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Tesaro (NASDAQ:TSRO) has quietly been one of the top performing stocks of the past six months. After a lackluster IPO in June 2012 and subsequent dip in its share price, Tesaro has seen shares nearly double. However, we think the inexorable climb in TSRO is likely to be short-lived. Tesaro's primary drug candidate is an uninspiring chemotherapy-induced nausea and vomiting ("CINV") drug that has completed no new trials since being discarded for a tiny fraction of its current valuation several years ago.

Please click here for our complete report on Tesaro.

CINV drugs are a dime a dozen. The first class of treatments, called 5-HT3 inhibitors, have four drugs currently on the market: Anzemet, (Sanofi-Aventis), Kytril (Roche), Zofran (GlaxoSmithKline) and Aloxi (Eisai). The second class, called NK-1 antagonists, currently only has one leading drug on the market: Merck's Emend. Tesaro's drug candidate, Rolapitant, is attempting to join Emend as a viable NK-1 antagonist.

But numerous problems abound. Most importantly, a pharma with a strong track record in the CINV sector has a drug candidate further along in its trials and closer to commercialization. By the time Rolapitant is approved, competitor Helsinn's Netupitant will likely be dominating the CINV market alongside Emend. Beyond that, Rolapitant's main attraction over Emend would be if it can last longer or provide nausea relief. But Rolapitant's Phase II trials don't indicate that either should be the case. In terms of lasting longer than Emend, Rolapitant's efficacy for delayed-onset CINV barely reached statistical significance, and there's reason to believe that a larger sample size in Phase III trials will erase that statistical significance. In terms of providing a nausea benefit, Rolapitant's promise as seen in its Phase II trial was a function of an aberrant placebo group. If the placebo group reverts to the mean in Phase III, Rolapitant's nausea benefit should disappear.

So how can we reconcile Rolapitant's dismal prospects with its lofty $700 million market capitalization? For that, we need to look no further than a key financier behind Tesaro: the controversial biotech billionaire Dr. Phillip Frost, chairman of Opko Health (NYSE:OPK).

Back in 2009, Rolapitant was an abandoned drug candidate discarded by big pharma Schering-Plough to Opko for a measly $2 million cash upfront and up to $27 million additionally if all milestones were met. Opko proceeded to flip Rolapitant to Tesaro a year later for more than four times as much, and following Tesaro's IPO in 2012 and subsequent share rise, the same drug is now valued more than 15x higher. Yet no new trials have been completed for Rolapitant since Schering-Plough's original Phase II trials! By something akin to alchemy, Tesaro's lead compound has magically risen in value from $2 / $29 million to roughly $500 million today without any new clinical trials or other catalysts for an upward revaluation. But then again, with Dr. Phillip Frost as a cornerstone investor in the series of transactions that have led to today's Tesaro, as well as a current holder of TSRO shares, we don't think any of our followers should be surprised.

Needless to say, we have shorted Tesaro on the expectation that shareholders will be disappointed when the market discovers that Rolapitant is much more likely to be a sugar pill than a stimulant for investors' portfolios.

