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We have published an initiating coverage report on Raptor Pharmaceutical Corporation (NASDAQ:RPTP) on August 29, 2013, with a price target of <$4.00. A PDF version of the full 68-page report can be found at gravityresearchgroup.com/reports.

Raptor Pharmaceutical Corporation ("RPTP") recently had its flagship drug, Procysbi, approved by the FDA to treat nephropathic cystinosis ("cystinosis"). RPTP currently trades at $12.72/share and analysts have set a median price target of $13.00/share. However, we believe that the present value of future cash flows RPTP can expect to earn from Procysbi is less than $4.00/share even under ideal conditions, including 100% peak cysteamine market share, universal acceptance by payers, and an average selling price of $250,000/year in the US and $150,000/year in the rest of the world. We assign zero value to RPTP's pipeline due to strong evidence that the fundamental theories behind its leading indications are flawed.

1) Raptor Pharmaceutical Corporation ("RPTP") is attempting to sell Procysbi in the US for an average selling price of $250,000 per patient per year: more than 25x the price of current market leader Cystagon when the two drugs are nearly identical and the most significant benefit to patients is that Procysbi only needs to be taken twice a day as opposed to four times a day. Predictably, payer reception has been mediocre. Achieving a true average selling price of $250,000/patient/year would require an even higher sticker price (as high as $400,000/patient/year depending on how much RPTP can squeeze from patients without private insurance)-making Procysbi within spitting distance of being the most expensive drug on the market.1 This seems outrageous given that the only difference between Procysbi and Cystagon (the current market leader for cystinosis patients) is enteric coating. Enteric coating is a commonly-used barrier applied to many oral drugs and supplements that are unstable in acidic environments but can be safely released in basic solutions. For the most part, this is used to prevent treatments known to have negative side effects when digested in the stomach from being digested there. The enteric will prevent those treatments from being digested until they reach the intestine, which contains a more basic medium. Procysbi consists of a standard capsule filled with tiny cysteamine spheres coated with enteric, whereas Cystagon is a standard capsule filled with cysteamine powder. Unfortunately for RPTP, its Phase 3 clinical trials indicated that, rather than reducing negative side effects by being absorbed in the intestine, the enteric coating on Procysbi made them worse when compared with Cystagon.

All the other top-priced drugs are novel formulations for orphan diseases, cancer, and other indications. While insurance companies and government payees accept high prices for drugs that are expensive to develop, RPTP acquired the rights to Procysbi six years ago for $2.6mm, with FDA approval nearly guaranteed. Enteric coating has been around for over 100 years, and we were unable to find any case in which an approved drug was coated with enteric and the resulting drug was denied FDA approval. The bar is set low when a minor tweak such as enteric is being added to a drug that has already been approved-the company sponsoring the clinical trials must simply show that their drug is not significantly worse than what is already out there in terms of efficacy and safety. Analysts believe that insurers will unanimously cover the drug without questioning the pricing. Management and bulls have contended that since the community of patients is small and each insurer has no more than a handful of patients, they will not bother denying coverage.

We disagree. An insurance company interviewed by BioCentury indicated that long-term clinical benefit and cost savings, neither of which are readily apparent, would be necessary for the firm to consider covering Procysbi. The fact that zero insurance companies have signed up for RPTP's capitation program indicates to us that even companies who have currently granted coverage want to keep the option of canceling it later.

While there will be some coverage, we believe investors underestimate the risk of formularies and insurers rejecting Procysbi in favor of Cystagon, and approvals in the near future will still be subject to constant scrutiny should the drug not provide a significantly better long-term prognosis for patients. At least one payer has already elected not to cover the drug at all.2 Further, the term "coverage" can be misleading. While some insurance companies may technically cover the drug, nearly all the payer formularies we found with Procysbi listed classify the drug as "non-formulary", which translated to increased copayments for patients (as high as 50% of the price!) if not a total inability to access the drug. These included Wellcare,3 Coventry,4 MVP Healthcare,5 Unity Health,6 Univera Healthcare,7 Medica,8 Arkansas BlueCross BlueShield,9 Group Health,10 and Health Alliance.11 Given the extraordinary price and lack of differentiation compared with existing therapy, this was no surprise to us. An industry veteran predicted it as well in May 2013 (emphasis added):12

