CPEX Pharmaceuticals, Inc. CPEX
April 27, 2010 - 2:57am EST by
sunny118
2010 2011
Price: 21.40 EPS $0.00 $0.00
Shares Out. (in M): 3 P/E 0.0x 0.0x
Market Cap (in M): 59 P/FCF 0.0x 0.0x
Net Debt (in M): -17 EBIT 0 0
TEV: 42 TEV/EBIT 0.0x 0.0x

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Description

For an enterprise value of $42mm you can buy a growing $23mm/yr royalty that will likely last for 15 years.  Based on this royalty, CPEX Pharmaceuticals ("CPEX") is worth $40.00/sh, 87% more than today's closing price of $21.40/sh. 

CPEX is a simple business that has one main asset, a growing royalty stream on a profitable drug, Testim, for testosterone replacement in men, which is sold by Auxilium Pharmaceuticals ("AUXL").  As testosterone cannot be patented, the key ingredient in Testim is CPE-215, which enhances permeation and absorption of pharmaceutical molecules across skin, nasal mucosa and eyes.  For use of CPE-215, CPEX receives a 12% royalty on all sales of Testim from AUXL.

Our fair value target of $40.00/sh is based on a DCF and before fellow VIC members write off an analysis based on a DCF, note that it is easy to triangulate to similar values.  First, the financing proposal of Cowen Healthcare Royalty Partners, LP ("Cowen"), one of the largest and most respected royalty funds, for the tender offer an activist investor filed last week arrives at $35.00/sh, 64% above the current share price.  Second, CPEX is likely to announce it is exploring strategic alternatives in the next two weeks (RBC Capital Markets has been hired as investment banker and Goodwin Procter LLP as legal advisor) and AUXL is the most logical buyer and could pay $50.00/sh, 134% above the current share price.  Third, recent royalty transactions have occurred at 4-6x EV/revenue, more than 100% above CPEX's value of 1.8x EV/revenue.

CPEX owns the CPE-215 technology because when Bentley Pharmaceuticals ("Bentley") was acquired by Teva Pharamecueticals ("Teva") in June 2008, Teva wanted only Bentley's generic business.  CPEX was created through a taxable, 1:10 stock dividend.  The company kept a very low profile until January 7, 2010 when activist investor Richard Rofe of Arcadia Capital Advisors ("Rofe") announced that he was willing to buy CPEX for $14/sh.  On April 22nd, Rofe raised his offer to $16/sh with the assistance of Cowen, who is financing 94% of the purchase price in return for an ownership of less than 50% of the Testim Royalty.  The financing of Cowen reveals that the royalty alone is worth $30.00/sh (there is an additional $5.00/sh of value for other assets). 

By the end of next week the Board of CPEX must reply to Rofe's offer.  The stock price is trading well above the offer and it's a fraction of the value of the royalty so they will reject it.  As the company has been under activist pressure since early January, CPEX is highly likely to run an auction, a message that the Trout Group, CPEX's outside IR firm, stated has been received from multiple large investors. 

Assuming that CPEX is sold at $40.00/sh, management and board RSUs/options will be worth $13.5mm and severance for the top three executives will be $4.9mm.  This large payout for running a microcap company for less than two years makes a sale very palatable.  A sale to AUXL at $50.00/sh takes the total value for management and the board to $24.5mm.  CEO John Sedor is 65 years old and lives in Philadelphia (350+ miles away from CPEX's office in Exeter, NH) and at a price of $40.00/sh, he will make $7.0mm from his current stock ownership, RSUs, options and severance.  I've interacted with him multiple times over the phone and in face-to-face meetings and my impression is that he's a broken man from the constant barrage of Rofe (13D filings and press releases) and other shareholders (investor meetings and letters to board members) and is very likely to acquiesce to a sale of CPEX. 

Background:

CPEX began public trading on June 19, 2008 as a sub-$40mm market cap spin-off.  As best we can tell, there was no marketing and the value of CPEX was obscured by excessive R&D and corporate overhead spending as management attempted to develop Nasulin, an inhaled insulin medication for diabetics.  After 9 years and 15 Phase I & Phase II studies, management finally killed Nasulin on April 12, 2010.  From 2007-2009, management spent 100-134% of the revenue received from the Testim royalty, which was a colossal waste of shareholder funds and resulted in CPEX reporting net income losses of $2.9-4.9mm/yr.  In our opinion, this spending on Nasulin gave management a reputation as extremely poor capital allocators as they frequently ignored shareholders that asked that the Nasulin program be discontinued - a February 11, 2009 note from Gabelli & Company highlights Nasulin as "a big gamble in a forsaken market" and the associated "excessive R&D spending representing the biggest risk to our investment thesis."  Rofe's 13D filings rail against management for this spending and provide further color. 

Business Description:

CPE-215 allows drugs to be absorbed across membranes, most frequently skin or nasal mucosa, which allows for more accurate drug dosing than drugs administered orally, which are subject to degradation initially by the stomach and secondarily to first-pass metabolism in the liver before reaching the bloodstream.  Relative to injectable drugs, CPE-215's membrane absorption avoids the pain & lower patience acceptance of an injection, the required medical personnel potentially required to administer the injection, and the higher manufacturing costs given the need for sterile conditions when manufacturing injectable drugs.

Testim is a testosterone gel used once a day for the treatment of hypogonadism in men by rubbing the gel onto shoulders or upper arms for enhanced absorption by CPE-215.  Hypogonadism leads to low energy, muscular atrophy, loss of libido, erectile dysfunction, irritability, and poor concentration.  Testim has been on the market in the U.S. since February 2003 and has a 22% share of total prescriptions for the gel segment of the U.S. testosterone replacement therapy market (per NPA data from IMS Health); Testim is also sold in Canada and 15 European countries.  While hormone replacement for women going through menopause is well known, for men hypogonadism is largely undiagnosed.  Current estimates are that 9 in 10 men with the condition are untreated; that this condition is continuing to be recognized explains past sales growth of 28% in 2009 and 31% in 2008. 

CPEX receives a 12% royalty on sales of Testim and AUXL has guided to 2010 sales of $185-195mm, 12-22% growth.  At the midpoint of $190mm, CPEX earns $22.8mm and has no expenses, aside from collecting the payment.  While I don't have direct access to the information, other sellside and buyside firms with access to weekly prescription data report that YTD Testim sales are running ahead of AUXL's guidance.  AUXL reports pre-market on Monday, May 3rd.

