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Transcept’s (NASDAQ:TSPT) new drug for insomnia, Intermezzo, received a Complete Response Letter on October 26, 2009, in which the FDA acknowledged that it was effective. However, the agency failed to approve the drug because of concerns about dosing and potential next day residual effects. Transcept addressed, and in my opinion, has successfully answered these issues in a resubmission of the NDA, whose PDUFA date is July 14, 2011. I believe that the FDA will grant approval on that date, but the FDA has become an extremely risk adverse on safety issues and there can be no certainty.

I subjectively assess the odds of receiving approval at better than 80%. In that event, I think that the stock price could increase 30% to 60% from the current level of $8 to perhaps $10 to $13. The market capitalization is currently $108 million. If I am wrong and the FDA issues another complete response letter, I think that the stock could sell at a 20% or greater discount to the current cash level of $4.30 per share, i.e $3.25 or less.

If I am right and the product is approved, what happens next? One of the problems for investors in small biotechnology stocks is that gaining reimbursement for a newly approved drug has become a slow and arduous process in which sales progress in the first year can be modest. Two recent examples are Somaxon’s (NASDAQ:SOMX) launch of its insomnia drug Silenor and NeurogesX’s (OTCPK:NGSX) launch of the capsaicin pain patch Qutenza. Concern that uptake may be slow could cause the stock to flatten or decline following the expected bounce on approval as investors wrestle with the question of how quickly sales will take off.

I estimate that the addressable market for the middle of the night awakening (MOTN) market in the U.S. is $1 billion or more: Intermezzo would be the only drug approved for this indication. I have to admit that I have no great confidence in my estimates on how rapidly sales will ramp. I am assuming a launch in 3Q of 2011 with only minimal sales of $8 million in 2011. My 2012 sales estimate is $50 million and my 2013 estimate is $125 million. These estimates are lower than Street estimates for 2011 of $20 to $25 million; for 2012 of $80 to $120 million; and for 2013 of $175 to $250 million.

Barring a generic launch, I could see sales reaching $500 million in 2016. Transcept has licensed Intermezzo to Purdue Pharma in the U.S. under a royalty agreement and has retained certain co-marketing rights. On my estimate for achievable U.S. sales of $500 million in 2016, I can project a potential range EPS of $1.75 to $2.50 depending on how agressively the company decides to spend on S, G & A and R&D.

Investors will also debate the intellectual property position of the company. Intermezzo is based on a generic drug zolpidem (Ambien) and does not have composition of matter patent coverage. There are two issued patents that describe the delivery of hypnotic agents across the oral mucosa and methods of use thereof. These expire in 2025 and 2027, but are not particularly strong patents. In May of 2011, Transcept received a notice of allowance of a patent that specifically covers the use of an oral formulation of zolpidem that is suitable for oral absorption and is to be used to treat MOTN. This patent is somewhat stronger, is expected to issue this year and could provide more meaningful protection though 2028. It is almost a certainty that a generic company will launch a paragraph IV challenge to Intermezzo within a half year or year of launch. In the worst case scenario, this could lead to a generic entry three years after launch or late 2014. I am still trying to assess this situation and don’t have a lot of confidence in predicting what will happen.

See here for a more in-depth report describing the reasoning behind these comments and estimates.

Source: What Happens After Intermezzo's Likely FDA Approval