The FDA's yay or nay for Chelsea Therapeutics' (NASDAQ: CHTP) experimental drug Northera, indicated as a potential treatment for hypotension in patients with primary autonomic failure, is now imminent. As most biotech investors know by now, a regulatory decision from the FDA should come no later than tomorrow. So, today is pretty much the last day to decide whether Chelsea is worth the risk and how best to position yourself ahead of this binary event, in case you are going to dip your toes into these turbulent waters.
With that in mind, let's consider the good, the bad, and the ugly for Chelsea Therapeutics.
· Last month, the FDA's Cardiovascular and Renal Drugs Advisory Committee gave the drug an overwhelmingly positive 'yes' vote, i.e., 16-1.
· A recent study showed that the FDA sides with its Advisory Committees on positive votes about 88% of the time. Keeping with this idea, I think the near unanimous positive vote for Northera makes it politically difficult for the agency to issue a second CRL.
· Chelsea believes Northera could see peak sales of $375 million within 5 years. So, Northera presents an intriguing value proposition for investors given that Chelsea's current market cap is only $377 million.
· Many committee members qualified their 'yes' vote by stating they lowered their standards because Northera is an orphan drug for a disease with limited treatment options. Moreover, they had significant reservations over the trial design, the drug's effectiveness, and long-term safety profile.
· Northera appears to only be effective for 1-2 weeks, according to data presented at the Advisory Committee.
· The FDA reviewer was overtly negative regarding Northera's clinical data and trial design.
· Postmarketing studies are a near certainty if Northera is approved.
· Northera's label, if approved, could restrict the drug's use to 1-2 weeks. That would cut deeply into the drug's commercial potential.
· Chelsea Therapeutics is burning approximately $3.8 million per month. Per my estimates, I believe the company has only enough money on hand to keep operating for 9 months. My estimate only accounts for monies spent on current operating costs, not a commercial launch or postmarketing studies.
· A solo commercial launch of Northera will run around $120-$150 million per industry averages. In short, Chelsea has less than $40 million on hand now, nowhere near enough to launch the drug without partnering, outright selling the company, or diluting the heck out of shareholders.
Brief thoughts going forward
I personally don't see much remaining upside in this trade. While bulls believe a multiple of 2-3 should be applied to Northera's potential peak sales, there are significant risks going into tomorrow's FDA decision. If the FDA does restrict the drug's use to 1-2 weeks at a time, I think Chelsea will find it near impossible to find a partner or a buyer. And a solo launch will be an unmitigated disaster for Chelsea shareholders for the reasons outlined above.
Under the best case scenario, Northera gets approved with a postmarketing study requirement to address the lingering efficacy and safety issues. The problem is that a potential partner could use the postmarketing study as leverage to lowball Chelsea. Indeed, there is a better than average chance that a postmarketing study could show the drug is either (A) unsafe or (B) not effective over the long-term. Looking at this issue through the eyes of a potential partner/buyer, Northera looks like a drug that could eventually be pulled from the market because its initial clinical data left too many unanswered questions.
So, why would a partner pay a hefty premium for such a drug? Simply put, they won't, and you shouldn't but into the hype of a potential billion dollar tender offer if Northera is approved.
The FDA approves Northera Friday, but the label contains problems that ultimately hinder the drug's commercial success. Chelsea shares initially move upwards on the approval but end the week below $5 a share. As commercialization issues hang over the drug going forward, shares sink into the $3's within a month.
My preferred trading strategy is thus either an Put strategy with a $3 Strike, or a possible Iron Butterfly with a $5 pin. Shorting is too risky because the FDA does literally whatever it wants, and it may very well end up surprising everyone. In fact, they usually do. Going long appears to be unfavorable because the stock has already moved 132% ahead of this regulatory decision. Put simply, I think the upside potential is nearly maxed out and has not factored in the significant regulatory and logistical issues facing Northera going forward.
Additional disclosure: If I go short, I will use Options.