Most investors have probably never heard of Sol-Gel Technologies (NASDAQ:SLGL). That wouldn't be too surprising. It's a small Israeli-based dermatology company with a pretty limited pipeline. The pharma stock tumbled in 2018 to drag the company's market valuation well below $100 million and likely off the radar of most investors.

But the narrative may have changed. Sol-Gel delivered positive late-stage results for two of its drug candidates in the second half of 2019. That nudged the company's market valuation above $300 million at the start of this year, although it has cooled off a little. Should investors take this small-cap stock seriously as it prepares to file two new drug applications (NDA) to the Food and Drug Administration in 2020?

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What differentiates Sol-Gel Technologies?

Dermatology might not stand out as a noteworthy investing opportunity. One of the three pillars of Sol-Gel's long-term strategy is to develop and maintain leadership positions in acne and rosacea treatments. Hardly exciting stuff.

But the company's technology platform might grab the attention of investors who take the time to understand it. The company's name refers to the "sol gel" process, which is used to control the microscopic properties of certain materials. In this case, Sol-Gel Technologies creates microscopic silica shells to encapsulate active pharmaceutical ingredients and deliver them below the surface of the skin. 

That ensures the ingredients are more active (some might degrade on the surface of the skin), reduces the side effects of treatment (some ingredients create tolerability issues when applied topically), and prolongs the shelf-life of a product (many dermatology ingredients degrade over time in non-encapsulated formulations). 

Encapsulation isn't new to dermatology, but the sol-gel approach could extend advantages. Silica is inert (limiting safety concerns or interactions with active ingredients) and can be more finely controlled than other polymers commonly used for encapsulation, such as cellulose. Additionally, Sol-Gel is using its technology platform to encapsulate multiple ingredients that have synergistic activity but cannot otherwise be formulated together. 

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Can success in the clinic translate to the market?

Sol-Gel demonstrated the potential of its technology platform in clinical studies of its first two drug candidates, Epsolay and Twyneo.

Epsolay is a microencapsulated benzoyl peroxide cream developed to treat rosacea. While topical benzoyl peroxide is known to be an effective treatment for rosacea, it's generally poorly tolerated due to itching and burning. Therein lies the rationale for encapsulating it. 

In two phase 3 trials, individuals were randomized to receive Epsolay or the vehicle alone (the cream without active ingredients -- benzoyl peroxide in this case). The primary endpoints were the proportion of individuals to achieve clear or almost clear skin as measured by the Investigator Global Assessment (IGA) scale and the absolute change in inflammatory lesions. 

After 12 weeks of treatment, an average of 46.8% of individuals receiving Epsolay achieved success on the IGA scale, compared with only 21% of individuals receiving the vehicle. The absolute difference of 25.8% was statistically significant. Epsolay also outperformed the vehicle, with an average reduction in lesion count of 26.6% versus baseline. 

Both primary endpoints put Epsolay at the top of the field in recent rosacea clinical results. The next closest competitor, Soolantra, achieved an absolute difference of 24% on the IGA scale compared with the vehicle, and a 22.8% reduction in lesion count compared with baseline, both measured at 12 weeks. 

Based on the clinical results, Sol-Gel estimates Epsolay could achieve peak annual sales of $75 million to $100 million. That's impressive, but it pales in comparison to internal estimates for the company's acne product. 

Twyneo is a dual-ingredient formulation of microencapsulated benzoyl peroxide and microencapsulated tretinoin. The two ingredients target different aspects of acne, but couldn't be practically combined in one product due to storage and delivery limitations. 

In two phase 3 trials, individuals were randomized to receive Twyneo or the vehicle. After 12 weeks of treatment, individuals receiving the drug candidate achieved greater reductions in both inflammatory and non-inflammatory lesions compared with those receiving the vehicle. The differences between Twyneo and the vehicle were statistically significant. 

However, the studies showed somewhat mixed results on the IGA scale. One study showed that 38.5% of individuals receiving the drug candidate achieved success on the IGA scale, versus only 11.5% of those receiving the vehicle. That's a difference of 27%. The other study showed success in 25.4% and 14.7% of individuals receiving Twyneo or the vehicle, respectively, a difference of only 10.7%. 

While the IGA outcomes of Twyneo compared with the vehicle were statistically significant in both phase 3 acne studies, there's a massive gulf between 27% and less than 11%. The market success of the drug might be determined by which number is more reflective of the real-world results. There's a lot at stake: Sol-Gel Technologies estimates Twyneo can achieve peak annual sales of at least $350 million. But analysts expect other acne treatments with smaller IGA success rates versus the vehicle to achieve only about half of that. 

Company

Drug or Drug Candidate

Highest Difference in IGA, Drug Candidate vs. Vehicle

Peak Annual Sales Estimate

Sol-Gel Technologies

Twyneo

27%

$350 million to $400 million

Cassiopea 

Winlevi

14%

$400 million

Bausch Health Companies 

Arazlo

12.5%

N/A

Paratek Pharmaceuticals and Almirall 

Seysara

11.4%

Up to $200 million

Foamix Pharmaceuticals 

Amzeeq

11.2%

Up to $250 million

Data source: Sol-Gel, analyst estimates.

Investors might be comforted somewhat in the large difference between Twyneo and the field, which at least provides breathing room in the event the proportion of real-world individuals achieving clear or almost clear skin doesn't come close to 27%.

Nonetheless, Sol-Gel appears to have a path to generating meaningful revenue from Epsolay and Twyneo. The company expects to file the NDA for Epsolay in the first half of 2020 and the application for Twyneo in the back end of the year. That means both could launch in 2021 in a best-case scenario. 

That also suggests 2020 will be a relatively low-key year for the company. Therefore, aside from regulatory developments, investors will want to keep an eye on revenue and cash. Sol-Gel generated $19 million in sales from generic dermatology products in the first nine months of 2019 -- not much, but enough to significantly reduce operating losses. It ended September with $57 million in cash, which is likely not enough to execute two market launches, but probably enough to plow through another year of operations. 

An under-the-radar stock to keep an eye on

Sol-Gel Technologies is a small-cap stock with promise, but the dermatology space is notoriously difficult to conquer. That's doubly true for a tiny business with limited resources. If the promising clinical results from Epsolay and Twyneo lead to regulatory approvals and are supported by real-world results once on the market, then the company should earn more recognition from Wall Street and a much higher market valuation. 

This is a risky stock right now, but it could be worth a small position for investors with a higher tolerance for risk and a long-term mindset. That said, investors might be inclined to wait for a better entry point or at least more visibility into the road ahead, which could be provided on the upcoming fourth-quarter 2019 earnings call, which has yet to be scheduled.