CPEX's patents for the use of CPE-215 with testosterone expire in January 2025.  A recent generic application from Upsher-Smith was rejected by the FDA in August 2009 on the basis that a generic version of Testim would not be bioequivalent unless it used CPE-215.  Specifically, the FDA stated that "the practical effect of this determination is that any application for a testosterone gel product that has different penetration enhancers than the reference listed drug cannot be submitted as an abbreviated new drug application (ANDA) and, instead, will have to be submitted as a NDA under section 505(b) of the Act."  While we always hesitate to say that something is impossible, conversations with CPEX and AUXL management, life science investors, and scientists indicate that this ruling from the FDA makes it impossible to create a generic substitute for Testim without infringing CPEX's CPE-215 patent.

Our forecast of Testim revenue is based on the average of BofA/ML and Citi forecasts (small shops with more aggressive forecasts, such as Roth, are excluded) from 2010-2013 followed by flat Testim revenue for 3 years and annual sales declines of 10% through the end of 2024.  It's far more likely that Testim sales will continue to grow after 2013 and there is no obvious reason to think they will shrink.  Additionally, once the patents for CPE-215's use with testosterone expire in January 2025, CPEX will continue to receive a royalty of approximately 2% of Testim sales, but we ascribe no value to this.

Our Testim sale estimates:
2010E: $188.1mm (+17.3% yoy; as noted, YTD prescriptions are running ahead of AUXL guidance)
2011E: $209.2mm (+11.2% yoy)
2012E: $226.4mm (+8.2% yoy)
2013E: $241.9mm (+6.9% yoy)
2014E: $241.9mm (0.0% yoy)
2015E: $241.9mm (0.0% yoy)
2016E: $241.9mm (0.0% yoy)
2017E: $217.7mm (-10.0% yoy)
2018E: $195.9mm (-10.0% yoy)
2019E: $176.3mm (-10.0% yoy)
2020E: $158.7mm (-10.0% yoy)
2021E: $142.8mm (-10.0% yoy)
2022E: $128.6mm (-10.0% yoy)
2023E: $115.7mm (-10.0% yoy)
2024E: $104.1mm (-10.0% yoy)
2025E: $0.0mm (-100.0% yoy)

Valuation:

Our estimates of the value of the Testim royalty range from $30.00-45.00/sh.  Additionally, other assets at CPEX are worth $5.00/sh given:

1.       $2.50/sh of net liquid assets, which assumes more than $10.0mm for management severance, banker fees, legal fees, etc.

2.       $0.75/sh of fixed asset value, which is based on the appraised tax value of the wholly owned corporate office and 14 acres of land; no value is given to other PP&E.

3.       $1.75/sh of value for the probability weighted value of a royalty from Serenity Pharmaceutical's Phase III drug, for which CPEX holds a ~2.5% royalty (more information below).

Therefore, our estimated fair value of CPEX is $35.00-50.00/sh, which is 64-134% above today's closing price of $21.40/sh.

Based on our DCF we value the Testim royalty at $35.00/sh using the above sales forecasts for Testim, $2.0mm/yr of corporate overhead, $2.0mm/yr of R&D, a 35.0% tax rate, and a 10.0% discount rate.  There is a small deferred tax asset, but we assume it shelters no taxes. 

The value of the Testim royalty based on Cowen lending Rofe $40mm for his tender offer is $30.00/sh.  While Testim revenue is forecast to grow in the future, if we assume 2010 Testim revenue of $190mm (midpoint of AUXL guidance), CPEX will receive $22.8mm and the revenue sharing agreement will entitle Cowen to $10.5mm, which is 46% of the Testim royalty.  Cowen receives 65% of the royalty on the first $125mm of sales and 10% of the royalty on sales over $125mm.  $40mm of debt for a 46% share of the Testim royalty puts the royalty value at $87mm, which is $30.00/sh.  The Cowen loan is a senior claim, but we estimate it has been underwritten to a 20%+ IRR, which we believe offsets the seniority as this should be priced to a low teens IRR and shows that other royalty funds could bid more aggressively (recent royalty fund offering books have shown royalty debt financing at an average yield of 15).  It's interesting to note that Cowen is optically financing 94% of the $42.6mm purchase price (Rofe's equity of $2.6mm is just 6% of the purchase price).  But given the large cash balance and positive working capital of CPEX, Rofe will not need to put equity into CPEX and therefore Cowen is financing 100% of the acquisition price.  Alternatively if he did invest $2.6mm we estimate far higher net liquid assets upon close so Rofe would be able to immediately pay himself a dividend equal to or greater than his equity investment. 

We understand that it is a bit unorthodox to view the value of the financing in this manner, but we want to point out that a royalty fund is willing to underwrite $15/sh (94% of the $16/sh offer) with targeted return rates above normal royalty funds while receiving less than 50% of the royalty revenue.  Moreover, the return to equity is absurd as we estimate that Rofe would make at least 10x his investment.  This is the kind of financing LBO investors achieved in the early 1980s: 100%+ IRR on equity and 20%+ IRR on debt.  But it shows the value private market buyers see in the Testim royalty and an auction will be run to monetize this value. 

Another way to view the Cowen financing is to assume that another royalty fund or private equity buyer was able to get the same financing deal and paid $25/sh for CPEX (please note that we think other royalty funds will provide a much better financing package).  $25/sh results in CPEX purchased for a market cap of $71mm.  Assuming $40mm of Cowen-like financing and $7mm of net cash after management severance, banker & legal fees, the buyer would need to make a total equity investment of $24mm.  For this $24mm equity investment, his share of the year 1 royalty will be more than $12mm, which is >50% his equity investment.  The point of this exercise is that other buyers looking to pay a price closer to fair value, will value this royalty higher than the current price (note, they'll also likely get a better financing package).

