Top Biotech Pick For 2012: Zogenix

| About: Zogenix, Inc. (ZGNX)

Tis the season to look for top picks for maximum gains in 2012. In the biotech space, one needs to look no further than the San-Diego based specialty pharmaceutical company, Zogenix (NASDAQ:ZGNX). What began as a small, private start-up in 2006 has developed into a thriving public company focused on treating central nervous system disorders and pain. Key ZGNX developments and assets include:

  1. FDA approved drug, Sumavel DosePro, with triple digit year-over-year U.S. sales growth.
  2. Positive Phase 3 results for a second drug, Zohydro, seeking FDA approval.
  3. New Drug Application (NDA) for Zohydro to be submitted to FDA in Q2 2012.
  4. Licensing deal agreement for a third drug, Relday, seeking FDA approval.
  5. $70 million in cash on balance sheet
  6. Huge insider buying at 2010 IPO and at September 2011 follow-on offering
  7. Institutional ownership increased by 18,109,313 shares in Q3 2011.

What also makes Zogenix so attractive as a top biotech stock pick for 2012 is the likelihood that ZGNX’s depressed stock price ($2.19 at time of this writing) will return to the valuation it commanded just a year ago at $6.90 (52-week high reached shortly after IPO) when it had only one (#1) of the seven bullish attributes listed above.

So let’s take a look at the three things that make Zogenix an undervalued biotech gem for 2012: top management, valuable drug assets, and major insider & institutional funding.

1. Zogenix’s Top Management

A big key to Zogenix’s early success is its founder, Cam Garner. Garner is one of the best in the business at creating and growing specialty pharmaceutical companies into attractive acquisition targets for bigger pharma. His track record of success is legendary as illustrated by taking his profitable business model to tiny Dura Pharmaceuticals (valued at $5 million when Garner took the helm) and executing a strategy that resulted in Dura being acquired a decade later by Irish drugmaker Elan Corp. (NYSE:ELN) in a stock deal worth $1.8 billion.

That Dura business model has been replicated in multiple Garner creations in the years since his 2000 Dura transformation resulting in similar outcomes - premium takeovers greatly benefitting early investors. Examples include Cam Garner-founded companies DJ Pharma (sold to Biovail Corp. for $212M), and Xcel Pharmaceuticals (sold to Valeant Pharmaceutical for $282M).

Garner’s successful model is built upon picking a strong management team first. Second is finding a niche market and product to sell. And, third is focusing your sales efforts on doctor specialists (instead of primary care physicians) who work in your niche market.

The top seats of management at Zogenix are filled with many trusted, former Elan Pharmaceutical alums that worked alongside Garner at Elan after the Dura acquisition. The first recruits were pharmaceutical industry executive sales veteran, Richard Hawley (Zogenix CEO since August 2006), and drug development expert Stephen J. Farr (Zogenix President since May 2006). Later on, more management seats were filled by top-notch Elan alums Mark Thompson (VP, Sales and Managed Markets), Stephen Jenner (VP, Marketing), and Cynthia Robinson (Chief Development Officer).

After Zogenix got venture capital from founding investors Cam Garner, Jim Blair (Domain Associates), Scott Glenn (Windamere Ventures), David Hale (Hybritech Founder), Clarus Ventures, Thomas, McNerney & Partners, Abingworth Management, Chicago Growth Partners, and Scale Venture Partners, the team identified the products to acquire and sell.

2. Zogenix’s Valuable Drug Assets

Sumavel DosePro (Drug Asset #1)

The choice of Stephen Farr as the first President of Zogenix was a big clue to what product and niche market Cam Garner and company had their eye on. Farr was recruited from Aradigm Corporation where he served as Senior Vice President and Chief Scientific Officer. In 2003, Farr led the effort at Aradign to identify and acquire the novel drug delivery technology now called DosePro. He also led the development of DosePro’s application for the drug, sumatriptan, for the treatment of migraines.

Just three months after its May 2006 founding, Zogenix acquired the product, Intraject Needle Free Technology (later to be renamed DosePro) and related assets from Aradigm Corporation for $4 million.

In just 18 months after acquiring this technology, a New Drug Application (NDA) for sumatriptan DosePro was submitted to the FDA. Just over a year later, the FDA approved Sumavel DosePro needle-free delivery system to treat migraine headaches.

As of January 2010, Sumavel DosePro is now being commercially sold in the U.S. and Europe as the first single use, needle-free product for treating acute migraine and cluster headaches. Sumavel unit sales and prescription sequential growth have been very robust in this $3.5B market.

Sales growth of Sumavel DosePro since FDA approval:

Q1 2010: $1.9M

Q2 2010: $4.2M

Q3 2010: $5.7M

Q4 2010: $6.8M

Q1 2011: $7.5M

Q2 2011: $8.7M

Assuming that Sumavel DosePro can gain a conservative 1% share of the 12.2 million triptan prescriptions per year, this translates into annual Sumaval revenue of $59 million according to Zogenix’s projections. Regulatory approval to market Sumavel DosePro has also been granted in Germany, United Kingdon, Denmark, Sweden, and Norway.

Zohydro, Deal With Elan (Drug Asset #2)

While Sumavel DosePro was undergoing clinical trials in 2007, Zogenix was moving forward on its second drug development opportunity. Thanks to the familiarity of Elan’s drug pipeline by Zogenix’s founder and management, Zogenix moved to strike a license agreement deal with Elan Corporation to develop and commercialize a late stage, controlled-release opioid (now called Zohydro) for the treatment of pain. This drug opportunity was attractive because hydrocodone is the most widely prescribed drug in the United States representing a $13B market opportunity.

