Auxilium Inches Toward FDA Approval for Xiaflex

Auxilium Pharma (AUXL) is currently awaiting a decision from the U.S. Food and Drug Administration (FDA) on its key pipeline candidate, Xiaflex, which is under FDA review for the treatment of Dupuytren’s Contracture. In September, Auxilium received a major boost in the form of a favorable recommendation from the FDA’s Arthritis Advisory Committee for Xiaflex for the treatment of Dupuytren’s Contracture.

Dupuytren’s Contracture is a condition that affects the connective tissue in the palm known as palmar fascia. The company estimates that approximately 240,000 Dupuytren’s candidates could exist in the U.S. and the EU. This represents significant commercial opportunity for Auxilium.

Xiaflex is also being studied for the treatment of Peyronie’s disease and frozen shoulder syndrome. According to the company, there are at least 450,000 potential patients annually in the U.S. and the EU for Dupuytren’s and Peyronie’s. Approval for both indications could help Xiaflex sales cross $1 billion.

Meanwhile, Auxilium is looking to conduct additional studies for the frozen shoulder syndrome indication. Frozen shoulder syndrome is a disorder of diminished shoulder motion and almost 3% of people, especially women, develop this problem over their lifetime.

Auxilium has a development, commercialization and supply agreement with Pfizer Inc. (PFE) for Xiaflex for the treatment of Dupuytren’s and Peyronie’s in Europe and certain Eurasian countries. With the European deal in place, we believe the company will intensify its search for partners for other non-European and non-North American territories.

The advisory panel’s unanimous recommendation (12-0) brings Xiaflex a step closer to receiving approval. Although the FDA is not required to follow the advice of the panel, it usually does so. A response from the agency should be out shortly. We have a Neutral rating on the stock.

Comments

[SumZero:]

BioSpecifics Technology Corp (BSTC) - Target ($52.94) Special Situations Update
October 14

Expect BSTC takeout within months.


BSTC will be taken out by AUXL. Auxilium received proceeds, net of offering expenses and underwriting discounts and commissions, of about $115.7 million. AUXL has around $70mm in cash on B/S and around $40mm credit facility.

115.7 + 70 + 40 = 225.7 / 6.08mm shares of BSTC = $37 per share

However, I believe AUXL will be forced to sweeten the offer price above $40, to the $45+ per share range.

Note: The capital raising filing details beyond normal corporate G&A use, that the funds could be used for strategic or corporate acquisitions.

Oct 15 11:28 AM

[SumZero:]

BSTC/AUXL

Thesis:
Yesterday the FDA’s Arthritis Advisory Committee voted 12-0 in favor of FDA approval of a new drug, Xiaflex. BioSpecifics Technology Corp (ticker: BSTC) holds a topline royalty on Xiaflex and Auxilium Pharmaceuticals Inc (ticker: AUXL) is commercializing Xiaflex. Assuming formal FDA approval in two months and sales of $500 mm in 2013, which is consistent with sellside expectations, BSTC will generate $4.16 of EPS and AUXL will generate $2.50. At the current share prices of BSTC and AUXL, this puts BSTC at 7x P/E and AUXL at 14x P/E. For both companies, Xiaflex is the vast majority of value. Therefore, an arbitrage exists buying BSTC and shorting AUXL.

This spread exists since AUXL has greater liquidity and is better known to investors (sellside coverage). However, yesterday’s FDA review has BSTC on biotech investor’s radar screens and BSTC is committed to return cash to shareholders through selling BSTC, selling the Xiaflex royalty, or dividend payments.

Summary:
BSTC owns a royalty in Xiaflex which was reviewed by the FDA Arthritis Advisory Committee on September 16, 2009 for the treatment of Dupuytren’s disease. Dupuytren’s causes collagen to buildup resulting in an inability to open one’s hand and can only be treated with invasive surgery that must be repeated throughout a patient’s life. Xiaflex contains two enzymes that break down collagen allowing the patient’s hand to return to normal use. Following a very positive FDA review, consensus is that Xiaflex will receive formal approval from the FDA in about two months and Xiaflex will be on the market two months later in January 2010.

While the FDA has not given its final approval to Xiaflex, the risk Xiaflex is not approved is very low as adverse effects are minor, the only current treatment option is surgery (this is an orphan drug), and the FDA advisory panel voted 12-0 in favor. Importantly, hedging with AUXL eliminates this risk as the value of AUXL’s two other drugs is minor – investors own AUXL for Xiaflex.

The big uncertainty is the size of the market for Xiaflex, but as shown in the attached spreadsheet, this trade is profitable regardless of market size. In fact, if sellside expectations prove to be too optimistic, the pair trade is most profitable as AUXL bears all costs and negative fixed cost leverage will hammer AUXL’s profit margins while BSTC collects its royalty.

BSTC is committed to return royalty payments to investors through dividends and/or a sale of the company or the royalty. On the other hand, AUXL will reinvest profits attempting to develop new drugs and the track record for biotech is miserable (I can share data). While AUXL is likely to incinerate the profits of Xiaflex, BSTC will monetize its royalty for the benefit of shareholders. The President and his family own slightly more than 20% of the fully diluted shares and has stated, “no plans to acquire products or anything – no empire building goals.” Current employee headcount is 5.

BioSpecifics and Auxilium History:
In June 2004 BSTC entered a development and license agreement giving AUXL the right to develop Xiaflex in return for a royalty sales and markup on the production costs. Pulling it together, BSTC receives approximately 12% of revenue from Xiaflex sales without incurring any costs. AUXL is responsible for research & development costs, the expense of coordinating Xiaflex’s FDA review, production of Xiaflex vials, and creating a sales & marketing team to sell Xiaflex.

