A.P. Pharma: Side Effect Issue With Competitive Drug Is A Huge Positive

| About: Heron Therapeutics, (HRTX)

Investment Thesis

The FDA issued a safety communication on June 29, 2012 further advising physicians on the link of ondansetron (Zofran) to QT interval prolongation; this condition can cause abnormal heart rhythms that in some cases may be life threatening. This follows a previous communication on the same concern on September 11, 2011. Because AP Pharma's (APPA.OB) competitive product in development, APF530, is not linked to QT interval prolongation, this gives APF530 a meaningful differentiation from ondansetron in terms of safety. In addition, ondansetron can no longer be given as a single 32 mg infusion and will now have to be given in roughly three infusions over a twelve hour period. Some contacts I have spoken with think that these factors will cause a major erosion in ondansetron sales. If their assessment is correct, this could be a huge positive for A.P. Phama as ondansetron currently accounts for one third of the market.

A.P. Pharma has been one of the best performing stocks in biotechnology so far this year. Since I published my initiation report on April 25, 2012 in which I recommended purchase, the stock has increased from $0.42 to $0.68 per share, an increase of 60%. This did not result from any single new catalytic event, but rather widening investor awareness of and excitement about the potential of the company's lead drug APF530 for chemotherapy induced nausea and vomiting or CINV.

In my report, I cited three potentially important catalysts for the stock in 2012: the re-filing of the NDA in mid-2012, potential approval in early 2013 and a possible partnering deal in late 2012 or early 2013. I also pointed out that there was the potential that the second most widely used drug for CINV, ondansetron, was drawing the concern from the FDA for its potential to cause QT interval prolongation, a condition that can lead to heart attacks. Last Friday, the FDA took further action to inform health care providers and patients of this risk of ondansetron and changed the package label to try to prevent the use of high doses of ondansetron.

Another drug used to treat CINV that belongs to the same chemical class as ondansetron and APF530, Anzemet, was previously linked to QT interval prolongation; on December 17, 2010 the FDA warned against its use and sales plummeted from 100,000 vials sold per month to almost no vials. The FDA warning on ondansetron's propensity to cause QT interval prolongation does not appear to be as strong as that for Anzemet but investors have to wonder what effect this will have in the marketplace. I think that the FDA was reluctant to take strong measures against ondansetron because of its long record of reasonably safe use; it was introduced in 1991 and has been used in millions of patients without widespread reports of QT interval prolongation. Still, this is a serious condition and I think that if ondansetron were a new drug seeking approval that its link to QT interval prolongation might prevent approval.

In a thorough study reported in March 2012, APF530 reported clean results in a QT interval prolongation study. The active pharmaceutical ingredient of APF530 is granisetron and in that study, APF530 and an older formulation of granisetron (Kytril) both came out with a clean bill of health, even at a dose 5 times the therapeutic level. This obviously confers an important safety advantage to APF530 over ondansetron in the clinic. It obviously can only be positive, but how much so is difficult to judge. A physician has to ask if this is an acceptable risk with ondansetron when another agent with comparable efficacy and without the risk is available.

There is also another important issue in that the 32 mg intravenous dose of ondansetron has been withdrawn from the market. Instead of the patient getting one 32 mg dose at one setting, a patient requiring this amount of dosage will be given three smaller doses spaced four hours apart. Instead of receiving one 32 mg dose of ondansetron and being done, the patient will have to spend almost twelve hours at the infusion center to receive the needed dosage.

With the diminished safety to benefit ratio of ondansetron, physicians at this point have two other options to consider, generic granisetron and Aloxi; neither are linked to QT interval prolongation. APF530 will be another option if it gains approval in early 2013. One of the major attractions of granisetron is that it is now generic and cheap. This could be attractive to some physicians or their institutions. However, some of this volume may also switch to Aloxi and APF530, whose longer acting formulations offer meaningful clinical benefits over the short acting ondansetron and granisetron formulations.

In 2011, Aloxi had 55% of the CINV market; ondansetron (Zofran) had 33% and granisetron (Kytril) 12% based on number of vials sold. I had projected that in 2016 Aloxi would have 35% of the market, APF530 17%, ondansetron 35% and granisetron 13%. My thinking was that APF530 would gain most of its market share from Aloxi. I think that there is now the potential for the ondansetron share to meaningfully drop and for the other three drugs to gain share. For the time being, I am not changing any projections, but it does give me greater confidence in my market share projections for APF530. I would point out that each additional percentage point share of the market that APF530 captures results in $11 million more of sales; my current estimate for 2015 sales of APF530 is $185 million.

In my initiation report, I established a price target of $5.40 for A.P. Pharma by 2015. This would be a thirteen fold increase and I recognize that a moonshot price target like this raises eyebrows and suspicions about the seriousness of my analysis. However, huge moves with biotechnology stocks can occur. Let me give you some recent examples. Arena (NASDAQ:ARNA) was $1.92 on January 1, 2012 and rose to $11.68 at the close on June 21 (up 6 fold). Threshold Pharmaceuticals (NASDAQ:THLD) went from $1.38 on January 1, 2012 to $8.80 on the close on March 30 (up 6 fold). Looking at some oldies but goodies, Human Genome Sciences (HGSI) soared from $3.32 on July 27, 2009 to $30.58 on December 31, 2009 (up 9 fold) and Dendreon (NASDAQ:DNDN) from $4.02 on March 30, 2009 to $55.43 on May 3, 2010 (a 14 fold increase).

The common thread with each of these situations was the change in perception by investors from thinking that these companies had serious, perhaps intractable issues to a belief that the fundamentals were coming together. Now we know that Dendreon has subsequently dropped back to a recent price of $7.40 and Human Genome Sciences to $13.40 as initial optimistic projections were not met. However, my point is that when perceptions change dramatically huge price movements can occur in a short period of time. The examples of DNDN and HGSI suggest that the price can overshoot. If my price target for A.P. Pharma of $5.40 is reached it would likely be before 2015.

For a more detailed discussion of this issue please refer to my just published report.

Disclosure: I am long APPA.OB, ARNA, DNDN.

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