Summary Of Highlights

  • Rolapitant is not a compelling new entrant into the crowded CINV space. Chemo-induced nausea and vomiting ("CINV") is not a new market and is already filled with effective drugs, several of which are off-patent or will be going off patent in the near future. There are two classes of CINV drugs: 5-HT3 inhibitors and NK-1 antagonists. There are already 4 approved 5-HT3 inhibitors and 1 approved NK-1 antagonist, Emend. In addition, prior to Rolapitant's expected launch date in 2016, the market will see two additional entrants (AP Pharma's (APPA.OB) APF530) and Helsinn's Netupitant. For a roughly $1B market in the U.S., that is too many drugs competing for shares of revenue. Rolapitant's niche - NK-1 antagonists - limits the opportunity even more, as NK-1 antagonists account for only 20% or so of the CINV market. This leaves Rolapitant competing with both Emend - which soon goes off patent - and Netupitant for a small portion of the market. Bullish analyst reports assume that NK-1 antagonists will greatly increase their market share vis-à-vis 5-HT3 antagonists. This could happen, or on the other hand, this anticipated shift in the CINV market away from 5-HT3 antagonists could just be a bit of wishful thinking on analysts' part. In any case, Rolapitant will be launching in the less developed segment of the highly competitive CINV space against multiple NK-1 antagonist rivals.
  • Rolapitant Phase II data is not compelling. If Rolapitant were a clearly effective drug with a neatly differentiated efficacy profile, there would be reason to think that Rolapitant might overcome competitive obstacles to become a commercial success. However, Rolapitant's thoroughly uninspiring Phase II results leave us skeptical that the drug will find much market uptake if and when it is eventually launched. Tesaro management has said that they believe Rolapitant can have a differentiated profile from other CINV drugs due to two factors: longer half-life, and a benefit in controlling nausea. However, the Phase II results leave a lot of doubt as to whether Rolapitant can achieve either of these benefits.
  • The Phase II results for Rolapitant showed a P-Value of .045 for efficacy in controlling delayed-onset CINV. This is just barely good enough to meet the threshold for statistical significance and far from demonstrative of powerful efficacy. There are numerous CINV drugs on the market that can treat acute CINV. Rolapitant clearly demonstrates the ability to treat acute CINV (P-value of .001). But in delayed-onset CINV, Rolapitant just barely made the grade, and this was in a small trial where statistical flukes are more common. In a larger, more robust Phase III trial, there is good reason to expect that Rolapitant will be unable to demonstrate efficacy in treating delayed-onset CINV. Without this feature, Rolapitant loses much of its unique benefit profile that would help it stand out in the crowded CINV market. Rolapitant's proponents have suggested that the drug has a unique benefit in treating nausea that other CINV drugs have been unable to achieve. This may be true, but the basis for this claim originates from a very small trial where the placebo appears to have significantly underperformed its normal level of response. Again, as with the apparent benefit in delayed-onset CINV, we suspect the results seen in Phase II were a statistical quirk driven by small trial size rather than anything more meaningful.
  • Schering-Plough sold Rolapitant for a mere $2M up-front/$29M total. We are familiar with the concept that assets can be repackaged into a new shell and be revalued. But at some point, the line is drawn between a clever financing deal and pure alchemy. In 2009, after it had stopped development of Rolapitant, Schering-Plough licensed it away to Opko Health for $2M cash up-front and a total maximum consideration of up to $29M. Opko held the drug for a year without doing any clinical development and flipped it to Tesaro for $6M upfront and milestone payments of up to $115M plus royalties back to Opko. Already, it appeared Tesaro was paying a rich premium to get the drug from Opko. Now Tesaro shareholders are paying four times more to invest in the drug than Tesaro management paid when they licensed in Rolapitant from Opko in December 2010. Add it up, and Rolapitant is now valued at nearly 20x where it was when Schering-Plough disposed of it in 2009. It gets even more incredible considering the next point.
  • There have been no new completed trials of Rolapitant since 2008. Since Schering-Plough stopped internal trials of Rolapitant following the mediocre Phase II readouts in 2008, Rolapitant has provided no new clinical results for investors to analyze whatsoever. Thus, the nearly 20-fold jump in Rolapitant's valuation has come entirely from investors' shifting perceptions of Rolapitant's value rather than any new insights into Rolapitant's actual clinical profile or chances of achieving market acceptance. While there is always the chance that a discarded drug that saw development halted years ago will end up being a blockbuster in the hands of new ownership, we see plenty of reasons for skepticism. With Rolapitant revalued at 18x, the valuation Schering-Plough had for it, Tesaro is priced for perfection and any hitches along the way - be it an issue with the FDA, a strong launch for upcoming competitor drug Netupitant, Rolapitant being unable to maintain its benefit in delayed-onset CINV patients, or any of several other potential negative catalysts - will leave Tesaro shares vulnerable to a steep correction.

Introduction To Tesaro

Tesaro was founded in May 2010 by ex-MGI Pharma employees with the intention of becoming a new oncology-focused biopharma company. Tesaro proceeded to in-license several product candidates, the most notable of which is Rolapitant, an NK-1 inhibitor that seeks to prevent chemotherapy-induced nausea and vomiting, commonly known as CINV. Tesaro has also licensed several other less-developed drug programs that are too premature in development to have obtained much value. The street largely discounts the Tesaro pipeline outside of Rolapitant.

After obtaining several private financings, Tesaro went public in June 2012 to raise capital for the development of Rolapitant through Phase III. It wasn't a particularly well-received IPO, with the stock pricing at $13.50 and trading more or less flat for many months on minimal volume.

But over the past couple of months, interest in Tesaro has heated up. TV personality Jim Cramer called it his "favorite speculative biotech stock" in November. Several equity research analysts gave Tesaro favorable coverage in recent reports, and, most recently, Tesaro priced a secondary offering at $18/share. Now with shares spiking to $24 in recent weeks, investors have started to tune into the story of this previously overlooked biotech.

Tracking The Timeline Of Rolapitant

Rolapitant's Phase II trials began several years ago, when Schering-Plough initiated three Phase II trials for Rolapitant for the conditions of postoperative nausea / vomiting, nausea / vomiting and cough in 2006 and 2007. The trial summaries are available at www.clinicaltrials.gov.

