Approval In Peyronie's Only Part Of The Auxilium Story

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With the FDA's decision date on the approval of Xiaflex for the treatment of Peyronie's disease looming (September 6), considerable attention has come to Auxilium Pharmaceuticals (NASDAQ:AUXL) in recent weeks. While the FDA's decision is absolutely a significant event for the company, investors shouldn't overlook the company's challenges in its existing specialty pharmaceuticals business, as well as the efforts that will have to go into making Xiaflex a winner in Peyronie's assuming approval.

The FDA - Will They Or Won't They?

Time and time again, the FDA has demonstrated that predicting the agency's behavior is challenging at best. In the case of Xiaflex for Peyronie's disease, I'm optimistic. The results from two Phase III studies showed efficacy, as there was a placebo-adjusted reduction in curvature in both the IMPRESS I and IMPRESS II studies.

The studies also showed a statistically significant reduction in "bother score"; a patient-assessed measurement of various quality of life issues related to Peyronie's. Although this measure barely met statistical significance on a placebo-adjusted basis and the FDA can be notoriously fussy about non-objective criteria, the due diligence I've done with urologists suggests to me that they generally accept this as a real metric and consider the Xiaflex results to be meaningful.

Of course, there are side effects with Xiaflex, including unsurprising issues like penile pain, swelling, and hematoma (the drug is a collagen-cleaving compound injected directly into the penis). There were also three reported cases of penile rupture, which is admittedly horrifying but rare (three cases out of 551 patients getting Xiaflex).

On balance, I say the FDA approves Xiaflex. Around 50% to 60% of Peyronie's patients today get injections, but they are seldom efficacious and surgery is often the only effective alternative. While Peyronie's disease is admittedly not a life-threatening disease, there can be serious quality of life issues involved and I believe the lack of effective non-surgical alternatives will sway the agency toward approval.

But Approval Is Only Part Of The Story

I'd say there's a 70% chance that the FDA approves Xiaflex for Peyronie's, but that's only part of the challenge facing the company. As the company's experience with Xiaflex in Dupuytren's contracture ("Dupuytren's") has shown, it's not enough to just have the only non-surgical option on the market. Although the outcomes data in Dupuytren's is pretty good (and there are some potentially serious side effects if the drug isn't administered properly), reimbursement has been more of a challenge than initially expected and the drug's revenue is trending well below the theoretical potential (around $60 million for 2013 revenue versus a market potential once estimated at $500 million or more) after three and a half years on the market.

On the plus side, the urologists I spoke to not only know about Xiaflex, but are looking forward to it. My sample size was not large (28 urologists who deal with the condition), but they all said they would like an effective non-surgical option and that even if Xiaflex didn't always work particularly well, it didn't seem to preclude a later surgery.

They also mentioned that surgery is hardly a perfect treatment option. Around 10% to 20% of patients undergoing surgery for Peyronie's see insufficient straightening and/or serious side effects, depending on which of the procedures they undergo. As one common procedure involves shortening the penis and another presents risks related to graft materials, there are definitely some patient concerns about the surgical options.

In any case, these urologists suggested that Xiaflex could get about one-third of the treatment market, with about two-thirds of that coming from displacing other injections and the remainder coming from displacing surgery. That said, many of the urologists said that they were going to be cautious with the therapy at first - doing their own "mini-trials" to determine which patients would respond best. They also suggested that, in their opinions, this would be a drug that would require a high level of detailing and training, which will place more stress on Xiaflex's sales force and the company's marketing expenditures.

Testim Still A Real Worry

One of the reasons I'm cautious about Auxilium is that due diligence with urologists suggests that success will depend in large part on a strong marketing effort, and I'm not sure the company has adequately demonstrated that they can deliver.

The company's Testim product for low testosterone has not been performing all that well of late. While it may be true that the testosterone replacement market isn't all that healthy anyway (despite ongoing marketing efforts from AbbVie (NYSE:ABBV) and Lilly (NYSE:LLY)), Testim's share continues to fall - from over 20% in Q2'2012 to 17.2% in Q1'2013 to 16.3% in Q2'2013. It certainly doesn't help matters that Auxilium is likely to see intensifying competition from generics, as well as the potential introduction of an oral option (Androxal) from Repros (NASDAQ:RPRX) that offers comparable efficacy with none of the drug handling issues of testosterone gel products.

In addition to the ongoing erosion in Testim, there are the aforementioned issues with Xiaflex in Dupuytren's - a situation that seems similar to Peyronie's to me in many respects. All told, I think Auxilium shareholders may be making a mistake if they think that Xiaflex will sell itself in Peyronie's, and I'm not convinced that the company has demonstrated the ability to drive sales in challenging situations.

Will Xiaflex Meet Its Potential?

Between Testim and the urology drugs acquired in the Actient deal, Auxilium should have the critical mass it needs to make Xiaflex a success if the FDA grants approval. But there's a big difference between having the ability to execute and actually executing, and that is the post-approval risk to this story.

The potential markets for Xiaflex in Dupuytren's and Peyronie's look broadly similar, and my concern is that the experiences will be similar. While at least one sell-side analyst is in print with a nearly $200 million revenue estimate for Xiaflex in Peyronie's in 2015, I don't share nearly that level of optimism. Instead, I'm looking for $75 million to $100 million in revenue for 2015, which would make it clearly more successful in Peyronie's than it had been in Duputryen's.

As part of my base case, I see Xiaflex topping out at about $250 million (50% of market potential), long-term revenue growth of 5% (as Testim fades, Xiaflex grows, and the Actient deal adds very profitable revenue) and strong free cash flow margins commensurate with a specialty pharmaceutical company. Unfortunately, that only works out to about $17 in fair value.

In a more bullish case where Xiaflex does capture close to $200 million in revenue in 2015, $300 million in 2017, and longer-term peak revenue above $400 million, I could see the fair value bumped to $21 or $22, as the erosion of Testim is still a significant risk factor. On the flip side, the failure to secure approval in Peyronie's could lead to a fair value in the mid-to-high single digits unless the company can step up the Dupuytren's sales to offset the eventual erosion of Testim.

The Bottom Line

All told, it looks as though the bulls believe Xiaflex in Peyronie's could be worth about $14 or $15 per share, with about two-thirds of that already in the stock. Given the challenges the company has seen in Xiaflex and Testim, though, I'm reluctant to give the company full credit at this point, and instead project a net present value of about $10 to $11 per share right now. If the company proves it can execute (or investors choose to believe it can), there's definitely some upside from here. Between the one-two punch of approval risk and execution risk, though, I don't see enough value in the shares today to make this a must-own stock apart from those investors who want to try to trade going into (and after) the FDA's decision.

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.