Are Investors Giving Lilly Too Much Credit?

| About: Eli Lilly (LLY)

Good or bad, it hasn't been boring to be a Lilly (NYSE:LLY) shareholder lately. Sell-side analysts continue to bat this name around, as quite a bit of the stock's value is tied to a pipeline that isn't expected to really start delivering for at least five years -- and many skeptics believe Lilly's demonstrated problems with R&D and pipeline development ought to merit a discount. But then there's the good news to consider as well -- a sooner-than-expected payoff tied to Bristol-Myers' (NYSE:BMY) acquisition of Amylin and clinical data on an Alzheimer's drug that gives the bulls at least some hope.

The question I have, then, is whether this is a Big Pharma stock that really deserves to be trading near its 52-week high.

Solanezumab Results Raise More Questions Than Answers

A week ago, Lilly announced data from its two pivotal studies of solaneumab ("sola") in the treatment of mild-to-moderate Alzheimer's disease (AD). Like Johnson & Johnson (NYSE:JNJ) and Pfizer's (NYSE:PFE) drug bapineuzumab, sola failed to reach its primary endpoints, but unlike bapineuzumab, there were enough positive trends in the data to keep this drug alive at least a little longer.

Sussing out the data from EXPEDITION-1 and -2 is not an easy task, but here goes a simplified version. Basically, the drug failed to show improvements in cognition and function for patients with mild to moderate AD. A pre-specified sub-group analysis, though, showed a statistically significant reduction in cognitive decline in patients with mild forms of AD. As this was a pre-specified analysis, it's not exactly the same sort of "data mining" that small biotechs are infamous for, but it's also not up to the gold standard of clinical trial efficacy.

It gets even more confusing as you go along, though. The EXPEDITION-2 study was changed before database lock, switching the endpoints from cognition and function to just cognition in mild patients. But this trial failed to meet its endpoint as well. So, what we seem to have is a suggestion of efficacy in a group of patients in one study ("-1"), but insufficient statistical efficacy with that group in the other study ("-2").

How Will The FDA Handle This?

I don't want to give the impression that the FDA is absolutely rigid when it comes to analyzing less-than-perfect data, particularly in a disease as under-served as AD (where only Pfizer and Forest Labs (NYSE:FRX) have approved branded drugs on the market). That alone gives Lilly a better chance when it comes to dealing with the FDA.

That said, I'd be very surprised if Lilly filed for approval on the basis of this data. While I would not completely rule out the possibility of some sort of approval contingent on Lilly running a pivotal confirmatory story (this has been done more than once in cancer, for instance), the more likely scenario is another full-scale pivotal Phase III study with the trial designed around measuring cognitive decline in mild AD patients. That latter scenario would suggest a possible launch in 2015 or 2016.

An Effective Drug For Mild Patients Is Still Worthwhile

I think it's safe to say that sola is not going to live up to the prior dreams of Lilly bulls; this does not look like a drug with $10 billion potential. That said, investors shouldn't sleep on what an effective drug in mild AD patients could be worth. Roughly 40% of AD patients are categorized as mild, suggesting 3 million or so potential patients in the U.S. and a similar number outside the U.S. (and perhaps even more when you factor in undiagnosed patients). Take 3 million (or 6 million) patients and multiply that by several thousands of dollars per year (the drug's probable selling price), and you get into the billions of dollars relatively quickly.

Keep several things in mind, though. First, no drug gets 100% of its addressable market. Second, I still don't see how the odds of sola approval for mild AD can be thought of as much more than a long-shot possibility at this point. Third, there is still the possibility of future competition in AD -- Merck (NYSE:MRK), Bristol-Myers, Biogen Idec (NASDAQ:BIIB), and Roche (OTCQX:RHHBY) are all working on AD drugs that could conceivably overlap with a sola launch. Lastly, Lilly's current valuation already assumes that somehow, some way, Lilly will find new sources of revenue in the second half of this decade to offset patent expirations, and the potential of sola has to be offset against pipeline failures like pomaglumetad.

Still Grinding The Axe?

I've never been shy about my skepticism and lack of enthusiasm for Lilly, so bulls may just dismiss this as another "Oh, there he goes again..." sort of thing. So be it; I'm just trying to figure out what Lilly is worth to me as an investor and you're free to agree or disagree as you wish.

And to be (more) fair, I do see some good things at Lilly. Even if sola ultimately fails, Lilly has a BACE inhibitor for AD that is worth watching. Elsewhere, the company is continuing to develop what could be a strong and varied franchise that treats diabetes at almost every relevant level, and maybe cancer drugs like ramucirumab can surpass tempered expectations and become multi-threat winners.

All of that is tempered by what I see as a long-term record of poor R&D/pipeline performance and successive "It's not our fault" excuses from management. For better or worse, Lilly has built up a high risk/high reward pipeline that is unusual for Big Pharma, and the confusing results for sola and failure of pomaglumetad (for schizophrenia) don't help that image.

While I'll admit that sola still has more hope than I would have thought just two weeks ago, Lilly is still not my top pick in Big Pharma. When I want high risk/high reward stories I turn to biotech, and I just don't think today's valuation on Lilly is proper reward for the risk involved, even if the market currently disagrees with me.

Disclosure: I am long OTCQX:RHHBY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.