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Over the course of the last year-and-a-half, Keryx Biopharmaceuticals (NASDAQ:KERX) has successfully resurrected itself with its new lead candidate, Zerenex, an iron-based phosphate binder for Chronic Kidney Disease (CKD) following the failure of lead oncology drug perifosine in 2012. As biotech and pharmaceutical investors are no doubt aware, the entire biotech sector has performed extraordinarily well, with valuations increasing nearly 120% (measured by the IBB) over the past 2 years, including KERX which has risen from its ~$1.50 lows to over $15. Recently though, on the evening of January 21, 2014, Keryx announced a secondary stock offering up to $90 MM in stock as well as a key business hire: Vice President, Payer Access. These actions by management are well-timed given the stock's recent 52-week highs, and follow the positive recent events including Japanese approval by Keryx's partner (triggering a $10 M milestone payment) as well as positive Phase 2 data late last year in non-dialysis CKD patients. But what does this capital raise and new hire really mean for investors?

Diving into the press release, the following quote stands out:

"Keryx intends to use the net proceeds from the sale of its common stock to fund pre-launch/launch inventory build-up and pre-commercial/commercial activities related to Zerenex, the ongoing development of Zerenex in pre-dialysis, and other general corporate purposes."

This means it is unlikely that KERX found or will find a commercial partner (i.e. big pharma or a dialysis provider such as DaVita) to launch Zerenex. This of course, begs the question, what do strategic acquires/partners know that we don't know? Based on a go-it-alone objective analysis of the CKD and dialysis market for Zerenex, there is significant commercial risk for Keryx. It is my own belief that the capital markets are underestimating these risks, and there is opportunity for investors to make money on the short side or with puts following likely FDA approval (PDUFA date of June 7) as the commercial launch disappoints.

Zerenex - Zerenex is ferric citrate, an orally available compound that binds to phosphate that is designed to treat hyperphosphatemia in patients with CKD on dialysis. In the United States, there are an estimated 395,000 dialysis patients, approximately 90% of whom receive a phosphate binder. There are also an estimated 350,000 dialysis patients in the EU (Source: Sanofi 20-F). Zerenex has completed a US-based Phase 3 clinical program, conducted pursuant to a Special Protocol Assessment (SPA) agreement with the Food and Drug Administration (FDA), and has a Prescription Drug User Fee Act (PDUFA) goal date of June 7, 2014. Keryx also plans to file shortly for approval in Europe as well. The publicly available evidence (the positive trial results and SPA, multiple drugs approved, one of which (Velphoro) recently was approved) suggests the drug stands an above average chance of approval in the CKD Dialysis setting. The drug is also being evaluated in the non-dialysis setting, and has positive Phase 2 results, which will be discussed later.

CKD Dialysis Market Landscape - Following approval, Zerenex will be facing a challenging competitive landscape for a number of reasons.

Both Generic and Entrenched Competitors - Current phosphate binders, principally Renvela (Sanofi/Genzyme), Fosrenol (Shire), and PhosLo (Fresenius) will all be generic by the time Zerenex enters the market. According to Sanofi's 20-F, first-filer generic Renvela will be entering the market into March of 2014 with additional generics following in September. As a result, premium-priced Zerenex will be competing with multiple generics in the same indication. Zerenex has touted several advantages over these drugs, however, in summary Zerenex appears only to be incrementally better, if at all, in key categories.

In addition to the generic competitors, Fresenius / Galenica have launched Velphoro after receiving FDA approval in December 2013. Now, while Velphoro appears to have dosing advantages over Zerenex, the key fact here is the partnership with Fresenius, a major, vertically integrated dialysis provider. Given that Fresenius receives profits on the sales of Velphoro, which phosphate binder will be used in their dialysis clinics? Furthermore, while it may simply have been convenient to expand the partnership with Galenica (they have been partners on previous products), why would they have selected this compound and not Zerenex? Dialysis providers are the world experts on the costs of dialysis and key stakeholder needs. Any incremental and small percentage savings in EPO (which is seeing decreased use) are dwarfed by the hundreds of millions in savings from generic phosphate binders.

The net result here is Keryx's potential market penetration is substantially lower than the market anticipates and is likely relegated to the other major dialysis provider in the US, DaVita. This provides DaVita and other, smaller dialysis centers pricing power and negotiating leverage. Of course, one has to wonder if these providers would adopt Zerenex in the face of cheaper alternatives.