Below are highlights of the three Phase II trials conducted by Schering-Plough. The nausea and vomiting trials were completed in 2008, while results were never posted for the coughing trial.

TitleConditionPhaseSponsorReceived Date

Completed
Date

A Randomized Controlled Study of Rolapitant for the Prevention of
Nausea and
Vomiting Following Surgery (Study P04937AM1) (COMPLETED)
Postoperative Nausea and VomitingPhase IISchering-
Plough
October 2007July 2008
A Multicenter, Randomized, Controlled Trial of SCH 619734 for the Treatment of Chemotherapy-
Induced Nausea and Vomiting (Study P04351AM2)

(COMPLETED)

Nausea; VomitingPhase IISchering-
Plough
October 2006March 2008
Study of the Efficacy and Safety of SCH 619734 in Subjects With Chronic Cough From an Unknown Cause (Study P04888AM1)

(COMPLETED)

CoughPhase IISchering-
Plough
July 2007October 2007

Prior to the sale of the NK-1 product to Opko in 2009, there was relatively little discussion about the drug candidate. The compound was not mentioned in the Schering-Plough 10K in the year prior to its acquisition by Merck in November 2009. We found no noteworthy discussions of it in scientific journals.

When Merck acquired Schering-Plough in 2009, the FTC required a small number of divestments, one of which was that Schering-Plough sell off its NK-1 receptor antagonist assets. Merck's Emend was the only NK-1 receptor antagonist approved for chemotherapy-induced nausea and vomiting, and the FTC was concerned that the newly merged Merck/Schering-Plough would disregard its Rolapitant product given that Emend was already on the market. Proponents of Rolapitant claim that Merck was forced to divest the asset, rather than voluntarily parting with it. We believe this interpretation is mistaken, and that Schering-Plough would have sold Rolapitant for a trifling sum of money regardless.

Based on our analysis, it appears that Schering-Plough seemingly thought this drug had little value. According to Opko's 10-K:

Development of Rolapitant and the other assets had been stopped at the time of our acquisition and there were no ongoing clinical trials. None of the assets acquired have alternative future uses, nor have they reached a stage of technological feasability. [sic] (emphasis added)

Bear in mind that Schering-Plough's trials were completed by early 2008. The Merck/Schering-Plough merger was not proposed until March 2009. Thus, Rolapitant had been clinically idle for quite a while prior to being divested. In addition, Schering-Plough had already decided to try to license it to a third party rather than continue developing it internally, prior to when the merger proposal was announced.

To summarize, Schering-Plough ran Rolapitant through Phase II, and then decided to quit developing the drug internally. Given this, they were willing to sell, and accept a token amount of money for the drug. Specifically, on October 12, 2009, Schering-Plough entered into an asset purchase agreement with Opko Health to sell Rolapitant and other NK-1 assets. Opko paid a mere $2 million cash upfront, with up to $27 million in milestone developments. Based on our reading of the filings, Opko would not have to pay any royalties to Schering-Plough if the drug successfully achieved FDA approval and was commercialized.

From Schering-Plough's perspective, Rolapitant was worth anywhere from $2m to $29m in 2009. Remember, Schering-Plough had already been shopping Rolapitant around prior to the merger, and apparently the Opko deal was the best offer they could obtain. Schering-Plough had stopped developing the drug internally, was attempting to license it out in early 2009, and nine months later, could get nothing more than $2M upfront from Opko. Clearly Rolapitant was not an in-demand asset that other pharma companies were clamoring to obtain at the time of the sale.

At that point, Opko took control of Rolapitant and retained ownership of it for merely one year, before flipping the drug to Tesaro. In this time period, Opko ran no clinical trials on Rolapitant, and did nothing else that would otherwise cause an upward revaluation of Rolapitant. Despite the fact that there was seemingly zero new information that should increase the value of Rolapitant, Opko proceeded to sell Rolapitant to Tesaro at a gigantic profit.

Did Tesaro Get Ripped Off When It Bought Rolapitant

Opko licensed Rolapitant to Tesaro in December 2010, giving Tesaro exclusive rights to the drug compound. In return, Tesaro paid Opko $6 million upfront and issued 1,500,000 shares of Series O preferred Tesaro stock to Opko. Furthermore, Tesaro agreed to make milestone payments of up to $115 million ($30 million in regulatory and initial sales milestones, and $85 million in annual net sales milestones) in addition to giving Opko a sizable royalty, likely in the low teens range, should Rolapitant be a commercial success.