We believe the Testim royalty is worth $45.00/sh to AUXL using the above sales forecasts for Testim, zero corporate overhead, $2.0mm/yr of R&D, a 20.0% tax rate, and a 10.0% discount rate.  While we assume a 20.0% tax rate, AUXL has very large NOLs and it's likely that AUXL's true tax rate is 0% - sellside models use tax rates of 0% or 2% in their EPS forecasts.  A sale of CPEX likely won't close until late 2010 and therefore we estimate potential accretion to 2011 EPS (also AUXL isn't expected to be EPS positive in 2010 given high spending to launch a new drug, Xiaflex).  Acquiring CPEX at $50.00/sh ($45.00 for Testim + $5.00 of other assets) would add 37c to EPS, which is 56% accretion to 2011 consensus EPS of 66c.

If anyone would like more detail about our valuation, we're happy to provide it in Q&A.

Risks:

The biggest risk is that the board ignores shareholders and refuses to run an auction.  In past conversations with CEO & President Sedor, he has personally noted that the Testim royalty is worth far more than the current share price of CPEX Pharmaceuticals - it's always possible that he ignores this value.  But, I believe it's very likely that CPEX announces it is exploring strategic alternatives at the end of next week when they reject Rofe's offer as:

1.       CPEX has been getting barraged by investors for nearly four months.  I became aware of CPEX after Rofe's initial $14/sh offer in early January and following months of interaction with the company, I believe that CPEX's board and management team realize that as long as they're a publicly traded company they're going to be under assault.  A few months ago CPEX would not have cancelled the Nasulin program or written an open letter to shareholders (http://www.cpexpharm.com/files/pdfs/pr/2010/pr-041210.pdf) stating that their strategic priorities will "consider a variety of strategic alternatives to enhance shareholder value" and that the company "will review offers to acquire CPEX."  We are optimistic about the company's recent change in tone and actions. 

2.       39% of CPEX shares have traded since Rofe's offer of $14/sh in early January and the vast majority of these shares are now in the hands of shareholders that want change.  Conversations with shareholders (both investors that owned stock before Rofe's initial offer and those that own stock after the offer) leave us confident that shareholders have little faith in the current management team and are communicating their desire for an auction to the board. 

3.       CPEX has already hired investment bankers and legal advisors. 

4.       The Trout Group, CPEX's outside IR (contact info below), noted that because CPEX management is not returning calls, large outside investors have contacted Trout Group demanding that CPEX run an auction.  While it's a stretch to extrapolate too much from investor interaction with IR, I believe that the overwhelming desire of shareholders is for a sale process. 

Assuming that CPEX does run an auction, it's possible that the process fails.  This seems very unlikely given the simplicity of running a sale (contact AUXL, half a dozen royalty funds, and a half dozen private equity firms and you'll have a number of bids) and the simplicity of valuing CPEX. 

While we believe that the threat of generics was removed last year, it's always possible that another generic drug maker targets Testim.  In addition to the FDA's rejection of Upsher-Smith, offsetting this is the relatively modest size of Testim revenue at ~$200mm/yr.  While a rough guess, a generic drug maker would likely cut the price of Testim by 80-90% taking revenue to $20-40mm/yr, which is a fairly small market.  Additionally, the Hatch-Waxman law provides a 30 month stay for any generic application so if a new generic competitor emerged tomorrow, the earliest their drug could be on the market is October 27, 2012.  Between now and then CPEX will collect more than $60mm of royalty revenue and today's enterprise value is $42mm.  Lastly, AUXL's CFO has stated that Testim is dependent on a large sales force to educate doctors about hypogonadism to drive prescriptions - a large and expensive sales force is not the business model of generic drug makers.

Lastly, while mark to market is always a risk, it's interesting to note that after Rofe's offer of $14/sh the stock has never closed below $14/sh.  It seems reasonable to assume that the stock will never close below his current offer of $16/sh, implying downside of 25%, which is far less than upside potential.  Also, the fact that the current share price is well above Rofe's offer indicates that investors aren't buying CPEX because they think the $16/sh offer is fair.

Serenity:

CPEX has the right to receive a royalty on a drug being developed by Serenity Pharmaceuticals Corporation to treat Nocturia, a condition causing an individual to wake multiple times in the night to urinate (frequently an issue for older men).  CPEX has entered into a licensing agreement with Serenity allowing Serenity to use CPE-215 to develop a nasal spray.  Under the agreement, CPEX will be entitled to certain milestone payments and a low single-digit royalty on sales of the product.  On April 1, 2010 Serenity announced that it had entered into a global agreement with Allergan, Inc. for the development and commercialization of this product, which is currently in Phase III clinical trials.  CPEX has no expenses associated with Serenity and we therefore view it as a call option. 

Valuing Serenity is a bit difficult, but we believe it is worth $1.75/sh on a probability weighted basis and could be worth significantly more.  An estimate of the probability that a Phase III drug receives FDA approval is approximately 20% although Serenity is effectively reformulating additional drugs so the probability should be higher.  Also, we estimate a market size of $250mm in annual sales, but discussions with clinicians indicate a market size many times larger.  If we assume a 2.5% royalty, $250mm of annual sales, a 10 year life for the licensing agreement, a 35% tax rate, a 10% discount rate, and a 20% chance the drug is approved by the FDA, we come to $5.0mm of value, which is worth $1.75/sh. 

While my diligence on Serenity has been limited, I did speak with CEO Sam Herschkowitz and was extremely impressed as he has decades of pharma experience and along with partners has funded more than $10mm of Serenity's development expenses.  Drug development is risky, but: (i) Serenity is led by industry veterans; (ii) is reformulating a drug, which is much lower risk than new drug development; and (iii) the recent Allergan agreement is a strong vote of confidence.  If Serenity is able to successfully commercialize this drug and it reaches its market potential (about $1 billion), this royalty stream could be as valuable as the Testim royalty.    

Summary:

This is a small stock that has averaged 21k sh/day for the past month so is likely a PA trade for many members of VIC.  But, the risk-reward is very asymmetric given fair value 64-134% above the current price and very little downside given a current EV/royalty of just 1.8x.

Contact information:

CEO/Pres John Sedor: jsedor@cpexpharm.com, (603) 658 6100
CFO Robert Hebert: rhebert@cpexpharm.com, (603) 658 6100
Outside IR Chad Rubin of The Trout Group: crubin@troutgroup.com, (646) 378 2947 (CEO and CFO of CPEX are not currently returning calls, but Chad is)
AUXL IR Will Sargent (for information on Testim): wsargent@auxilium.com, (484) 321 5926

Catalyst

Formal announcement that CPEX is exploring strategic alternatives by the end of next week. 
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    Description

    For an enterprise value of $42mm you can buy a growing $23mm/yr royalty that will likely last for 15 years.  Based on this royalty, CPEX Pharmaceuticals ("CPEX") is worth $40.00/sh, 87% more than today's closing price of $21.40/sh. 

