Upcoming FDA Decision Creates Upside And Catalyst For Recro Pharma

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About: Recro Pharma, Inc. (REPH)
by: Rational Expectations
Summary

An FDA decision (PDUFA date) for the painkiller IV Meloxicam from Recro Pharma is expected in under 2 weeks on March 24, 2019.

Base rates suggest an 80% probability of success. Other delivery methods of the Meloxicam are already approved, reducing risk.

This is a material opportunity relative to the company's enterprise value, and Recro Pharma's cash-generative contract manufacturing assets offer some downside protection.

We see a probabilistic fair value in the mid-$30s, representing a multiple of the current share price. Of course, this upside is binary, fully dependent on drug approval.

Recro Pharma (REPH), a smallcap U.S. pharma company has a Food and Drug Administration (FDA) decision on its main drug pending on March 24, 2019. The chance of approval appears to be approximately 80%, using base rates for drugs at a similar approval stage, and the drug's value, if approved, is likely in the $1B range. That alone would create upside in the stock, but Recro Pharma separately owns a drug manufacturing facility that generates operating income of $23.5M.

Given that the company's market cap is just over $200M (EV $230M) at the time of writing, it appears that there is upside in the event of IV Meloxicam approval, but some downside protection from the manufacturing facility.

What Is IV Meloxicam?

IV Meloxicam is a long-acting painkiller (COX-2 inhibitor) to be administered in hospitals after surgery to address acute, post-operative pain. Meloxicam is already approved as an oral formulation, as such the novelty here is in the IV (intravenous) delivery method.

It is important to note that unlike many painkillers, Meloxicam is not opioid-based. This means that substituting Meloxicam for other opioid-based painkillers, may go some way to helping reduce the opioid problems the U.S. is experiencing. Since one route to opioid addiction is to be introduced to the drug after a medical procedure and then continue to use it. Currently, opioids are used in 73% of cases for inpatient pain control. Usage of IV Meloxicam could reduce medical opioid usage.

What Are IV Meloxicam's Chances Of Approval?

Here base rates can be useful. This means examining similar drugs at a similar stage of the approval process. The probability of success at the New Drug Application (NDA) stage is 85% according to Biomedtracker data. That covers the probability that the drug will be approved at some point after multiple approvals.

More specifically, we are interested in the outcome later this month, from the same study approval on the second review is 80%, so that's where IV Meloxicam currently sits relative to other drugs at the same stage.

Though the FDA obviously raised concerns after the first review in May 2018, we don't believe objections are likely to be blockers to ultimate approval and Recro Pharma was able to resubmit an NDA within four months in September 2018. The primary objection in the FDA's Complete Response Letter was, per the Recro Pharma 10-K. "data from ad hoc analyses and selective secondary endpoints suggest that the analgesic effect did not meet the expectations of the FDA."

What Is The Market Size For IV Meloxicam?

Similar drugs have annual revenues in the $300M range. For example, Ofirmev, part of Mallinckrodt, had sales of $290M in 2016 (see slide 10 of presentation), Ofirmev has some similarities to IV Meloxicam as an IV-administered painkiller marketed to hospitals.

The company believes it can address a market of 12M surgeries a year with a 26% uptake and an $80 dosage cost. That would equate to a $250M sales run-rate for IV Meloxicam. This is relatively consistent with the sales achieved by Ofirmev.

It therefore appears reasonable to value IV Meloxicam in the $1B range if approved, assuming a 10-year life and a 60% contribution margin.

What's The Value Of The Contract Manufacturing Facility?

Recro Pharma also owns a drug manufacturing facility in Gainesville, GA (pictured below) that has contracts primarily with Novartis (NYSE:NVS) and also Teva (NYSE:TEVA), Lannett (NYSE:LCI) and Pernix (OTCPK:PTXTQ). The operation is relatively stable generating $25M of operating income and $33M of EBITDA. We value the facility at 10x operating income for a valuation of $250M. In the tightly regulated drug manufacturing industry, the facility's regulatory approvals, sales relationships and track record create a relatively significant moat.

Funding/Dilution Risk

Recro Pharma currently has just under 22 million shares in issue. Were IV Meloxicam to be approved, further funding would be needed to ramp the salesforce to around 100 on the company's projections, and bring the drug to market. Of course, the CDMO asset together with undrawn debt funding offers some liquidity. Nonetheless, assuming an incremental $50M of liquidity is needed (representing an estimated $30M of salesforce costs and $20M of approval milestone payments), that would represent share issuance of just under 6M at current levels.

Given we are interested in the upside case of drug approval, we assume incremental dilution to a 28 million share count (from 21 million) in our valuation below. Of course, optimistically post-approval the share price may rise, hence supporting a smaller level of dilution, but that is not assumed in our base case. Also, there is some variability in the liquidity the company will need. It is also possible that Recro Pharma is acquired post-approval by a larger pharma company that can realise efficiencies with its own salesforce reps.

Aggregate Valuation

Based on the above pieces, we have a potential $1B drug with an 80% chance of approval (so $800M probabilistic value), paired with a manufacturing asset valued at $250M. We conservatively value Recro Pharma's other pipeline drugs at zero. Thus, a $1.02B valuation against a 28M share count (assuming some incremental issuance as described above). Hence, we arrive at a valuation of $36/share, roughly 4x the price at the time of writing.

Risks

The primary risk is the binary approval outcome. There is an estimated 1 in 5 chance that the drug is not approved. In theory, the cash-generative contract manufacturing asset provides some support in this scenario, though in practice cash burn associated with the approval process will likely erode some of that value. Cash burn is currently running at $12-$15M per quarter.

Secondary risks are that equity issuance after any FDA approval occurs on a larger scale or at lower prices than assumed, and that in resubmitting their FDA, Recro Pharma revise the labeling in a way that reduces the addressable market and/or pricing potential for IV Meloxicam. Bringing the drug to market may also prove to be slower or more expensive than forecast.

Conclusion

In the event of approval before the end of the month, Recro Pharma looks to offer material upside to investors because IV Meloxicam appears to have a value (if approved) of roughly five times Recro Pharma's current market capitalization. Approval seems likely as 8 out of 10 drugs at this NDA stage are approved. We therefore see compelling risk/reward for Recro Pharma as the March 24 PDUFA date approaches.

Disclosure: I am/we are long REPH. 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.