Tesaro appeared to be paying top dollar for a drug that was essentially discarded by its original big pharma creator only a year before. As we summarized before, the maximum that Opko paid for Rolapitant in 2009 was $29 million, and that's if all milestones were ultimately paid out. From the perspective of upfront cash, Opko only paid $2 million to acquire the drug.

Yet in flipping the drug to Tesaro, Opko got $6 million upfront (3x what they had paid), and an equity stake in Tesaro that amounted to 10% of the company (2% ownership post-IPO) that is now worth close to $15 million. So already, Opko has magically turned $2 million into $21 million without any clinical progress on Rolapitant.

Furthermore, Tesaro agreed to part with up to $115 million in milestone payments to Opko should Rolapitant development proceed successfully. Tesaro also gave up some Rolapitant rights in Japan and Latin America to Opko, and also agreed to pay a stiff tiered royalty on Rolapitant sales to Opko as well. Remember that Opko only offered $27 million in milestone payments to Schering-Plough. Tesaro paid a king's ransom for a discarded drug Opko bought for little more than spare change.

Who's Getting The Worst Deal Of All? Common Tesaro Shareholders!

If the preceding information seems strange, it gets crazier. Bizarrely enough, the value of Rolapitant has continued to soar despite the fact that, now more than three years later, there is still little new clinical data, just another presentation of seemingly redundant (and in any case, not particularly impressive) Phase II results at ASCO 2012 for a compound that was "Phase-III ready" back in 2009. Again, despite no new completed trials since the three conducted by Schering-Plough from 2006 to 2009, Rolapitant's value has soared from a mere $29 million when Schering-Plough sold it to Opko to now more than $500 million today (discounting the current cash balance, given future cash burn and valuing the rest of Tesaro's pipeline at acquisition cost - in line with other Wall Street analysts who ascribe little present value to the pipeline ex-Rolapitant). Anyone buying into Tesaro at this point is definitely late to the party.

It's worth noting that even at the IPO price of $13.50/share, Tesaro was priced way over its fair value. Quoting from a letter Tesaro representative Hogan Lovells sent on behalf of the company to the SEC on June 15th, 2012, we find this warning:

(click to enlarge)

Oddly enough, the price was dramatically changed in Tesaro's actual prospectus, filed just 12 days later:

(click to enlarge)

We're a little confused how Tesaro could come up with two wildly different fair value quotations for their stock within two weeks. In any case, regardless of which version of Tesaro's May 31st value estimation you use, the IPO was sold to investors with a lot of premium - which has only inflated further still post-IPO.

Opko Health And Dr. Frost: Examining The Rolapitant Deal's Middleman

Of particular interest is the middleman in the Rolapitant transaction: Opko Health. Opko's CEO, Phillip Frost, remained an investor in Tesaro as of the IPO date when his Frost Gamma Investments Trust vehicle converted its nearly 200,000 preferred shares to an estimated 55k common shares. Frost's buy-in price was well below the ultimate IPO price, let alone the current trading levels. Opko also owns a 2% stake in Tesaro as a result of the original preferred shares issued as consideration for Rolapitant.

In examining Frost's historical deals, we have found that he has a tendency to make deals that turn out very well for himself and substantially less so for common shareholders who follow his lead. Most notably of all was the infamous situation with Protalix that we highlighted last year. To make a long story short, Frost acquired a large holding of Protalix stock on the cheap, and shares subsequently rose to a far higher price in the public market. Soon thereafter, Protalix, with Frost still at the helm, announced a massive secondary offering at a jaw-dropping 86 percent discount from the market price. Shares collapsed. Reuters summarized the carnage:

On Thursday, [Protalix's] shares fell as much as $30.45 to a low of $5.91. They were trading at $6.31 at the close. The slump has reduced the company's market value to less than $500 million from about $2.39 billion before. David Burke, a spokesman for the company, confirmed the pricing, but declined to talk about why the shares had been sold at such a discount. [emphasis added]

Investors lost $1.8 billion in a single day as a result of the capital raise. That's a catastrophic loss of shareholder value, which Frost, as a member of Protalix's board, was supposed to be maximizing. We don't deny that Frost is good at making money for himself, but investors following his lead often end up holding the bag.

