Ram Selvaraju: Fall In Love With These Biotech Stocks

Includes: IRWD, MRK, PFE, PTX
by: Life Sciences Report

When it comes to unearthing dynamic micro-cap biotech investment opportunities, Ram Selvaraju is a master. Selvaraju, managing director and head of healthcare equity research at Aegis Capital Corp., has selected nine names destined to attract investors willing to take calculated risks, which he shares in this interview with The Life Sciences Report. He also explains why he expects 2013 will be another good year for the biotech industry.

The Life Sciences Report: Is biotech going to continue its bullish trend during 2013?

Ram Selvaraju: Yes, I think so, George. The main and important consideration is the stance of the U.S. Food and Drug Administration [FDA]. There has been a lot of discussion about how the FDA has been moderating its previously risk-averse stance. Moderation was clearly the case in 2012, when we had nearly 40 drugs approved -- almost double the rate at which the FDA was approving drugs in lean years such as 2007 and 2008. Clearly, there has been a paradigm shift. We think enthusiasm for small-cap biotech stocks will continue as long as the FDA is approving drugs that ought to be approved, and doing it in a timely fashion.

TLSR: I'm wondering if that relaxed stance filters down to phase 1, phase 2 and end-of-phase 2 meetings with drug developers, to facilitate getting drugs into pivotal clinical trials.

RS: I'd point to two specific areas where this is indeed the case. First, you can look at provisions in the Generating Antibiotic Incentives Now [GAIN] Act of 2011, a piece of legislation designed to speed up the development and approval of novel antibiotics. The idea is to essentially force the FDA to be more proactive, to suggest faster and smaller clinical trials for novel antibiotics and antibacterial agents, and to facilitate the process so products get onto the market as quickly as possible. Everyone knows we need these drugs, with superbugs popping up in hospitals all over the country. If you are an antibiotics drug developer, the FDA's stance is going to benefit you in phase 1, phase 2 and phase 3, not just when the product is under review after all clinical development is completed.

Second, if you're a small-cap oncology drug developer, the same philosophy applies. The FDA is very focused on approving oncology drugs that target significant unmet medical needs, and that give hope to patients who have failed multiple lines of existing approved therapies. The FDA's stance is going to benefit you even if you don't have a drug currently under review, and even if you are only embarking upon early-stage clinical development.

TLSR: Have you somewhat migrated out of your hepatitis C virus [HCV] investment thesis?

RS: No. We still believe that HCV is a hot area. We just don't put a lot of stock in the companies that got there first, such as Vertex Pharmaceuticals Inc. (NASDAQ:VRTX) and Merck & Co. Inc. (NYSE:MRK). We are much more bullish on companies like Gilead Sciences Inc. (NASDAQ:GILD), with its nucleotide polymerase inhibitor sofosbuvir [GS-7977], and Achillion Pharmaceuticals Inc. (NASDAQ:ACHN), with its group of protease inhibitors that are currently in early- to mid-stage clinical development. We think Gilead and Achillion are much more likely to be leaders.

We still believe the HCV marketplace is very attractive, and that investors are going to be heavily focused on this market for several years to come, even though individuals in America don't get HCV at the same frequency that they once did due to broad-based screening of the blood supply. There is a massive undiagnosed, and therefore untreated, population out there that represents a good commercial opportunity for companies with HCV drugs in clinical development. No question: Investors are interested in this area, and we want to keep our hand in that game.

TLSR: Could we talk about some companies? Go ahead with an idea.

RS: At this juncture, we are looking primarily at companies with significant value-driving catalysts this year. One of these is antibiotic developer Trius Therapeutics Inc. (TSRX). We have been bullish on Trius for quite some time. It recently raised capital; it is very well-funded. It is highly unlikely that there will be an additional near-term dilutive capital raise. We think investors should take a look at this company now, and consider this a reasonable and timely entry point.

TLSR: Go ahead and talk about the catalyst. When is it anticipated?

RS: It is expected to occur in the second half of March, with the release of top-line data from a second phase 3 trial of the company's novel antibiotic, tedizolid phosphate, a member of the oxazolidinone family. This is a confirmatory trial for skin structure infections. Since the designs of the first phase 3 trial and this one are virtually identical, we believe the second trial will be positive as well. We are very enthusiastic about the upcoming data release.