This agreement was amended in December 2008 as Pfizer acquired the rights to commercialize and market Xiaflex in Europe and other territories outside the United States. Therefore, Pfizer will bear the cost of European Union regulatory approval and sales & marketing expense. Pfizer’s involvement is positive as:
- Pfizer paid $75mm on signing and agreed to $410mm of additional milestone payments. While big pharma companies are desperate to replenish their drug pipelines, this is a significant amount and indicative of Pfizer’s confidence that Xiaflex will be approved by the FDA and that Xiaflex has significant potential.
- Pfizer used its extensive experience with the FDA’s review process to guide AUXL through the review.
- Pfizer is planning to submit Xiaflex for EU approval in 2010. Pfizer has stated they believe existing clinical studies of Xiaflex are sufficient to satisfy the EU.

As with the sales of Xiaflex in the US, BSTC receives approximately 12% of Xiaflex revenue in Europe without incurring any costs – BSTC’s Xiaflex royalty is consistent regardless of geography or indication.

Valuation:
The attached spreadsheet details the calculation of BSTC’s fair value and sensitivity tables. The market value awarded to AUXL shows BSTC has 78% upside. The most reasonably conservative estimates have been used. For example, $340mm of value is given to AUXL’s existing drug, Testim, which is $50-100mm above market consensus. Likewise, it is assumed AUXL receives 100% of Pfizer milestone payments despite the targets for these payments never being made public. As sensitivities show, one can use even more draconian assumptions and the spread remains attractive.

The model assumes $500 mm of Xiaflex sales – $300 mm of sales in the US and $200 mm of sales outside the US through Pfizer. Diligence shows this to be a reasonable estimate, however, yesterday’s FDA advisory committee meeting discussed limiting access to Xiaflex to certain physician specialties and/or mandating a patient registry. It’s unclear if the final FDA decision will require either of these, but either would be extremely profitable for this spread trade as AUXL’s fixed costs would crush its profitability while highlighting the superior value of BSTC’s topline royalty. Additionally, if the new sales force that AUXL is currently hiring is not able to ramp sales as quickly as Pfizer’s existing sales force, this spread trade is more profitable than currently forecast as BSTC earns more than AUXL outside the US.

This value discrepancy exists principally for three reasons:
- AUXL’s market capitalization is 7x BSTC’s.
- While 16 brokerage firms cover AUXL, just 1 brokerage firm covers BSTC and this firm is Hapoalim of Israel, which initiated in June.
- BSTC’s royalty at 12% is higher than average (based on limited biotech/pharma experience), so investors may be ignoring BSTC due to typical royalty assumptions.
- AUXL sellside seems to ignore the BSTC royalty, which has two impacts. First, analysts aren’t calling attention to BSTC leaving it undiscovered. And second, sellside cost estimates may be too low as they’re ignoring that AUXL must pay BSTC its royalty both for sales in the US and Pfizer sales overseas – for sales through Pfizer, BSTC earns more than AUXL.

Catalysts:
Yesterday’s FDA review brings attention to BSTC. Additionally, BSTC management is starting to meet with investors as shown by yesterday’s presentation at BioCentury “NewsMakers in the Biotech Industry” conference.

BSTC is committed to dividending cash and/or selling itself or the royalty. As BSTC will monetize its royalty the valuation gap won’t persist indefinitely.

AUXL may help to close this valuation gap by purchasing BSTC. Purchasing BSTC is a win-win for AUXL given that it simplifies their story and provides accretion to their earnings; BSTC management is very open to a sale to AUXL.

It appears possible AUXL will do a secondary offering as they will be FCF negative for quite a while and the costs to hire and ramp a sales force for Xiaflex’s launch is substantial. A secondary would be ideal for this pair trade as it dilutes AUXL shareholders and the extra cash would be used to create a big Xiaflex launch, which would benefit BSTC given its topline royalty.

Brief Information on Xiaflex:
Accurately sizing the market for Xiaflex’s treatment of Dupuytren’s disease is difficult. First, it is difficult to estimate the number of annual patients as the only current cure is invasive surgery so there is a large population of “watchful waiting” sufferers. Second, one needs to estimate the percentage of patients that will choose Xiaflex over surgery. Third, one needs to estimate the number of vials required per patient. Lastly, one needs to estimate the price per vial. To simplify, $500mm seems a reasonable mature market estimate. This thinking is consistent with a number of sellside analysts. I am happy to share my work.

Additionally, Xiaflex has the ability to treat Peyronie’s disease, which causes extreme penis curvature and appears to have a market size similar to Dupuytren’s. Again, market size estimates are difficult to make with precision as Peyronie’s is significantly under diagnosed because the only current treatment is to have the penis shortened through surgery (Peyronie’s is found in more than 5% of men undergoing an autopsy). Hence, the majority of men suffering from Peyronie’s likely do a simple internet search and find that they would need to have their penis shortened and never visit a doctor. While a rough estimate, it appears that the potential market size for Peyronie’s is similar to Dupuytren’s. As Xiaflex is also being investigated to treat other diseases, such as frozen shoulder, it has potential to be a blockbuster. Additionally, patents are pending through 2027 resulting in a very long tail making Xiaflex a very valuable drug.

More information can be found at:
biospecifics.com – corporate presentation is helpful
ir.auxilium.com – corporate presentation is helpful
BSTC Pres/Prin Executive Officer/Prin Financial Officer: Tom Wegman – thomas_wegman@biospeci... [phone]
AUXL IR: Will Sargent – [e-mail], [phone]
FDA briefing documents and webcast: fda.gov/AdvisoryCommit.../...

Oct 15 11:28 AM