If a quality specialty pharmaceutical company like Salix Pharmaceuticals (SLXP) is trading at a discount, you can usually rest assured that it's because the story has a little too much of what Wall Street hates most - uncertainty. In the case of Salix, the uncertainty surrounds just why the FDA rejected its application for subcutaneous form of Relistor and what, if anything, that means for the oral form of the drug. FDA issues are no trivial thing for a company like Salix, but nevertheless this stock looks like a name worth owning.
Strong Results For The Second Quarter
It's hard to find much to quibble with in the company's second quarter results. Revenue rose 36% from last year (and 6% from the first quarter), largely on the strength of Xiafan (up 34% from last year and roughly two-thirds of revenue). Apriso was also a solid grower (up 51%), but the sales contribution is modest (roughly 10%).
Salix did outperform on margins as well. Gross margin improved more than a half-point from last year, while operating income jumped 45%. Salix's operating income definitely surpassed sell-side expectations, but largely due to the timing of SG&A and R&D expansions - on a fundamental level, the profitability of the base business really hasn't changed as much or as quickly as this quarter's report may suggest.
The Relistor Conundrum
Unfortunately for shareholders, Salix offered up a case in point as to why you can never just assume what the FDA is going to do. Contrary to most expectations, the agency rejected the company's application to market a subcutaneous (injected) version of Relistor for the treatment of opioid induced constipation (OIC).
As is generally the case, there wasn't much additional information about the contents of the agency's complete response letter (Biopharmese for "rejection"), other than that additional data was needed. The company will meet with the agency in September, at which point the company (and hopefully, investors) should know more about the pathway to get this drug approved.
If there's any good news, it was that this injected form of Relistor wasn't expected to be a big seller for the company anyway. The problem, though, is whether this rejection has any bearing on the company's plans to submit its application for an oral form of Relistor in September. You wouldn't necessarily think that the two are linked, but see above as to what happens when you make assumptions about the FDA.
Suffice it to say, oral Relistor is a bigger deal to Salix - likely worth well over $100 million in annual sales. It's also worth noting that the OIC space could get a lot more crowded, with Nektar (NKTR) (partnered with AstraZeneca (AZN)), Alkermes (ALKS), Theravance (THRX), and Cubist (CBST) all looking to get involved. In other words, time is money (and market share).
Still A Multi-Shot Story
Relistor is important (the oral form, at any rate), but Salix is not just a one-trick pony. The company is still looking to get Xiafan approved for IBS, and hopes to secure approvals for budesanide in ulcerative colitis and crofelemer in chronic diarrhea.
Solesta, too, is starting to look like a real opportunity. Salix acquired Solesta's parent company (Oceana) for about $300 million, but the sales potential of this fecal incontinence bulking agent could be in the multiple hundreds of millions of dollars down the line. Long-term follow-up has shown a 60% response rate (meaning a 50% or better decline in incontinence episodes), and that's pretty good by the standards of this condition.
There are challenges here too, of course. For starters, Salix wants a new reimbursement code for Solesta and securing that (or failing to) could have a pretty meaningful impact on uptake. Also, I'm not entirely sure how GI docs are going to feel about a 4-shot treatment regimen. And, of course, there's competition out there from the likes of Endo Pharmaceuticals (ENDP) and sellers of more generic (and less effective) bulking agents.
The Bottom Line
Companies at Salix's stage of development have their risks, and that's just how it goes. I remember similar ups and downs in the earlier years of Endo Pharmaceuticals and what ultimately became Valeant (VRX). Heck, investors need only look at the turbulence around Forest Labs (FRX) to see how the middle ground of "not biotech, but not Big Pharma" can be treacherous.
All of that said, I have liked Salix for a while and I still do. Even with an elevated discount rate (perhaps overstating the risk of the company in the process), the prospect of exiting the next decade with over $2 billion in revenue and robust free cash flow makes this an appealing stock. I see fair value in the low $60s and Salix is high on my potential list of stocks to buy, with frankly my only hang-up today being a personal one tied to the amount of exposure I already have to healthcare.