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FDA approval is undoubtedly a major event in the life of a biotech company, but it is only a part of the puzzle. Marketing an approved drug is a battle in its own right, as investors in Auxilium Pharmaceuticals (AUXL) know all too well.

The company has found it difficult to drive market acceptance of its Testim testosterone gel and Xiaflex injection for Dupuytren's contracture and expectations have come down markedly. While the company's current products could still have billion-dollar potential, investors need to be prepared for a long, difficult slog to realize that potential.

Testim Testing Patience

While the market for supplemental testerone gel in the U.S. has been growing nicely (from 15-25% a year, depending on whose estimates you accept), Auxilium's Testim has been something of a disappointment. Despite attractive pricing compared to Abbott Labs' (ABT) Androgel, Abbott still holds more than two-thirds of the market according to IMS data, while Auxilium makes do with less than 20%.

Making matters more challenging, the market is getting more competitive. Teva (TEVA) will be rolling out Bio-T Gel under license from Biosante (BPAX), Endo Pharmaceuticals (ENDP) is selling its Fortesta gel and looking for FDA approval for its Aveed long-acting injection (injectable long-acting testosterone has proven popular in Europe), and Repros (RPRX) is developing a once-daily pill. On top of all that, generic competition from Androgel will be coming on in 2015.

All of that said, Auxilium hasn't given up. The product works and the company has gotten more active with rebating. That seems to be leading to increasing prescriptions being written for Testim, particularly since the summer of 2011. While scrip growth is looking good (up double-digits in March), profitability will still be a challenge with that heavier rebating/discounting.

Xiaflex Off To A Slow Start

The bigger challenge for Auxilium is the slow adoption of Xiaflex, its unique injectable treatment for Dupuytren's contraction. Where analysts once boasted of $500 million-plus potential with this drug, sales in 2011 were less than $60 million.

There are a lot of positives to Xiaflex. Not only do patients avoid the pain and complications risk of surgery, but the injection procedure is about 90% successful on the first attempt (based on average of about 1.1 vials used per case) and the long-term reoccurrence rates have been about one-third less than with surgery.

The trouble is, the drug has to be injected in the right spot (a nodule in the cord) and there is a risk of damage to tendons, nerves, and vessels if performed incorrectly (and these are expensive problems to replace). Although I've spoken to physicians who cite that risk as a reason to continue performing surgeries, I think there's another factor at work - money.

Auxilium recently got new CPT codes for the Xiaflex procedure (specific coding simplifies reimbursement) and the codes (excluding the initial consult) stack to about $215 on a national average, in addition to covering the cost of the drug. The procedure fees for surgical options, though stack from $300 to over $500. If the same doc can make more with a surgery (and feels more comfortable with the surgery), that's a compelling reason to continue.

As time goes on and more data stacks up on Xiaflex, this could change. Insurance payers, especially private payers, have often changed coverage decisions and reimbursement rates in response to long-term outcomes data and it seems fair to think that the same could happen here. The problem is is that this takes time and Wall Street is notoriously impatient. So while Dupuytren's contracture is indeed likely under-diagnosed and under-treated and changing reimbursement could favor Xiaflex, it could take a while for a multi-hundred million dollar market to develop for this drug.

New Indications A Wildcard

Part of the beauty of the Auxilium story is that, if it works out, the company may well have an entire pipeline in a single product and that's great for margins. In particular, the company has early trials underway for adhesive capsulitis ("frozen shoulder"), lipomas (being handled by BioSpecifics (BSTC)), and cellulite.

The bigger near-term delta, though, is Xiaflex for Peyronie's disease. This soft tissue disease impacts about 7-10% of men and features the formation of fibrous plaques in the soft tissue of the penis - creating an abnormal curvature that can lead to erectile dysfunction and/or pain. There are few good treatment options at present, as surgery carries a host of decidedly unpleasant side-effects and risks.

The potential for Xiaflex in Peyronie's could be quite large; while the incidence rate is considerably lower than in Dupuytren's (which may impact 20% of adults, male and female), the treatment requires multiple injections of the drug.

The problem with this indication is in the clinical trials. There have been a lot of trial design changes through Phase 2 and Phase 3 and the company is going to need to see strong results from secondary endpoints like "intercourse constraint" and "intercourse discomfort". Unfortunately, phase 2 results for these endpoints were not statistically significant. It's also worth noting that there seems to have been inconsistent placebo responses in earlier studies and the FDA just loves to haggle and quibble with issues of statistical power and p-values.

Could A Buyout Give Investors A Happy Ending?

Investors certainly have not ignored the fact that new CEO Adrian Adams has a long history of selling the companies he runs (Inspire, Sepracor, and KOS). What's more, I do think that Auxilium could benefit from a larger, more powerful sales effort - maybe not so much in driving Testim share growth, but in getting more docs to try Xiaflex instead of surgery.

With the potential synergies for Xiaflex in urology and surgery, I could see a company like Johnson & Johnson (JNJ) or Endo Pharmaceuticals seeing value in this company. What's more, if that cellulite indication really works, companies like Allergan (AGN) and Medicis (MDX) could enter the mix as well.

All of this being said, bears are going to point out a not-insignificant detail - at least in the cases of Sepracor and Inspire, the takeout prices were below the trading prices of the stocks when Mr. Adams took over.

The Bottom Line

Valuing Auxilium is a thankless task and I'm fully confident that both bulls and bears will hate my projections with equal gusto.

In my view, the low-end value for Auxilium is around $13 - that presumes that Testim peaks at around $250 million and that Xiaflex caps out below $200 million (either failing altogether in Peyronie's, or achieving very modest success). In this scenario, Auxilium garners a low revenue multiple (4x) due to disappointment over the growth trajectory.

A more middle-path approach doesn't change the Testim assumption, but bumps the Xiaflex number to $300 million on the basis of better penetration in Dupuytren's and a some usage in Peyronie's. This middle ground includes a higher revenue multiple (5x) and boosts the target to nearly $20.

Lastly, my more bullish scenario again doesn't change the peak of Testim, but boosts Xiaflex to $500 million on the assumption of solid adoption in both Dupuytren's and Peyronie's. Boosting the revenue multiple another notch (6x) and factoring in the incremental revenue raises the fair value to about $32.

Admittedly, these targets are not nearly as impressive as the roughly $40 price target that the stock carried a couple of years ago, but that's the nature of pre-approval hope and post-launch reality. If there's a one-third chance of each outcome, value today would be around $21.50 - not enough undervaluation to attract my interest. That said, if Auxilium can really dial in the marketing and drive better Xiaflex utilization (to say nothing of getting favorable clinical results in Peyronie's and cellulite), a $30-plus stock price could still be possible some day.

Source: Auxilium Pharmaceuticals Has The Approvals; Can It Get The Revenue?