Other examples abound. Just look at SearchMedia Holdings (now renamed Tiger Media), Winston Pharmaceuticals (OTCPK:WPHM), Safestitch (SFES.PK), Castle Brands (NYSEMKT:ROX), Tiger-X Medical (OTCQB:CDOM), or Non-Invasive Monitoring Systems (OTCQB:NIMU) to see the sorts of returns investors can get when following Frost into investments. In each case, shares have collapsed, representing a close to total 100% wipeout of shareholder value. Frost has a tremendous edge in these types of situations, because he invests early-stage through private transactions, such as Protalix at under $2/share, then proceeds to take the companies public at far higher valuations. As another example, this Seeking Alpha article by a Frost supporter argues that Frost's entry price was an average of 20 cents with respect to Chromadex, well below the $3/share it began publicly trading at, and also below the prevailing average price at which Chromadex has traded throughout its lifespan. Unfortunately, many of Frost's publicly traded ventures have turned out to be busts, and common shareholders often end up losing the vast majority of their invested capital.

Tesaro seems to be only the latest example of Frost's dangerous co-investment opportunities. Frost's cost basis in Tesaro is less than $8 / share, a large discount to both the IPO price of $13.50 and the currently elevated price of $20. Tesaro is a high-flying stock with an unproven lead drug, just like Protalix before it blew up in 2007. Is history about to repeat itself?

(click to enlarge)

CINV Treatments: Where Will Rolapitant Fit In?

Of course, there is more to Tesaro's story than the colorful cast of characters that are invested in it, and it's important to get a clear read on the prospects for Tesaro's lead pipeline project: Rolapitant. There is a lot of confusion out there about the state of the anti-nausea/vomiting drugs for treating patients suffering the side effects of chemotherapy. Depending on which research report one reads or with whom one talks, one gets the idea that Tesaro either has as few as only one serious competitor, or that it has quite a few competitors. There are also two main types of CINV drugs, and there has been a good deal of debate about whether these drugs are complements, competitors, or in some sort of middle ground between those two poles. Add it all up, and we're confident that many investors are trading with incomplete and potentially prejudicial information about Tesaro's future prospects.

Firstly, courtesy of AP Pharma's website is a description of CINV:

Prevention and control of nausea and vomiting, or emesis, are paramount in the treatment of cancer patients. The majority of patients receiving chemotherapy will experience some degree of emesis if not prevented with an antiemetic. Chemotherapy treatments can be moderately emetogenic, meaning that 30-90% of patients experience chemotherapy-induced nausea and vomiting (CINV), or highly emetogenic, meaning that over 90% of patients experience CINV, if left untreated. Acute-onset CINV occurs within the first 24 hours following chemotherapy treatment, with the highest risk period occurring within the first four hours. Delayed-onset CINV occurs more than 24 hours after treatment and may persist for several days. Prevention of CINV is significant because the distress caused by CINV can severely disrupt patient quality of life and can lead some patients to discontinue chemotherapy. The unmet need is greatest with patients receiving highly emetogenic chemotherapy, particularly delayed-onset CINV.

There are two primary types of drugs that are used to treat CINV: first, there are 5-HT3 inhibitors, and secondly, there are NK-1 antagonists. Chemotherapy can cause nausea and vomiting by triggering the release of various chemicals that provoke emesis (nausea and vomiting). 5-HT3 inhibitors and NK-1 antagonists both work to counteract this effect of chemotherapy. 5-HT3 inhibitors block the release of serotonin in the gastrointestinal tract, while NK-1 antagonists block a dominant ligand known as Substance P (SP) from reaching the area of the brain that controls the vomiting reflex.

Tesaro: The Bull Case Centers On The Management Team's Experience

In equity research reports examining Tesaro's prospects, analysts invariably laud Tesaro's management team for their experience in the CINV space. Indeed, we readily acknowledge that Tesaro's management has had demonstrable success in the CINV arena. However, the bullish analysts are telling only half the story. The other half should scare Tesaro's investors greatly.

The part discussed in glowing reports is as follows. Tesaro was founded by ex-employees of MGI Pharma. MGI Pharma had considerable success marketing several pharmaceutical products in North America and was subsequently acquired by Eisai. One of the successful drugs was Aloxi, which is perhaps the premier 5-HT3 inhibitor for treating CINV presently. Between the success of Aloxi and various other MGI Pharma products, the management team was able to sell the company to Eisai for a handsome profit.

This backstory gives analysts promoting Tesaro an easy pitch to sell: Tesaro is headed by oncology experts who know the CINV space, have had pharmaceutical success before, and know how to sell a company to a bigger player at a considerable profit. Give them a new CINV drug, this time an NK-1 antagonist instead of a 5-HT3 inhibitor, and it is practically a done deal that they will be able to achieve the same success at Tesaro taking market share in the NK-1 sub-field of CINV as they did a decade ago launching Aloxi to its market-leading position in the 5-HT3 inhibitor segment.

Bullish Analysts Disregarding A Massive Problem

But there is a glaring hole in this story, one that threatens to destroy the entirety of the bull case built on management's glowing history and its ability to repeat the success of Aloxi with new drug Rolapitant. To find it, we have to review MGI Pharma's history, specifically when they were preparing Aloxi for market in North America.

