ViroPharma: Lev Acquisition Appraisal

ViroPharma (VPHM) recently acquired Lev Pharmaceuticals (LEVP.OB) for $443 million ($2.75 per Lev share), primarily for its orphan drug Cinryze, which is used to treat HAE (hereditary angioedema). There are additional payouts of $0.50 per share if Cinryze gets approved by the FDA, and another $0.50 per share if total sales of Cinryze reaches $600 million within a decade, which would make the total price $617 million.

ViroPharma was previously consistently losing money before it acquired the orphan drug Vancocin from Eli Lilly (LLY) for $116M. This turned out to be a stroke of genius, as ViroPharma was able to aggressively hike the price of Vancocin, resulting in annual revenues of $200M in 2007, and more than recouping the cost of acquisition in merely 2 years. I was hoping that the CEO would be able to repeat his past performance and use ViroPharma’s large cash hoard to make another brilliant acquisition. However, on examining the Lev acquisition, I believe that the CEO may have traded hard cash for a very risky endeavor this time around.

HAE is caused by a genetic mutation leading to low serum levels of C1 esterase inhibitor and unchecked inflammation. Patients suffer sporadic attacks of swelling that may occur in the hands, legs, face, throat, genitals or gastro-intestinal tract. These attacks are very painful but usually spontaneously resolve, although swelling of the airways can lead to death by suffocation. An estimated 1 in 30 000 people suffer from HAE, which suggests a total patient population of 10 000 in the US, with 4 600 diagnosed cases (while a simple blood test provides a definitive HAE diagnosis, many patients are misdiagnosed as having an allergic reaction).

ViroPharma is projecting that one quarter of the diagnosed patients will buy its drug at an annual cost of $300 000, which would make annual sales $345M. This “rob-Medicare-and-insurers” business model was made popular by Genzyme with its flagship product Cerezyme, currently the poster child of exorbitant drug pricing, with an average annual treatment cost of $300 000. Many health-care economists argue that the Orphan Drug Act is now doing more harm than good, and is a major contributor to the rapidly inflating cost of health insurance. Increasingly, the orphan drug companies are being seen as extorting their profits from vulnerable patients with their legally sanctioned drug monopolies. Some form of government regulation may well be crafted in the future to moderate the excesses caused by the current Orphan Drug Act.

The Orphan Drug Act stipulates that the first company that completes a clinical trial demonstrating the efficacy of a drug against an orphan disease is granted a monopoly for that drug. There are five companies currently developing drugs for HAE (Dyax, Jerini, Pharming, CSL Behring, and Lev). CSL Behring and Lev both prepare a C1 esterase inhibitor concentrate from human plasma, and both drugs have a long history of use in Europe.

Because the two drugs are essentially the same entity and theoretically cannot be granted orphan drug status simultaneously (the other companies’ drugs are generally considered independent molecules and will not block each other’s orphan drug status), most analysts believe that FDA will avoid a thorny decision by assigning both drugs orphan status, but for slightly different indications. Cinryze (Lev’s drug), will likely be approved for prophylactic treatment, while Berinert (Behring’s drug) will likely be approved for acute treatment of HAE.

Some analysts cite Cinryze’s prophylactic use as reason to assign a higher price to Lev, since prophylactic use will be much more profitable, but I believe this is an incorrect argument, as doctors can always prescribe drugs for off-label use. Therefore, there will most probably be at least two, and probably more, drugs competing head-to-head for the same patients. Hence, I believe that pricing of Cinryze is not likely to approach that of Cerezyme, which has no competition whatsoever.

Finally, a major unknown is the frequency of drug use expected with HAE patients. In the case of Cerezyme, its target disease is Gaucher’s disease, which is caused an inability to break down certain fats, leading to an accumulation of toxic products in organs. Prophylactic treatment in Gaucher disease is widely accepted, as continued buildup of lipids eventually leads to organ failure.

In the case of HAE, the medical community has not come to a consensus treatment regime. Studies in Europe suggest that HAE patients suffer an average of 7 attacks a year, and there are reports that many patients are able to sense the onset of an HAE attack, much like how some people can sense migraine attacks, and may be able to reach emergency rooms in time.

As it is unclear how many HAE patients actually die from the attacks, doctors in Europe tend to treat patients with infrequent attacks acutely, reserving prophylactic treatment for patients with very frequent attacks. In the US, due to the lack of an approved drug, many HAE patients obtain HAE drugs through “personal importation” from Europe, and keep several vials at home or with their doctors for acute administration during an attack. Many doctors may be tempted to stick to status-quo even with an available approved drug. Certainly, their insurers will likely pressure them to use the drug sparingly.

In the best case scenario, all companies price their drugs at a high level and insurers stomach the cost. If 1500 patients pay $150 000 annually, this will result in $225M in revenue, and perhaps $10M in manufacturing costs and $65M in taxes, resulting in $150M in net income. This would be approximately 25% annual return on the $600M acquisition cost.

In the worst case scenario, competition brings the cost of drugs down, and this is combined with insurers willing to treat patients on an acute basis only. Berinert and comparable HAE drugs are priced at around $800 a dose in Europe (one dose is used in a mild attack, 2 doses in a severe one). I will assume that competition in the US brings down Cinryze’s price to $1500 a dose (since an FDA approved drug should carry a premium). If 1500 patients suffer 10 attacks annually and use 2 doses each time, this will result in an annual revenue of $45M, which after $10M in manufacturing costs and $10M in taxes yield $25M in net income, or a paltry 4% return on investment. Note that the above scenarios are just guesses. There are considerable uncertainties about the potential patient pool size and final pricing levels and treatment regimes. In addition, there is an outside chance that Cinryze may prove helpful in heart attacks and strokes.

