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Thesis

Synergy Pharmaceuticals (NASDAQ:SGYP) is Ironwood Pharmaceuticals' (NASDAQ:IRWD) only competition in the $2 billion Chronic Constipation and Irritable Bowel Syndrome with Constipation (IBS-C) market. Following the path of Ironwood, Synergy also released positive topline data following the completion of its Phase 2b/3 clinical trials of the key compound plecanatide. Synergy's clinical trials indicate that its product remains a viable, and quite possibly, better alternative to Ironwood's Linzess product. Despite Synergy's recent appreciation, I believe the company still remains radically undervalued and represents a viable target for acquisition by Big Pharma.

The understated IBC-C and Chronic Constipation market opportunity

As previously mentioned, the IBS-C and Chronic Constipation represent a 2 billion dollar market opportunity. This is according to figures stated on Synergy's site, I believe this figure is an understatement. Chronic Constipation is an ailment afflicting 15% of the U.S., 45 million people, given that other developed countries demonstrate a similar prevalence, it seems to me that the dollar value of the market is far north of the original figure.

Contextualizing Synergy through Ironwood

At the time of Ironwood's IPO, investors paid $175 million for 17.6% of the company, resulting in a market cap just north of $994 million. Ironwood's offering followed the release of its Phase 2b results by roughly 16 months. At the same time, the terms of Ironwood's partnership with Forest Laboratories (NYSE:FRX) and ex-U.S. partner Amirall, dictate that Synergy will have to share in both the costs and profits on sales of Linzess in the U.S., resulting in shareholders only retaining 47% of the future value of Linzess. Therefore, Ironwood's implied capitalization at the time of its IPO was actually slightly greater than $2.1 billion. In contrast to Ironwood, Synergy currently maintains complete ownership over the profits that will be generated from its competing plecanatide compound. Despite this point, Synergy is currently valued at $372 million, a long ways off from Ironwood's implied valuation of $2.1 billion (on Ironwood's IPO date).

What can be drawn from this?

For starters, Synergy is radically undervalued. Which leads to the question: What is Synergy's fair valuation? Let's state the figures:

  1. Both Synergy and Ironwood are targeting the same market

  2. Both of their compounds are identical in their mechanism of action

  3. Synergy's Drug development pipeline is nearly identical to Ironwood's in regards to timeline

  4. Given Synergy's recent disclosure of positive topline data and drug with an identical mechanism of action, it seems fair to assume that its highly likely that Synergy's compound will receive FDA approval at the same rate, if not faster than Ironwood. This is in consideration of the fact that Ironwood has already demonstrated the efficacy of the new class of drugs

Therefore, by beginning with Ironwood's capitalization, we can discount to arrive at a fair valuation for Synergy Pharmaceuticals. Ironwood reported its positive phase 2b clinical trial data in October 2008, roughly one and a half years before its IPO on February 2010. Using the previously arrived at figure of $2.1 billion and discounting it by an absurd rate of 50% over 1.5 years, I arrive at a present value of $1.1 billion. That is to say a staggering 195% disconnect from Synergy's current valuation and what I believe the company should be valued at.

First-in-class does not equate to Best in class

Now some may make the case that Synergy will have the disadvantage of being the second drug to reach the market. This is not necessarily the case. Synergy's late entry leads to a series of implications. First and most saliently, it takes the brunt of the marketing costs off of Synergy's hand, given that Ironwood is the first to market, this gives them the responsibility to aggressively advertise in order to grow the until recently non-existent Chronic Constipation and IBS-C market. Secondly, given that healthcare costs associated with Chronic Constipation and IBS-C exceed $25 billion annually, the market seems large enough to allow for the co-existence of both Synergy and Ironwood. To name a few examples; think of Vioxx and Celebrex, Viagra and Cialis, Provenge and Xtandi. The markets for these drugs were so large that it naturally leads to presence of multiple solutions.

This is compounded by the preliminary data released by Synergy, in which its phase 2b/3 clinical study results met both primary and secondary end points, but more interestingly- its incidence of diarrhea were lower than figures released in Ironwood's phase 3 studies. This holds special significance in that physicians typically view drugs targeting the same market on a risk/benefit scale. Plecanatide's reduced side effect profile could lead to a widespread shift to Synergy's compound following its debut into the market grown by Ironwood.

Synergy Pharmaceuticals: Buy out opportunity and possible suitors

When we talk about Big Pharma, their biggest concern isn't litigation or halts in production, it's the loss of patent exclusivity. When pharmaceutical companies lose their patent exclusivity; that represents a sizeable chunk forever lost from their revenue stream. It's an unavoidable aspect of the business, the upshot is, if the company is in a position to worry about the loss of patent exclusivities, they're typically well off enough to afford shopping around for new drugs, new potential streams of revenue. By buying out small cap pharmaceutical companies and their portfolio of drug-related patents, they ensure the maintenance, if not outright growth of their income.

Considering Synergy's positive topline data and its undervaluation, I believe the company represents a prime candidate for acquisition by Big Pharma. The expected size of the Chronic Constipation and IBS-C market alone, merits a closer look by companies such as Pfizer (NYSE:PFE), Johnson & Johnson (NYSE:JNJ), Eli Lilly & Co. (NYSE:LLY), and Novartis (NYSE:NVS). Acquisition by Novartis would be an interesting turn of events, especially given the expectations that surrounded Novartis following FDA approval of its IBS-C product, Zelnorm, before being pulled off the market for possible cardiovascular side effects. All four companies listed have over $4 billion in cash listed on their balance sheets. (With Johnson & Johnson boasting over $15 billion) In contrast to Synergy, I don't believe Ironwood represents an attractive buyout candidate in light of its partnership with Forest Laboratories, where a buyout of Ironwood in the $1.5-2 billion range would only purchase 47% of the profits generated from Linzess. Meanwhile, an acquisition of Synergy would synergize (Pardon the pun) quite nicely with the strengths offered by Big Pharma. Namely, the robust sales and marketing team developed in the process of becoming a healthcare giant. Presumably, after a buy out and expected FDA approval, Synergy's Plecanatide could be well on its way to becoming the next big blockbuster.

Source: Positive Top Line Data For Synergy: A Ripe Time For Acquisition