Dialysis Bundling Oral Drugs - In addition to the generic and Velphoro challenge, dialysis over the past couple of years has been moving from a "fee-for-service" business model to a "bundled" business model. Simply put, for each patient, dialysis providers will be reimbursed a fixed cost (although adjusted for multiple factors), and the goal of this bundling is in no uncertain terms to reduce the costs of dialysis. Up until now, the pharmaceutical industry lobby has successfully delayed oral drugs from being included in the bundle. As a result, oral drugs including phosphate binders and sensipar (NPS / Amgen) have enjoyed high prices. Now these oral drugs are slated to be added to the bundle in 2016, it is hard to envision in this new era of austerity to see Zerenex used ahead of the soon to be generic phosphate binders, as the dialysis providers are incentivized to keep costs down.

Anemia Treatment Exists - Drugs already exist to treat iron deficiency, including both oral and IV drugs. Many publications have looked at IV vs. oral iron drugs, and the conclusions have been mixed. Now, there is no doubt many of these previous oral and IV drugs have serious limitations and sub-optimal outcomes, however, the new drug Injectafer (from Fresenius and others) are seeing increased sales and are improving iron delivery. Rockwell Medical's triferic, which also may enter the market soon, appears to have advantages over current treatments as well. The point here is anemia is currently treated and treatable in dialysis patients, and Keryx will need to fight for its share.

Against this challenging market landscape, KERX is entering the market with key disadvantages.

Weak Intellectual Property - The FDA's active moiety for NCE status is defined here, and ferric citrate by any reasonable chemistry definition does not fit the definition given multiple "ferric" compounds approved, and the inorganic nature of ferric citrate. This means that Zerenex will only have 3 years of exclusivity rather than 5. Bulls argue that this is irrelevant, given the patent protection "through 2024 at a minimum" as stated by management in the JPM presentation. Closer inspection of the intellectual property reveals no composition of matter patents, but a method of use patent which expires in 2017 and manufacturing patents which expire in 2022 and 2024. Patent term extension for the 2017 patent is theoretically a possibility, and likely the best hope for protection of Zerenex. However, there are arguments on both sides that are compelling concerning the long-term protection of Zerenex. Every conference Keryx management ends up commenting on the IP position of Zerenex. It is not normal for management of a biotech or pharmaceutical to repeatedly have to address IP for an impending drug launch. These concerns are real, and while it is impossible to say for certain, it is likely that these challenges along with the market concerns above have kept Big Pharma or the large dialysis players (DaVita, and perhaps Fresenius a few years ago?) on the sidelines. Judging by the recent capital raise, these potential acquirers and/or partners will remain on the sidelines indefinitely, forcing Keryx into a solo, doomed launch. This is the key implication of the IP debate.

Perils of a solo launch - A biotech launching its own drug is expensive and risky. It is also the potentially most rewarding option as well, since all the value inherent in the asset may be captured by the company. The number of biotech companies that have successfully launched a product by themselves is exceedingly small. Some recent successes have been in the orphan space (AEGR, NPSP) or in the very targeted hospital space (NASDAQ:PCRX). These types of launches of course require a smaller, focused sales force targeting a small number of key opinion leaders/prescribing physicians who generally lead the field and are highly influential in making treatment decisions. Many of these successful launches also include premium priced products. The net result is a successful launch with minimal investment. At the opposite end of the spectrum are large primary care treated indications, where we have seen failure (VVUS, AMRN). Keryx has pointed out that they will be targeting a core group of 3,000 nephrologists and focus on dialysis practices, which are not primary care-like markets. However, this is most certainly not an orphan or hospital-based indication, and as pointed out earlier, this is a competitive space filled with branded (i.e. drugs still pushed by sales reps and promotions) as well as generic competitors. Ultimately, Keryx will have to launch in the dialysis setting and the most relevant comp is probably Hematide from AFFY. Here, the drug was being trialed by Fresenius (i.e. the provider was making adoption decision, not the practicing physician). Furthermore, DaVita was not trialing the product. In the case of Keryx, Fresenius has its own phosphate binder and we also expect DaVita to stay on the sidelines. Again, the dynamics of the dialysis and CKD markets (see below) result in a likely high spend for minimal revenue, thereby destroying shareholder value.

