Xenoport More Interesting After Washed Out Expectations

| About: XenoPort, Inc. (XNPT)

It hasn't captured nearly as much attention as Human Genome Sciences and its troubled launch of Benlysta in lupus, but XenoPort (XNPT) too has seen some serious disappointment with the launch of its drug Horizant. While XenoPort's lead drugs are unlikely to ever live up to initial hopes and legal wrangling with its partner Glaxo (GSK) will suck away precious cash, these shares may have been beaten down to a point of value.

Horizant - Efficacy Not The Issue; Cost-Benefit Is

Central to the XenoPort story today is the thus far disappointing launch of Horizant - the company's gabapentin prodrug for restless leg. While XenoPort and its partner Glaxo were able to navigate the shoals of the FDA approval process, approval and commercial launch has not been the key to easy money.

The issue with Horizant isn't so much about efficacy as it is about cost and the differentiation between Horizant and generic forms of Mirapex and Requip. Although there are some advantages to Horizant (superior bioavailability, better efficacy in some patients, a better dosing profile for those with daytime symptoms, and fewer side-effects), the benefits are not enough to coax insurance companies into paying as much as 20x more than the generics.

As a result, previously lofty sales expectations have come crashing down - from over $500 million a few years ago to sub-$100 million in some cases today. More worrying still, recent prescription data suggests no particular momentum in prescription growth, meaning that whatever potential Horizant does have, it's coming to be slow in developing.

Poor Sales Leading To A Serious Rift

XenoPort management is clearly not convinced that the problems with XenoPort are solely attributable to its price or generic competition. Instead, management has accused Glaxo of insufficiently promoting and supporting the drug, and has declared its partner in breach of the agreement - demanding that Glaxo mend its ways or return its rights to the drugs.

It's not at all uncommon to see corporate managements cast around for scapegoats or others to blame, and in some ways it seems like XenoPort's accusations are a stretch. After all, insurance companies and PBMs like Express Scripts (ESRX) have been unrelenting in pushing generics on policy members and demanding punitive co-payments for branded alternatives. Moreover, Glaxo has supported this drug with a roughly 500-person sales force.

But let's not be hasty. There are a few issues here that at least merit a little consideration. For starters, this action from XenoPort seems to have come shortly after the companies met to discuss the 2012 sales plan - suggesting that Glaxo's plans were well short of XenoPort's expectations. Also, prescriptions haven't really accelerated much since XenoPort claimed the breach, suggesting that Glaxo hasn't gone out of its way to push harder.

What's more, Depomed (DEPO) has done considerably better with an extended-release formulation of gabapentin (Gralise) for postherpetic neuralgia, despite a smaller sales force. Now, this is very much an apples-to-oranges comparison, but I can see where XenoPort management might be coming from.

It's worth noting, though, that Glaxo has sued XenoPort to maintain its rights. Maybe it's just a formality or a means of maintaining negotiating leverage, but it does suggest that Glaxo is willing to spend money to keep its rights.

Is A New Form Of Baclofen Going To Be A Little Bit Of History Repeated?

Making matters more challenging for investors, the next drug in XenoPort's queue may find a similar problem waiting for it. XP19986 or arbaclofen placarbil (NYSE:AP) is a prodrug of R-baclofen that the company has in Phase 3 studies for multiple sclerosis-related spasticity. Phase 3 data should be in hand shortly and the odds of approvable efficacy and safety look pretty solid.

Unfortunately, AP is going to be competing against a much cheaper generic option. AP should have some meaningful advantages, including twice-daily dosing and easier side-effects, but that may not be enough to drive strong sales.

All of that said, there's still an angle for potential success here. Roughly one-quarter to one-third of MS patients receiving baclofen see insufficient benefits (and some would argue the number is close to 50%) and there is a real chance that AP will offer an effective treatment option for these refractory patients. If that bears out, $80 million or more in revenue could be attainable.

XP23829 Is Interesting, But Will XenoPort Partner It Too Soon?

XenoPort does have one really interesting potential drug in its pipeline - XP23829, a prodrug of monomethyl fumarate (MMF). Although Biogen Idec's (BIIB) BG-12 (dimethyl fumarate) is not generally referred to as a prodrug of MMF, that is how it works. BG-12 has gotten a lot of attention for its strong efficacy in treating multiple sclerosis, but there are drawbacks to its dosing schedule and side-effect profile.

In other words, XenoPort may have something similar to BG-12 on its hands, but one with a more consistent efficacy profile, better dosing, and lower GI side-effects. With nausea, diarrhea, and abdominal pain being fairly consistent side-effects of BG-12, a more tolerable drug could improve patient compliance and tolerability.

The problem is that it doesn't sound as though management is going to take this one very far. It's still very early in the game, but it sounds like the company would like to partner it after Phase 1 results. Unfortunately, while partnering at such an early stage saves capital, it typically costs the company a lot in terms of milestones and royalty rates. Perhaps XenoPort can drive a better bargain than most post-Phase 1 partnerships on the basis of a more certain clinical path (given that it's a prodrug and similar to BG-12), but investors could see a lot of long-term value leave through the door if this is partnered too early.

The Bottom Line

Although prodrug development is attractive from a pipeline risk standpoint and can offer up incrementally better drugs (and sometimes dramatically better), XenoPort is running into a common problem - competition with existing generics where the prodrug has a difficult case to make to justify the higher branded pricing.

I really don't know how the Glaxo dispute will play out, but recent examples (Amylin (AMLN) - Lilly (LLY), for instance) suggest they'll end up going their separate ways. Unfortunately, that would put XenoPort in the unenviable position of building up a salesforce large enough to do the above-average detailing that Horizant is going to require if it is to surpass $100 million in revenue. Perhaps the company can find a replacement partner to take on Glaxo's role, but the sluggish prescription penetration seen to date is not going to appeal to many large pharmaceutical companies.

The good news, such as it is, is that even at $100 million in peak sales for Horizant and $80 million for AP, these shares ought to be worth close to $7 a share - more than 50% ahead of today's price. Keep in mind, though, that $100 million may yet be way too optimistic for Horizant and it's going to be a long road to that level of sales. I do realize that I haven't mentioned the potential of Horizant in postherpetic neuralgia, but that's because I don't think it will be a material revenue-generator.

As for '829, I don't normally like assigning any value for compounds before reporting Phase 2 data, but even with the assumption of unimpressive royalties and a heightened discount rate suggests this program is worth another incremental $1.

All in all, then, XenoPort's fair value may well be close to $8 on the basis of two sub-$100 million drugs and a very early-stage potential MS drug. Should XenoPort find an acceptable resolution for its dispute with Horizant and find a new way to motivate prescribers, there could be further upside.

Disclosure: I am long AMLN.