From an MGI Pharma 10-K, we find this interesting piece of information:

We obtained exclusive United States and Canada Aloxi license and distribution rights from Helsinn Healthcare SA in April 2001. On July 25, 2003, approval was received from the FDA to market Aloxi for the prevention of acute and delayed CINV.

So MGI Pharma relied on Helsinn's expertise in finding and developing the drug, and then licensed it in North America and made it a commercial success. That is all well and good.

However, the key to that success last time, Helsinn Healthcare, may end up being the very obstacle that causes Rolapitant to end up being a spectacular commercial failure. For, you see, Helsinn is not on MGI/Tesaro management's side anymore. In fact, Helsinn is bringing what appears to be a superior NK-1 product to market that will directly compete with and could very well defeat Rolapitant in the commercial marketplace.

Helsinn has developed a combination 5-HT3 and NK-1 antagonist (using, ironically enough, Aloxi as the 5-HT3 inhibitor) that has the opportunity to take the CINV market by storm, since there has not yet been a combination drug for CINV. Helsinn's product, Netupitant-Palonosetron FDC ("Netupitant"), showed superior efficacy results in Phase II clinical trials relative to existing treatment options. All indications point to Netupitant being a superior product that will have an overwhelming advantage in the CINV marketplace versus Rolapitant.

Despite Netupitant coming to market first and having a very promising opportunity, analysts are discounting it entirely. Deutsche Bank, for example, in their initiating report on Tesaro concludes that Netupitant will achieve almost no market share - in large part due to their expectation that Netupitant will show no nausea benefit in Phase III. Yet in Deutsche Bank's own base case for Tesaro, where they arrive at a preposterous $27 price target for TSRO, they assume that Rolapitant has no nausea benefit either. Even with no nausea benefit, Deutsche Bank assumes that Rolapitant will conquer the market and Netupitant will almost entirely fail to gain traction. We find their NK-1 antagonist market share model baffling:

That's the bull case in a nutshell right there. Despite Helsinn's track record of leading the CINV space, and having a drug, Netupitant, that will likely show strong Phase III results and launch in 2014, well ahead of Rolapitant, Netupitant for whatever reason is going to fail and Rolapitant will overcome multiple handicaps to become the dominant player. Oddly enough, Deutsche Bank wrote: "We don't view Eisai and Helsinn's NK-1 [Netupitant] as a competitive threat to Rolapitant no matter how strong the Phase 3 looks." This sort of headstrong conviction that Netupitant will fail, regardless of how the data reads out, seems like the work of a biased underwriter of Tesaro's public offerings. Indeed, Deutsche Bank received substantial investment banking fees for being an underwriter on Tesaro's follow-on public offering earlier this year.

As an additional point, the graphic above also assumes that the NK-1 share of the CINV market is going to double in size over the next decade. It's possible, but certainly not a sure thing either.

Rolapitant: Simply Too Late To Market

Helsinn's Netupitant has already completed a Phase III trial, with study results expected to be released shortly. This is in stark contrast to Tesaro's Phase III Rolapitant trial, which is still in its early stages. Rolapitant may have had a first mover advantage back in 2009 when Opko picked up the drug, but after being left idle for years, that opportunity came and went. Now Helsinn, perhaps the foremost biotech in the CINV space, has seized the advantage and is expected to have Netupitant on the market in 2014. By contrast, Rolapitant is not expected to hit market until the latter half of 2015 at the earliest.

Compounding this already substantial problem, Rolapitant is being developed in two forms, an oral form and an intravenous "IV" form. Unfortunately for Tesaro shareholders, the oral form is the one that is in Phase III, while the IV form is still in Phase I. Tesaro has said that there are various reasons why the market needs an IV form of the drug, including "certain concerns associated with payer pre-approval, logistics and pharmacy availability that are sometimes associated with oral formulations of drugs utilized by cancer patients."

As further summarized by various investment bank research reports, the IV formulation of the drug has much better prospects for taking market share than the oral formulation. This idea is backed by Emend's market experience as well. Emend, the first NK-1 antagonist on the market, originally launched in 2003 in oral form. The IV form, launched fairly recently in 2010, has already taken share to the extent that it accounts for more than 80% of Emend usage, according to Tesaro's most recent 10K. So there is good reason to suspect that the IV form of Rolapitant would have much better commercial prospects than the oral version.

