A Look At Orexigen's Fair Value Today

Jan.20.11 | About: Orexigen Therapeutics, (OREX)

>>See Part I, Eight Factors That May Impact Approval of Orexigen's Weight Loss Drug

We estimate Orexigen Therapeutics, Inc. (Nasdaq: OREX) fair value at $88/share if Contrave is moderately successful. Using a 60% probability of Contrave approval and 50% probability of minimal sales thereafter for any reason, we consider OREX fair value today near $25/share.

Jefferies & Co. highlights the opportunity:

As for the market, with over 34% of the U.S. population being obese (BMI>30) and another 32% overweight (BMI of 25–30), the numbers are astounding. Strictly on-label in technically obese patients, the 70 million patients theoretically represent a >$125 billion market (at $5/day). Reimbursement will be the largest roadblock to broad adoption in our view, but we believe solid coverage would just make the difference between blockbuster and mega-blockbuster sales (we assume an approximate cost of $5/day). With obesity being the largest preventable cause of death in the United States, the many associated co-morbidities (diabetes, heart disease, etc.), U.S. healthcare costs for obese patients approaching $150 billion/year, and pressure from the current federal administration to address obesity, we believe state and private payers should perhaps increasingly start to reimburse more for efficacious and safe obesity drugs.[1]

The acid test in drug commercialization analysis: would we suggest Contrave to patients whom we care about and who meet the eligibility criteria? No, not generally. We would suggest it to chronically obese patients otherwise exposed to bupropion. That’s the Contrave component that may cause its primary risks (notably about 1/1000 seizure probability and modest blood pressure elevation on average).

In 2009, approximately 6 million patients were prescribed bupropion for a range of depressive disorders and as an aid to smoking cessation. The average BMI [body mass index] of bupropion users is 30.9, and approximately 68% have a BMI of ≥27 kg/m(2). Accordingly, in 2009 there were approximately 4 million overweight or obese patients who received bupropion therapy. These data corroborate the known association between obesity and depressive disorders, and highlight bupropion is a common prescribed antidepressant among obese patients.[2]

We would consider it curious to approve bupropion for depression and seasonal affective disorder but not Contrave for obese patients otherwise taking bupropion. If one third of such patients prefer Contrave and it’s approved, about 1.3 million patients may take Contrave solely from the annual bupropion patient base. That’s near our supposition of annual Contrave users in total: 2% of about 70 million obese American adults, equal to 1.4 million patients at any time on average in near-future years if it’s commercialized without unexpected adverse development.[3]

To put that in context: in 1996 before it was outed, “doctors wrote a total of 18 million monthly prescriptions for one or the other of the two drugs in the phen-fen combo, a daytime/night-time mix. Redux racked up an additional 2.4 million prescriptions in just its first six months, according to IMS America Ltd., a pharmaceutical-research firm.”[4]

We assume Contrave will sell at $5/day if it’s approved (in line with Jefferies & Co. analysis) and yield Orexigen a 25% average royalty. We capitalize royalties at 10x considering patent life and possible extensions. That results in 1.4 million patients (2% of about 70 million obese American adults annually) x $5/day x 365 x 25% royalty with a 10x multiple: $6.4 billion potential value. We consider substantial contingent milestone payments for Contrave and Orexigen’s net cash to offset its future overhead and share of further Contrave study costs if it’s commercialized. Then $6.4 billion divided by a future diluted 60 million shares equals $107/share potential OREX value.[5]

If Contrave sales ramp in two years and we require a 10% annual return, that $107/share is $88/share potential present value. The question with OREX trading near 1/10th that price: with what probability will value anywhere near that materialize?

Adam Cutler of Conaccord Genuity told Bloomberg Television in December: “We think there’s a high probability of approval of that drug [Contrave] sometime next year.”[6] Cory Kasimov at J.P. Morgan estimated a 75% probability of Contrave approval in due course.[7]

A bit dour by nature, we use a 60% probability of Contrave approval later this year and suppose no value in Orexigen’s other assets. Then 40% probability of $0 value plus 60% probability of $88/share present value is $53/share potential fair value. Suppose only 1% (0.7 million) of obese American adults use Contrave on average rather than 2%. If we double the resulting royalty for estimated global income, we’d arrive at the same $53/share.

That would be a fraction of obese American adults already taking buprupion for depression, smoking cessation or seasonal affective disorder without the greater mean weight loss on Contrave.

Finally let’s consider a 50% probability that, if it’s approved, Contrave sales are weak due to any reason that may include weak emergent multi-year efficacy or a post-approval cardiovascular ((NYSE:CV)) outcomes study that finds material CV risk attending Contrave in a way that can’t be contraindicated:[8,9]

Click to enlarge

Click to enlarge
What accounts for the variance between that estimated fair value table and analysts’ ~$18 OREX price target? One possibility: discount rate with professional considerations. Leading analysts may be reticent to apply discount rates that result in price targets higher than twice the current stock price when 100% near-term gain is a slam dunk and there’s little professional benefit to targeting more.

