Optimistic on Titan - Initiating Coverage With Outperform

Jun. 1.11 | About: Titan Pharmaceuticals, (TTNP)

We are initiating coverage of Titan Pharmaceuticals (NASDAQ:TTNP) with an Outperform rating and $4.50 price target. The biggest catalyst we see for the shares is the impending release of data from Titan’s second, confirmatory, phase 3 trial on Probuphine, dubbed Pro-806. Based on the impressive data from the phase 2 and previous phase 3 study, Pro-805, we fully expect the data to be positive. Management expects this data to become available in the next few weeks.

An important aspect of this second phase 3 trial will be the direct comparison of Probuphine with an open-label 12 mg and 16 mg sublingual buprenorphine tablet, Suboxone. We note that management is attempting to show an overall lower drug exposure and reduced systemic adverse events, improve retention and compliance, and non-inferiority in efficacy and patient satisfaction. Another goal of this trial is to satisfy European regulatory authorities, which require active comparators prior to approval.

Opioid addiction is a major health and social issue, especially in the U.S. An estimated 7 million people worldwide, nearly 4 million of whom are in the U.S., are abusing or addicted to opioids. We note the number of patients in the U.S. receiving methadone treatment in the last several years has remained fairly constant at about 200,000, whereas the number of patients in the U.S. receiving buprenorphine has grown to over 500,000. It is clear the market is shifting from methadone to buprenorphine thanks to its improved characteristics, such as a lower pharmacologic ceiling effect, increased safety margin, and superior therapeutic window of efficacy. Suboxone posted sales of $1.2 billion globally in 2010.

We believe Titan’s Probuphine can capture over 20% of the market from the sublingual formulation. We also believe that Titan’s commercialization partner can charge a premium price to Suboxone and Subutex because of the superior characteristics of the drug. This is easily a $500 million opportunity.

We further note there is significant upside to this figure if Probuphine is used for the treatment of chronic pain, a multi-billion dollar market in the U.S. We believe that Probuphine could address many of the issues that limit opioid use and encourage opioid abuse today. Buprenorphine is an established and approved analgesic for the treatment of acute and chronic pain. It is approximately 25-50X more potent than morphine, while also having a pharmacologic ceiling effect that provides an increased safety margin.

We see the ideal time to strike a deal for the U.S. and Canadian rights to Probuphine in the fourth quarter 2011. By that time, Titan would have presented top-line data from the Pro-806 program, submitted the full data for publication in a peer-review journal, met with the U.S. FDA for a pre-NDA meeting, and be on track to file the NDA in the first quarter 2012.

Our thesis is that partners will want to be involved in the preparation of the new drug application, so a deal will come before the actual filing. At this point it is difficult to say whether Titan will form one global commercialization partner or look to strike regional alliances. Regional deals may make more sense given differences in how opioid addiction is treated in the U.S. vs. the EU, as well as physician comfort with implantable technology like Titan’s ProNeura. We believe Titan is looking for a partner with a strong commercial presence in addiction medicine, chronic pain, or specialty CNS disorders.

An upfront payment on Probuphine could bring significant cash to Titan. Management will be looking for upfront cash, along with regulatory and sales-related milestones, and royalties on worldwide sales. Probuphine should be a very profitable drug for Titan’s partner. Gross margin should be in the 90% range. Roughly 80% of the market can be effectively targeted by a small sales force of only 40-50 representatives. We think management will look for a royalty rate in the twenties, which should allow Titan to become profitable shortly after the Probuphine launch.

Fanapt Royalties Set to Accelerate

Besides our bullish stance on Probuphine, we are also starting to see signs that the initial inventory stocking on Fanapt from the first quarter 2010 has been worked through, and we expect that reported sales at Novartis (NYSE:NVS) will start to track end user demand by the third quarter 2011. As a reminder, Titan is eligible to receive 8-10% royalty on sales of Fanapt.

Novartis paid Vanda Pharmaceuticals (NASDAQ:VNDA) $200 million upfront to license the U.S. and Canadian rights to the product in October 2009. Vanda is eligible to receive up to an additional $265 million in backend milestones. The hefty deal terms reinforce our belief that Fanapt is a $250 million product worldwide, and that Titan’s royalty will begin to substantially accelerate in the coming quarters as the product takes hold.

Valuation

We see Titan shares as meaningfully under-valued today. We believe that Fanapt alone is worth $1 per share based on the discounted future cash royalty payments. As a reminder, Titan has no ongoing costs associated with these royalties besides the credit facility payment to Deerfield Management, so the net amount is pure cash income to the company. The cash from Fanapt royalties helps management pay for the Probuphine phase 3 trial and fund general corporate expenses.

We see Fanapt royalties at $4.6 million in 2011, growing to over $16 million per year around the time of the patent expiration in April 2017. The cumulative net present value of these cash flows, assuming a modest 10% discount rate, is $58.9 million. Based on 59.3 million shares outstanding, the Fanapt royalty is worth approximately $1 per share.

Our “optimistic” scenario for Probuphine includes positive phase 3 data from the Pro-806 trial, positive meetings with the FDA later in the year, a new drug application in early 2012, and approval in late 2012 with a launch in early 2013. We expect a U.S. deal in the fourth quarter 2011, which should bring upfront cash in the area of $20 to $25 million, a similar approval milestone in late 2013, backend milestone totaling $200 million, and a 20-22% royalty on sales.

Under this scenario, we see the net present value of Titan’s cash from a deal, risk-adjusted backend milestones, and royalties on sales worth $206 million, or $3.50 per share. To account for the risk of this “optimistic” scenario, we are using an aggressive 17.5% discount rate. This is similar to the company’s cost of capital based on the March 2011 financing.

Titan should exit the second quarter 2011 with an estimated $8 million in cash. We forecast this will be enough to fund operations into the first quarter 2012. Therefore, a deal with upfront cash is important for later this year. If not, Titan may need to raise $10 million or so to keep timelines on track, as well as continue to negotiate with partners from a position of strength. We believe the company only needs an estimated $10 million to make it to cash flow positive operations based on Fanapt and Probuphine royalty payments.

Titan Pharma Sum-Of-Parts Value

Fanapt Royalties

$59

Million

Probuphine Value

$206 Million

ProNeura Technology

$10

Million

Cash To Breakeven

($10) Million

Total Firm Value

$265 Million

Shares Outstanding

59

Million

Price Per Share

$4.50

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This is our initiation of coverage. Our target is $4.50 per share. Our rating is Outperform. The biggest risk we see is the potential failure of the second, confirmatory phase 3 trail on Probuphine. If this trial were to fail to meet statistical significance, or match the positive data from the first trial, our valuation of the stock would be meaningfully impacted to the downside, and our recommendation would be under review.

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