Perhaps most importantly, we believe Trius is the only small-cap antibiotic drug developer focusing on a drug that is not a member of a crowded class. Currently there is only one other approved drug that belongs to the oxazolidinone class: Pfizer Inc.'s (NYSE:PFE) Zyvox [linezolid], which does about $1.4 billion [$1.4B] in sales a year -- a very successful agent. If we look at Trius' market cap, it is currently trading at a roughly $200 million [$200M] market valuation and at about a $100M+ enterprise value. We think that is extremely low for a company that's already in phase 3 and that has a risk-mitigated asset with a previously reported positive phase 3 study. The company is substantially undervalued,, and it could be the beneficiary of fast-tracking under the provisions of the GAIN Act.

A lot of investors have had concerns about Trius because tedizolid would directly compete with Zyvox, which has a composition of matter patent expiring in May 2015. We have looked at the situation very carefully, and we don't believe that a generic of Zyvox will be introduced in 2015 because Pfizer has an additional patent covering a crystalline form of Zyvox that doesn't expire until 2018. Moreover, Pfizer has indicated that it has reached a settlement with Teva Pharmaceutical Industries Ltd. (NYSE:TEVA), which was in line to launch the first generic of linezolid. We now think that a generic will hit the market in late 2016 or early 2017. If its second phase 3 trial is positive, Trius' tedizolid could potentially be on the market by the middle of 2014. It would have a good two-and-a-half year runway in which to build sales, which could be in the $300-400M range in the U.S. and $200-300M outside the U.S. That is very doable.

Finally, the company has a very nice third-party licensing deal in place with Bayer Pharma AG, which represents some validation of tedizolid. Investors could get a heck of a lot for their money if they invest in the company at these levels. That's why we like Trius.

TLSR: Tedizolid's mechanism of action is the same as linezolid, right?

RS: That is correct.

TLSR: Some patients treated with linezolid may have developed mutated strains of bacteria for which the product may no longer be effective. Will that confer cross-resistance to tedizolid?

RS: That's a very good question, and I'm glad you asked. For a long time, there was hardly any resistance to linezolid. It was very popular because bacteria seemed to find it very difficult to evolve resistance to the drug. However, in recent years, linezolid resistance has been developing and climbing. Now, about 1% of individuals receiving linezolid wind up showing resistance, and we expect that figure to continue to climb -- although in our view, it's not going above 10% anytime soon.

Tedizolid, however, appears to be active against a broad spectrum of linezolid-resistant strains. It is not a given that if a patient is resistant to linezolid, he or she automatically will be resistant to tedizolid. In fact, it is more likely that using Trius' drug would provide benefit to patients with resistant bugs. That is a very positive feature.

TLSR: Your implied return here is 200%, with your target price of $14. Is that what you expect from the results of the phase 3 data that are anticipated in the second half of March?

RS: Our price target is an 18-month target. We are factoring in not only the impact of the phase 3 trial, but also the impact of a formal filing at the FDA, the FDA's acceptance of the filing and eventual drug approval. We expect approval in mid-2014, assuming that Trius files on the back of positive phase 3 results in the middle of this year. I would say that we are among the more bullish groups on the Street with respect to this company.

TLSR: What's your next idea?

RS: A word on Ironwood Pharmaceuticals Inc.'s (NASDAQ:IRWD) and its drug Linzess [linaclotide], which was approved by the FDA at the end of August and has been launched here in the U.S. The stock is at about $13 right now, with a market cap of about $1.4B and an implied enterprise value of around $1.2B. Ironwood is attractive primarily because linaclotide, a member of the same class of drugs as Synergy's plecanatide, has gone through four positive phase 3 trials. It was launched in mid-December with Ironwood's marketing partner Forest Laboratories Inc. (NYSE:FRX), which booked $19M in Linzess sales in the last two weeks of December alone. Even if investors assume that a significant proportion of that number was due to channel stuffing and stocking, they could still legitimately expect Linzess to be a $100M+ generator in 2013. We certainly expect it to become a blockbuster drug eventually.

TLSR: Another name?

RS: We recently picked up coverage on the specialty pharma company Pernix Therapeutics Holdings Inc. (NYSEMKT:PTX). We're very bullish on the company, primarily because we like its organizational strategy. Pernix recently relisted on the NASDAQ, and we think that is very positive.