    CPEX is a simple business that has one main asset, a growing royalty stream on a profitable drug, Testim, for testosterone replacement in men, which is sold by Auxilium Pharmaceuticals ("AUXL").  As testosterone cannot be patented, the key ingredient in Testim is CPE-215, which enhances permeation and absorption of pharmaceutical molecules across skin, nasal mucosa and eyes.  For use of CPE-215, CPEX receives a 12% royalty on all sales of Testim from AUXL.

    Our fair value target of $40.00/sh is based on a DCF and before fellow VIC members write off an analysis based on a DCF, note that it is easy to triangulate to similar values.  First, the financing proposal of Cowen Healthcare Royalty Partners, LP ("Cowen"), one of the largest and most respected royalty funds, for the tender offer an activist investor filed last week arrives at $35.00/sh, 64% above the current share price.  Second, CPEX is likely to announce it is exploring strategic alternatives in the next two weeks (RBC Capital Markets has been hired as investment banker and Goodwin Procter LLP as legal advisor) and AUXL is the most logical buyer and could pay $50.00/sh, 134% above the current share price.  Third, recent royalty transactions have occurred at 4-6x EV/revenue, more than 100% above CPEX's value of 1.8x EV/revenue.

    CPEX owns the CPE-215 technology because when Bentley Pharmaceuticals ("Bentley") was acquired by Teva Pharamecueticals ("Teva") in June 2008, Teva wanted only Bentley's generic business.  CPEX was created through a taxable, 1:10 stock dividend.  The company kept a very low profile until January 7, 2010 when activist investor Richard Rofe of Arcadia Capital Advisors ("Rofe") announced that he was willing to buy CPEX for $14/sh.  On April 22nd, Rofe raised his offer to $16/sh with the assistance of Cowen, who is financing 94% of the purchase price in return for an ownership of less than 50% of the Testim Royalty.  The financing of Cowen reveals that the royalty alone is worth $30.00/sh (there is an additional $5.00/sh of value for other assets). 

    By the end of next week the Board of CPEX must reply to Rofe's offer.  The stock price is trading well above the offer and it's a fraction of the value of the royalty so they will reject it.  As the company has been under activist pressure since early January, CPEX is highly likely to run an auction, a message that the Trout Group, CPEX's outside IR firm, stated has been received from multiple large investors. 

    Assuming that CPEX is sold at $40.00/sh, management and board RSUs/options will be worth $13.5mm and severance for the top three executives will be $4.9mm.  This large payout for running a microcap company for less than two years makes a sale very palatable.  A sale to AUXL at $50.00/sh takes the total value for management and the board to $24.5mm.  CEO John Sedor is 65 years old and lives in Philadelphia (350+ miles away from CPEX's office in Exeter, NH) and at a price of $40.00/sh, he will make $7.0mm from his current stock ownership, RSUs, options and severance.  I've interacted with him multiple times over the phone and in face-to-face meetings and my impression is that he's a broken man from the constant barrage of Rofe (13D filings and press releases) and other shareholders (investor meetings and letters to board members) and is very likely to acquiesce to a sale of CPEX. 

    Background:

    CPEX began public trading on June 19, 2008 as a sub-$40mm market cap spin-off.  As best we can tell, there was no marketing and the value of CPEX was obscured by excessive R&D and corporate overhead spending as management attempted to develop Nasulin, an inhaled insulin medication for diabetics.  After 9 years and 15 Phase I & Phase II studies, management finally killed Nasulin on April 12, 2010.  From 2007-2009, management spent 100-134% of the revenue received from the Testim royalty, which was a colossal waste of shareholder funds and resulted in CPEX reporting net income losses of $2.9-4.9mm/yr.  In our opinion, this spending on Nasulin gave management a reputation as extremely poor capital allocators as they frequently ignored shareholders that asked that the Nasulin program be discontinued - a February 11, 2009 note from Gabelli & Company highlights Nasulin as "a big gamble in a forsaken market" and the associated "excessive R&D spending representing the biggest risk to our investment thesis."  Rofe's 13D filings rail against management for this spending and provide further color. 

    Business Description:

    CPE-215 allows drugs to be absorbed across membranes, most frequently skin or nasal mucosa, which allows for more accurate drug dosing than drugs administered orally, which are subject to degradation initially by the stomach and secondarily to first-pass metabolism in the liver before reaching the bloodstream.  Relative to injectable drugs, CPE-215's membrane absorption avoids the pain & lower patience acceptance of an injection, the required medical personnel potentially required to administer the injection, and the higher manufacturing costs given the need for sterile conditions when manufacturing injectable drugs.

    Testim is a testosterone gel used once a day for the treatment of hypogonadism in men by rubbing the gel onto shoulders or upper arms for enhanced absorption by CPE-215.  Hypogonadism leads to low energy, muscular atrophy, loss of libido, erectile dysfunction, irritability, and poor concentration.  Testim has been on the market in the U.S. since February 2003 and has a 22% share of total prescriptions for the gel segment of the U.S. testosterone replacement therapy market (per NPA data from IMS Health); Testim is also sold in Canada and 15 European countries.  While hormone replacement for women going through menopause is well known, for men hypogonadism is largely undiagnosed.  Current estimates are that 9 in 10 men with the condition are untreated; that this condition is continuing to be recognized explains past sales growth of 28% in 2009 and 31% in 2008. 

    CPEX receives a 12% royalty on sales of Testim and AUXL has guided to 2010 sales of $185-195mm, 12-22% growth.  At the midpoint of $190mm, CPEX earns $22.8mm and has no expenses, aside from collecting the payment.  While I don't have direct access to the information, other sellside and buyside firms with access to weekly prescription data report that YTD Testim sales are running ahead of AUXL's guidance.  AUXL reports pre-market on Monday, May 3rd.

