Is AEterna Zentaris Really Worth All This Fuss?

 |  About: AEterna Zentaris, Inc. (AEZS), Includes: AMGN, BMY, KERX, RHHBY, SNY
by: Stephen Simpson, CFA

As a general rule, if you want to get the hate mail rolling in, write about a controversial biotech stock. And since I'm feeling a decided lack of people questioning my intelligence, ethics, and consanguinity of my parents, I thought I would wade into the maelstrom that is AEterna Zentaris (NASDAQ:AEZS).

A New Contender For A Sizable Market

Treatment-resistant cancers are a popular target for biotechs and pharmaceuticals these days, as the thresholds of approvable efficacy tend to be more reasonable and the lack of alternatives usually supports very profitable pricing. One of the larger markets within this group is resistant colorectal cancer; although colorectal cancer is generally very treatable if caught early, not all patients are so lucky and the sheer frequency of the cancer makes the treatment-resistant population sizable.

AEterna Zentaris does have several other drugs in its pipeline (more on those later), but the alpha and omega for now is perifosine - an oral drug that inhibits Akt activation. Put very simply (and perhaps too simply), perifosine interferes with signaling within cancer cells and prompts them to die (apoptosis) and seems to enhance the efficacy of other cancer-fighting drugs.

With close to 125,000 eligible patients each year in the U.S. and Europe combined, this is very much a worthwhile market. AEterna's marketing and development partner Keryx (NASDAQ:KERX) is handling the trials, and the drug is presently in a pivotal Phase 3 study called X-PECT. Results are expected shortly (March or April of this year).

Should the drug get approved, there is a good chance that it could become the drug of choice for the 2nd/3rd line colorectal cancer market. Perifosine would compete there with Xeloda and Avastin from Roche (OTCQX:RHHBY) (Xeloda is being paired with perifosine in the Phase 3 X-PECT study), Eloxatine from Sanofi (NYSE:SNY), Erbitux from Bristol-Myers Squibb (NYSE:BMY), Vectibix from Amgen (NASDAQ:AMGN). Other drugs under development for similar applications include (and are not limited to) aflibercept from Sanofi and Regeneron and brivanib from from Bristol-Myers.

And Now The Controversy

Every biotech has to deal with the risk that any given drug simply does not work, or does not work well enough (or safely enough) to get FDA approval. In the case of bulls and bears on perifosine, it's pretty much all-out war.

Bulls point to Phase 2 data on the drug that showed strong survival benefits (eight months or more) in groups that got the drug. Skeptics say that the analysis of Phase 2 results was flawed and that the study was too small to have solid predictive value. On top of that, the patients that have been enrolled for Phase 3 are likely to be sicker (have failed more prior therapies) and more challenging. And if that wasn't enough, there's also a drumbeat based on an analysis conducted (in part) by's Adam Feuerstein that shows a fairly rotten history of small-cap biotechs getting drugs through Phase 3 trials successfully.

But wait, there's more.

Skeptics also like to point out that in the partnerships AEterna has secured for perifosine thus far (covering the U.S. and Japan), the upfront payments have been quite low (suggesting low confidence on the part of the marketing partner) and the reputation/capabilities of the partner perhaps not so great.

There's also an issue of patent coverage on the drug. Some of the perifosine patents roll off next year (2013), leaving the company vulnerable to a window of just five years of marketing exclusivity (based on Hatch-Waxman) if the companies cannot garner follow-on extensions. Patent coverage for Europe is more robust, though, and should extend out to 2013.

On top of all that, there is the normal "he said, he said" that goes on between bull and bear camps with any small biotech, not to mention rumors of impending buyouts, partnership agreements, financings, and so on.

Reading The Tea Leaves?

Frankly, arguing about whether perifosine works or not is pretty silly at this point. The FDA demands pivotal trials precisely because nobody knows for sure and the signals from earlier-stage studies can be misleading.

