Transcept is a specialty pharmaceutical company focusing on the development and commercialization of two drugs: Intermezzo, a sublingual tablet used to treat insomnia when a person wakes up in the middle of the night and cannot fall back asleep, and TO-2061, an adjunctive therapy for patients with obsessive compulsive disorder who have not adequately responded to standard first-line treatments. If approved, Intermezzo would be the only available insomnia medication designed for as-needed use following a middle-of-the-night awakening. The stock price of TSPT tanked after the FDA delivered a complete response letter (“CRL”) in mid-July stating that, while TSPT has proven that Intermezzo is an effective treatment following middle-of-the-night awakenings, it has failed to demonstrate that Intermezzo can be used safely – because Intermezzo might unacceptably impair next-morning driving ability. Transcept will meet with the FDA on September 14th to discuss what if any paths forward are available for Intermezzo. The company expects to update investors on the meeting and on its strategy going forward at some point during the second half of October or the first half of November.
I recently bought TSPT stock because, whatever the results of the September meeting with the FDA, management should have the opportunity and willingness to create incremental value for shareholders. If TSPT reports that there is still a viable path to obtain approval for Intermezzo then the price of the company’s stock could skyrocket, because the size of the market for an insomnia drug that treats middle-of-the-night awakenings is so large relative to the company’s market cap ($36.2 million). TSPT traded as high as $11.88 in June; its current stock price is $2.68. Meanwhile, if the prospects of Intermezzo and TO-2061 look dim, then TSPT can still create significant value for shareholders by liquidating or by merging with a cash-hungry technology company that has a superior pipeline. There’s limited downside because TSPT’s cash and functional equivalents minus liabilities substantially exceed its market cap. I’m reasonably confident that management will adopt the strategy that maximizes shareholder value because among other reasons the company’s officers and directors and their affiliates own a large portion of its stock and management has already demonstrated that it will promptly downsize as necessary to preserve shareholder value.
TSPT’s Liquidation Value Substantially Exceeds Its Market Cap
TSPT’s balance sheet provides exceptional downside protection. Tangible book value per share as of July 31, 2011 is $4.31. Cash, U.S. Treasuries, and money market funds comprise roughly 96% of total tangible assets. What’s more, the balance sheet does not reflect the value of Transcept’s intellectual property. Transcept’s stock closed today at $2.68.
Transcept’s cash burn is low. Quarterly cash burn during Q2 2011 amounted to 26 cents per share. The company announced on July 15th that it planned to reduce operating expenses by eliminating roughly 45% of its workforce, which should further reduce cash burn going forward.
Management Will Likely Adopt the Strategy That Maximizes Shareholder Value
The current discount to liquidation value is unwarranted because among other reasons management’s incentives and track record support the proposition that it will make the hard decisions necessary to maximize shareholder value. Transcept’s executive officers, directors, affiliated former directors and their affiliates beneficially owned roughly 57% of its common stock as of June 30. The CEO, Glenn Oclassen, bought more TSPT stock on August 10-11. Last month’s layoffs suggest that Oclassen is proactive about tough decisions: TSPT received the CRL around July 13 and, notwithstanding its strong cash position, it announced the 45% downsizing two days later.
A Double-Dip Recession Would Have Relatively Little Impact on TSPT
Another source of downside risk for stocks is the possibility of another recession. But a double dip over the next year would have less impact on TSPT than most other companies because Transcept does not yet sell a product or service. Transcept ought to hold up better during a recession than most other development-stage life sciences companies because it has a stronger balance sheet and consequently less need to raise equity over the near-term. (Of course, if there is a rout in the stock market, then the price of TSPT could well decrease, because among other reasons some shareholders could panic or be subject to forced selling.)
A Tiny Company Tackling a Huge Market = Enormous Upside
Transcept has enormous upside because it’s a tiny company developing a product, Intermezzo, that meets an acute need of a large number of people. The market cap of TSPT is $36.2 million. Meanwhile, the National Institute of Neurological Disorders and Stroke, which is part of NIH, reports that insomnia affects about 40% of women and 30% of men. The Stanford Sleep Epidemiology Center estimated in a 2008 study that middle-of-the-night awakening is the most common form of insomnia and affects roughly one-third of the population at least three times a week. The Wall Street Journal reports that U.S. doctors wrote 60 million prescriptions for insomnia in 2010.
Transcept should receive a large share of the profits when and if regulators approve Intermezzo. It has an agreement with Purdue Pharmaceutical Products, a much larger pharmaceutical company, whereby, when and if Intermezzo is approved, Purdue will assume all subsequent costs relating to commercialization of the product in the United States (including post-approval studies) and pay TSPT royalties of roughly 20% of net sales plus one-time payments of up to $90 million. Transcept owns all rights to Intermezzo outside the United States and expects to enter into strategic alliance(s) with established pharmaceutical companies to commercialize Intermezzo in foreign markets.
