We listened to Cempra (NASDAQ: CEMP) management's investor conference call after receiving the Complete Response Letter (CRL) from the FDA regarding regulatory application for Solithromycin's approval for the treatment of adult community-acquired bacterial pneumonia (CABP). The management plans to meet with the FDA to discuss FDA's request for a comparative safety trial to study possible hepatotoxicity of Solithromycin. On reviewing the medical literature (source), we believe that the idiosyncratic liver toxicity seen with prolonged Telithromycin use may be related to blockade of α-7 nicotinic acetylcholine receptors (due to decreased vagal activity caused by pyridine piece of Telithromycin. This pyridine piece is also believed to be behind other side effects like worsening of myasthenia gravis seen with Telithromycin.
Solithromycin does not have this pyridine piece in aryl-alkyl side chain and does not significantly block α-7 nicotinic acetylcholine receptors. Mild elevation in liver enzymes seen with Solithromycin in previous clinical trials is a class effect of macrolides, and was clinically insignificant and reversible after stopping therapy. The overcautious stance of FDA seems to be due to its previous bad experience with serious side effects seen with prolonged Telithromycin use after approval (with even few deaths). Although Solithromycin is a first-in-class fluoroketolide macrolide, FDA seems to be taking an overcautious approach due to it being another ketolide macrolide antibiotic (Telithromycin is a ketolide macrolide).
At present, we will not speculate on the timeline, size, design or the cost of comparative safety trial requested by the FDA till we get more information from the management after its meeting with FDA. We still believe that Solithromycin would be eventually approved for the treatment of adult CABP in 2018 considering the unmet need for a broad spectrum and efficacious oral antibiotic for this clinical indication. We will not speculate on a possible restricted label for the drug for the treatment of adult CABP at present.
Cempra is currently trading at a market cap below the cash reserves on its balance sheet. We performed a repeat enterprise DCF valuation using forecasted risk-adjusted revenues from Solithromycin in the treatment of gonorrhea, and Taksta for the treatment of acute bacterial skin and soft structure infections (ABSSSI), and prosthetic joint infections. A single 1 gm dose of oral Solithromycin has shown excellent clinical efficacy for the treatment of gonorrhea (source) for which the current standard of treatment is intramuscular ceftriaxone and oral azithromycin. Resistance to the current standard of therapy is increasing in gonorrhea and there is great need for newer more efficacious therapies like Solithromycin. Moreover, we do not expect serious side effects like hepatotoxicity with single 1 gm dose of Solithromycin. Gonorrhea is an important public health problem as per CDC. The annual incidence of gonorrhea is 400,000 cases per year in the US and 900,000 cases per year in Europe. Worldwide incidence of gonorrhea is 110 million cases per year. A phase 3 trial of Solithromycin for the treatment of gonorrhea is ongoing and the results are expected in 2017.
Taksta (fusidic acid) is being tested in a phase 3 trial for the treatment of ABSSSI and the results are expected in Q1, 2017. A phase 2 trial of Taksta for the treatment of prosthetic joint infections is ongoing and the results are expected in 2017 as well. Fusidic acid is available in Europe but not in the US. Antibiotics for the treatment of ABSSSI, especially methicillin-resistant staphylococcus aureus (MRSA) is another area of on-going therapeutic research and blockbuster drug sales. Linezolid had $1.3 billion global sales in 2011. Cubicin had $800 million of US sales in 2012.
Valuation of the common stock:
Using inputs of drug launch in 2018, peak 50% market penetration for the treatment of gonorrhea (worldwide) at patent expiry in 2032 (see spreadsheet for trajectory), probability of reaching the market=67% (average for drugs in phase 3), cost of treatment per patient= $120 (similar to 1 gm oral dose of branded Zithromax), $80 per case in the Europe, and an average of $2 (rest of the world), we modeled peak $123.4 million in risk-adjusted revenue globally from this indication (at patent expiry in 2032) (after adjusting royaties payable to Optimer and Scripps Institute).
Using inputs of drug launch in 2020, annual incidence =10,000, peak 23% market penetration for the treatment of prosthetic joint infection (U.S.) at patent expiry in 2029 (see spreadsheet for trajectory), probability of reaching the market=67%, and cost of treatment per patient= $10K, we modeled peak $15.5 million in risk-adjusted revenue in the U.S. from this indication (at patent expiry in 2029).
Using inputs of drug launch in 2018, annual incidence =600,000 (ABSSSI related hospitalizations, with Taksta used at discharge), peak 12.3% market penetration for the treatment of prosthetic joint infection (U.S.) at patent expiry in 2029 (see spreadsheet for trajectory), probability of reaching the market=67%, and cost of treatment per patient= $4,000 (similar to 10-day course of oral Linezolid branded), we modeled peak $197.7 million in risk-adjusted revenue in the U.S. from this indication (at patent expiry in 2029).
Using these inputs, we modeled peak $324.6 million in risk-adjusted revenue from these 3 clinical indications in 2029. We input COGS=25% of revenue, and R&D was amortized over 5 years. Income taxes were adjusted with applicable deferred tax assets. We used reinvestment rate of 80%. Cost of capital was input=15% for first 5 years, then decreased to 12% for next 5 years, and then 10% (average cost of capital is about 8.5% for mature pharmaceuticals). McKinsey's NOPLAT formula was used to calculate the terminal value of free cash flow.
We calculated the value of operations (using enterprise DCF method)= $368.36 million from these 3 clinical indications. After adjusting for non-operating assets like cash reserves and liabilities, and using diluted share count, we calculated fair value for Cempra's common stock= $10 (using enterprise DCF method).
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Risks in the investment:
It is possible that on-going clinical trials for Solithromycin in gonorrhea and Taksta in above mentioned indications may fail, regulatory agencies might not approve the products, unexpected side effects might be seen in future, clinicians might not widely prescribe the products or insurers might not reimburse them. Competing products from other companies might gain significant market share in the planned clinical indications. The company may also need to raise more cash to fund its operations in future through equity and/or debt financing, which might put downwards pressure on the stock price. It is also unclear how much will be the cost of FDA requested comparative safety trial and how this will affect the company's cash reserves.
Conclusions: While we still remain optimistic about Solithromycin eventual approval for the treatment of adult CABP in 2018, the purpose of this article was to value Cempra's common stock (removing Solithromycin in adult CABP, pediatric CABP and NASH/COPD indications). We have shown using our valuation that Cempra's common stock is undervalued at its current price level and could be worth $10 (using just Solithromycin in gonorrhea and Taksta in ABSSSI/prosthetic joint infections indications). Solithromycin's European MAA application is pending (decision in early 2017). EMA has been more lenient in drug approvals than FDA (with precedents like pirfenidone, Translarna, etc.). European approval for Solithromycin in adult CABP (with the condition of a post-approval safety study) and possible change in the FDA Commissioner (with Trump administration) could open up the possibility of FDA negotiation and 2017 approval in the U.S. We are not optimistic about Solithromycin's commercial potential in NASH and COPD due to its GI side effects (like nausea, diarrhea, potential for hepatotoxic effects on long-term use) which may limit its long-term use in these clinical indications.
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Disclosure: I am/we are long CEMP.
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.