A Disappointing, But Not Altogether Surprising, Failure For JNJ And Pfizer

by: Stephen Simpson, CFA

Some diseases are notoriously hard targets for new pharmaceutical development, and Alzheimer's may well be one of the worst. There are very few drugs on the market for the disease (Forest Labs' (NYSE:FRX) Namenda and Pfizer's (NYSE:PFE) Aricept are the two most prominent), but Johnson & Johnson (NYSE:JNJ), Pfizer, and Elan (NYSE:ELN) hoped to defy the odds and bring a new Alzheimer's drug to market - bapineuzumab.

Unfortunately, Pfizer's news announcement Monday after the close largely brings that hope to an end.

No Data, Just The Conclusion

Pfizer did not release any data with the announcement, saving that for a medical conference presentation later this summer. It's an unfortunate reality that medical and scientific conferences still often insist on a degree of exclusivity that stands in the way of open and honest communication with investors.

In this case, though, it really doesn't sound like the data matters. In this first of four Phase 3 studies, one that investigated the drug in mild-to-moderate Alzheimer's among those with the ApoE4 gene, the drug showed "no cognitive or functional improvement". Moreover, the drug was apparently so unimpressive that there will be no additional dosing of the drug in a follow-on extension of the study.

This Is Where Post-Hoc Gets You

While there are three more studies (which examine the drug in a mix of disease severities and carrier/non-carrier statuses) yet to be released, it would be foolish for investors to put much hope on a sudden reversal of fortunes.

Bapineuzumab was definitely something of a long-shot on the basis of Phase 2 data. Simply put, the Phase 2 data was a mess - the drug not only failed the primary endpoint as designed, but failed convincingly. What the companies (Elan and Wyeth at the time) did, then, was conduct a series of post-hoc studies that they believed identified patients who responded - basically rewriting the standards of the study after the fact.

Worryingly, even this post-hoc analysis showed no particular correlation between doing and response - suggesting that the amount of the drug had no bearing on the outcome of the patient. This is the sort of thing that junk biotech companies engage in all the time, particularly with oncology drugs in small Phase 2 studies, and it's a big part of the reason that most of the follow-on Phase 3 studies fail miserably - the companies have a vested interest in pushing on (and collecting paychecks), and there's really no downside for management to try.

I'll give Elan and Wyeth a little bit of a break here - the need for an effective Alzheimer's drug is indeed great, and I don't mind that they wanted to try. While this news is indeed disappointing for Elan shareholders (who were going to enjoy some financial upside due to an arrangement that gave the company almost half of Johnson & Johnson's share of the profits), it really won't move the needle too much for either Pfizer or JNJ.

Assessing The Impact

As I said, I think this will ultimately be a non-issue for Pfizer and JNJ - I don't think any analyst had this drug in their models (at least not on a fully de-risked basis) and the small chance of success made it more of a "would be nice if it works out" sort of long shot.

Said differently, assume that success would have paved the way for $5 billion in sales, split about 50/50 between Pfizer and JNJ. Using the 40% estimated probability of success that J&J mentioned using for its own calculations in the Elan deal (from the 10-K), that works out to $1 billion in sales for companies whose drug sales annualize out to more than $24 billion and $60 billion. Keep in mind, too, that JNJ was going to split those proceeds with Elan and it's hard to see a major stock reaction to a drug trail failure that I believe few analysts would have given a 40% probability of working.

And as far as the R&D spending? That was a sunk cost and already factored into estimates. With approximately 85% or so of drugs put into human testing failing to reach market, failure at Big Pharma is what you might call a "known unknown".

Still, for Pfizer this is just another swing and yet another miss. The company had an agreement to develop and market Medivation's (NASDAQ:MDVN) Dimebon for Alzheimer's and paid a $225 million upfront payment from Pfizer to Medivation on the basis of a positive study conducted in Russia. But that drug failed too, and dealt a significant setback to the notion of doing early stage clinical work in Russia. There have also been other, lesser, failures at earlier stages of development. Sooner or later, Pfizer has to ask themselves if this is really a space they want to continue investing hundreds of millions of dollars.

Clearly, this is a much bigger loss to Elan. Tysabri (a multiple sclerosis drug it shares with Biogen Idec (NASDAQ:BIIB)) is the company's only commercial product, and one that is arguably under some threat from newer compounds from Novartis (NYSE:NVS), Sanofi (NYSE:SNY), Teva (NASDAQ:TEVA), and Biogen Idec. With one other drug in Phase 2 studies (for Alzheimer's as well), bapineuzumab could have made a big difference for Elan. Still, though, the net per-share impact to Elan looks to be in a range of $2 to $5 based on assumed probabilities of success ranging from 20% to 50%, and the company should have double-digit fair value on the basis of just Tysabri.

Where To Now?

I'm also curious what this failure says about the Alzheimer's space as a whole.

But others are still trying. Lilly (NYSE:LLY) is expected to announce Phase 3 data on solanezumab in this third quarter, though many analysts seem even more skeptical of this drug than they were of bapineuzumab. Baxter (NYSE:BAX), too, is still at it - hoping that immunoglobulin (IG)-based drug Gammagard shows meaningful efficacy.

While it's impossible to grant a high probability of success to any of these drugs, companies are going to keep trying. I have no problem with Big Pharma continuing to work on drugs for this disease, but biotech investors need to remember the painful lessons of Alzheimer's disease drug development and give these drugs the above-average discount rates and skepticism they deserve. Go in with your eyes open and realize that this an exceedingly risky space - even for some of the biggest and most experienced companies in drug development.

As for the three companies directly involved, JNJ and Pfizer both look modestly undervalued (Pfizer more so than JNJ) and worth a look (again, Pfizer more so than JNJ), while Elan is a much riskier play that would be more interesting if this disappointment pushes the stock into the single digits.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.