Somaxon Pharmaceuticals: Will FDA Approval Ever Pay Off?

Includes: PG, SOMX
by: Kinetic Investments

It has been nearly a year since Somaxon Pharmaceuticals (NASDAQ:SOMX) received FDA approval for its lead product, Silenor, for the treatment of insomnia characterized by difficulty with sleep maintenance.

After the approval announcement Somaxon's stock more than doubled, analysts raised their price targets, there was a successful secondary offering to fund the upcoming drug launch, investors were enthusiastic, and Silenor was destined for commercial stardom.

Or so it seemed ...

In the 10 months since Silenor's March 2010 approval, Somaxon's investors have painfully witnessed a "slow bleed" from its short lived intra-day high of $10.60 all the way down to its November intra-day low of $2.52, only to watch it crawl into its current two month range of $2.70 - $3.40.

(One-year chart can be accessed here.)

Apparently FDA approval is not a guarantee of ever increasing shareholder value. So what caused this stock's decline and made it such an attractive target for short sellers?

I'll give you the short's short list:

  • The drug's active ingredient, doxepin hydrochloride, has been around for decades and was previously used in much higher doses as an anti-depressant.
  • The exact mechanism by which Silenor exerts its sleep maintenance effect is unknown.
  • The company did not have an established sales force or experience bringing a new drug to market.
  • When a partnership with Proctor & Gamble (NYSE:PG) finally materialized, it was widely viewed as unfavorable and many felt it was too little, too late.
  • Cash burn surrounding the drug's launch was higher then expected, necessitating further dilution before the company could even begin to generate meaningful revenues.
  • The company was faced with multiple ANDA filings under PIV just months after the drug's launch and was left no choice but to initiate costly litigation.

So where's the upside to this stock, you ask?

If a key patent (or the legal system) fails Somaxon, the earliest possibility of generic competition comes in 2013. This allows the company more than two years to generate revenues, find a way to extend its market exclusivity, and "explore strategic alternatives." It should be noted that an analyst recently suggested that 2012 sales could exceed $150M (the current market cap is $101M).

A favorable court ruling, however, would be a definitive "game changer" as the threat of generic competition could be eliminated until 2020. I imagine such news would lead to a bit of short covering, a sharp spike in PPS, and a good opportunity to take some profit.

Why pick Silenor over its competition?

Doctors like to prescribe effective, safe and non-habit forming drugs. When the safety and side effect profiles are compared to those of some of its competition in the crowded prescription sleep aid market, Silenor could almost be mistaken for a chewable children's vitamin. While Silenor's "sleep onset" data also matches up well, it is the "sleep maintenance" effectiveness that sets it apart from its peers. The fact that three major generic drug makers were so quick to challenge Silenor's patents only solidifies my belief that it is a superior product. For more on Silenor, click here.

Somaxon Pharmaceuticals may seem to be fighting an uphill battle as I write this, but I believe that its patents will ultimately hold and its sales and marketing partnership with Proctor & Gamble will eventually pay off. While it's hard to imagine this stock reaching $10.60 again any time soon, I believe it will vastly outperform its sector in 2011.

I would think that anyone with an average under or around $3.00 is sleeping just fine these days and should look forward to seeing some healthy gains as the year rolls on and sales roll in.

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

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