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William Meyers, OpenIcon (18 clicks)
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Vertex Pharmaceuticals (VRTX) closed on Tuesday, September 10, at $81.32, which means it has more than doubled since its 52-week low of $38.44, since November 28, 2012. Vertex is only down about 11% from the 52-week high of $89.96, yet there are some signs it is in some trouble, at least short term. With a couple of drugs already commercialized and a mid-sized pipeline, Vertex might be highly profitable in the long-run. Is that enough to compensate for short-term risk, at the current price?

Looking at second quarter 2013 results, the short-term issues are clear. Revenue was $311 million, down 26% from $418 million in Q2 2012. Usually a company with two relatively newly-approved drugs ramps revenue up. Indeed the newest drug, Kalydeco (ivacaftor) for Cystic Fibrosis (CF) saw revenue more than double y/y to $99 million from $45 million. Royalties on products marketed by other companies also increased, up 47% to $49 million.

The downfall was from Incivek for Hepatitis C. Sales in the quarter were $155.8 million, down 52% from $327.7 million in Q2 2012. A protease inhibitor, its label is for genotype 1 HCV only (there are several genotypes of hepatitis virus). It is administered with pegylated interferon and ribavirin, which together had been the standard, and not particularly effective, treatment before newer classes of drugs began to arrive. The race for HCV cures has been heating up for years now, with several improvements over interferon/ribavirin, but usually administered in combination with them, already on the market. The numbers show Incivek is losing the battle for market share. Vertex management believes patients are delaying using therapies like Incivek that involve interferon/ribavirin, which require injections and frequently have unpleasant side effects. Instead they are looking forward to new all-oral treatments.

Since Incivek is the major revenue generator, and is in a tailspin, why did the stock jump, up 62%, on April 19, 2013 from the previous close of $52.87 to a close of $85.60? On April 5 Vertex got a non-exclusive agreement to combine VX-135 (not Incivek, but a polymerase inhibitor) with Bristol-Myers Squibb's Daclatasvir in a once-daily all-oral regime for genotype 1 HCV infections (see Vertex April 5, 2013 press release). In addition to a Phase 2 study for genotype 1, Vertex planned a Phase 2 study that also included genotypes 2 and 3. But "further clinical development activities beyond Phase 2 studies are not covered as part of the agreement." VX-135 licensing rights had been acquired in 2011 from Alios BioPharma. Daclatasvir at the time was in a Phase 3 trial.

On April 18, 2013, Vertex announced statistically significant results in a Phase 2 trial combining Kalydeco with VX-661 in CF patients having two copies of the F508del mutation (see Vertex VX-661 Phase 2 result press release). F508del is the most common mutation causing CF. Nearly half the global CF population have two copies of this mutation, while another third have one copy, with a different mutation in the second copy. Lung functioning improved significantly compared to the placebo group. VX-661 is a "corrector" that aids Kalydeco, which is a potentiator. As a monotherapy VX-661 showed improvements in patient lung functions, but did not reach statistical significance.

CF affects about 30,000 people in the U.S. and about 70,000 worldwide.

VX-661 is just one of several correctors Vertex is studying. The most advanced corrector is VX-809, which is in two large Phase 3 studies in combination with Kalydeco.

In addition, on July 29 Phase 3 results of Ivacaftor as a monotherapy showed statistical significance in CF patients with non-G551D mutations.

The Kalydeco (ivacaftor) label currently covers only patients with the G551D mutation, and therefore only about 5% of CF patients overall. Clearly a two-drug regimen that covers most CF patients would be far more valuable. While we can't be sure until the FDA makes a decision, the Phase 2 statistics appear to indicate the Phase 3 results should be strong enough to gain an approval.

Certainly we have a mixed picture overall. The Cystic Fibrosis program seems strong, but the HCV program seems problematic given the competition, notably from Gilead (GILD). Vertex ended Q2 with $1.43 billion in cash, so clearly it can carry on its drug development programs for some time even if Incivek revenue declines faster than Kalydeco revenue ramps.

In Q2 net loss was $57 million on a GAAP basis and $6 million on a non-GAAP basis. GAAP R&D expense was $222 million. Clearly by cutting R&D Vertex could have shown a profit. But typically when pharmaceutical companies are in the early stage of commercialization they want to expand sales (especially internationally), expand the labels of approved drugs when possible, and develop pipeline candidates, if necessary by licensing or buying candidates or entire companies. In effect they are reinvesting investor's money, and usually that is a good strategy. Onyx Pharmaceuticals (ONXX), which is about to be acquired by Amgen (AMGN), made its investors a good return following this strategy.

The Vertex Pharmaceuticals pipeline is only mid-sized at this point. In addition to the CF and HCV trials underway, VX-787 for influenza A in validated its mechanism of action in a Phase 2a study and VX-509 for rheumatoid arthritis data from a Phase 2b trial is expected later in 2013. RA, however, is a crowded field, with several potential new drugs heading to market, if approved.

At $80 per share VRTX has a market capitalization of $18.6 billion. Onyx Pharmaceuticals is selling for $10.4 billion, but had revenue in Q2 of $146 million. On the other hand, Onyx revenue was trending up, while Vertex revenue has been trending down, and we can't assume VRTX is an attractive takeover candidate.

Most likely in the long term (three to ten years) Vertex will be a good investment. If the current pipeline does not work out, Vertex has the cash and the expertise to acquire new candidates. It is the short-run that is problematic.

Having recently looked now at all of the biotechnology stocks in the Nasdaq 100, I would say I'm least impressed by Vertex, at this price. Call it the dog of the lot, not because it has lost value, but because it has gained so much value this year. A lot of unproven future success is priced in already. I'm willing, given the usual caveats, to see value in a pipeline. That just about sums up my biotech investment strategy. When other investors see more value than me in the pipeline, as they seem to currently in Vertex, then I'm betting there is no Alpha to be had. On the other hand, at a lower price, with good news, or perhaps if I gain a better understanding of Vertex's pipeline with time, I could change my mind. Just for instance, I rejected both Onyx and Biogen Idec (BIIB) in 2007, but bought them in 2008 when their value propositions became clearer to me.

Source: Vertex Pharmaceuticals: Dog Of The Nasdaq 100 Biotechs

Additional disclosure: I sold my remaining ONXX at the end of August.