There’s a little more. We ignore Empatic (Orexigen’s second weight loss drug candidate), modeling it to cannibalize some portion of Contrave sales if approved and considering it iffy due to teratogenicity of zonisamide. We ignore OREX-003 for the same reason: zonisamide. OREX-004, however, is intriguing.

That’s the combination of naltrexone and fluoxetine, a/k/a Prozac, for obsessive-compulsive disorder. Orexigen discontinued development of OREX-003 and OREX-004 in late 2008 amidst management change, macreconomic recession and limited cash (about one year worth of operating funds). OREX-004 patents could, just possibly, be considerably valuable if commercialized as a Prozac Plus.[10]

For emphasis: OREX may be worth peanuts if the FDA declines to approve Contrave. Analysts have deemed that possibility around a 25% probability and we suppose 40%. OREX is potentially suitable for professionals managing diversified portfolios, not for essential retirement savings. Its retrospective present value anywhere between $0 and $88/share may be consistent with this note.

We distinguish between retrospective value and fair value. Retrospective value can be known later. Fair value is determinable today: it’s what “the investor should feel justified in paying, and in having paid, without regard to what the market does thereafter.”[11] We considered Orexigen’s fair value today around $26/share.[12]

OREX trades near half its high price of $18/share in 2007 despite being three years nearer drug commercialization with an FDA panel that voted in favor of its lead candidate. With apparent value around $88/share upon successful Contrave commercialization and anywhere near 75% probability that FDA will approve Contrave this year, OREX appears probabilistically mispriced today whether it ultimately declines or advances.

[1] Corey Davis, Ph.D. et al., “Orexigen Therapeutics; Initiating Coverage: The 2-Second, 2-Pill Workout,” February 2, 2010 from Jefferies & Company, Inc.

[2] Orexigen Briefing Information for the December 7, 2010 Meeting of the Endocrinologic and Metabolic Drugs Advisory Committee accessed via http://tinyurl.com/4995khx, p. 156.

[3] “In 2007-2008, based on measured weights and heights, approximately 72.5 million adults in the United States were obese” (B. Sherry, PhD et al., “Vital Signs: State-Specific Obesity Prevalence Among Adults --- United States, 2009,” August 3, 2010 accessed via http://www.cdc.gov).

[4] R. Langreth, “Critics claim diet clinics misuse obesity drugs” in The Wall Street Journal March 31, 1997 p. B1.

[5] Orexigen reported 47.6 million common shares and 8.5 million stock options outstanding in its most recent quarterly report (Orexigen Therapeutics, Inc. 10-Q filed November 4, 2010 and accessed via http://www.10kwizard.com). We view the options as basically equivalent to common shares and assume that further option grants increase its shares plus options outstanding to 60 million.

[6] December 22, 2010 Bloomberg Television interview accessed at http://www.bloomberg.com/video/65481742/.

[7] Cory Kasimov et al., “Orexigen Therapeutics: Third Time’s a Charm; FDA Panel Back Contrave,” December 8, 2010 from J.P. Morgan Chase & Co.

[8] For example, material CV risk only in men could lead to a simple contraindication for male patients.

Men on both placebo and Contrave appeared more than twice as likely as women to have hypertension or outlier blood pressure readings.[10] That may be associated with cardiovascular (CV) risk. Perhaps a large CV outcomes study will find modest but material CV risk for men and not women on Contrave. (This wouldn’t be commercially detrimental if the overwhelming majority of Contrave patients are female, and such finding may be a marketing boost for female patients in whom it’s deemed to present unexceptional CV risk.)

[9] Orexigen Briefing Information for the December 7, 2010 Meeting of the Endocrinologic and Metabolic Drugs Advisory Committee accessed via http://tinyurl.com/4995khx, p. 270 (table 75).

[10] The National Institute of Mental Health estimates that “OCD affects about 2.2 million American adults”: http://www.nimh.nih.gov/health/publications/anxiety-disorders/nimhanxiety.pdf.

[11] Ben Graham and David Dodd’s Security Analysis 1951 edition.

[12] By fair value we mean the fundamental value of a security in contradistinction to its price. “This independent value has a variety of names, the most familiar of which is intrinsic value. It may also be called indicated value, central value, normal value, justified selling price, reasonable value, fair value, appraisal value, and investment value” (Graham and Dodd’s Security Analysis 1951 edition with apostrophes excluded). We favor “fair” among the synonyms because it’s concise. “Our notion of the intrinsic value may be more or less distinct, depending on the particular case…. Even a very indefinite idea of the intrinsic value may still justify a conclusion if the current price falls far outside either the maximum or minimum appraisal” (Graham and Dodd’s Security Analysis 1940 edition, like the 1934) or is probabilistically attractive.

Disclosure: I am long OREX. The author manages a limited partnership and separate accounts, including personal accounts, that own stock or call options on stock of Orexigen Therapeutics, Inc. The author increased these positions after the December 7, 2010 FDA Endocrinological and Metabolic Drugs Advisory Committee meeting. The author may buy or sell any position at any time. The author may change positions in light of emergent facts or considerations, including new price-to-value-estimates of the author’s current and alternative investments.