Investing in Small Cap Pharmaceuticals: Noven, Barrier, Penwest and Endo

by: The Wall Street Transcript

On January 8, The Wall Street Transcript interviewed FTN Midwest Securities Corp. analyst Timothy Chiang on small cap specialty pharmaceuticals. Key excerpts follow:

TWST: Why the smaller names? Is that where the opportunity has been?

Mr. Chiang: I think smaller cap names, especially those with market capitalizations below $1 billion, have significant operating leverage, especially when new products are approved and launched. Also, I think these companies could benefit from consolidation in the specialty pharmaceutical industry. In 2006, companies like Noven (NOVN-OLD), Penwest (PPCO), Barrier (OTC:BTRX) and CollaGenex (OTCPK:CGPI) benefited from their products receiving FDA approval. In the case of Noven, they had the approval and the launch of the Daytrana patch. That's the first ritalin patch for the treatment of attention deficit hyperactivity disorder to be approved by the FDA. Barrier was granted FDA approval on Vusion (an antifungal ointment for treatment of diaper dermatitis), and Xolegel (another topical antifungal for chronic skin rashes). For CollaGenex, it was the approval and launch of Oracea, a once-daily oral doxycycline for the treatment of rosacea.

TWST: You mentioned three names early on. Are you still recommending them?

Mr. Chiang: I am still recommending Barrier and CollaGenex shares, with buy ratings on both. I have a buy rating on Noven, whose shares are up approximately 60% this year. Some of these names may take a break in 2007, but my feeling is that out of the names that we've talked about, Penwest is probably the one name that has somewhat disappointed the market this year, largely because the launch of Opana ER has been slow to ramp.

But 2007 might be a better year for both Penwest and Endo (NASDAQ:ENDP) (its development partner for Opana ER). Endo's flagship product Lidoderm continues to do well. So I think the market's expectations have been broadened on those products, but it's still possible that Opana ER meets expectations longer term. Endo has a large sales force of almost 600 people marketing Opana ER.

TWST: Why has it been disappointing?

Mr. Chiang: I think Endo had difficulties getting its initial marketing material approved by the FDA's DDMAC division. Also, I think Opana ER is a product that sells at a significant premium to generic OxyContin. I also think Endo's management team went through a transition in the middle of 2006, which took away from the initial launch of the drug. I am hopeful 2007 will be a better year for Opana ER's launch, which in turn could benefit Penwest and Endo.

TWST: Let's touch on the others. What's the outlook on Barrier?

Mr. Chiang: That's an interesting company. They have an extensive pipeline of products for the treatment of acne and psoriasis. They have a number of antifungal products as well. I think the market has had a difficult time valuing this company largely because the company's first two products that were approved this year probably have peak sales potentials around $35 to $40 million, but it looks like the company's pathway to profitability may not occur until 2009 or 2010. So my feeling is the pipeline may create the upside potential for this company.

We think at least three or four Phase II studies will be completed by the first half of 2007. Again, some of the products that they hope to provide Phase II results for include topical Rambazole (for acne treatment), oral Rambazole (for acne and/or psoriasis treatment), and Azoline, an antifungal.

So I think the market is looking for more clues as to what the potential of their new drug pipeline is, and I think we will get those clues in the first half of next year.

TWST: The other one you mentioned was Noven, which had a great run.

Mr. Chiang: Noven had a very strong year, largely because it was a story that surprised a lot of investors on Wall Street. They have a strong partnership with Shire, one of the leading companies in the field of ADHD. Daytrana has been heavily promoted by Shire, which benefited the product's ramp. It's currently annualizing sales around $75 to $85 million a year, making it one of the most successful specialty pharma launches in 2006.