Why We're Initiating Coverage of Trius Therapeutics With an Outperform Rating

| About: Merck & (MRK)
We are initiating coverage of Trius Inc. (TSRX) with an Outperform rating and $10 price target. By any measure of valuation we’ve selected, the stock looks sizably undervalued at today’s price. We have performed a discounted cash flow (DCF) analysis based on forecasting $750 million in worldwide sales of Torezolid in 2020, looked at comparative deals for late-stage antibiotics, and looked at Trius compared to its two closest competitors. Under all three metrics we see the stock as having significant upside.

Torezolid Poised to Be Best-In-Class

Trius lead pipeline candidate is Torezolid, a second generation oxazolidinone being developed for the treatment of serious gram-positive infections, including methicillin-resistant Staphylococcus aureus (MRSA). Based on clinical data from Phase I and Phase II studies, Torezolid offers several key advantages over the market leading product in Pfizer’s (NYSE:PFE) Zyvox (linezolid), a first-generation oxazolidinone with worldwide sales over $1.1 billion in 2010. These advantages include far more rapid bacteriocidal onset, far more convenient once-daily dosing, a shorter course of therapy at only 6 days vs. the 10 to 14 days recommended with Zyvox, and superior cure rates in difficult-to-treat MRSA infections.

Additionally, Trius plans to make Torezolid available in both an oral and IV formulation, providing an advantage to Pfizer’s Tygacil and Cubist’s (CBST) Cubicin. These three products generated sales of over $1.4 billion in the U.S. alone in 2010, gaining sizable market share as the therapeutic window on generic vancomycin is rapidly closes. We believe physicians will quickly convert the next leap forward in the treatment of acute bacterial skin and skin structure infections
and MRSA in Torezolid.
Phase 2 Data Impresses

In 2009, Trius initiated double-blind Phase 2 study that evaluated three oral doses of Torezolid (200, 300, or 400mg) QD over 5-7 days for complicated skin and skin structure infections. S. aureus was the most common pathogen isolated in 90% of patients (139/154), and 81% were MRSA. The primary endpoint was anti-bacterial response as assessed by the investigator at 7 to 14 days post end of treatment. Investigators also assessed early response rates at days 2, 3, and 5, as well as infection relapse rate at test of cure. The data demonstrate strong efficacy on the primary endpoint of cure rate:

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The efficacy data on Torezolid looks very impressive in our view. The once-daily 5-to-7 day dosing schedule presents both patients and physicians with a high compliance and highly effective treatment for serious gram-positive infections and MRSA, regardless of infection type, presence of systemic signs of infections, and lesion size.

The data compares extremely well to Pfizer's $1.1 billion Zyvox (linezolid). We have gone back and looked at previous Phase 3 data presented by Pfizer on Zyvox, and concluded that a cure rate of 80% is about average. We encourage investors to go back and view this Phase 3 data on Zyvox, which was presented at the AAC meeting in December 2000 (#3408-3413), the ICACC meeting in June 2005 (#2260-2266), and most recently in a briefing document provided by the FDA Anti-Infective Drugs Advisory Committee meeting in November 2008. The cure rate for Zyvox noted in this briefing document was approximately 77%.

We also have compared the Phase 2 data of Torezolid with data presented in the FDA briefing document for the review of ceftaroline in August 2010. We note that ceftaroline, a product the FDA's Anti-Infectant Advisory Committee voted unanimously (21-0) to approve offers lesion healing at 74%, far below the 94% seen with Torezolid. As a point of reference, the standard of care, generic vancomycin, offers leasion healing at only 66%. The FDA approved ceftaroline in September 2010,

Phase 3 Proceeding Well

Trius is currently conducting a Phase 3 trial testing 200mg once-daily Torezolid head-to-head in a non-inferiority study to 600mg twice-daily Zyvox (linezolid). The program began enrollment in August 2010, and based on conversations with management, enrollment is proceeding very well. We anticipate the trial to complete enrollment later this year and offer data early in 2012. Trius will conduct a second IV-to-oral step-down Phase 3 trial also testing non-inferiority to Zyvox prior to filing the new drug application, which we model in early 2014. We are expecting results from a Phase 1 lung pharmacokinetic study to offer data later this quarter. If positive, this could provide even further differentiation from competitors such as Tygacil and Cubicin.

Undervalued By Any Measure

We have conducted three separate valuations analyses of Trius and concluded that the s
tock is signfiicantly undervalued at today's price.

Our first analysis looks at eight previous deals between large pharmaceutical companies and small-cap biotechs for late-stage antibiotics. These deals include:

J&J's (NYSE:JNJ) acquistion of doripenem at Penisula Pharma in 2005 for $245 million.
2) Pfizer's acquisition of dalbavancin and anidulafungin at Vicuron Pharma in 2005 for $1.9 billion.
3) Astellas' (OTCPK:ALPMF) in-license of telavancin at Theravance in 2005 for $231 million.
4) Forest Lab's (NYSE:FRX) acquistion of ceftaroline at Cerexa in 2006 for $580 million.
5) Novartis' (NYSE:NVS) in-license of PTK-0796 at Paratek in 2008 for $485 million.
6) The Medicines Co's (NASDAQ:MDCO) acquistion of oritavancin in 2009 for $138 million.
7) Forest Lab's in-license of NLX-104 at Novexel in 2009 for $305 million.
8) Cubist Pharma's acquistion of CXA-201 at Calixa Therapeutics in 2009 for $403 million.

It is clear to us this is an area of interest for large-cap pharmaceutical companies. Names such as Pfizer, J&J, Novartis, and Astellas have spent hundreds of millions of dollars over the past several years. With a potential best-in-class molecule, we believe Trius could fetch $300+ million on a take-out.

We have also conducted a DCF analysis to value Trius. Once approved, we believe the market will rapidly convert to Trius’ Torezolid product. There is clear precedence that backs up our belief. The market rapidly shifted from generic vancomycin to the more effective Zyvox a decade ago, and newer products such as Cubicin and Tygacil are gaining share on Zyvox now. Assuming FDA and EMEA approvals in 2015, we are modeling Torezolid worldwide sales of $750 million by 2020. Assuming Trius seeks to commercialize Torezolid in the U.S. on its own and partners in EU, we see net income in 2020 of $230 million, with EPS of $5.75. Based on our DCF analysis, we see Trius fairly valued at market capitalization of roughly $250 to $275 million based on these projections.

Finally, on a simple comparison to its peers, Trius looks vastly undervalued. The two closes competitors are Cubist Pharmaceuticals and Optimer Pharmaceuticals (NASDAQ:OPTR). Cubist has a market capitalization of nearly $900 million. Optimer has a market capitalization of nearly $450 million. We see Trius following down the same path as these two companies, only several years behind. The current market capitalization of Trius at just shy of $100 million significantly discounts the company's future potential.

We have concluded that a market capitalization of $250 million is fair for Trius based on the potential best-in-class characteristics of Torezolid. This equates to a price target of $10 per share. Our rating is Outperform.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.