsimiklis, CFA - Economist

Scientific Advisory Network

Under the supervision of Dr. Vincent Ossipow, Sectoral has established a proprietary network of talented researchers and clinicians in complementary disciplines worldwide.

The Scientific Advisory Network (SAN) is designed to support Sectoral with scientific due diligence in its investment process. SAN’s members include:

Amanda Adler, MD, Ph.D. Epidemiology / Diabetes Addenbrooke's Hospital, Cambridge, 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 Institute for Systems Biology, Seattle, WA, USA

Henry I. Miller, MS, MD Health Policy / Regulation Hoover Institution, Stanford, CA, USA

Olivier Schaad, Ph.D. Genomics University of Geneva, Geneva, Switzerland

Adam Smith, D.Phil. Drug Discovery The Nobel Foundation, Sweden

Jeffrey P. Somers, JD Law Morse, Barnes-Brown & Pendleton, Waltham, MA, USA

Contact Information Phone: +1 514 849 8777 ext. 223 Fax: +1 514 849 6777

1000 Sherbrooke St. West, Suite 2120, Montreal QC H3A 3G4, Canada

www.sectoral.com

The Sectoral Asset Management Inc. newsletter is published quarterly by Sectoral Asset Management (“Sectoral”), Montreal, Canada. It is provided solely for purposes of evaluating Sectoral's advisory services. This newsletter is not an offer, recommendation or solicitation to buy or sell securities or units of any Fund. Any commentary within the report is for informational purposes only and is general in nature. This document contains certain statements that may be deemed forward-looking statements. They are based on certain assumptions, analyses of historical trends, current conditions, expected future developments and other factors. Certain information has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. Past performance is no guarantee of future results. Investing in healthcare companies involves a high degree of risk, and prices of these companies' stocks may be very volatile. Sectoral may hold securities of issuers referred to in this report in portfolios under management. You may request performance updates by emailing Jérôme Pfund at jerome@sectoral.com. SECTORAL228