"Gary Owens, chair of Tower & Watson Rx Collaborative P&T Committee, said that Procysbi will surely be excluded from closed formulary plans, or only covered under exception. About 20%-25% of plans are closed formulary. He does not envision that new patients will be started on Procysbi, unless they have trouble tolerating Cystagon. And he expects use of the drug to be hemmed in by clinical edits to verify that it isn't being wrongly prescribed or a patient being controlled on Cystagon isn't requesting Procysbi for what the plan considers a trivial reason."

We would consider the convenience of taking doses twice a day as opposed to four times to be a "trivial reason", and believe RPTP's planned international expansion will be even more challenging than the US. There are precedents of governments and private payers refusing coverage for truly novel orphan drugs that are necessary for patients to survive with no viable alternatives. Soliris, is the only drug available to treat two life-threatening orphan indications: paroxysmal nocturnal hemoglobinuria ("PNH") and atypical hemolytic uremic syndrome ("aHUS"). Government healthcare in Ontario and New Zealand do not cover Soliris at all, and the UK has refused to cover Soliris for aHUS without further information on costs and benefits. The United Kingdom's National Institute for Health and Care Excellence, has publicly stated that drugs should not cost more than £20,000 to £30,000 per quality-adjusted life year.13 Soliris has no similar alternatives, while Procysbi does-we believe that there will be significant resistance to the prices RPTP is proposing within most European countries that analysts have not factored into their valuations of RPTP. Even in the event that Procysbi is accepted by payers, it is very likely that it would be covered with stipulations: perhaps it would only available to children, or only available to take at night, or only available as a fail-step solution for patients. Any of those limitations would drastically reduce the potential market size for the drug. Additionally, payers are constantly re-evaluating coverage, and coverage today doesn't necessarily translate to coverage tomorrow-especially if sufficient evidence of long-term advantages in taking Procysbi as opposed to Cystagon fails to materialize

2) Based on RPTP's Phase 3 trials, Procysbi caused nearly three times as many negative side effects as Cystagon: RPTP claims to investors that Procysbi improves the side effects and quality of life for cystinosis patients. However, outside of reducing the number of times patients have to take pills from four times to two times each day, Procysbi's published clinical results indicate the opposite. Rather than improving the side effects for patients, Procysbi made some of them dramatically worse, with three times as many gastro-intestinal side effects reported when compared with Cystagon, and new adverse side effects that weren't even present when patients were treated with Cystagon!14 See http://www.procysbi.com/docs/Procysbi-Full-Prescribing-Information.pdf for RPTP's comparison of adverse reactions taken directly from its prescribing information (Cystagon is "Immediate-release cysteamine").15

While there have been claims regarding a reduction in odor, these were based on only four patients, and we find the significance of those results to be highly suspect due to the fact that half of the patients reporting lesser odors were also taking decreased cysteamine doses.16 Additionally, some caretakers and patients are reporting the exact opposite (along with other negative side effects) on the Cystinosis Research Network Facebook page:17

"So here is a thought...Procysbi is awesome! It allows us to sleep through the night and live less by the clock. However, the odor that emanates from her breath and body is far worse and for far longer than [C]ystagon (Kacy had virtually no odor). I worry about this socially."

"Jen Laura smelled worse on [RP]103, and Susan Laura threw up tons. Dr[.] Dohil was suggesting she try of mixture of both but I don't think she would even try it again"

"I thought Tanner didn't have an odor and then found out he was flushing it down the toilet."

"Landon started Procysbi and has been having a hard time in the morning with vomiting."

"I couldn't tolerate Procysbi - I had 12 [hour] nausea that made it impossible to drink enough. It resulted in a significant bump in my creatinine (which returned to baseline upon stopping the Procysbi). I'm back to Cystagon."