Tesaro stated in its offering documents that it "expect[s] to launch an IV formulation of Rolapitant approximately one year following the launch of the oral formulation." This expectation hinges on Tesaro's ability to convince the FDA to accept a bridging safety study for the IV formulation in order to gain approval, rather than more time-consuming studies. Add it all up, and the desirable IV form of Rolapitant - the one that is expected by analysts to be able to really compete with Emend - is not coming until late 2016, and that is at the earliest.

Furthermore, the oral version of Emend will likely already have been genericized by the time oral Rolapitant hits the market, whereas the IV version of Emend will still be on patent when IV Rolapitant hits market. If it weren't for Netupitant, we could see some signs of hope for the IV formulation of Rolapitant in the marketplace, though it is hard to imagine any scenario in which the oral formulation of Rolapitant ends up having much commercial success.

By then, Helsinn's superior Netupitant will already have been on the market for three years, and for doctors, patients, and insurance companies focusing on cost-effective therapies, the arrival of generic Emend will also be a looming threat. Emend is already in the process of going off-patent for the oral formulation, and the market-preferred IV formulation loses patent protection in 2019. By the time the IV Rolapitant launches in 2016, and that is if everything goes per plan, it will be up against generic oral Emend, along with a well-established second generation NK-1 antagonist, Netupitant, that will have had several years already on the market winning over doctors' and patients' trust. Given the competitive landscape Rolapitant will be facing when it finally reaches market, its probable commercial prospects can be summed up fairly simply: Dead on arrival.

The Rolapitant Phase II Results: Adequate But Nothing Special

The bullish case for Tesaro has one more key tenet, in addition to the claim that the management team is exceptional. The second argument is that Rolapitant is a clearly superior product to Emend (and conveniently forgets to account for Netupitant entirely). For the sake of argument, we will temporarily enter a parallel universe in which Netupitant doesn't exist and compare Emend with Rolapitant as if they were the only players in the NK-1 antagonist market.

The first argument for the superiority of Rolapitant in comparison with Emend is that Rolapitant is longer lasting. CINV drugs - both NK-1 antagonists and 5-HTC inhibitors alike - have had problematic efficacy issues in treating delayed-onset vomiting. Typically the drugs on the market show powerful benefits in patients experiencing vomiting within 24 hours of a chemotherapy session, but if the patient does not experience vomiting until after 24 hours, the current crop of CINV drugs has had limited benefits.

Thus, any company that can bring a drug with longer half-life to market should stand to benefit. This is in fact the argument for AP Pharma's new 5-HTC inhibitor, APF530. There are two classes of CINV patients: moderately emetogenic (prone to vomiting), and highly emetogenic. Thus far, Aloxi has been approved for moderately emetogenic patients with delayed-onset (24+ hours after treatment) CINV. But there is still a void in the highly emetogenic class of patients that suffer from delayed-onset CINV. AP Pharma has a table that shows the current situation:

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Given that there is only one NK-1 antagonist on the market, Emend, and that it is not effective for delayed-onset CINV, let alone delayed-onset CINV in highly emetogenic patients, there would be a real opportunity for Rolapitant (and rival Netupitant) if it were to achieve clinical success in this market segment.

However, the Phase II data presented for Rolapitant, while marginally encouraging, is far from a slam dunk in terms of showing a benefit in delayed-onset patients:

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A P-value measures how strongly the data show a real difference between a treatment group and the control group. The closer you get to zero, the better the chance that your drug has a real impact rather than simply having success due to random chance or statistical noise. 0.05 is generally considered the cutoff between a drug having a real effect or not, and any result over 0.05 is considered not statistically significant.

As the results show above, Rolapitant is very effective in treating the acute group, with a P-value of 0.001, and there is little chance that Rolapitant's benefits shown in Phase II will disappear once the drug enters Phase III testing. Unfortunately for Tesaro, however, the acute CINV market is already saturated with effective drugs. For Rolapitant to have a real shot at commercial success, it needs to maintain the benefit within the delayed-onset subset of patients as well. But as you can see, the P-value for delayed-onset is just a hair's length away from being statistically insignificant (in fact, it probably is statistically insignificant once you take multiplicity rules into account).

Lots of times, drugs that put up seemingly solid clinical benefits in Phase II see those benefits vanish in the more rigorous Phase III trials. Here, Rolapitant is going into Phase III with the thinnest bit of statistical significance on their side. And if it misses its target in Phase III, the drug's commercial prospects are quite small. There is absolutely no need for another undifferentiated NK-1 inhibitor to come on the market in 2016 with Emend going off patent and Netupitant already having launched by that point.

