Vivus's Qnexa And Its Potential Value

Feb.24.12 | About: Vivus, Inc. (VVUS)

Vivus's (NASDAQ:VVUS) chances of getting FDA approval for Qnexa, its investigational drug combination for obesity, have never looked better. To suggest that the process has been difficult would be to say that War and Peace is a little wordy or that Michael Jordan could play a little ball.

Nevertheless, a surprisingly positive panel vote has investors excited that the FDA very well may approve the first prescription drug for obesity in over a decade. The question investors may want to ask then, aside from what the chances are that the FDA goes along with its panel, is how much appreciation potential may be left in the shares.

Assessing The Odds Of Approval

All three would-be contenders in the prescription obesity market have had serious issues getting their drugs through the FDA approval process. Arena Pharmaceuticals (NASDAQ:ARNA) has been set back by concerns about cancer, cardiac risk, and a relatively low rate of efficacy for Lorqess. With Orexigen (NASDAQ:OREX), the efficacy of Contrave has also been a concern (though it seems more effective than Arena's Lorqess), but the FDA was even more concerned about the side-effect profile and cardiovascular risk - so much so that it ignored a narrowly favorable panel recommendation and demanded a large CV outcomes study before reconsidering the drug.

For Qnexa, the issue has never really been efficacy - everybody seems to agree that it works, and works well enough to be worthwhile. The issues, though, have been the familiar ones -- cardiovascular and cancer -- as well as risks tied to potential birth defects.

With the 20-2 panel vote, though, it seems that the experts selected by the FDA are on board with the risk-benefit trade-off on Qnexa. Birth defects are still a concern, but even the FDA itself seems reasonably pleased with the risk mitigation strategy proposed by the company.

The big hang-up will be the CV risks. The FDA is well-nigh obsessed with the cardiovascular safety profile of obesity drugs, even though simply being obese is in itself a serious risk to long-term cardiovascular health. Although the panelists seemed content with the requirement for Vivus to run a large post-approval CV outcomes study, there is a risk (I will estimate 1-in-3) that the FDA turfs this panel vote and demands a large CV outcomes study before granting final approval. Remember, the FDA did this with Orexigen, and it also surprisingly demanded a large CV study from Amylin (AMLN) before approving its diabetes drug Bydureon, even though CV risks hadn't been an issue earlier in the approval process.

Yes, the FDA is under intense public pressure to approve a drug that can help the 80 million or so obese adult Americans. That said, the FDA has been burned badly before on obesity drugs, and the agency also arguably has a duty to show a certain amount of internal consistency in its decisions. Accordingly, I would not treat FDA approval as fait accompli just yet.

What Is Qnexa Worth?

Whether or not the FDA demands a CV study before approval, I do believe Qnexa will eventually make it to the market (in other words, a "when," not "if" question). With that in mind, it's very much worth assessing what this stock may be worth.

In order to get a sense of the potential value, I ran a scenario analysis based on projected sales, profitability, and market valuations. Allow me a moment to explain the inputs and the logic of the approach.

I started with an assumption of 80 million obese Americans - lower than the 100 million number thrown out by many analysts, but consistent with the CDC's estimate of 33% of the adult population. I used an estimate of $1,500 in annual Qnexa costs ($125 per month). I then made projections of Qnexa's market penetration six years from today (early 2018).

For purposes of legibility, I excluded the detailed estimates on gross margin, SG&A, and R&D, and instead presented a range of operating margins based on a large group of comparable biotech companies including names like Amgen (NASDAQ:AMGN), Celgene (NASDAQ:CELG), Alexion (NASDAQ:ALXN), Cubist (CBST) and Vertex (NASDAQ:VRTX). I then provided a range of multiples to the operating income and an estimated share count. Lastly, I discounted these results back at a rate of 20%.

The results are as follows:

Low Low-Med Med High CV
Annual cost ($) 1,500 1,500 1,500 1,500 1,500
% penetration 0.5% 1.0% 2.0% 5.0% 1.0%
# of users ('000) 400 800 1,600 4,000 800
Revenue ($, '000) 600,000 1,200,000 2,400,000 6,000,000 1,200,000
Op margin - low 25% 25% 25% 25% 25%
Op margin - med 30% 30% 30% 30% 30%
Op margin - high 35% 35% 35% 35% 35%
Op inc - low ($, '000) 150,000 300,000 600,000 1,500,000 300,000
Op inc - med ($, '000) 180,000 360,000 720,000 1,800,000 360,000
Op inc - high ($, '000) 210,000 420,000 840,000 2,100,000 420,000
Multiple - low 8 8 8 8 8
Multiple - med 12 12 12 12 12
Multiple - high 16 16 16 16 16
Est. shares out. 95,300 95,300 95,300 95,300 95,300
Discount rate 20% 20% 20% 20% 20%
Implied VVUS share price:
Low scenario 4.22 8.43 16.87 42.17 4.88
Med scenario 7.59 15.18 30.36 75.91 8.79
High scenario 11.81 23.62 47.23 118.08 13.67
Click to enlarge

As you can see, I also included a column ("CV") to show the potential impact if approval and launch is delayed by three years due to a demand from the FDA for Vivus to run a pre-approval CV outcomes study.

I find it interesting how quickly the numbers scale up. Based on the demonstrated efficacy of Qnexa, I find it hard to believe that it would garner less than 1% of its target market (the 80 million obese Americans), unless either Arena or Orexigen get approval and significantly split the market among them - an outcome I find quite unlikely given the efficacy of Arena's Lorqess and the side-effects of Orexigen's Contrave.

Personally, I would assign a one-third-probability of the "CV - Medium" outcome and a two-thirds probability of the "Medium-Medium" outcome, suggesting fair value today in the area of $23 (very nearly the closing price on February 24). Please note, though, that this includes no additional capital demands for that potential CV study, no explicit contribution from overseas sales of Qnexa (nor from any other indications), nor any value to Vivus' erectile dysfunction drug, avanafil (which I believe is presently worth about $0.50 to $2.00 per Vivus share).

The Bottom Line

I have long had my doubts on whether the FDA would allow any of this current generation of obesity drugs to hit the market, but it seems like Vivus has gone a long way towards satisfying the FDA's own panel of chosen experts. While I still believe that a pre-approval study is a risk that investors cannot ignore, I do believe that Qnexa will eventually hit the market as an approved drug to treat obesity.

After Qnexa, it will be a toss-up to see whether there is a second drug to hit the market and succeed. Even if Orexigen's Contrave can pass its CV outcomes study, the side-effect profile could limit its commercial potential. Likewise, I think Arena is the longer shot of the three - perhaps not so much from a safety/approval standpoint, but from the perspective of its lower efficacy. That said, if Qnexa is contra-indicated for women of child-bearing age, this could be a niche that Lorqess can fill.

While the scenario analysis I presented is admittedly simplistic and limited, it does suggest that Vivus shares could still be significantly undervalued relative to the potential of Qnexa. It also highlights the potential risks if approval is delayed, if competing drugs grab share, or if the drug simply fails to resonate with the market. As always, do your own due diligence and decide accordingly.

Disclosure: I am long AMLN.