One way or another, we will know soon enough. But just to throw a little more lighter fluid on the bonfire, consider how the two sides have reacted to the delay in reporting final results from this study. While the study was supposed to end around the end of 2011, that deadline has been extended. Bulls think this is because the survival data on the drug is good; bears say it could be tied to enrollment issues or perhaps abnormal placebo response.

Looking For Bottom Line Numbers

So now for the real question - what is this stock worth if the drug works? In an attempt to answer the question, I played around with a wide range of assumptions, including market penetration, pricing, royalties (from Europe), and company expenses.

On the revenue side, I used a base case of peak revenue in Year 5 of $174 million (to AEterna). Fueling this estimate were the following assumptions:

Peak Year - Year 5 (after launch)
U.S. Market Share 35% U.S. Patients 56,286
European Market Share 25% European Patients 81,182
Japanese Market Share 15% Japanese Patients 21,218
ASP - US $32,000 Royalty - US 10%
ASP - Europe $23,760 Royalty - Europe 20%
ASP - Japan $30,000 Royalty - Japan 15%
Click to enlarge

For those playing at home, I think the patient numbers are pretty well agreed-upon by most parties. I believe U.S. market share could vary between 20-45% at peak depending upon the efficacy. Likewise, I believe that efficacy will inform the ultimate ASPs, but I see a range of about $25,000 to $45,000 for the U.S.. The European royalty rate is admittedly more of a guess, with a probable range of 15-25% (again influenced by the final efficacy data).

Going forward, I think AEterna will significantly ratchet up its SG&A expenses, particularly if it believes it can use the revenue from perifosine to build out the infrastructure to hang on to and market its own drugs in the future. Moreover, I estimate that the ongoing need to develop its pipeline of other candidates will likely keep R&D spending at or above $25 million for the foreseeable future. All in all, I see peak profitability (in Year 5) of nearly 64% margins - a hefty number to be sure.

Taking that figure (which works out to about $112 million), there are a few directions valuation analysis can go. One is to simply apply a multiple (10x in this case, to account for the risk of the U.S. patent coverage), discount back (15% a year for me), and divide by the sharecount. That produces a target of $5.25, with no additional value given to additional perifosine applications (in multiple myeloma, for instance), AEZS-108 (endometrial cancer), or other compounds. Based on similar comparables, I think the shares should carry perhaps $0.75 to $1.25 value for those prospects.

There is another way to evaluate the shares, though, and that's to consider the full life cycle cash flow value of perifosine as it goes off-patent in the U.S. and Europe. That analysis results in a lower target value for perifosine (about $3 per share), which is not surprising as cash flow analysis of biotechs is seldom as generous as multiple/ratio-based analysis.

Now, there's still one more step to take, and that is to adjust for the likelihood of a negative trial result (which would likely zero out the value of perifosine). I'm going to be very conservative here and give it a 50/50 shot. Do that, then, and fair value for AEterna Zentaris stock falls around $2.50 to $3.50. Given that I think a lot of my assumptions are on the more conservative side, I'd go with $3.50 but fully acknowledge that the implied value jumps immediately (doubles) if and when that positive Phase 3 data arrives.

The Bottom Line

If those numbers I used above are even close to accurate, it seems pretty clear that the market is expecting perifosine to fail. More specifically, it looks like the Street is baking in about a 75% chance that X-PECT results in failure.

What's also clear to me is that this is a fairly binary outcome. If X-PECT data is as great as the bulls hope it will be, AEterna could have a legitimate honey pot on its hands with respect to those European rights. If the data is bad, it's pretty much back to square one and the hope that AEZS-108 and drugs deeper in the pipeline eventually pan out - those prospects may be worth $1 or more per share, but they're not going to trade that way, at least not at first.

I wish I had some sort of ground-breaking insight into whether the drug works or not, but I don't and I won't pretend that I do. The rewards of success seem to outweigh the probable punishments for failure, though, so investors who are open to taking high-return/low-probability swings may just find that this stock is one to buy and hold for the next few months.

Disclosure: I am long OTCQX:RHHBY.