    CPEX's patents for the use of CPE-215 with testosterone expire in January 2025.  A recent generic application from Upsher-Smith was rejected by the FDA in August 2009 on the basis that a generic version of Testim would not be bioequivalent unless it used CPE-215.  Specifically, the FDA stated that "the practical effect of this determination is that any application for a testosterone gel product that has different penetration enhancers than the reference listed drug cannot be submitted as an abbreviated new drug application (ANDA) and, instead, will have to be submitted as a NDA under section 505(b) of the Act."  While we always hesitate to say that something is impossible, conversations with CPEX and AUXL management, life science investors, and scientists indicate that this ruling from the FDA makes it impossible to create a generic substitute for Testim without infringing CPEX's CPE-215 patent.

    Our forecast of Testim revenue is based on the average of BofA/ML and Citi forecasts (small shops with more aggressive forecasts, such as Roth, are excluded) from 2010-2013 followed by flat Testim revenue for 3 years and annual sales declines of 10% through the end of 2024.  It's far more likely that Testim sales will continue to grow after 2013 and there is no obvious reason to think they will shrink.  Additionally, once the patents for CPE-215's use with testosterone expire in January 2025, CPEX will continue to receive a royalty of approximately 2% of Testim sales, but we ascribe no value to this.

    Our Testim sale estimates:
    2010E: $188.1mm (+17.3% yoy; as noted, YTD prescriptions are running ahead of AUXL guidance)
    2011E: $209.2mm (+11.2% yoy)
    2012E: $226.4mm (+8.2% yoy)
    2013E: $241.9mm (+6.9% yoy)
    2014E: $241.9mm (0.0% yoy)
    2015E: $241.9mm (0.0% yoy)
    2016E: $241.9mm (0.0% yoy)
    2017E: $217.7mm (-10.0% yoy)
    2018E: $195.9mm (-10.0% yoy)
    2019E: $176.3mm (-10.0% yoy)
    2020E: $158.7mm (-10.0% yoy)
    2021E: $142.8mm (-10.0% yoy)
    2022E: $128.6mm (-10.0% yoy)
    2023E: $115.7mm (-10.0% yoy)
    2024E: $104.1mm (-10.0% yoy)
    2025E: $0.0mm (-100.0% yoy)

    Valuation:

    Our estimates of the value of the Testim royalty range from $30.00-45.00/sh.  Additionally, other assets at CPEX are worth $5.00/sh given:

    1.       $2.50/sh of net liquid assets, which assumes more than $10.0mm for management severance, banker fees, legal fees, etc.

    2.       $0.75/sh of fixed asset value, which is based on the appraised tax value of the wholly owned corporate office and 14 acres of land; no value is given to other PP&E.

    3.       $1.75/sh of value for the probability weighted value of a royalty from Serenity Pharmaceutical's Phase III drug, for which CPEX holds a ~2.5% royalty (more information below).

    Therefore, our estimated fair value of CPEX is $35.00-50.00/sh, which is 64-134% above today's closing price of $21.40/sh.

    Based on our DCF we value the Testim royalty at $35.00/sh using the above sales forecasts for Testim, $2.0mm/yr of corporate overhead, $2.0mm/yr of R&D, a 35.0% tax rate, and a 10.0% discount rate.  There is a small deferred tax asset, but we assume it shelters no taxes. 

    The value of the Testim royalty based on Cowen lending Rofe $40mm for his tender offer is $30.00/sh.  While Testim revenue is forecast to grow in the future, if we assume 2010 Testim revenue of $190mm (midpoint of AUXL guidance), CPEX will receive $22.8mm and the revenue sharing agreement will entitle Cowen to $10.5mm, which is 46% of the Testim royalty.  Cowen receives 65% of the royalty on the first $125mm of sales and 10% of the royalty on sales over $125mm.  $40mm of debt for a 46% share of the Testim royalty puts the royalty value at $87mm, which is $30.00/sh.  The Cowen loan is a senior claim, but we estimate it has been underwritten to a 20%+ IRR, which we believe offsets the seniority as this should be priced to a low teens IRR and shows that other royalty funds could bid more aggressively (recent royalty fund offering books have shown royalty debt financing at an average yield of 15).  It's interesting to note that Cowen is optically financing 94% of the $42.6mm purchase price (Rofe's equity of $2.6mm is just 6% of the purchase price).  But given the large cash balance and positive working capital of CPEX, Rofe will not need to put equity into CPEX and therefore Cowen is financing 100% of the acquisition price.  Alternatively if he did invest $2.6mm we estimate far higher net liquid assets upon close so Rofe would be able to immediately pay himself a dividend equal to or greater than his equity investment. 

    We understand that it is a bit unorthodox to view the value of the financing in this manner, but we want to point out that a royalty fund is willing to underwrite $15/sh (94% of the $16/sh offer) with targeted return rates above normal royalty funds while receiving less than 50% of the royalty revenue.  Moreover, the return to equity is absurd as we estimate that Rofe would make at least 10x his investment.  This is the kind of financing LBO investors achieved in the early 1980s: 100%+ IRR on equity and 20%+ IRR on debt.  But it shows the value private market buyers see in the Testim royalty and an auction will be run to monetize this value. 

    Another way to view the Cowen financing is to assume that another royalty fund or private equity buyer was able to get the same financing deal and paid $25/sh for CPEX (please note that we think other royalty funds will provide a much better financing package).  $25/sh results in CPEX purchased for a market cap of $71mm.  Assuming $40mm of Cowen-like financing and $7mm of net cash after management severance, banker & legal fees, the buyer would need to make a total equity investment of $24mm.  For this $24mm equity investment, his share of the year 1 royalty will be more than $12mm, which is >50% his equity investment.  The point of this exercise is that other buyers looking to pay a price closer to fair value, will value this royalty higher than the current price (note, they'll also likely get a better financing package).

    We believe the Testim royalty is worth $45.00/sh to AUXL using the above sales forecasts for Testim, zero corporate overhead, $2.0mm/yr of R&D, a 20.0% tax rate, and a 10.0% discount rate.  While we assume a 20.0% tax rate, AUXL has very large NOLs and it's likely that AUXL's true tax rate is 0% - sellside models use tax rates of 0% or 2% in their EPS forecasts.  A sale of CPEX likely won't close until late 2010 and therefore we estimate potential accretion to 2011 EPS (also AUXL isn't expected to be EPS positive in 2010 given high spending to launch a new drug, Xiaflex).  Acquiring CPEX at $50.00/sh ($45.00 for Testim + $5.00 of other assets) would add 37c to EPS, which is 56% accretion to 2011 consensus EPS of 66c.