Zerenex in CKD non-dialysis patients - Keryx management and bulls have been touting this patient population as a huge opportunity for Zerenex. On the surface, the argument is compelling: Zerenex helps control phosphate levels as well iron-levels with a single drug! These patients require less ESAs (EPO) and iron and ultimately will have better outcomes (e.g. delayed dialysis initiation, fewer cardiovascular events, etc.). However, Sanofi/Genzyme/Shire have been down this road before. The FDA has already indicated that outcomes data is essential for phosphate binders in CKD. This type of data requires many patients in the trial, and requires them to be followed for extended periods of time. This could be very expensive indeed, and shortcuts could lead to non-statistically significant outcomes, a very real risk. It very well may be that decreasing phosphate in this population doesn't impact morbidity and mortality. Press releases and conference call transcripts appear to suggest that Keryx may choose the anemia route, that is, avoiding trying to get Zerenex approved as a phosphate binder. They would demonstrate the anemia benefits of Zerenex in patients as compared to IV or oral iron agents to improve hemoglobin and other iron indicators (TSAT, ferritin). At a minimum, Keryx will need to discuss with the FDA the potential approval pathway and clinical trial(s) required. Then, they will need to run the trials and prepare an sNDA for the new indications and wait for approval. It is difficult to envision a scenario in which this happens quicker than 2 or 3 years from now, more than enough time for the drug to commercially fail in the dialysis population, for the IP issues to come to fruition, and for investors to ultimately lose their money and interest in what is a debatable opportunity (oral iron is dirt cheap and phosphate binders will be generic).

Now, while the phosphate binders include non-dialysis patients on their EMA labels, this does not mean Zerenex has a large commercial potential in Europe. If you think the market headwinds are challenging in the US, things are even worse in the EU with austerity, especially with the presence of generics. European countries don't pay premium prices for incremental improvements. Overall, this potential anemia indication is a smoke screen and distraction from the imminent challenging commercial opportunity in the dialysis population.

Financials and Valuation - With the steady rise of the stock, the price now stands at roughly ~$15/share, although the follow-on stock offering may result in a drop in the share price as the market absorbs the excess supply. The market cap stands at roughly $1.3 B, which given the commercial challenges in the dialysis population and the far-off opportunity in non-dialysis patients, is significantly more than fair value. It is very difficult to imagine a scenario where Zerenex reaches $300 MM annually in the out-years, which means that the company is being valued today at 4x those peak sales. This is an incredible valuation given the IP risk alone. Clearly, Zerenex is many years away from peak sales, and so to justify the lofty valuation today, market must be anticipating even higher sales! Given that the most successful phosphate binder, Renvela, never reached blockbuster status [over a billion in annual sales; Renvela sold €653 M (~$880 M) in 2012], once it goes generic it stands to reason that Zerenex will never come close. Bulls cite the massive pre-dialysis patient population, which is still only a theoretical market, but as I discussed earlier, there are significant risks here and it is likely that Zerenex will be a commercial failure before approval occurs in this additional patient population.

To management's credit, they have taken advantage of the steady stock price increase (and potentially overvalued stock) to raise capital. As of September 30, 2013, KERX had cash and cash equivalents of $68 M, but with $90 M more soon in the coffers and $10 M for Japanese approval, and an estimated ~$15 M in operating expenses for the quarter, a reasonable estimate of cash is ~$150 M. KERX will not need additional capital in the near term, although another financing is likely as the launch disappoints and the commercial expenses with a lack of material revenue are realized.

Conclusions - While novel treatment options in CKD are a positive for patients and other key stakeholders, investors must objectively access a biotech company's asset value with respect to the company's equity value. It is hard to rationalize commercial success for Zerenex when the clinical benefit of the product is that of a phosphate binder plus oral iron and the company is now commercializing alone. Ultimately, however, the value proposition for Zerenex just isn't there for patients and for the providers that have to absorb the cost. Keryx's ~$15 share price and ~$1.3 B market capitalization significantly overestimate the intrinsic value the asset and the stock is tremendously overvalued given significant commercial risks that we have articulated (a solo launch into the competitive, cost-conscious CKD dialysis market of a product of modest clinical benefit and weak intellectual property). While the drug stands an above average chance of FDA approval in June, this fundamental mispricing is likely to be corrected in 2H 2014 as the commercial launch disappoints.

Source: Keryx Biopharmaceuticals: Grim Realities Of The Dialysis Market Will Result In Commercial Failure