Cempra Is Dead, Long Live Cempra!

| About: Cempra, Inc. (CEMP)

Summary

Cempra has lost ~75% of its value in the past month in the wake of manufacturing issues and a mixed FDA Advisory Committee meeting for its lead product, Solithromycin.

Multiple pathways exist for Solithromycin ahead of its late-December PDUFA date, with potential upside if the FDA allows a near-term launch without requesting additional studies.

Despite being short Cempra into the the FDA Advisory Committee meeting, I believe the market has overreacted, and Cempra is a potentially attractive long opportunity near current prices based on risk/reward.

Background

Cempra (NASDAQ:CEMP) is developing Solithromycin (under the proposed name of Solithera), a fourth-generation macrolide antibiotic for the treatment for the treatment of Community Acquired Bacterial Pneumonia (CABP) as the lead indication, with others potentially to follow. The company has filed New Drug Applications for Solithromycin oral and IV formulations to treat CAPB, with PDUFA decision dates set for December 27 and 28.

Cempra and Solithromycin have had a difficult time lately, after issues were identified at a contract API manufacturer and a mixed FDA Advisory Committee that highlighted safety concerns but did narrowly vote 7-6 in favor of Solithromycin approval. As a result, the stock price has declined from its 52-week high of $34 to the current price near $6-7 a share as investors attempt to digest uncertainty over the future of Solithromycin.

Although I had previously been publicly negative on Cempra (and short the stock into the FDA Advisory Committee meeting), I now believe the market has overreacted and that Cempra presents a potentially attractive opportunity on the long side at current prices ahead of the upcoming PDUFA dates.

What are the possible outcomes for the December PDUFA dates?

I see four possible outcomes from the upcoming PDUFA date:

Scenario #1: Approval and Launch in 2017

Scenario #2: CRL with No New Clinical Studies (Launch 2018)

Scenario #3: CRL with New Clinical Studies (Launch 2020)

Scenario #4: CRL and No Path Forward

What is Cempra worth under these various Solithromycin scenarios?

The current market for CABP is about 10 million prescriptions a year. The company has suggested that a price of $400-500 for a course of therapy is supportable, and this suggests a market opportunity of $4.0-5.0 billion.

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Source: Cempra investor presentation

For all scenarios, I conservatively assume Solithromycin can capture 10% share in five years after launch at a net price of $400 per TRx after discounts, rebates and COGS. For expenses, I assume $100 million a year until launch, increasing to $200 million a year after launch to reflect the increased cost of commercial infrastructure. I also include the current NOLs through 2015 of $250 million, $250 million in cash and assume a 10% cost of capital to determine a current valuation based on discounted cash flow.

Scenario #1: Approval and Launch in 2017

In this scenario, the FDA would outright approve Solithromycin, but likely with multiple label restrictions (e.g., Black Box warnings) and a comprehensive Phase IV and/or REMS program to monitor safety. I assume the manufacturing issues are resolved to support a launch in 2017. The current $250 million cash should be adequate to reach positive cash flow. Using the assumptions above, this yields a current valuation of ~$17.5 a share.

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Scenario #2: CRL with No New Clinical Studies (Launch 2018)

In this scenario, the FDA would issue a CRL reflecting manufacturing issues, but would not request additional clinical studies, instead putting in place multiple label restrictions (e.g., Black Box warnings) with a comprehensive Phase IV or REMS program in place to monitor safety post approval. I assume the time to resolve manufacturing issues and re-file the NDA delays the launch until 2018. The current $250 million cash should be adequate to reach positive cash flow. Using the assumptions above, this yields a current valuation of ~$15.8 a share.

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Scenario #3: CRL with New Clinical Studies (Launch 2020)

In this scenario, the FDA would request Cempra conduct additional Phase 3 clinical study(s) similar in size/duration to the prior studies in order to secure approval. I assume this would delay approval until 2020. Since it requires an additional ~$250 million in financing beyond the current $250 million in cash, I zeroed out the current cash from the valuation. Using the assumptions above, this yields a current valuation of ~$4.8 a share.

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Scenario #4: CRL and No Path Forward

In this scenario, the FDA would request Cempra conduct a major clinical study looking at the long-term safety in 20,000+ patients in order to secure approval. This would likely prove to be cost-prohibitive, and further development would be terminated. In this case, I believe the stock would likely trade close to its current cash level of ~$250 million in cash. Given 52.4 million shares outstanding, the value of the cash is ~$4.8 a share.

What is the current market price suggesting?

Looking across all four scenarios, they really separate out into two sub-scenarios. The first is a near-term approval with no additional clinical studies (Scenarios #1 and #2) that support a valuation of $15-18 a share. The other is the FDA requests additional clinical studies (Scenarios #3 and #4) that support a valuation near $4-6 a share.

At current prices near $7 a share, the market is pricing in ~80% odds that the FDA will request additional studies and delay launch (~$5 a share outcome) and ~20% odds of a near-term approval (~$15 a share outcome).

My take

There is a need for new antibiotics to treat CAPB, due to emerging resistance and safety issues with existing drugs. Further, it is difficult to truly assess safety within clinical trials compared to widespread use in a broader post-market patient population. Because of this, I believe the market is placing too high of a probability that Solithromycin launch is delayed by years or never comes to market.

I think the most likely outcome is that the FDA will issue a CRL due to manufacturing issues, but will not require additional clinical trials, supporting a launch probably in 2018. The case for a CRL related to manufacturing issues is supported by recent CRLs for Valeant's (NYSE:VRX) latanoprostene bunod and Ocular Therapeutix's (NASDAQ:OCUL) Dextenza. If I am right, I believe shareholders at current prices will likely be rewarded. If I am wrong, there is likely downside, but significantly less compared to the 80% downside that is typical for a small biotech heading into an FDA PDUFA date.

Disclosure: I am/we are long CEMP.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.