The Signal in the Inovio and Roche Deal Noise

Biotech deals aren't always easy to decipher, which is certainly the case with Inovio Pharmaceuticals (INO -5.10%) and Roche (RHHBY 1.20%). The recent collaboration looks pretty simple on the surface: Roche gains exclusive worldwide rights to developmental vaccines for prostate cancer and hepatitis B, while Inovio captures $10 million up-front funding for near-term research and up to $412.5 million in future milestone payments. Pretty cut-and-dry. Inovio's technology has finally been vindicated, right?

Perhaps, but don't get too excited.

Although Inovio could certainly use hundreds of millions of dollars in milestone payments, the risk-to-reward ratio heavily favors Roche in the deal. Let's consider the conditions surrounding prostate cancer vaccine INO-5150, one of the two vaccines in the deal.

Growing competition for prostate cancer treatments
Hy Levitsky, head of cancer immunology experimental medicine at Roche, told Genetic Engineering and Biotechnology News, "INO-5150 will allow promising combination opportunities with the Roche portfolio, particularly with our emerging cancer immunotherapy molecules." Why focus on the vaccine's potential in a combinational therapy instead of as a monotherapy?

Simply put, any new product would have to exceed a pretty high bar set by currently available options to be a success with patients. Take a look at the first half sales for the leading monotherapy treatment options in prostate cancer:

Source: Company SEC filings.

Each drug competes or is being studied in overlapping patient populations, which has created a competitive market. Zytiga from Johnson & Johnson has attracted late-stage patients that would have otherwise been prescribed Xtandi from Medivation, while Xtandi could attract pre-chemotherapy patients currently taking Zytiga pending results from an ongoing phase 3 trial.

It doesn't end there. Patients got a big boost earlier this year when Xofigo from Bayer was approved for castration-resistant prostate cancer when symptomatic bone metastases are present. The drug is a much more effective and specialized option for individuals in that subpopulation, which will only intensify competition as sales ramp up after launch.

The biggest loser from each approval, expanded or otherwise, has been Dendreon and its once-heralded prostate cancer vaccine Provenge. I'm actually surprised Provenge managed to capture $141 million in sales from January to June. Doctors have become more comfortable with more conventional treatments such as Zytiga and Xtandi than the vaccine, which must be prepared for each individual patient. It may have sounded like a big leap toward individualized medicine at the time of its launch, but the market doesn't reward style points. Convenience and simplicity are king.

DNDN data by YCharts.

For those of you keeping score at home, there are now three major monotherapies jockeying for position. That makes the search for an effective combinational therapy, perhaps even an all-in-one (able to treat all stages of disease) drug, that much more lucrative. And that's where the market is headed.

Johnson & Johnson may have enjoyed a historic launch for its blockbuster Zytiga, but it isn't resting in the lead. The pharma giant recently shelled out $650 million for Aragon Pharmaceuticals and its developmental prostate cancer drug ARN-509, which could be used in non-metastatic forms of the disease. Similar to Xtandi, the drug is an androgen receptor signaling inhibitor. If that isn't scary enough for Medivation (or Dendreon), there's big potential for it to be combined or at least used in a regimen with Zytiga. Can anyone compete with Johnson & Johnson?

The real value of the Inovio-Roche deal
Enter Roche, which wields the developmental drug MPDL320A. The beautifully named molecule is one of three major anti-PD-1 drugs being investigated as a revolutionary cancer immunotherapy. It's behind Merck and Bristol-Myers Squibb in development, but could have the advantage when it comes to selectivity. Roche's drug binds to only one of the receptors in the PD-1 pathway, PD-L1, which scientists believe will give it an advantageous safety profile.

While hopes are already high for Roche's disruptive drug candidate, Inovio's vaccine has the potential to increase its value. For instance, even if INO-5150 proves ineffective on its own, it's not out of the question to believe the two will be a more effective immunotherapy together -- with separate mechanisms of action -- than they could ever be on their own. Each could have a compounding, not additive, effect on the effectiveness of the other.

There is still a lot to prove, however. Neither drug has advanced past mid-stage trials, so investors can't be sure either will actually work, let alone a combination of the two. But the potential for Roche is huge. 

1+1 = Investment worthy?
Shouldn't all of this potential for a combinational therapy put Inovio on your investing radar? Before you're lured by the company's small market cap, consider the multiple uphill battles it faces. Inovio had just $23 million in cash at the end of June. While it's true that the vaccine company can take advantage of grants for funding more readily than other small pharma companies, the exclusively early-stage pipeline will require substantially more funding in the future.

It's also worth noting that Inovio hasn't been the most investor-friendly company in the past few years. The number of shares outstanding is up 80% since 2010! Potential milestone payments from Roche will be few and far between in the coming quarters and years, so expect even more dilution.

Foolish bottom line
Who does the risk-to-reward balance favor the most? Inovio gets to issue the press release of a lifetime and the potential to capture hundreds of millions of dollars in milestone payments in the next decade (mostly back-loaded). But the company still has to deal with funding issues for the foreseeable future and the possibility that INO-5150 fails, which would deflate shares pretty quickly. Now think about the deal from Roche's perspective: The potential reward is adding value to its novel cancer immunotherapy drug and being able to successfully compete in the prostate cancer market -- a hurdle few companies can clear. The risk is going it alone with its own cancer immunotherapies -- the plan to begin with -- and losing $10 million on an up-front payment plus development costs. Seems clear to me.

Editor's note: A previous version of this article had an incorrect sales figure for Provenge and has been updated. The Fool regrets the error.