Preparing for Inspire Pharmaceutical's 2011 Phase 3 Catalyst

Includes: AGN, ISPH
by: Chimera Research Group

As most everyone in the biotech space is focused on the events coming in September/October, it’s a good idea to scan for companies with longer term, yet largely ignored, future catalysts. One such company with an impending future catalyst is Inspire Pharmaceuticals (NASDAQ:ISPH).

Inspire is a biopharmaceutical company focused on researching, developing and commercializing prescription pharmaceutical products for ophthalmic and pulmonary diseases.(1) Inspire receives revenues through several product offerings targeting bacterial conjunctivitis, allergic conjunctivitis and dry eye. The referenced future catalyst involves their Phase 3 drug candidate Denufosol Tetrasodium, an inhalation solution for cystic fibrosis. According to the Company:

  • In June 2008, Inspire announced top-line results from TIGER-1, its first Phase 3 trial with denufosol for CF. The trial demonstrated statistical significance for its primary endpoint of change in FEV1 from baseline compared to placebo (45 ml treatment group difference, p=0.047)
  • In November 2009, Inspire announced patient enrollment was complete in TIGER-2, its second Phase 3 trial with denufosol. TIGER-2 is a 48-week randomized, double-blind comparison of 60 mg TID of denufosol to placebo in approximately 450 patients with mild CF lung disease (FEV1 > 75% and < 110%)
  • Inspire expects top-line results from TIGER-2 in the first quarter of 2011

As the catalyst is expected in the first quarter of 2011 (up to seven months away), it gives me ample time to slowly build my position. Before I discuss a potential trade structure for this catalyst, however, it is necessary to assess the risk of ISPH. As mentioned, the Company already generates product revenues which is a good risk mitigant as most small cap biotechs lack any revenue whatsoever. What matters, however, is the amount of cash generated or burned.

A quick look at ISPH’s most recent financials reveals an estimated total cash burn of around $53~$65mln for 2010.(2) As of June 30, 2010 ISPH maintained total cash and equivalents of $106mln and cash burn was $22.9mln, year-to-date, which means the Company should burn $36mln for the remainder of the year resulting in a year-end cash balance of $70mln. Based on my reading of Company guidance, I would expect cash burn to be less next year (2011) given the numerous one-offs included in the cash burn numbers in addition to (possible) revenue growth implying that ISPH will have at least 18 months worth of cash as of year-end 2010. This is a solid position to be in entering a Phase 3 catalyst and will allow me to be more aggressive with the trade structure.

Before I go into the trade structure, let me first identify some other positive elements supporting a medium term position (need to build a position over a 7 month period):

  • New CEO: Adrian Adams, named CEO in February, has substantial industry experience and sold the two prior companies he led including Sepracor and Kos Pharmaceuticals; I like CEOs with M&A experience.
  • Ownership: ISPH maintains an interesting roster of institutional holders (both active and passive) including Deerfield and S.A.C. Capital.
  • Low (and decreasing) short interest: Short interest is around 5% and has declined over the past several months; although a high short interest can add fuel to the upside for a positive Phase 3 outcome, an excessively high short interest, i.e. over 20% can represent a high degree of risk in a long-biased trade; current short interest seems about right.
  • Revised agreement with Allergan (NYSE:AGN): ISPH recently amended the terms of its agreement with Allergan with respect to Restasis and (now defunct) Prolacria; this basically removes uncertainty and provides greater transparency with future revenues; shareholders bid up the shares nearly 10% on the news.

For this trade, I am going to use a hedged synthetic structure. A pure synthetic (i.e. not hedged) is basically an equivalent stock position (delta of 1). For example, a long synthetic would comprise a short Put and a long Call at the same strike – this basically gives the exact risk profile of actually owning the shares. One can also create a short synthetic which would be comprised of a short Call and a long Put.

In terms of price target, ISPH currently trades near its 52 week low. The Company traded close to $8 a share during 2010. The success of the Phase 3 news should provide substantial upside for the Company given the nature and disease target of the drug candidate. Recent analyst price targets suggest upside to at least $9 per share.

Returning to the trade, here is the structure (amounts are for example only):

SELL 10 MAR 5.0 Strike Put @ 1.80 ( =10 x 100 x (1.80) =(1,800) Credit)

BUY 10 MAR 2.5 Strike Put @ 0.35 ( = 10 x 100 x 0.35 = 350 Debit)

BUY 10 MAR 5.0 Strike Call @ 1.70 ( = 10 x 100 x 1.70 = 1,700 Debit

SELL 10 MAR 10.0 Strike Call @ 0.65 ( = 10 x 100 x (0.65) = (650) Credit)

Initial Trade P&L = (400) Credit








MAR 2.5





MAR 5.0





MAR 7.5



MAR 10.0

At expiration, here is the P&L (amounts are approximate):

< $2.50 = $(2,100)

= $4.50 = $0

> $10.00 = $5,300

P&L (at expiration)

I like this structure for several reasons. First, I can put the structure on for a credit – for this trade and this size, I received a credit of $400 – that is, I am initially getting paid to do a long trade – a nice situation to be in.(3)

Next, my entire risk and reward is completely defined. I know for example, that my maximum risk is $2,000 and my maximum profit is over $5,000. I also know that if the shares end up above $4.50 a share, I will not lose any money (I actually make money).

Due to my analysis, I am highly confident that the shares will trade above this value into Phase 3 data – of course I could be wrong. This structure also allows me to make many adjustments over the trade time line. For example, if the market crashes in September/October and it takes ISPH with it, I can buy back the 10 Strike Calls I sold at a profit. If the shares rally later on, I can likely sell them again at a higher premium level further reducing my risk.(4) Also, at the end of the trade (i.e. at expiration in March 2011), if the shares trade between 2.50 and 5.00 I maintain the option to take delivery of the shares should I so desire.


  1. Source: Company website.
  2. Per August 5, 2010 2Q 2010 Results; based on Company 2010 Guidance.
  3. It should be noted that I needed to leg-in to the components of this structure in order to achieve the best prices.
  4. Of course the shares my never fully recover which will have the impact of increasing the cost and overall loss on the trade in a negative scenario.

Disclosure: Net long ISPH through options

Disclaimer: This article is presented for discussion purposes only and should not be construed as investment advice. The author is neither licensed nor qualified to offer investment advice. Investing in companies prior to the announcement of clinical trial or regulatory events is extremely risky, and should only be undertaken by those who can afford to lose their entire investment. While reasonable efforts were made to ensure that the data included in this article is correct, investors should consult primary sources prior to making investment decisions.