We also believe that the company's strategy of being extremely acquisitive is likely to continue in 2013, and that is eventually going to pay dividends. Very few companies are as good as this one in terms of identifying and realizing synergies from a sales and marketing perspective between its endogenous sales force and the sales forces of the companies that it acquires. In 2012 alone, Pernix, which started with a market cap of around $200M, did acquisitions amounting to $130M. It is a very aggressive company. The CEO of the firm, Cooper Collins, came up through the ranks of the sales organization. He utilizes that experience to full effect in his management of the company.

If investors look at Pernix's current valuation of about $237M, and then look at its projected growth rate from a revenue-and-earnings perspective, the only conclusion they can reach is that this company is fundamentally undervalued.

TLSR: Ram, this is a dramatically different type of company than you typically cover. What do you like about it?

RS: It has a wide array of marketed products. It is also profitable. We expect it to do $0.34 in earnings this year and $0.50 next year, but we also expect it to grow from roughly $140-150M in revenue this year to close to $200M in revenue next year, which is significant. Over time, that's going to trickle down to the bottom line. For the company to be trading at less than two times projected 2013 sales currently is an indication that now is a good entry point for investors.

We believe the company will continue to be acquisitive, and also hope that one of its acquisitions has a beneficial impact on the company's effective tax rate, which is pretty high at around 40%. Even without lowering its effective tax rate, Pernix's future acquisitions are going to be strategically beneficial, and the company is going to significantly grow both top and bottom lines going forward.

TLSR: I did note that the company has grown its revenue dramatically over the past four years, yet the stock price doesn't reflect that at all. In fact, shares are down 20% over the past two years. Do you think the company is being punished for being acquisitive?

RS: Yes. In recent months, the company's acquisitive strategy has not resonated as much with investors as it ought to have.

TLSR: I've been looking at the company, and I couldn't determine any specific binary event or other share-price mover. What do you see?

RS: I would disagree. This is strictly a dollars-and-cents story. Basically, this company is going to go through a number of binary events, but it is also going to go through a number of value-driving catalysts, none of which, in and of themselves, are binary events. Earnings releases, future acquisitions, prescription trends -- these are all value drivers for Pernix.

If the company continues to stick to its very disciplined approach of identifying good bolt-on acquisitions, and sticks to paying for them with equity as opposed to debt, thereby keeping its debt load relatively manageable, it will be successful. It also has to remain aggressive about identifying and implementing cost synergies in its sales and marketing infrastructure. Eventually, growth on the bottom line is going to catch up with growth from the top line, which over the course of the past two years has been very significant.

[For Ram's six additional biotech picks, click here]

TLSR: It's been a pleasure, Ram. Thank you.

RS: It's been my pleasure. Thank you.

This interview was conducted by George S. Mack of The Life Sciences Report.

Raghuram "Ram" Selvaraju's professional career started at the Geneva-based biotech firm Serono in 2000, where he discovered the first novel protein candidate developed entirely within the company. He subsequently became the youngest recipient of the company's Inventorship Award for Exceptional Innovation and Creativity. Selvaraju started in the securities industry with Rodman & Renshaw as a biotechnology equity research analyst. He was the top-ranked [#1] biotech analyst in The Wall Street Journal's "Best on the Street" survey [2006] and went on to become head of healthcare equity research at Hapoalim Securities, the New York-based broker/dealer subsidiary of Bank Hapoalim B. M., Israel's largest financial services group. While at Hapoalim, Selvaraju was regularly featured in The Wall Street Journal, Barron's, BioWorld Today, and Reuters/AP. He was also a regular guest on the Bloomberg TV program "Taking Stock," appeared with Bloomberg TV's on-air correspondents Betty Liu and Gigi Stone and was a guest on CNBC's "Street Signs with Herb Greenberg." He is currently an analyst with Aegis Capital Corp.

1) George S. Mack of The Life Sciences Report conducted this interview. He personally and/or his family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Life Sciences Report: Merck & Co. Inc. is not affiliated with Streetwise Reports. Streetwise Reports does not accept stock in exchange for services. Interviews are edited for clarity.
3) Ram Selvaraju: I personally and/or members of my immediate household own shares of the following companies mentioned in this interview: None. I personally and/or members of my immediate household am paid by the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview.

I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.