Should Johnson & Johnson Bet On An Antipsychotic Acquisition?

| About: Johnson & (JNJ)

Last week marked the end of a two-year case involving Johnson & Johnson's (NYSE:JNJ) subsidiary Janssen Pharmaceuticals and the U.S. government. The case alleged that Janssen marketed antipsychotics, including the blockbuster drug Risperdal, to elderly patients who had dementia and confusion despite evidence of increased stroke risks in such patients. As a result, J&J has agreed to pay a whopping $2.2 billion fine for administrative and civil penalties.

In retrospect, $2.2 billion is nothing major for J&J, considering its $45.5 billion in annual gross profit. However, the fine highlights a significant problem in the antipsychotic market. This is a competitive space, with billions of annual revenue up for grabs, and many diseases that have no FDA approved product. Therefore, top-selling drugs such as Risperdal or Abilify are often used off-label to treat such diseases, but have side effects that are sometimes more harsh than the benefit.

A far superior drug

This fact is where Acadia Pharmaceuticals' (NASDAQ:ACAD) pimavanserin comes into play. Already, the company has produced data confirming that it lowered psychotic episodes in patients with Parkinson's disease psychosis ((NASDAQ:PDP)). In fact, the FDA declared that pimavanserin's data was so robust that no confirmatory Phase III studies would be necessary, setting up an FDA approval late next year. Hence, pimavanserin will be the first drug approved to treat the disease.

But more importantly than pimavanserin's ability to reduce psychotic episodes is its best-in-class safety profile. So far, the only common side effect reported on pimavanserin is occasional headaches, which is significantly better than the tremors, blurred vision, strokes, and in some cases, death that comes with other drugs in the same class.

As a result, investors and analysts are highly optimistic regarding pimavanserin's potential in lowering psychotic episodes in patients with Alzheimer's disease psychosis ((NASDAQ:ADP)) and schizophrenia. Also, with secondary endpoints of reducing anxiety and anger in its ADP trial, along with its safety profile, pimavanserin could easily become the go-to off-label drug for treating many diseases, as neither physicians nor patients will be concerned with harsh effects.

Takeover or partnership target?

As most know, pimavanserin's peak sales estimates have abruptly risen from just $300 million to over $2 billion as analysts assess the potential of this drug both on and off-label. These rising estimates have pushed shares higher by nearly 900% over the last year, from a market cap of $200 million to nearly $2 billion.

This fact, combined with expiring patents and large lawsuits in the space, makes Acadia and interesting takeover or partnership candidate. Interestingly, given J&J's recent troubles, a partnership/acquisition might make sense.

First off, Johnson & Johnson is a very acquisitive company with a lot of cash, but has focused on building its oncology segment over the last few years. J&J purchased Cougar for $1 billion back in 2009, which has turned out well with the success of Zytiga. The company also has a partnership with Pharmacyclics (NASDAQ:PCYC) for its drug ibrutinib.

Ibrutinib is an orally administered BTK inhibitor being developed to treat several forms of leukemia and lymphoma. It has several Breakthrough and orphan drug designations, with some analysts projecting peak sales to reach $9 billion globally. This one drug has warranted a $9 billion market capitalization for Pharmacyclics, despite not yet being FDA approved, as Pharmacyclics receives 50% of revenue and is responsible for just 40% of costs. Therefore, investors are optimistic, and this excitement has pushed shares of both J&J and Pharmacyclics higher in recent years.

A big pharma need

There's little arguing that J&J is clearly excelling in oncology, yet the company is lagging with antipsychotics. In 2008, Risperdal had a 22% share of the antipsychotic market, with annual sales of $3.8 billion . But in 2007 Risperdal lost its patent exclusivity, and its $3.8 billion actually reflected a 24% year-over-year decline. In 2010, sales were just $2 billion, thus showing the rapid decline of this blockbuster drug.

In recent years, Johnson & Johnson has not made too many attempts to rebuild its place atop the antipsychotic market. However, in the last few months, J&J has become slightly more aggressive. For example, the company signed a deal with Evotec with the goal being to develop new treatments for Alzheimer's disease.

J&J has already agreed to fund $10 million for early stage research, as Evotec is believed to have great research in the relationship between molecular and cellular changes in the brain. J&J is prepared to pay another $125-$145 million for milestones, and royalties if any products make it to the market.

Final Thoughts

Clearly, the J&J deal is great for Evotec, but very small for J&J. The company still needs a blockbuster in the space, one that is near FDA approval, and pimavanserin would fit this need.

With that said, Acadia still looks to be a great investment by itself, trading at one times peak sales. Therefore, I wouldn't worry if such a partnership does not take place for Acadia. But for Johnson & Johnson, it does trade at a premium to the market at 21 times earnings, and much of that premium is given due to its growth with oncology products and excitement for launches such as ibrutinib.

However, to maintain that excitement the company must continue to produce blockbuster products, and with its troubles in treating psychotic diseases, pimavanserin would be a nice addition to keep the stock trading higher.

Disclosure: I am long JNJ, ACAD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.