Omeros Doesn't Look Like That Much Of An Opportunity

| About: Omeros Corporation (OMER)
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Biotechnology is hard enough all on its own without investors complicating things with low-potential drugs in difficult markets. With that in mind, I don't see significant opportunity in Omeros (NASDAQ:OMER). The company's near-term pipeline for ophthalmology and knee surgery isn't all that promising, and the early-stage pipeline of MASP-2, PDE10, PDE7, GPCR, and PPAR-gamma has far too little supporting data at this point to validate a high valuation or multiple.

OMS302 Likely To Make It, But Will It Matter​?

Of all of the compounds under development at Omeros, OMS302 ('302) is both the farthest along in development and the most likely to reach the market. Unfortunately, I'm not certain there's a substantial market opportunity for it.

'302 is a combination of two previously-approved (and now generic) drugs, ketorolac and phenylephrine, designed to be administered with standard irrigation solution during cataract surgeries (intraocular lens replacement surgery). Together, the drugs help to maintain pupil dilation and reduce post-operative pain.

Phase III results were successful - the combination did show statistically significant pupil dilation and reduction in post-op pain. As a result, the company should make an NDA filing presently.

Unfortunately, I don't think this drug is going to amount to much. Although both constituents have been used in a pre-surgery setting, there has been no meaningful signal in clinical trials to demonstrate superior efficacy to the combination when used during the surgery. Maintaining proper pupil dilation is not really a problem with the current approach, and I fear that investors have made too much of the pain aspect of this combination.

Modern cataract procedures are relatively pain-free - a review of journal literature suggests that around 50-60% of patients experience no pain, with an additional one-third experiencing "slight discomfort." Even Omeros' own study reflects relatively little pain - 15% of the placebo group saw moderate to high pain, while about 7% of those receiving the drug combo had that experience. What's more, there a variety of drugs available on a post-op basis for those experiencing pain - ranging from Bausch & Lomb's Lotemax to a host of generics.

In my mind, then, this will restrict usage/acceptance of the compound to fairly limited situations. Perhaps there will be a niche in the premium market (about 15% of procedures) where co-pays and reimbursement are not an issue, but I struggle to see the utility of this drug in a normal clinical setting - it adds cost to the procedure for modest (at best) benefits.

All of that said, I'm not sure that investors need to worry about generic substitution or compounding. Some have suggested that surgeons could simply use generic epinephrine and lidocaine drops, but I'm not sure that's a viable approach - ophthalmic epinephrine contains preservatives that could be problematic in a surgeon setting, while lidocaine has only weak (and inconsistent) anti-inflammatory properties.

OMS103HP Could Have A Tougher Road

Omeros' other late-stage drug is OMS103HP - a combination of ketoprofen, amitriptyline, and oxymetazoline targeted for use as an addition to irrigation solution for knee surgery. Not unlike '302, the objective here would be to reduce post-op pain and inflammation for patients undergoing knee surgery.

Unlike cataract surgery, post-op pain is still a relevant concern for knee procedures, even those performed with minimally invasive techniques (like an arthroscope). Unfortunately, the clinical development progression as not been as favorable.

A Phase III study of '103 in ACL repair procedures failed to achieve its primary endpoint. Likewise, a Phase III study in menisectomy delivered a failure on its primary endpoint (the Knee Injury and Osteoarthritis Outcome Score, or KOOS), while meeting the secondary pain endpoint. The company has opted to launch a second Phase III study, this one with pain as the primary endpoint, and that should begin in the first half of 2013.

Here, too, I have serious doubts about the market potential for this drug. The narcotic-sparing benefits seen in earlier studies are nice, and the FDA has accepted pain endpoints before (as with Cadence Pharmaceuticals' (CADX) Ofirmev), but I do not believe that Omeros has met the burden of proof with respect to showing that '103 is meaningfully superior to the current standard of care of administering steroids and pain medication during and/or after a knee surgery procedure.

That is relevant, as the reimbursement environment has forced hospitals to clamp down on procedure costs for more routine surgeries. Without a demonstrated superiority to the standard of care, Omeros will be hard-pressed to sell the combination at any real premium to generic alternatives. What's more, investors should also realize that the medical community often has a regrettably cavalier attitude regarding patient pain - it's not objectively quantifiable (there's no blood test for it), and hospitals and doctors both have a long history of being stubborn about adopting new practices with only pain reduction as the benefit.

A Pipeline That Sounds Sexy, But Is Far From Primetime

One of the things that concerns me about Omeros as an investment is the amount of attention given to its early-stage pipeline. Regrettably, this is an all-too-familiar situation in biotech - companies with poor (or even just mediocre) late-stage prospects try to divert attention to the "potential blockbusters" deep down in the pipeline. While I happily acknowledge that Omeros is exploring some interesting areas of biotech, there's just far too little data to get excited at this point.

OMS721 is an early-stage MASP-2 inhibitor that should enter the clinic in 2013, as the company has indicated that it intends to file an IND in the second quarter of 2013. In theory, this could be a powerful drug - offering a weekly or semi-monthly subcutaneous injection for patients suffering from paroxysmal nocturnal hemoglobinuria (PNH) and/or atypical hemolytic uremic syndrome (aHUS).