Personally, I believe that a 25-30% return on investment is probably the best that can be achieved in this acquisition. An extra $150M in annual earnings will add an EPS of $2.14 to VPHM’s bottom line, which could well bring the stock to the low $20s. However, a flop will mean exchanging $600M in cash ($8.57 per share) for $25M net income, which would be a net loss of about $5-6 per share (depending on the earnings multiple you assign).

The most likely outcome is somewhere between the two extremes, and on balance, the acquisition is likely neutral to the share price. However, this acquisition adds substantial risk to ViroPharma, and for that reason, I have chosen to liquidate my position in VPHM.

Disclosure: none

Comments

[Genedr:]

I agree with most of your analysis. However, what is your take on the fact that VPHM will likely wait on closing of this deal until the FDA decision. If the FDA bawks, VPHM walks? I see this as the linchpin for a successful acquisition and profit. If approved, Lev will be first to market which is always a valuable position to enjoy.

2008 Aug 03 08:11 AM

[Genedr:]

I agree with most of your analysis. However, what is your take on the fact that VPHM will likely wait on closing of this deal until the FDA decision. If the FDA bawks, VPHM walks? I see this as the linchpin for a successful acquisition and profit. If approved, Lev will be first to market which is always a valuable position to enjoy.

2008 Aug 03 08:11 AM

[jodabutcher:]

You are ill informed and should read closely before you write your articles....If the deal doesn't turn out great Viropharma will only pay 443 million and the cash portion is in the 300 million dollar range with the rest in stock.If the deal flops they can back out of it totally. And there is a possibility that they will get both acute and proph. approval if the other company gets an unuproval letter from the FDA. In addition, the drug from LEV has advantages over the other competitive drug due to the half life of the drug and other factors and also the drug may have other ailments that it may be approved for and Lev has other compounds that they are working on that Viro will now own in addition to their staffof excellent scientists that will now be working with Viro...Do your homework and don't rush to post!!!!

2008 Aug 03 10:19 AM

[jodabutcher:]

You are ill informed and should read closely before you write your articles....If the deal doesn't turn out great Viropharma will only pay 443 million and the cash portion is in the 300 million dollar range with the rest in stock.If the deal flops they can back out of it totally. And there is a possibility that they will get both acute and proph. approval if the other company gets an unuproval letter from the FDA. In addition, the drug from LEV has advantages over the other competitive drug due to the half life of the drug and other factors and also the drug may have other ailments that it may be approved for and Lev has other compounds that they are working on that Viro will now own in addition to their staffof excellent scientists that will now be working with Viro...Do your homework and don't rush to post!!!!

2008 Aug 03 10:20 AM

[hoopdreamer...:]

Your article missed the mark by a wide margin. Number one, its incredibly ignorant to assume a. someone can "feel" an attack coming and b. That they would want to have the attack in the first place and just catch it early. These attacks can be debilitating, grotesque and deadly. Some patients are severe enough they they would rather treat as a preventitive and as the lev trial showed, when they do get breakthrough attacks they tend to be much less severe. Other people that only get an attack once every few months, of course it would make less sense to treat prophylactically. Whatever your background may be I think you should read a few less "Analyst" reports and read more about the disease before using migraine as your comparable.

2008 Aug 03 03:57 PM

[Value Geek:]

Genedr : FDA will almost certainly approve Cinryze, given its wide use and excellent safety record in Europe. From the press releases I've read, it would appear that the acquisition is not contingent on FDA approval, since there is an additional payout on final approval, and Viropharma has already spent $20M buying up some Lev shares. I think there is an extremely high probability that this acquisition will be consummated. Certainly, Lev's current stock price suggests that arbitrageurs have a similar view.

The very bullish case for Lev rests on the outside chance that C1 INH will be helpful in myocardial infarction, which is of course a huge market. I believe that to date, only animal studies have taken place, and the results are conflicting, so this application is very very speculative and undeveloped.

2008 Aug 04 10:36 AM

[jodabutcher:]

you are wron...period! Viropharma has the option to back out completely if the fda doesn't approve and you didn't respond to my comment on the dollar amount you stated which was incorrect...please do your homework. Viro's management has been researching for years to find the right purchase and thier track record is perfect. I trust them and thier experts much much more than someone who just looks at press releases. Don't insult our intelligence.

2008 Aug 05 11:08 AM

[Uncommon Sense:]

I'm an intern at an M&A arb hedge fund and I looked at this deal pretty closely. First of all, the guy who wrote this article needs to read the merger agreement between Lev Pharma and Viropharma - it is an 8k and is filed with the SEC. The first contingency payment is only due if Lev obtains orphan status for the acute treatment of HAE (not prophylactic). The first payment can also occur if after two years of approval for orphan treatment of prophylaxis, no other companies receive orphan status for treatment of acute HAE. The second payment will only occur when Lev contributes $600M in total sales. Both CVRs are $1 per share.

I laughed when I read the first sentence of this article "Viropharma recently acquired Lev Pharmaceuticals". The deal is FAR from over - and the the annualized spread is huge (over 40% excluding CVRs) indicating arbs are staying out of the deal because of the enormous risk. In fact, if the FDA doesn't approve Cinryze, it will constitute a Material Adverse Effect (as defined in the merger agreement) and the deal will be terminated in which Lev will have no recourse. For some reason, you are claiming that LEVP will get a CVR if Cinryze is approved for prophylaxis... you're just wrong. Read the merger agreement before you write a huge article on a proposed transaction.

2008 Aug 15 08:42 PM

[jodabutcher:]

bravo uncommon sense....finally someone with brains posting somthing that makes sense!!!

2008 Aug 19 04:51 PM

[oldcurmudgeon2:]

Hey, Value Geek, don't feel bad, I thought your article made some excellent points.

2008 Aug 20 03:10 PM