    If anyone would like more detail about our valuation, we're happy to provide it in Q&A.

    Risks:

    The biggest risk is that the board ignores shareholders and refuses to run an auction.  In past conversations with CEO & President Sedor, he has personally noted that the Testim royalty is worth far more than the current share price of CPEX Pharmaceuticals - it's always possible that he ignores this value.  But, I believe it's very likely that CPEX announces it is exploring strategic alternatives at the end of next week when they reject Rofe's offer as:

    1.       CPEX has been getting barraged by investors for nearly four months.  I became aware of CPEX after Rofe's initial $14/sh offer in early January and following months of interaction with the company, I believe that CPEX's board and management team realize that as long as they're a publicly traded company they're going to be under assault.  A few months ago CPEX would not have cancelled the Nasulin program or written an open letter to shareholders (http://www.cpexpharm.com/files/pdfs/pr/2010/pr-041210.pdf) stating that their strategic priorities will "consider a variety of strategic alternatives to enhance shareholder value" and that the company "will review offers to acquire CPEX."  We are optimistic about the company's recent change in tone and actions. 

    2.       39% of CPEX shares have traded since Rofe's offer of $14/sh in early January and the vast majority of these shares are now in the hands of shareholders that want change.  Conversations with shareholders (both investors that owned stock before Rofe's initial offer and those that own stock after the offer) leave us confident that shareholders have little faith in the current management team and are communicating their desire for an auction to the board. 

    3.       CPEX has already hired investment bankers and legal advisors. 

    4.       The Trout Group, CPEX's outside IR (contact info below), noted that because CPEX management is not returning calls, large outside investors have contacted Trout Group demanding that CPEX run an auction.  While it's a stretch to extrapolate too much from investor interaction with IR, I believe that the overwhelming desire of shareholders is for a sale process. 

    Assuming that CPEX does run an auction, it's possible that the process fails.  This seems very unlikely given the simplicity of running a sale (contact AUXL, half a dozen royalty funds, and a half dozen private equity firms and you'll have a number of bids) and the simplicity of valuing CPEX. 

    While we believe that the threat of generics was removed last year, it's always possible that another generic drug maker targets Testim.  In addition to the FDA's rejection of Upsher-Smith, offsetting this is the relatively modest size of Testim revenue at ~$200mm/yr.  While a rough guess, a generic drug maker would likely cut the price of Testim by 80-90% taking revenue to $20-40mm/yr, which is a fairly small market.  Additionally, the Hatch-Waxman law provides a 30 month stay for any generic application so if a new generic competitor emerged tomorrow, the earliest their drug could be on the market is October 27, 2012.  Between now and then CPEX will collect more than $60mm of royalty revenue and today's enterprise value is $42mm.  Lastly, AUXL's CFO has stated that Testim is dependent on a large sales force to educate doctors about hypogonadism to drive prescriptions - a large and expensive sales force is not the business model of generic drug makers.

    Lastly, while mark to market is always a risk, it's interesting to note that after Rofe's offer of $14/sh the stock has never closed below $14/sh.  It seems reasonable to assume that the stock will never close below his current offer of $16/sh, implying downside of 25%, which is far less than upside potential.  Also, the fact that the current share price is well above Rofe's offer indicates that investors aren't buying CPEX because they think the $16/sh offer is fair.

    Serenity:

    CPEX has the right to receive a royalty on a drug being developed by Serenity Pharmaceuticals Corporation to treat Nocturia, a condition causing an individual to wake multiple times in the night to urinate (frequently an issue for older men).  CPEX has entered into a licensing agreement with Serenity allowing Serenity to use CPE-215 to develop a nasal spray.  Under the agreement, CPEX will be entitled to certain milestone payments and a low single-digit royalty on sales of the product.  On April 1, 2010 Serenity announced that it had entered into a global agreement with Allergan, Inc. for the development and commercialization of this product, which is currently in Phase III clinical trials.  CPEX has no expenses associated with Serenity and we therefore view it as a call option. 

    Valuing Serenity is a bit difficult, but we believe it is worth $1.75/sh on a probability weighted basis and could be worth significantly more.  An estimate of the probability that a Phase III drug receives FDA approval is approximately 20% although Serenity is effectively reformulating additional drugs so the probability should be higher.  Also, we estimate a market size of $250mm in annual sales, but discussions with clinicians indicate a market size many times larger.  If we assume a 2.5% royalty, $250mm of annual sales, a 10 year life for the licensing agreement, a 35% tax rate, a 10% discount rate, and a 20% chance the drug is approved by the FDA, we come to $5.0mm of value, which is worth $1.75/sh. 

    While my diligence on Serenity has been limited, I did speak with CEO Sam Herschkowitz and was extremely impressed as he has decades of pharma experience and along with partners has funded more than $10mm of Serenity's development expenses.  Drug development is risky, but: (i) Serenity is led by industry veterans; (ii) is reformulating a drug, which is much lower risk than new drug development; and (iii) the recent Allergan agreement is a strong vote of confidence.  If Serenity is able to successfully commercialize this drug and it reaches its market potential (about $1 billion), this royalty stream could be as valuable as the Testim royalty.    

    Summary:

    This is a small stock that has averaged 21k sh/day for the past month so is likely a PA trade for many members of VIC.  But, the risk-reward is very asymmetric given fair value 64-134% above the current price and very little downside given a current EV/royalty of just 1.8x.

    Contact information:

    CEO/Pres John Sedor: jsedor@cpexpharm.com, (603) 658 6100
    CFO Robert Hebert: rhebert@cpexpharm.com, (603) 658 6100
    Outside IR Chad Rubin of The Trout Group: crubin@troutgroup.com, (646) 378 2947 (CEO and CFO of CPEX are not currently returning calls, but Chad is)
    AUXL IR Will Sargent (for information on Testim): wsargent@auxilium.com, (484) 321 5926

    Catalyst

    Formal announcement that CPEX is exploring strategic alternatives by the end of next week. 