These two conditions have made Alexion's (NASDAQ:ALXN) Soliris a blockbuster drug (with incredibly high pricing), but Soliris has to be given as an infusion (less comfortable for the patient) and the safety profile is less than perfect (particularly with respect to acquired immune response). If OMS721 can demonstrate solid efficacy and a clean safety profile, it could be a winner. What's more, drug trials for rare diseases tend to be smaller, faster, and cheaper than regular drug studies.

Behind (or alongside) '721 is OMS824 - a PDE10 inhibitor that Omeros is studying as a treatment for schizophrenia and may investigate for Alzheimer's and/or memory disorders. Effective branded anti-psychotics are generally worth $1 billion or more in commercial sales, and there is very definitely a need for better drugs - particularly those that can treat both positive and negative symptoms, while offering better side-effect and tolerability profiles.

Further down the list, Omeros has compounds under development that target PDE7 (largely for movement disorders like Parkinson's and restless leg syndrome) and PPAR-gamma for addictions. The company also has an investigational G protein-coupled receptor (GPCR) program that targets the identification of ligands of orphan GPCRs.

Operational Decisions Leave Questions

It's not just Omeros' pipeline that gives me pause. A few years ago, the company agreed to settle a wrongful termination suit brought by its former CFO for $4 million. The former CFO had alleged that Omeros had submitted false timekeeping records to the NIH for work done under a federal grant. The CFO reported this to the audit committee and, he alleged, the company fired him in retaliation. While I appreciate that sometimes it makes economic sense for a company to settle, and insofar as I know the NIH accepted the company's explanation of the matter, it still looks bad.

I'm also concerned about the company's funding situation and the amount of dilution it has incurred. From 2007, the company's share count has increased from 2.2 million to 26 million. Even so, the company has only about $30 million in cash on hand and authorization to sell up to $60 million of stock in at-the-market transactions (ATMs). As an investor and analyst, I despise ATMs. Although I appreciate their convenience and I understand that biotechs have to raise money by whatever means are available, I find them to be excessively dilutive and I don't like the secrecy that goes with them - if I own part of a company (which is what being an investor means), I want to know what management is doing, and not just after the fact.

It's also worth noting that Omeros now owes about $20 million to Oxford Finance, but the structure and terms of the debt (a 9.5% interest rate) don't really concern me all that much at present.

Potential, But Not Much Value

My issue with owning or recommending Omeros today is that I think the stock offers too little reward relative to the risks at present. While '302 and '103 are relatively low-risk pipeline candidates, they don't offer much potential - arguably not even enough to fully fund the development of the rest of Omeros' pipeline.

I know sell-side analysts are calling for '302 to generate anywhere from $350 million to over $600 million in revenue, but I find that much too optimistic (remember, sell-side research analysts, particularly those at small firms, don't make money being negative on stocks). I believe that '302 can capture 50% share of the premium market (270K procedures in the U.S. per year) at a price of $250. I likewise believe that the company will get 5% of the standard IOC procedure market (153K procedures) and 2% of the much larger ophthalmic surgery market (200K procedures). That all works out to about $160 million in revenue potential.

Keep in mind, too, that selling '302 is not going to be a simple endeavor. While eye care companies like Novartis (NYSE:NVS), Allergan (NYSE:AGN), Sanofi (NYSE:SNY), and Bausch & Lomb have managed to sell new drug formulations at branded prices despite available generics, often that is in the context of drug life cycle management - the company stops selling a dose/version that is going off patent, switches patients to a patented alternative, and then leaves generic companies scrambling to rebuild the market. For Omeros, I believe it will be far more challenging and expensive, and even if the company finds a marketing partner I do not believe the royalties will be all that generous.

For '103, I see the company getting 15% share of the relevant knee procedure market (roughly 330K procedures), with an ASP of $300 per procedure. That suggests $100 million in potential revenue.

Given the early stage of the remainder of Omeros' pipeline, I would assign $40 million in enterprise value today, but that value could/would clearly go much higher if and when there is encouraging Phase II data on compounds like '721 or '824. At present, I am not assigning specific value to '201 in gyno/urological procedures.

Feeding those revenue estimates into my model (which incorporates a revenue multiple, the time to achievement of the revenue, and a discount rate), I come up with a per-share value of $4.50 for '302, $1.25 for '103, and $1.10 for the pipeline. In total, then, I believe Omeros shares are worth $6.85 today. While that is higher than the current share price ($5.75), it is not close enough in value to compensate for the risks involved, nor the opportunity cost of owning this stock relative to other biotechs.

The Bottom Line

While I can appreciate the idea of launching relatively simple combination drugs as a means of funding pipeline development, I think Omeros will be hard-pressed to make real money from its late-stage pipeline. At the same time, there's no reason yet to believe that any of the earlier stage drugs actually work - they might or they might not, and we won't really know anything until Phase II data (and even then, it's hardly certain).

In the meantime, I believe Omeros will continue to dilute shareholders to raise the funds it needs to continue developing its pipeline. While I freely acknowledge that other investor and analysts will disagree with these numbers and can generate much higher fair values on the basis of higher revenue assumptions, I'll be bypassing this stock when it comes to my own money.

Disclosure: 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.