For the most part, a company actually missing estimates on an operating basis and significantly increasing estimated expenses for the next year is enough to drive the stock down. Salix Pharmaceuticals (SLXP) is not an ordinary stock, though, and investors seem happy to look past the near-term turbulence in favor of the long-term opportunity in this focused specialty pharmaceutical company.
A Mixed End To The Fiscal Year
To its credit, if there's a good way to miss earnings, Salix pretty much found it. Revenue rose over 30% for the quarter (with sales of lead drug Xifaxan up 29%) and gross margins were flat. That the company exceeded estimates for SG&A spending and missed sell-side analyst estimates for operating income by about 10% was pretty much moot against the 40% overall growth and the ongoing momentum in its class-leading drug.
Right now the Salix story is about revenue growth and the potential leverage coming from additional product launches. Consequently, lower guidance that seems driven by increased sales efforts is really not bothering anybody all that much. And that's the story for 2012 guidance - management seemed a little conservative about revenue growth, but the roughly 25% increase in expense guidance (relative to prior expectations) seems logical relative to the prospects of driving higher sales in indications like hepatic encephalopathy (HE).
Managing The Xifaxan Story
Investors got a little nervous recently when the FDA issued draft guidance that would seem to make generic competition for Xifaxan a little easier. Xifaxan is currently very nearly 70% of Salix's revenue with approval in traveler's diarrhea and HE. Although there is an orphan drug designation that protects the drug out to 2017, investors have been worried that the patent coverage (which ostensibly stretches into the mid-2020's) may not be sufficient.
To that end, the FDA's guidance is a boost for Teva (TEVA), Mylan (MYL) or whomever else decides to try to overturn the patents in court. While a generic wannabe will have to establish efficacy in a clinical study in traveler's diarrhea, the HE indication will just require a subsequent pK study. Although this sounds bad for Salix, the fact is that bioequivalence studies could prove tricky for Xifaxan (it has a peculiar uptake in the body) and Salix will certainly fight to protect its patents.
Although generic competition spooked some investors recently, the long-term potential for Xifaxan remains quite strong on the basis of its potential approval for irritable bowel syndrome. Although the FDA sent the company back to the drawing board in 2010 (demanding a new trial), the data thus far has been encouraging.
What's more, irritable bowel syndrome is one of the Marie Celestes of the drug world - for whatever reason, programs here just don't seem to work out. Novartis (NVS) ended up pulling Zelnorm and Glaxo (GSK) bailed on Lotronex and sold it to Prometheus Labs. Although Lotronex is technically available, it's tightly restricted and Sucampo's/Takeda's Amitiza is the only other approved drug targeted for this indication.
Forest Labs (FRX) has filed for approval of linaclotide (which it developed with Ironwood), but it looks like the IBS market will be hardly over-saturated if and when Salix can get approval (perhaps late 2013 or early 2014). Based on the data seen to date, so long as the safety profile is relatively clean, an IBS indication could make Xifaxan a $2 billion-plus drug.
Other Pipeline Stories Worth Telling
Salix isn't solely about Xifaxan. The Solesta product it acquired with Oceana (for about $300 million) could be a $500 million a year product in fecal incontinence and rare competition to Endo Pharmaceuticals' (ENDP) AMS business in that market.
In addition to products for ulcerative colitis, chronic diarrhea, and reflux, Salix is also developing an oral form of Relistor under license from Progenics (PGNX). If this drug works out, and Phase 3 studies showed efficacy similar to injected Relistor (which is approved), it could be a billion-dollar drug, albeit one with only limited protection vis a vis Hatch-Waxman exclusivity. Investors should keep in mind, though, that potential competition from Theravance (THRX) and/or Nektar (NKTR)/AstraZeneca (AZN) could diminish this potential somewhat, but Salix should have a lead in terms of launch dates.
The Bottom Line
Salix was not cheap before this earnings report and the positive response to earnings certainly hasn't made it any cheaper. That's a bit frustrating to investors like me who might have wanted to pick some shares up on the cheap if the market overreacted to the earnings report.
That said, I'd hardly say the story is over for investors willing to take an optimistic or aggressive look at the company's future sales and cash flow potential. Salix absolutely needs FDA approval to sell Xifaxan for IBS for the stock to work from here, but the combination of Xiafaxan and oral Relistor (and no unexpected disasters with patents) could drive better than 20% annual revenue growth out through 2016.
So, in some respects then, this is just like most biotech stories - if the trial results are good and the FDA is cooperative, the stock is worth a lot more than today's price. If the trials go against the company, there will be a big sell-off and this is a name best avoided. At this point, I'd rather be on the long side of that binary bet.