    Messages


    SubjectRofe Selling Stock
    Entry04/27/2010 11:50 AM
    Memberbanjo1055
    Thanks for the writeup.  I have spent about five minutes on this so far, so please excuse this potentially dumb question, but why has a vehicle managed by Richard Rofe recently been selling stock in the $15-17 range?   Thanks...

    Subjectimpact of Androgel
    Entry04/27/2010 02:53 PM
    Membertyler939
    Are there any meaningful differences in results between Testim and Androgel (which I think has about 70% market share)?  I'm particularly concerned because Androgel will go generic in 2015.  FTC commissioner Jon Leibowitz, while investigating whether Solvay illegally kept generic competitors off the market, reportedly said that generics of the $300-per dose Androgel should price around $45.  Without meaningfully better results versus Androgel, I don't see how AUXL can hold Testim prices anywhere near current levels after 2015.

    SubjectRE: directors
    Entry04/28/2010 03:45 PM
    Membersunny118

    Dir Michael McGovern owns 365,137 shares, which is 14.4% of shares outstanding.  Dir James Murphy owns 117,168 shares, which is 4.6% so these two collectively own 19.0%.  Other directors and management own 34,988 shares, which is 1.4% (total of 20.4%).  The shares I've listed are the shares they currently hold (inclusive of stock in the names of other family members, but excluding options/RSUs). 

     

    I have not spoken with Dr McGovern (the phone number on Bloomberg is someone else named Michael McGovern), but his background is that he "serves as President of McGovern Enterprises, a provider of corporate and financial consulting services."  I once asked CEO/Pres John Sedor about the background of McGovern and he told me "he's a very smart businessman."  I have no additional context for this statement, but I think it's reasonable to assume that he understands how much money he can make for himself upon a sale of CPEX.

     

    When looking at Arcadia, one needs to also include the stock that Rofe personally owns which brings his total ownership to 124,579, which is 4.9%.  Since the original bid from Rofe, more than 45% of stock has turned over.  Add in Rofe's 4.9% and we're at 50% of the stock in hands of people that have bought since January 7, 2010.  No one that has bought stock is hoping that the Nasulin program is revived - everyone wants change.  In my conversations with other investors, I have high conviction that over 35% of the stock is with investors who do not approve the status quo. 

     

    And in my experience, once 1/3 or more of the stock is in unfriendly hands the board realizes they're caught.  I think it's very likely this board thinks "we're tiny, we have no business plan, we really only need 1 employee to cash royalty checks, and as long as we're a public company shareholders are going to be coming after us."  While it's understandable that they needed to hire RBC Capital for a fairness opinion on the tender offer, I think the reality is that they've tipped their hand and RBC Capital will be used for a sale process (I'm sure RBC is excited to run as a sale as they'll make much more than they'll make for the fairness opinion).

     

    Regarding ramping down R&D/overhead post Nasulin, I think that as a standalone company they'll slightly curtail R&D/overhead, but certainly won't drop it significantly, but I haven't spoken to CPEX management about this.  I assume that if CPEX was a private company they would have $2mm/yr for overhead and $2mm/yr for R&D.  But in reality, I don't know how they'd spend $2mm/yr on overhead so I believe this is conservative.


    SubjectRE: Rofe Selling Stock
    Entry04/28/2010 04:33 PM
    Membersunny118

    Rofe has sold stock.  On page 29 of his tender offer he explains his prior sales stating "the reason for these sales was that the price of CPEX's common stock generally traded at a materially higher price than that which the Purchaser intended to offer in its contemplated offer."  His cost basis was about $11/sh so he was selling at a gain of ~50%.  And while that still undervalued the stock, he did lock in a lot of profit.  But at the end of the day, it still didn't make sense to sell stock.  I've been involved in past situations with activists and have often been perplexed by their actions.  In talking with someone that knows Rofe, I was given the impression that he doesn't have a finance background and looks at things differently than most investment professionals, but is a royal pain in the ass.  And being a pain in the ass is probably the most important quality of an activist. 

     

    To give him credit, he's done the important things well.  He's done good work putting pressure on management and the board by highlighting prior poor capital allocation and spending practices.  I doubt they would have cancelled Nasulin and written an open letter to shareholders stating that they'll "consider a variety of other strategic alternatives to enhance shareholder value" and "review offers," if not for Rofe's pressure. 

     

    Moreover, what he's done that is really great is he got the Cowen financing public.  In doing this he's made it clear to the board, shareholders, and other private market buyers the value of the Testim royalty. 

     

    Lastly, because he has launched a tender offer, he cannot sell any stock.


    A final point - that is somewhat unrelated - but I realize I failed to make is that having previously worked in private equity there is a dynamic that will likely make private equity guys excited.  If you're an MD at a buyout shop you realize you'll do 1 or 2 deals per year.  So how do you make partner?  You get your name attached to a deal that is a multi-bagger.  In CPEX, the thinking will be, "It is very unlikely I don't get made whole from the Testim royalty, so I'm not going to be associated with a donut.  On the other hand, Serenity is a free call that I can identify ahead of time.  If Serenity works out - and the market is the size suggested ($1-3bn per page 10 of the investor presentation CPEX distributed in Jan 2010) then this royalty will be worth $100mm+ based on $25mm/yr of royalty revenue... this is a great dynamic." 

     

    While Serenity's drug, Ser-120, is in Phase 3 studies, it's  important to note that Allergan, a big pharma company, signed a deal on April 1st and "will make an upfront payment to Serenity of $43 million, potential development and regulatory milestone payments of up to $122 million, future potential sales milestones, and royalty payments on worldwide sales."  There's no guarantee, but they just put up money and they're not stupid.  Also, Allergan has a huge sales force - if Ser-120 receives FDA approval and Allergan wants to spend $250mm/yr gunning it with their sales force of a few thousand people, that's great for CPEX's royalty as CPEX is paid on top line sales, not profits.


    SubjectRE: impact of Androgel
    Entry04/28/2010 06:11 PM
    Membersunny118

    AUXL claims that Testim provides 30% higher testosterone absorption than AndroGel (page 41 of investor presentation), but there has not been a head-to-head trial (and it's extremely unlikely there ever will be a head-to-head trial).  The 30% higher testosterone absorption is the result of CPE-215's membrane absorption technology.