Predictably, patients on Cystagon and Procysbi have to take roughly the same total amount of the active drug (cysteamine). Giving the same drug at half the frequency, requires the patient to take twice as much drug per dose in order to achieve a similar response. When the drug already produces a number of unpleasant side effects, doubling the dose doesn't minimize those complications, but magnifies them as indicated by the clinical results. We believe initial success in launching the drug may be misleading, and that there will likely be a moderate number of patients who try the drug, but stop taking it due to the increased adverse effects

3) There is limited evidence of demand for the drug over its competitor, Cystagon: RPTP scrounged 43 patients for its Phase 3 trials, while a concurrent clinical trial for Cystaran, a drug developed by Sigma Tau to treat corneal crystal buildup in cystinosis patients, produced approximately 300 patients18.

4) Analysts currently have a median price target of $13/share for RPTP. We believe the market is currently massively overvaluing RPTP due to errors in analysis and certain critical factors that analysts covering the stock are not taking into account. These include the following items:

a. Analysts are grossly overestimating the total market size for Procysbi: Certain analysts have modeled out numbers that would require RPTP to not only take 100% of the estimated market of cystinosis patients currently on Cystagon, but also add additional patients on top of that. We find this to be absurd-cystinosis is a very serious, life-threatening disease, and the symptoms are very distinct. Patients experience excess build-ups of the amino-acid cystine in cells, and if left untreated with cysteamine, the cystine will build up into detectable crystals. The kidneys and eyes are particularly vulnerable to crystal formation, and we could not find any other diagnosis with similar symptoms. We are confident that any patient with a competent nephrologist would have diagnosed cystinosis immediately. Management, to its credit, has publicly stated on numerous occasions (as recently as August 8, 2013) that the US market in particular appears to be 400-500 cystinosis patients, and that there is no reason to revise those numbers.

b. Analysts are not accounting for the significant headwinds RPTP faces in its attempts to convince payers and patients to accept its drug at the price it is suggesting. These include the following issues:

i. Procysbi is priced at over 25x its competitor without significant positive differentiation

ii. Procysbi has been documented as causing nearly 3x as many instances of negative side effects compared with Cystagon and patients starting the drug following FDA approval have made complaints about those adverse effects, including vomiting and body odor described as "room-clearing". This leads us to believe that the initial success in launching the drug may be a red herring, and that there will likely be a moderate number of patients who try the drug, but stop taking it due to the increased adverse effects

iii. Lack of demand among patients for a new drug

See points 1, 2, and 3 for more details on these issues.

c. Analysts are failing to account for the 35% of the target US market that do not have private insurance per RPTP Management, failing to account for patients who have capped insurance or significant deductibles/copayments, and failing to account for the fact that many insurance companies have already classified Procysbi as "non-formulary": RPTP, through its RaptorCares program, offers financial assistance with deductibles and premiums, or Procysbi itself at no charge for such patients. This further limits the maximum possible revenue RPTP can expect to generate through Procysbi. RPTP Management explicitly stated that 35% of the target population was without private insurance during a recent call.19 Per our discussions with an industry expert, subject to state-by-state decision, Medicaid may choose not to reimburse RPTP more than the going price for Cystagon (approximately $10,000/patient/year), and patients unable to afford any private insurance are unlikely to be able to pay or be interested in paying anywhere near RPTP's asking price. Investors should take into consideration capped insurance policies, copayments reimbursed via RaptorCares, or any other nuances that would negatively impact the true average selling price.

d. Analysts have not accounted for the fact that a citizen petition could bring an end to RPTP's Procysbi exclusivity in three years: Subject to a citizen petition (typically filed by a competitor), the FDA may choose to revoke RPTP's orphan drug designation. There was a very similar case in 2012 where the FDA revoked an orphan drug designation for a company that produced a treatment that was nearly identical to an existing one after the manufacturer of the existing treatment filed such a petition. This would limit RPTP's timeline to truly monetize Procysbi to three years rather than seven. After three years, generic competition would be permitted to enter. If this were to happen, we believe the resulting fair value of the equity would be less than $2.50/share.

