I recently outlined a moderate-risk, high-reward opportunity in Momenta Pharmaceuticals (NASDAQ:MNTA). The rough probabilities and payoffs I estimated were an ~85% chance of a >200% gain, and a ~15% chance of a 5-60% drop. That’s a great bet, but given the risk of a large loss, not one to take a large position in. Ideally, you would want to invest in a portfolio of such opportunities so that several winners would more than offset a loser or two. Unfortunately, I don’t know of a large number of such investments, but I have found another in Pain Therepeutics (NASDAQ:PTIE).
Pain Therapeutics is a small drug development company whose most advanced clinical candidate is Remoxy, a long-acting oxycodone (an opiate pain killer) pill formulated to be difficult to abuse by recreational drug users. It is very similar to the new version of Oxycontin that Purdue Pharma got FDA approval for in April 2010. The active ingredient is the same, but the two use different formulation technologies to deter abuse.
In November 2008, an FDA advisory panel voted 11-8 in favor of approving Remoxy, but in December of that year the FDA issued a Complete Response Letter to PTIE, requesting additional information. PTIE (along with development partner, King Pharmaceuticals (KG)) announced last month that their resubmission of Remoxy had been accepted by the FDA with a response expected by June 23, 2011.
There are several reasons I’m particularly optimistic that PTIE will receive approval this June. First, at the FDA advisory panel review in November 2008 the main issues raised concerned the abuse deterrence of Remoxy (How effective was it? What claims could be put on the label? How do you manage the risks after approval?). There was no precedent for addressing these issues at the time. But now that Purdue has gotten approval for their version, there is a well defined pathway for PTIE and the FDA.
The other reasons I’m optimistic have to do what I’ll call “insider behavior” at PTIE and KG. I’ll first mention that the CEO of PTIE, Remi Barbier, owns over 14% of the shares outstanding, so at least at that level, management interests are very much aligned with shareholders. With that said, for several years PTIE has had a huge amount of cash, roughly $175 million (over $4/share), with no debt. It looked like a sort of insurance policy-- if Remoxy failed, the company could afford to start over from scratch. Then in October, management announced that it would be paying out a $2/share special dividend. In 2009, and more so in 2010, Barbier was a large seller of PTIE shares, selling over $200,000 worth almost every month last year.
Along with the announcement of the special dividend in October, the company announced that company executives had stopped their automatic stock sale plans. Both announcements suggested a new found optimism in PTIE’s prospects. Finally, PTIE announced January 28 that it had received a $5 million milestone payment from King for the filing of an Investigational New Drug application with the FDA for an abuse resistant form of oxymorphone. The original agreement between PTIE and KG allowed for the development of three abuse resistant opiate pain killers in addition to Remoxy, but for several years, there had been no advancements on any of the other drugs. So, this announcement also suggests a renewed confidence in the path forward for these drugs.
While FDA decisions are always somewhat unpredictable, based on the confidence shown by management at PTIE and KG, I’m putting Remoxy’s chances of approval at 75%. The next question then becomes, what would approval mean for the value of PTIE? PTIE will receive a 15% royalty on the first $1 billion of Remoxy sales in the U.S., and 20% on all sales after that. (PTIE will also receive 10% of sales outside the U.S., but since Remoxy hasn’t been filed outside of the U.S. yet, I’m ignoring that opportunity.) I don’t know exactly what the prospects are for Remoxy sales, but I think they were significantly improved when Pfizer (NYSE:PFE) offered to take over King.
In the announcement of the takeover offer there is an estimate for peak Remoxy sales of $500 million per year. That estimate might have been reasonable with KG promoting Remoxy, but I think sales are likely to be significantly higher with Pfizer. Here’s why. Oxycontin had sales of $2.9 billion in 2009 (.pdf), with roughly $2 billion of that in the U.S., and those sales were still growing. Remoxy has the same active ingredient, will be equally efficacious, and have similar abuse-deterrent properties. Pfizer has a well-established sales force in the pain area supporting Lyrica and Celebrex, both multi-billion dollar drugs. With Pfizer and Purdue promoting two nearly identical drugs (Remoxy, Oxycontin), I find it hard to believe that Pfizer will only reach $500 million in sales, leaving the other $1.5 billion to Purdue.
So here is a hypothetical outline of how sales might go. Let’s assume it takes 3 years to sell the first $1 billion of Remoxy (say, $200 million, $325 million, $475 million in years 1-3), providing $150 million of revenue to PTIE, plus a $15 million milestone payment for approval of Remoxy. Assuming annual operating expenses (~$24 million) and cash burn ($5 million) remain at recent levels, a 35% tax rate, and 44 million shares outstanding, PTIE will have roughly $208 million ($4.73/share) in cash at that point. That will be mid-2014 and let’s guess that Remoxy sales are expected to be $600 million over the coming 12 months, with PTIE receiving 20% ($120 million). Net income over those 12 months will be ~$62.4 million ($1.42/share), and a 15x multiple gives $21.27/share, plus cash gives $26/share. And I point out that this doesn’t attach any value to possible sales outside of the U.S. or the possibility that PTIE’s other pain drugs advance through the clinic.
$26/share represents over a 300% gain from recent levels around $6.16, but what is the downside? If Remoxy were not approved, PTIE could fall as low as $2 given current cash levels of just over $2/share. Ultimately I think it would recover some from there, as PTIE could probably re-file Remoxy again, and they do have a cancer drug in Phase 1 clinical trials. But let’s call the downside $2. So overall, I’m estimating a 75% chance of a 300+% gain and a 25% chance of a 68% loss. But there is also an option strategy to limit the downside. July $5.50 puts on PTIE (expiring ~1 month after PTIE expects to hear from the FDA on Remoxy) can be had for $1.00. So for roughly $7.16/share ($6.16/share + $1.00 per option) you get good odds on a modestly reduced (~260%) gain, but losses are limited to $1.66/share, or 23%.
This is still a fairly risky trade, but the upside far outweighs the down if my estimates are roughly correct. Combined with the Momenta trade described here, the odds of a loss on both drop below 5%. If just one of the two pays off, you’re still left with a gain of over 100% in a few years. If both pay off, even better.
Disclosure: I am long PTIE.