Viropharma, Lev Pharmaceuticals: An Attractive Biotech Pair

Lev Pharmaceuticals (LEVP.OB) is a biotechnology company, which has focused on developing a treatment for the serious, and potentially life-threatening disorder known as hereditary angioedema, which has no FDA approved treatments in the United States. Lev's treatment is known as Cinryze and the company is seeking approval for both acute and prophylactic indications with a PDUFA date of October 14, 2008.

In late January 2008, Lev received a complete response letter from the FDA for the acute indication seeking additional information regarding manufacturing, chemistry and controls used in the studies. Lev did not present the prophylactic treatment for approval for the late January 2008 decision. In early May, Lev presented in-depth findings to an FDA advisory panel for the prophylactic treatment of HAE where the panel unanimously recommended approval to the FDA which will be making its decision next week.

The action by the FDA advisory panel significantly increases the odds of approval by the FDA and the safety record of similar treatments in Europe has been excellent. I have spoken with several physicians who speak very highly of the treatment and feel that it will have significant demand right out of the gate and that the studies show that the treatment is safe and greatly improves the quality of life with those affected by HAE.

On July 15, 2008, Viropharma (VPHM) announced that they would be acquiring Lev Pharmaceuticals in a cash and stock deal worth approximately $443 million ($2.75/share) in upfront considerations with the potential for an additional $174.6 million ($1.00/share) in cash payments to Lev shareholders if certain milestones are met. The upfront considerations consist of $2.25 in cash plus $0.50 in shares of Viropharma (subject to a collar ranging from $10.03-15.68). Additional potential milestones include up to $1.00 per share in cash to shareholders of Lev under the following 2 circumstances: 1) $0.50 per share consideration under 2 potential scenarios: a) Cinryze is approved for acute treatment of HAE and orphan exclusivity is granted or b) orphan exclusivity for the acute treatment of HAE has not become effective for anyone for two years from the date of closing and date of FDA approval for prophylaxis, whichever is later; and 2) an additional $0.50 per share consideration when Cinryze reaches $600 million in cumulative net sales within 10 years of closing.

The deal was approved by both boards in July and was later approved by the FTC on September 3, 2008. As mentioned earlier, the PDUFA date from the FDA for both the acute and prophylactic indication is October 14, 2008. Following the FDA decision, shareholders of Lev will vote on the merger on October 21, 2008 with the closing of the deal occurring on October 23, 2008. In terms of what could derail the merger, the only major potential stumbling block would be if the FDA were to send Lev non-approvable letters for both the prophylactic and acute indications, which is very highly unlikely.

Potential Outcomes

1)      FDA approval for prophylactic with the request for additional information on acute: This in my opinion is the most likely outcome and would be positive for both shareholders of Lev and Viropharma as Cinryze would be able to move on to the market very quickly (remember there is no other approved treatments in the U.S. at this time) and significantly improve the lives of those inflicted with HAE. Viropharma would benefit from nearly immediate revenues and cash flows flowing to the company and allowing for the generation of additional product lines for the company to improve overall visibility on revenues and profits. In this scenario,  Viropharma would be able to request approval for acute once any questions are addressed and it would still be likely that Lev would be the first to market on the acute side. I would note that no other companies are currently attempting to gain approval on the prophylactic side for HAE.

2)      FDA approval for both prophylactic and acute indications. This would of course be the absolute best-case scenario for both Lev and Viropharma. Under this scenario, Lev shareholders would get the full $2.75 in upfront payments plus it is highly likely that they would received the additional $1.00 in milestone payments. Viropharma would of course greatly benefit from this scenario as well since market exclusivity would likely be granted for Cinryze for a period of 7 years thus very much increasing the likelihood of very strong profitability and cash flows for the company for several years to come.

3)      The FDA requests additional information for both indications. If it is a complete response letter with simple to address issues then the merger will likely still occur but in the unlikely event that additional clinical studies are required for both acute and prophylactic then Viropharma could decide to exit the deal. I have been in close contact with several people both within Lev and physicians and it would be extremely unlikely especially after the FDA advisory panel's opinion in May for an outcome to occur which would endanger the merger.

If Lev were to gain approval for Cinryze from the FDA they would be likely be given market exclusivity for a period of seven years. The estimated potential market for Cinryze is conservatively estimated at $200-300 million per year during the exclusivity period with an additional potential catalyst being any approval in later years for the treatment of heart attacks, which is also being studied by the company.

Valuation Targets

Clearly, the target for Lev Pharmaceuticals is the $2.75 acquisition price under the most likely scenario. There is the potential for up to $1.00 in additional value after the deal closes to as long as ten years out. It is very likely in my opinion that the second 0.50 will trigger within the 10 year period as Cinryze sales (assuming approval) should easily exceed $600 million on a cumulative basis. Discounting the two potential 0.50 payments gives a fair value of approximately $3 or slightly higher per share.

For Viropharma, the company will be using almost all cash for this deal with only a small number of shares that will need to be added to the float. In addition, the company has an additional product in the pipeline and will have strong cash flows especially while Cinryze and Vancocin overlap. Cinryze also has the longer term potential to help with heart attacks which if eventually approved would add significant revenues to the company several years down the road. Based strictly on the approval of Cinryze and the continued use of Vancocin and the healthy balance sheet of the company, I value the shares at approximately $20/share.

Disclosure: Author is long Lev Pharmaceuticals and Viropharma

Comments

[Dan Weiss:]

Ive been asked via email about what my thinking is on odds of each scenario and I would put #1 at a bit higher than 95% with about a 3-4% chance of scenario #2 and a minimal chance at #3. In order for the deal to be broken up it would require a class 2 resubmission which has an extremely low chance of occurring especially considering the number of successful studies Lev has completed, the unanimously positive review from the advisory panel and that the company is already working on post-approval continued studies.

Looking forward, I would expect acute approval in early 2009 and then continued studies on whether this could potentially be used for heart attacks thereafter. Again, this is a first mover advantage for Lev and orphan drug status is also a likely outcome thus minimizing potential competion for Lev/Viropharma going forward.

2008 Oct 09 05:07 PM

[Dan Weiss:]

FDA approval just granted on the prophylaxis side after the close today. This is clearly a major positive for LEV as the value should be at or above $2.75 per share on Monday morning. For Viropharma, this now gives much more certainty to the cash flows and earnings for the company going forward. Even after the acquisition of LEV, Viropharma will have significant cash and now will have an additional source of cash flows. The plan according to the press release is to have sales begin later this year so I would anticipate significantly higher than current estimate results for Viropharma next year.

2008 Oct 10 06:37 PM