e. Even without a citizen petition, US exclusivity will expire in 2020 and the patents covering Procysbi are unlikely to hold up in court: Generics will likely file Abbreviated New Drug Applications ("ANDAs") and enter the market when exclusivity expires (2020 in the US and likely 2023 in the EU). After that point, RPTP will no longer be able to sell its drug anywhere near an average price of $250,000/patient/year. We did not come across any analyst models that incorporated the impact of generic manufacturers. This is virtually guaranteed if Procysbi experiences any success-precedents have shown generic companies trampling each other to file ANDAs and Paragraph IV certifications to compete with orphan drugs with minimal revenue. One company booked $35.1mm from an orphan drug in FY 2010, and following the lapse of exclusivity in 2011, no less than five other companies challenged its relevant patents.

f. Analysts are underestimating the royalties and costs RPTP will owe to third parties: RPTP has to pay UCSD "mid-single digit" royalty fees, Healthcare Royalty Partners three tiers of royalty fees of between 2% and 12.25% of Procysbi revenue, and additional fees for distribution and manufacturing. Analysts are projecting gross-to-net revenue costs of as low as 2%.

g. It is impossible to arrive at certain analysts' price targets even using their own models and the assumptions they provided: Consistent with our statement that even using ideal assumptions RPTP is worth significantly less than it is currently trading at, we observed that it is impossible to arrive at certain analysts' price targets even using their own models and the assumptions they provided. This was frequently due to analysts' basing price targets off of forward multiples (such as revenue) as a means of valuation rather than profitability. We believe this is fallacious, and drugs should be valued as cash-generating assets with a finite life-revenue typically reaches its peak relatively quickly and the life cycle ends when the drug loses exclusivity or patent protection. Certain analyst valuations also contained human mistakes (such as significant errors in discounting to present value, forecasting based on incorrect inputs for prior periods, and miscalculating share counts).

Other disturbing inputs and assumptions we came across in analyst models include the following:

a. Implicitly assuming that Procysbi will successfully price near the top of all available drugs by using the price of $250,000/patient/year across all patients, including those on Medicaid, those without any medical coverage, and those with capped insurance or large co-payments that would be covered by RPTP. This would be groundbreaking because it would mark the first time a delayed-release version of a much cheaper drug successfully priced near the top of all drugs in existence

b. Removing General & Administrative and Research & Development expenses from the equation when valuing the future cash flows from Procysbi

c. Assuming a >50% Quarter-over-Quarter decline in Research & Development expenses

d. Using a 2.5% discount rate on future cash flows despite all the risks present

e. Valuing RPTP's other clinical pursuits at hundreds of millions of dollars despite strong evidence that those indications will not produce any meaningful revenue in the future

f. Grossly understating the interest expense despite the fact that it is clearly spelled out in the loan agreement

g. Using seemingly arbitrary share counts in future periods that ignore the dilutive effects of Management options, warrants, and stock-based compensation. In the course of our research, we did not come across any analyst models that properly accounted for the current fully-diluted share count

Based on our calculations, the maximum possible present value of cash flows that RPTP could generate for shareholders is less than $4.00/share. The target price is based off of assumptions that we made in order to arrive at the greatest possible value of future cash flows, and are far more bullish than our view of realistic scenarios that may play out for RPTP. Below are some of the key assumptions:

a. RPTP would be able to quickly gain 100% global market share of current cysteamine patients

b. RPTP would be able to successfully sell Procysbi domestically for the $250,000/patient/year average selling price it has announced to investors, implying an even higher sticker price in the US for private payers

c. RPTP would be able to successfully sell Procysbi for an average price of $150,000/patient/year in the EU and the rest of the world

d. RPTP, via its RaptorCares program, would refund a conservative 10% average copay across private payer patients in the US with no co-payments refunded in the EU or the rest of the world

e. We believe that after 2023, RPTP will be unable to maintain profitability without a new drug approval, and we believe there is compelling evidence that nothing in its current pipeline will materialize. We did not assign any value to the pipeline outside of Procysbi for cystinosis patients, and assumed that rather than face losses following FY 2023, RPTP would dissolve operations and distribute all cash to shareholders

We believe that even at $4.00/share, RPTP leaves investors with significant additional potential downside.