Speaking of disappearing benefits, we share the Street's skepticism that Rolapitant's so-called nausea benefit will hold up in Phase III trials. Healthcare analyst Poonam Arora addressed Rolapitant's impact on nausea in his article "Tesaro: Potential Nausea Benefit or Lack Thereof Key To Valuation." As you can tell from the headline, Arora found that Rolapitant's ability to prevent nausea would be an important determinant in whether or not Rolapitant finds success in the market. Management has been enthusiastic about Rolapitant's potential to prevent nausea and touts this feature as potentially giving Rolapitant a "differentiated profile" presumably from Emend that would lead to commercial success.

However, taking a deeper look at the data that Arora presented, it seems there is little reason to suspect that the nausea benefit will sustain itself in Phase III testing.

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Source: Seeking Alpha/Poonam Arora

Take a close look at the placebo table. You'll notice that for whatever reason, the placebo had a particularly poor showing in Rolapitant's Phase II trial, showing only 42% overall effectiveness. In the Phase III trials for Aprepitant (aka Emend), the placebo showed 64% and 66% effectiveness. If Aprepitant/Emend had tested against the same bizarrely ineffective placebo that Rolapitant tested against, Emend would have had a statistical nausea benefit as well. But the placebo outcome in the Rolapitant trial was a clear outlier, probably driven by the significantly smaller sample size used in that trial.

In fact, interestingly enough, you can see that Emend is more effective against nausea than Rolapitant, as Emend had 71% and 73% overall responses, compared to Rolapitant's mere 63% overall response rate. At least as far as nausea is concerned, Rolapitant may actually be inferior to Emend. Though the small size of the Phase II trial prevents us from drawing statistically significant conclusions, we can deduce from the Phase II results that Rolapitant probably has no nausea benefit. The promising P-value from the Rolapitant trial appears to be merely a statistical fluke caused by a small (91) patient sample size that led to the placebo showing weaker statistical results than usual placebos. Regression to the mean should occur in Phase III, and the placebo should be expected to go back to its usual rate of 65-70% response, and Rolapitant's nausea benefit should disappear.

It's also worth noting that the same statistical trend regarding the acute versus delayed-onset effectiveness of Rolapitant returns with a vengeance here. In the acute-onset group, Rolapitant displays a healthy 87% response rate, but against delayed-onset nausea, the response rate dives to 64%. Just as we noted above with the other set of data, it is clear that Rolapitant is much more effective against acute CINV symptoms than delayed-onset ones.

Conclusion: Rolapitant Is Not a Blockbuster Drug; Tesaro Significantly Overvalued

Put it all together, and it appears that Rolapitant is merely just another run-of-the-mill NK-1 inhibitor that has no benefits in comparison with Emend. Non-inferiority would be enough to get the drug FDA approval, but market acceptance is a whole different ballgame, and there is absolutely no reason to think that doctors are going to rush to Rolapitant when they can use a cheap generic version of equally effective Emend, or they can opt for the next-generation CINV drug Netupitant. We suspect Schering-Plough had similar thoughts when they agreed to sell the drug for a mere $2 million plus small potential milestone payments.

Remember, Helsinn Therapeutics has won the CINV game before. Sure MGI Pharma (now Tesaro) management did well licensing the drug for North American rights from Helsinn. But this time around Tesaro licensed a drug from the wrong team. Helsinn is further along with Netupitant, which shows every sign of being a superior drug than Rolapitant, and Netupitant will launch commercially long before Rolapitant does. If one's thesis is to bet on the management team that succeeded in the past, the smart money would be on Helsinn succeeding again, with Tesaro's Schering-Plough drug coming up short. This is particularly true since Rolapitant's benefit in delayed-onset CINV was statistically significant by the shakiest of margins, and the purported nausea benefit seems to be merely the result of a bizarre fluke in the placebo group that should disappear in more rigorous Phase III trials.

At this point, Tesaro's most valuable asset appears to be its cash balance of approximately $200 million, or $6 a share, considering the company's post-secondary share count of 34 million. However, with R&D expenses ramping up, a run rate of $80 million/year cash burn seems likely. In other words, that cash is not going to last too long. By the time Rolapitant gets around to its commercial launch, most of the cash will be gone.

Rolapitant is unlikely to ever achieve significant market acceptance, for numerous reasons we have outlined above. The rest of the pipeline is early stage and unproven. Wall Street has rightly discounted it greatly and assigns it almost no value. The Tesaro of 2015 will likely have one FDA approved drug with dim prospects of success in the CINV market, an uninspiring pipeline, and a greatly depleted treasury. Tesaro's fair value, as its prospectus initially warned, appears to be in the single digits, and we expect to see the stock trade there sooner or later.

Source: Tesaro's Rolapitant: Investors Pay 17x Premium For Discarded Drug

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