Pivotal phase 3 clinical trials began in March of 2010, which resulted in positive efficacy and safety results. We are now one quarter away from Zogenix’s second New Drug Application (NDA) submission scheduled for early Q2 2012. If Zohydro is approved, it would become the first acetaminophen-free, oral, single-entity hydrocodone, 12-hour extended release formulation on the market.

The likelihood of FDA approval for Zohydro is high for the following reasons:

Positive Phase 3 Trial Results, expressed this way by Chief Executive Officer Hawley of Zogenix, "These positive results represent an important step forward in the commercialization of our extended-release hydrocodone. Adding Zohydro as our second commercial product would be transformational for Zogenix's business, given the number of chronic pain patients and the growing physician demand for an acetaminophen-free hydrocodone product.

Acetaminophen-free formulation. The FDA is very concerned with the liver toxicity acetaminophen (APAP) can cause. In January 13, 2012, the FDA asked all drug manufacturers to limit acetaminophen in drugs on liver health concerns.

Zohydro will be the first acetaminophen-free hydrocodone product if approved. It will also be the first extended release (12 hours) single-entity hydrocodone.

Assuming that Zohydro can gain 1% market share of the 128 million hydrocodone prescriptions per year, this translates into annual Zohydro revenue of $248 million, according to Zogenix’s projections. Zogenix would enter the largest prescription drug category in the United States, hydrocodone pain products. Over 128 million prescriptions were filled in this drug category in 2010 representing a $7.5 billion market opportunity.

Relday, Deal with DURECT (Drug Asset #3)

And if Zogenix was not busy enough with the Zohydro New Drug Application and growing Sumavel DosePro sales this year, it has also recently inked another deal with DURECT Corporation to develop and commercialize a proprietary, long-acting injectable formulation of risperidone using DURECT’s SABER controlled-release formulation in combination with Zogenix’s DosePro needle-free drug delivery system.

Zogenix will initiate clinical studies for this new product candidate (Relday) in early 2012 after it files its third NDA since the inception of the company in 2006. The combined market opportunity for oral and injectable antipsychotic products is estimated at more than $16B in 2010.

Relday is an example of the unlimited partner licensing opportunities available with the DosePro technology.

3. Huge Insider Ownership and Recent Buying

This may seem like a remarkable achievement for a start-up company in such a short amount of time, but that is exactly how Cam Garner and company have planned and executed management recruitment, product identification and acquisition, and commercial sales growth many times over. It is a winning formula.

This successful model has attracted a loyal insider investor base who have continued to add to their Zogenix holdings at every opportunity and without selling a single share to date. In addition to the early Series A & B rounds of funding when Zogenix was still privately held, these same insider founding funders have added more to their positions in two subsequent public offerings.

The first public offering was in November 2010 when Zogenix held an IPO resulting in the sale of 14, 436,493 shares priced at $4.00 for gross proceeds of $57.7 million. The early investors’ preferred shares were converted to common stock in the deal yet they also continued to add to their positions by buying nearly half of the offering at $4.00/share. Most notable insider (board members) buys at this IPO were:

Domain Partners (Jim Blair, Director); 2,349,999 shares bought at $4.00

Scale Venture Partners (Louis Bock, Director); 1,839,645 shares bought at $4.00

Clarus Ventures (Kurt Wheeler, Director); 1,750,000 shares bought at $4.00

Chicago Growth Partners (Arda Minacherhomjee, Director); 550,000 shares bought at $4.00

Cam Garner (Chairman of Board); 30,000 shares bought at $4.00

And most recently in September 2011, Zogenix raised more capital via a follow-in offering of 30,000,000 shares priced at $2.00. The $56.9 million in proceeds would fund the regulatory approval of Zohydro, the initial clinical trial of Relday, and the ongoing commercialization of Sumavel DosePro.

In this recent offering, the committed insiders (board members and executive management team) again added to their ZGNX holdings by buying 9,165,000 shares out of the 30,000,000 shares offered. Most notable insider buys at $2.00 were as follows:

Domain Partners (Jim Blair, Director); 3,500,000 shares bought at $2.00

Clarus Ventures (Kurt Wheeler, Director); 3,500,000 shares bought at $2.00

Scale Venture Partners (Louis Bock, Director); 1,250,000 shares bought at $2.00

Ann Rhoads (CFO, Zogenix); 100,000 shares bought at $2.00

Richard Hawley (CEO, Zogenix); 50,000 shares bought at $2.00

And if those insider buys were not enough validation to the 2012 potential of Zogenix’s growth and stock price appreciation, institutional ownership in ZGNX skyrocketed in Q3 2011 by 18,109,313 shares to reach 25,250,372 shares, or 38% of outstanding shares.

The future looks very bright for Zogenix in 2012 due to the strong execution of management, near-term catalysts with drug assets (NDA submission for Zohydro, sales growth of Sumavel DosePro, new partner agreements, etc.) and strong funding support. These fundamental strengths along with likely buyout speculation should propel ZGNX stock back over $6.00 for a healthy 3-bagger gain.

For those reasons (and more to come in a second ZGNX article), Zogenix is my top biotech pick for 2012.

Disclosure: I am long ZGNX.