5) A citizen petition could bring an end to RPTP's Procysbi exclusivity in less than three years, and the patents covering Procysbi are unlikely to hold up in court: While RPTP's US patents covering Procysbi will not expire until 2027, Procysbi comes off exclusivity in the US in less than seven years. Subject to a citizen petition (typically filed by a competitor), the FDA may choose to revoke RPTP's orphan drug designation. There was a very similar case in 2012 where the FDA revoked an orphan drug designation for a company that produced a treatment that was nearly identical to an existing one after the manufacturer of the existing treatment filed such a petition. This would limit RPTP's timeline to truly monetize Procysbi to three years rather than seven.

Unfortunately for RPTP investors, the two flimsy patents it holds on its Procysbi drug are, in our opinion, virtually indefensible in court due to the fact that 1) using enteric coating is not a new or novel method of drug delivery, and 2) even if it were, there are countless ways to produce enteric coating and historical court precedents have shown that its use in drug delivery leaves massive loopholes for generic manufacturers to walk through. While RPTP's patents relating to its delayed-release cysteamine last until 2027, we believe that investors will soon find that those patents, like many other drug delivery patents depending on non-proprietary formulations, will not be considered novel or non-obvious in court, and will easily be overturned by generic competition. Precedents have shown that such patents are consistently rejected or circumvented even for much larger pharmaceutical companies with significantly more sophisticated drugs. Cystagon is produced by Mylan Laboratories, one of the largest generic pharmaceutical companies in the world-if there were any commercial success selling Procysbi at the prices RPTP has proposed, it would be foolish to think that Mylan would not jump at the chance to file an Abbreviated New Drug Application and compete with Procysbi immediately after the exclusivity period runs out. There are historical precedents showing that the concept of combining existing drugs with enteric is not novel, and patents for such drug delivery methods do not hold up in court. There is a specific precedent where Mylan was able to bypass a set of patents held by AstraZeneca for a drug that contained "a sugar seed, a drug layer, two sublayers, and an enteric coating"-it would be ill-advised to think that a patent on enteric coating alone is going to stave off competing generic pharmaceutical companies

We believe there is zero chance of RPTP's patents holding up in court-- what really matters is the exclusivity period granted by the FDA, and RPTP's exclusivity period expires in less than seven years from today. On top of that, given that Procysbi is merely a modified version of Cystagon and not a new chemical entity or a drug that would not be suggested by prior art, there is a meaningful possibility of a generic company successfully filing a petition to revert RPTP's exclusivity back from "orphan drug exclusivity" status to "other exclusivity" status-cutting the exclusivity period down from seven years to three years. Even if insurance companies were willing to foot the astronomical bill for Procysbi now, you can be sure they would cut off support the moment a cheaper generic version hits the market

6) We believe the other indications RPTP is pursuing with cysteamine have shown little to no evidence of efficacy, and given the functionality of cysteamine as an irreversible binding agent (which leaves little mystery as to by-products or indirect effects caused by the drug), the fact that it has been FDA-approved for treatment of cystinosis since August 1994,20 and its horrendous side effects, it is unlikely RPTP will be able to find new, undiscovered uses for the drug in the future. For example, it has already been tested on indications including HIV, schizophrenia, and depression, with unfavorable results. The consistent, horrendous side effects of cysteamine are extreme and preclude it from being used for any indications unless it is demonstrated to have a novel, necessary, and irreplaceable benefit. Those side effects include a resulting body odor that has been described as "room-clearing" by caretakers of cystinosis patients, vomiting, nausea, and other pains and discomforts. Pediatric patients frequently go out of their way to avoid taking pills (even disposing of them to avoid parental scrutiny) because of these side effects, despite the fact that not taking the medication significantly shortens their life expectancy. In addition, the reported negative side effects were nearly three times more frequent for patients taking RP103 (Procysbi) than for regular cysteamine. RPTP's pipeline includes the following:

a. RPTP is testing RP103 (enteric-coated cysteamine microspheres within a capsule, already FDA-approved for cystinosis and marketed as Procysbi) to treat Huntington's Disease because it increases brain-derived neurotrophic factor ("BDNF") levels, and investors are waiting for Phase 2 results from a study taking place in France. There has been past speculation that increasing BDNF levels in Huntington's Disease patients would be beneficial. The study commenced in October 2010 and was scheduled to last for 18 months, with potential for an additional 18 month extension. To date, no results have been reported. However, it has been shown through another study completed in May 2011 that BDNF levels are completely irrelevant for patients with Huntington's Disease,21 making RP103 useless even if RPTP's current study verifies its hypothesis. Further, SSRIs, of which there are dozens of brands (such as Paxil, Zoloft, Luvox, etc.), have already been proven to increase BDNF levels, without the negative side effects of cysteamine. Many SSRIs are now off-patent and selling for less than $1/pill. Even if BDNF levels had been determined to be significant for Huntington's Disease patients, there would be no market for cysteamine

b. RPTP is also testing RP103 (enteric-coated cysteamine microspheres within a capsule) to treat Nonalcoholic Fatty Liver Disease. RPTP's theory of why cysteamine would be useful in treating the disease is that RP103 will produce glutathione as a by-product, which would then improve the NAFLD condition. However, 1) glutathione has explicitly been shown not to be impacted in patients with the disease (a 2007 study published by Nara Medical University in Japan showed that glutathione levels were "similar" between healthy volunteers and patients with NASH)22 and 2) even if it were relevant, the result can be replicated by purchasing glutathione's precursor as a cheap over-the-counter supplement at a fraction of the cost of RP103 and without the horrendous side effects

c. RPTP's other indications (other than the above indications and cystinosis) for RP103 and RP104 (enteric-coated cysteamine tablets) and drug delivery systems are all "preclinical" and have not proven any efficacy. Investors should recognize that cysteamine as a medication does not involve sophisticated chemical reactions to produce a response. It is an irreversible binding agent which binds to cystine and removes it from a person (which helps cystinosis patients), and has been FDA-approved for nearly 20 years. If there were other ailments which would benefit from the use of cysteamine, they almost certainly would have been discovered by now. Further, cysteamine carries horrendous side effects that have been well-documented in medical studies as well as by cystinosis patients and caregivers-the only way it would be accepted as a treatment would be if there were no other treatments that produced a comparable outcome. As such, we believe it is extremely unlikely that cysteamine will be used to treat any other diseases

d. Convivia, RPTP's proposed treatment for Asian Flush, has been around for nearly 20 years and we believe it will never be approved or marketable in any market due to the fact that, while preventing production of the acetaldehyde, it also prevents the breakdown of ethanol and could lead to serious bodily harm, coma, or death. We believe its position as a drug to be used for recreational purposes with steep consequences will prevent it from ever being approved by any responsible drug oversight commission. RPTP announced an "exclusive agreement" with Uni Pharma to develop and commercialize Convivia in 2010 with no subsequent developments


Footnotes:

[1] Forbes

[2] Priority Health

[3] Wellcare

[4] Coventry

[5] MVP Health Care

[6] Unity Health

[7] Univera

[8] Medica

[9] Arkansas Blue Cross

[10] Group Health

[11] Health Alliance.org

[12] Invivo Blog

[13] National Institute For Health

[14] NCBI

[15] Section 6.1, Procysbi Prescribing Information Highlights (http://www.procysbi.com/docs/Procysbi-Full-Prescribing-Information.pdf)

[16] Halitosis in cystinosis patients after administration of immediate-release cysteamine bitartrate compared to delayed-release cysteamine bitartrate, Molecular Genetics and Metabolism 107 (2012) 234-236, July 6, 2012

[17] www.facebook.com/groups/6382741905/

[18] Access Data

[19] CFO on the April 30, 2013 Investor Call: "Yeah. So over 65% of the cystinosis patients we are aware of have private insurance. And then between Medicaid and Medicare, it's somewhere between 20% and 25% and the remainder are uninsured."

[20] Access Data

[21] Plosone

[22] NCBI

Source: Raptor Pharmaceutical Corporation: A Dose Of Reality For Investors