Intermezzo is so appealing because it would fill a unique niche: there are lots of medications that patients take before going to sleep because they anticipate some form of insomnia; but there is no approved medication specifically designed for use in the middle of the night when a patient has awakened and cannot fall back asleep. Intuitively, I suspect there are lots of people who don’t want to take an Ambien before going to bed every time they suspect that they might wake up and have difficulty falling back asleep, but who would welcome a product that would help them get back to sleep on the nights when they have actually been unable to do so.
Intermezzo Is Safer Than Many Real-World Alternatives
There is a significant possibility, in my opinion, that regulators in the United States, Europe and elsewhere will eventually approve a version of Intermezzo because, while use of Intermezzo can impact next-morning driving, Intermezzo has less severe consequences than many real-world alternatives.
Let me summarize the dialogue between TSPT and the FDA respecting driving impairment. Transcept sought to define impairment as the diminution in driving skills when a driver has a blood alcohol level of 0.08 (compared to when the driver is sober.) Transcept argued that Intermezzo is safe because (i) if patients use the medication as prescribed, by taking it at least four hours before driving, then it has a very small impact on driving skills; and (ii) if patients disregard the instructions and take it three hours before driving then Intermezzo still impairs driving less than either (a) BAC of 0.08; or (b) Zopiclone 7.5mg, a hypnotic prescribed in Europe for insomnia, taken 9 hours before driving. The FDA however rejected the proposition that the level of impairment resulting from BAC of 0.08 represents the threshold for clinically meaningful impairment here; the press release summarizing the contents of the FDA’s response does not explain how if at all the FDA proposes to define clinically meaningful impairment. The FDA also indicated that, before it will approve Intermezzo, TSPT must either demonstrate that patients will not suffer clinically meaningful impairment when they take Intermezzo just 3-3.5 hours before driving (i.e., contrary to the instructions) or that significant numbers of patients do not in fact misuse the drug. As noted, Transcept will meet with the FDA next month to discuss potential paths forward.
The most important reason why I believe that there is a significant probability that regulators will eventually approve a version of Intermezzo is because the consequences of taking Intermezzo 3 hours before waking are less severe than the consequences of some important real-world alternatives. As noted, Intermezzo has a much less severe effect than zopiclone 7.5mg; zopiclone is prescribed in Europe and Canada and its active stereoisomer, eszopiclone, is sold in the U.S. under the brand name Lunesta. Taking Intermezzo 3 hours beforehand also impairs driving much less than taking Ambien 10mg 4-5 hours beforehand. This fact is unsurprising since Intermezzo and Ambien share the same active agent, zolpidem; the principal differences between the two drugs are that Intermezzo has a lower level of zolpidem and Intermezzo is specifically formulated so that a larger proportion of the medicine enters the patient’s bloodstream shortly after it’s taken. I am unsure about the relative effects of Intermezzo 3 hours before driving compared to Ambien 7, 8 or 9 hours before driving (or compared to sleep deprivation). Of course, there can be other issues if a patient takes Ambien nightly. I strongly suspect that some people who wake up in the middle of the night and cannot fall back asleep take an Ambien or other sleeping pill and then suffer more severe negative consequences when they get behind the wheel the next morning. In addition, it is quite possible that patients who respond in other ways, such as taking an Ambien nightly 7 or 8 hours before driving, also suffer more severe negative consequences. There are plenty of cases, I suspect, where intermezzo is the safer alternative.
Catalysts for a Higher Stock Price
There are several types of outcomes that could allow me to book a gain on my investment in TSPT.
First, Intermezzo could move forward in the United States. Here are some possible solutions to FDA’s reservations:
- TSPT could boost the proportion of medication that is absorbed quickly through the mucous membrane rather than gradually through the gastrointestinal tract (so that less medication remains in the patient’s bloodstream when she wakes up).
- It could demonstrate that TSPT is effective at a lower dosage for all patients.
- It could demonstrate that the original dosage is safe for less sensitive sub-groups (e.g., men weighing over 150 pounds) and that a lower dose is safe and effective for more sensitive sub-groups.
Second, Intermezzo could move forward in a non-U.S. jurisdiction. One possible near-term catalyst could be execution of a distribution agreement with a larger European pharmaceutical company.
Third, TSPT could report a successful outcome of the ongoing Phase 2 study of TO-2061.
Fourth, TSPT could liquidate, or merge with a cash-hungry life sciences company enjoying a superior pipeline.
Transcept looks to me like a free option. If TSPT reports in mid-October that there is a credible path forward for Intermezzo, then the stock should appreciate massively. If Intermezzo and TO-2061 fail to pan out, then at the very least I should still break even – because cash and functional equivalents minus liabilities, per share, are 54% greater than today’s closing stock price.
There are a variety of risks. For example, Transcept discloses that its Collaboration Agreement with Purdue requires it “to continue development of Intermezzo at our expense until FDA approval.” It’s possible therefore that, in the event Intermezzo hit a dead-end and TSPT sought to liquidate, Purdue might be able to extract value in return for its consent to such a change of course. As another example, even if TSPT wins approval of Intermezzo, a manufacturer of generic pharmaceuticals might still be able to mount a successful challenge to the underlying patents.
The reader should also be aware that I have no experience or expertise respecting the FDA, life sciences or pharmaceutical companies.
[Disclosure: Long TSPT]