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Sarepta Therapeutics: Missed the Move, or Still Room to Run?

Sarepta Therapeutics (NASDAQ:SRPT) has, over the course of the past two months and change, made one of the great one-year moves of a generation. It has given investors nearly a 900% return since it closed on $3.46 on July 23, 2012 as of last Friday's close at $34.30 with a large portion of that move coming in just the last week.

The most recent move has come on the back of exciting news regarding a Phase IIb clinical study of the company's orphan drug Eteplirsen, which is designed to treat Duchenne's Muscular Dystrophy. Many have championed the results of this study as almost guaranteeing FDA approval of this drug, and the stock has certainly reacted as if this were the case, surging meteorically to $45 on the press release (and probably propelled further by a large amount of short covering to boot). However, in the two days following the initial stock price surge, it has come back to earth in large part, declining $10 before the end of trading on Friday the 5th of October. This has prompted me to question whether this is a good entry point, or if the stock is still overextended. My research, and consequently the outline of this paper, progressed as follows:

First I wanted to know a bit about the disease the drug is intending to affect positively, and then the mechanism of action through which the drug is designed to work. I then proceeded to thoroughly review the outcomes of the recently published study in an attempt to make a hypothesis of my own regarding future decisions that will have to be made in terms of drug approval. From there the next step from an investor's standpoint was obviously to take a rough stab at projecting future sales the drug could generate if approved by evaluating the addressable market, prices charged for other orphan drugs in the past, etc. I also took a look at managements statements regarding other potential applications of the drug or technology used to develop this particular drug and potential sales in overseas markets.

Then with all of the above in mind, I made an effort to decide if I would personally be comfortable entering the stock at this level.

Duchenne's Muscular Dystrophy: (DMD)

Let us begin by very briefly gaining an understanding of the targeted disease and why this particular drug is generating such excitement within the medical community and investment world.

DMD is caused by a mutation in the dystrophin gene. It is typically transferred to male babies by a female carrier, with approximately 1/3500 male children affected each year. It is a rapidly progressing disease, with most of children affected losing the ability to walk by the age of 9 or 10, and death typically occurring in the mid 20s.

Quite typically the disease process includes the following:

· Children will often develop a progressive restrictive respiratory impairment secondary to weakness and contracture of respiratory muscles. Ventilatory support is often necessary soon after losing walking ability.

· Weakness further leads to difficulty producing a forceful cough, leading to the buildup of secretions causing pneumonia, respiratory infections, and eventually the possibility of death.

· Vascular and other smooth muscles can also result in irregularities of the heart, diaphragm, kidneys, and gastrointestinal tract leading to obviously terrible comorbidities.

One can see what a devastating illness this truly is.
Additional Resource: Pathology, Implications for the Physical Therapist, 3rd edition. Written by Catherine Cavallaro Goodman and Kenda S Fuller.

Eteplirsen and its Mechanism of Action:

Let us expand upon the mutation in the dystrophin gene that is the root cause of this illness. Dystrophin serves a protective role for muscle fibers. It essentially protects muscle fibers from contraction-induced damage, basically preventing muscles from damaging themselves as they perform their typical actions. In essence, "The absence of functional dystrophin results in muscle membrane breakdown with muscle fibers being replaced by adipose and fibrotic tissue." This eventually leads to the profound weakness causing loss of ambulation, and respiratory or cardiac dysfunction or failure.

So with that understanding, we can begin to look at the way Eteplirsen works, and get a glimpse as to why the recently published study results were so exciting.

The drug is a genetic-based medicine, designed to address the underlying cause of DMD by enabling the production of a functional dystrophin. It utilizes Sarepta's novel and proprietary exon skipping technology to skip exon 51 on the mutated dystrophin gene. This enables the repair of specific genetic mutations that affect approximately 13% of the total DMD population.

Results of Phase IIB study: The buzz is created

The study consisted of 12 patients, still able to walk. The researchers looked at two primary outcome measures:

1. Six-minute walk test-this is basically just the distance these patients were able to walk in six minutes at baseline, and at conclusion of the 48 weeks of the study. This is a nice test to measure functional improvements, as loss of ambulation is a primary concern with this particular disease.

2. Production of dystrophin-This was measured via muscle biopsy, and recorded as a percentage of dystrophin positive fibers. Remember how important we established this dystrophin is.

So what did the researchers find?

1. For those patients receiving Eteplirsen at 50mg/kg of body weight per dosage, they improved in their six-minute walk test distance by an average of 27.1 meters

2. For the placebo group, the patients declined by an average of 60.3 meters. This suggests a net change of 87.4 meters (also known as an estimated treatment effect)

3. The mean change in dystrophin positive fibers from baseline for the patient group receiving the same 50mg/kg dosage was 41.7%.

4. The reported results state that data from clinical studies states that "The safety profile of Eteplirsen was evaluated across all subjects through 48 weeks and there were no treatment-related adverse events, no serious adverse events, and no discontinuations"

So from these results we can draw the following conclusions: The subjects receiving the medication walked better, produced significantly more dystrophin, and this was accomplished without any negative side effects. Viewed in this light, one can understand the excitement created from these results.

Addressable Market, Potential Sales and other Potential Avenues:

In the above commentary, we established that Duchenne's Muscular Dystrophy affects about 1/3500 male children born in the U.S. each year, and this particular drug has the potential to treat 13% of these. According to the CDC, there were approximately 4 million birth certificates issued in the U.S. in 2010 (the most recent data I found). Assuming half of these to be male children, the drug would then be applicable to about 75 patients domestically annually.

It is difficult to predict what the company would charge annually for Eteplirsen, though it is safe to assume it would be above the $100,000 per patient per year threshold. So domestically the numbers may look similar to these…

· At $100,000, sales of $7.5 million

· At $200,000, sales of $15 million

· These sales numbers are for each year's newly diagnosed patients. Obviously, the drug would be administered to previously diagnosed patients who are still appropriate for treatment. One may conservatively conjecture that these numbers could receive a multiple of 5x (i.e. patients diagnosed up to 5 years prior, continuing treatments after initial year, etc.) I do not believe it is unreasonable to hope for $75 million in annual sales domestically at a low end or mid range estimate.

Management noted during an interview last week with Mad Money's Jim Cramer that they would be open to partnerships to expand beyond North America. It is yet to be seen what these may consist of, but it is interesting to note as a potential for increasing revenues and profits for the company down the line.

Additionally, commentary from the recent press release concerning the science behind the drug is encouraging in terms of hoping they will manage to effectively treat other forms of Muscular Dystrophy, or at least a wider percentage of those with Duchenne's in the future. Quoted from the report:

"Sarepta is also developing other PMO-based exon-skipping drug candidates intended to treat additional patients with DMD"

And…

"On a broader scale, these results signify the promise and tremendous potential of our RNA-based technology to impact and modulate disease at the genetic level, which may lead to first-ever opportunities to target serious and life-threatening rare conditions at the origin of disease."

Potential Negatives: It's a necessity…

As exciting as the company's potential is, it would be unwise to ignore potential bear arguments:

· The study only consisted of 12 patients, and in fact two of them did not show positive results. Management explains this by the fact that they were too far progressed at the start of the study, but the thought remains.

· Though dystrophin production was improved in the study, the dystrophin is not 'complete'. It is a partial rendering so to speak, however functional.

· FDA approval is not guaranteed.

· There may be no immediate way to market the drug overseas even if approved.

· Currently the drug only targets 13% of those DMD patients.

· There can be no guarantee that the technology behind the drug can be expanded to the rest of these patients, or to other muscular dystrophies for that matter.

Investment Thesis:

Look folks, this is a long-winded discourse on the company's potential product. It is certainly exciting science, and I hope beyond hope that it will become a true life saver for those suffering from this particularly devastating disease.

I will certainly say that the potential is great, and if all of the positives looming come to fruition the stock may still be far from a top. However, with no sales to date the entire investment thesis must by default hinge on whether or not one believes Eteplirsen will gain FDA approval to go to market.

With a current market capitalization of $776 million at the time of this writing, and sales estimates only of the roughest quality at this point, one could be risking a lot investing at current prices. We must temper ourselves to remember that though the recent data is thrilling, the drug has yet to reach phase III of the approval process.

There will be a significant amount of time to pass before there are any additional catalysts beyond this recent clinical data release from the IIb study. After a meteoric rise, we may still be in for some profit taking for a while.

My advice, should it be asked for, would be to let the stock come in over the course of the next several weeks before beginning to build a position. And if you are as excited as many and simply can't wait, build a position incrementally and slowly to average cost down along the way. Then hope for the expected FDA approval, expanded application overseas, and future products in the pipeline!

Until more clarity is presented, I will use my rough average potential domestic sales number of $75 million annually, and apply a value of 7x annual sales to come up with a price I would be willing to initiate a long position. This indicates a share price roughly approaching $24 before I would be a buyer, despite my enthusiasm in the company. I acknowledge this is rather an unscientific valuation, but until future filings, this will be my personal rule.

As always, I advise each investor to do their own homework to reach independent investment decisions. I am particularly interested in hearing opinions on this company, especially those capable enough to make better sales and pricing estimates than I am equipped to make. It is, as always, my hope and intention in writing this article to spark cordial debate regarding SRPT in an effort to drag out all available information to reach the most educated decisions possible.

Source: Sarepta Therapeutics: Positive, Yet Cautious