     

    AndroGel is $300/month, not per dose.  www.drugstore.com has a 30 packet supply (which lasts 30 days) for $275.  Also Watson had said that they would cut price by 75% while FTC said 85% as you highlighted.  Neither of these datapoints is very important, but I wanted to note them.  Your question is very good and while it's naïve to think that AndroGel's generic introduction won't have an impact, I also think it's wrong to assume that Testim will get significantly harmed as:

     

    1.       My calls to doctors highlight that while it is common to switch to the generic when it is the drug you've been prescribing, it is not nearly as common when the drugs aren't bioequivalent - based on inertia the doctor isn't going to switch the patient.  The doctor has been giving the patient a drug that has been working and has no incentive to prescribe something different...if anything goes wrong the patient is back in his office upset.  I realize this isn't good for costs healthcare system wide, but good for Testim (and probably not a debate appropriate for the VIC message board).

    2.       If a patient's insurance continues to pay for Testim, the patient definitely is not going to switch.  And it seems that managed care's approach will be to tier pricing: if the co-pay was $25 for Testim when AndroGel had no generic substitute, it's moved up to $50 when generic AndroGel is on the market.  Calls to health care professionals and investors familiar with this revealed that they would be surprised if health insurance companies didn't continue to cover Testim; managed care generally never stops covering the drug once they've covered it - they just take more out of pocket.  Some people won't pay a higher co-pay while others will come out of pocket. 

    3.      There are examples where a competitor goes generic and the branded competitor doesn't take a hit.  And there are other examples where the branded drug takes a 50% hit.  Testim isn't a huge drug so it's unlikely to be in the crosshairs of managed care.  But it's a bit of a lifestyle drug so health insurance companies will care and tier pricing. 

    4.       AndroGel and Testim were described to me once as old school drugs that rely on big sales forces and therefore doctors tend to like one drug (because that sales rep is attractive or takes the doctor to the best steakhouse in town) and patients tend to like the one product they're on (because the doctor told him it was best).  To date, this hasn't been a price sensitive market - people use what they like and that is what their doctor is comfortable with. 

    5.       There are two pharma companies looking to enter the testosterone market with branded drugs in the 2011-2013 timeframe.  It seems unlikely that either company would be moving forward with these drugs if they assumed that generic AndroGel would take the majority of the market in 2016.  Endo is pursuing two branded testosterone drugs (I can elaborate more on both - in speaking with Endo it seems unlikely that Nebido can be on the market before 2013 and Fortesta is in a regulatory limbo with the FDA and at earliest will be on market in late 2011).  Also Eli Lilly is planning to get into branded testosterone assuming Axiron gets FDA approval as they licensed it from Acrux.   Second, both companies state their interest in the market is the ability to drive prescription growth through increased penetration as hypogonadism is significantly under diagnosed; Eli Lilly notes that only 10% of men suffering from hypogonadism receive treatment.

     

    So what's going to happen?  First, doctors at the margin may prescribe Testim less for new patients.  I think my forecast for sales to decline 10%/yr for 2017-fwd accounts for this.  Second, some portion of patients may switch to generic AndroGel.  If the only change I make the Testim sales forecasts in my original writeup is to assume a 25% Testim sales decline in 2016 rather than 0% growth, this knocks the value of the Testim royalty down by $3.50/sh (to be clear this forecast is: sellside estimates for 2010-2013; 0% yoy for 2014-2015; -25% yoy in 2016; -10% yoy 2017-2024).   So while this does dent value, from 2010-2015, I estimate $162mm of royalty is collected. 

     

    These data points are from a number of sources, including LPs that are doctors.  I have calls out to a couple other doctors (one that is a urologist) and will revise this response if their feedback is different.


    SubjectRE: RE: Rofe Selling Stock
    Entry04/29/2010 10:05 AM
    Memberbanjo1055
    thanks for the thorough writeup and replies. 

    SubjectRE: RE: directors
    Entry05/01/2010 07:27 AM
    Membergocanucks97
    the new director has a banking background. and his two previous companies were both sold.
    seems like an auction is inevitable here?
    Any idea why AUXL didn't attempt a buy-out before the activist came in? I went back to read the earning transcripts going back a few years, and the topic was never brought up. I guess they were losing money and probably had their focus tied up with the Xiaflex approval process. Maybe they can now take a look at buying out the royalty as they clearly have the resources and will be profitable?

    SubjectRE: RE: RE: directors
    Entry05/02/2010 11:17 PM
    Membersunny118

    We like Robert Forrester's appointment to the board.  Not only were his two prior companies sold, he started his career as an investment banker.  Similar to CPEX hiring RBC as financial advisor, we think they're tipping their hand a bit. 

     

    We believe that there could be a few different situations that have prevented AUXL from acquiring CPEX:

     

    1.       Within the world of life sciences, a lot of terrible capital allocation takes place.  Perhaps, AUXL management has been aware of this opportunity, but elected to take no action.

     

    2.       Perhaps they have approached CPEX in the past and were rejected.  Instead of launching a hostile offer, they have chosen to do nothing because they do not want the reputation as an overly aggressive partner.  It's one thing if AUXL buys CPEX in an auction, but it's another to launch a tender offer.

     

    3.       AUXL's shareholder base owns AUXL stock for Xiaflex.  Only a fraction of AUXL's $1.7b market cap is justified by Testim sales.  Perhaps AUXL mgmt/board decided to spend 100% of their time and resources on Xiaflex to avoid being distracted by Testim.

     

    We know that the CFO of AUXL is aware of how accretive a CPEX acquisition would be.  2011 is the first year that AUXL will be profitable.  They will now be valued on earnings and they should be interested in a very accretive deal. 


    SubjectRE: RE: RE: RE: RE: directors
    Entry05/18/2010 08:31 PM
    Membersunny118

    Sorry for such a terrible delay in replying.  I have owned BSTC in the past and I agree that BSTC CEO Tom Wegman would love to sell.  BTSC is a great example of the value that can be created in CPEX by focusing on shareholder value.  But I also know AUXL well and I don't think AUXL is more likely to buy BSTC:

    1.       For purposes of simplicity, assume that AUXL could buy either BSTC or CPEX at a 30% premium to today's closing stock prices.  In this scenario, the EV of BSTC is $73mm while the EV of CPEX is $256mm.  AUXL has $176mm of cash on its balance sheet and will be cashflow negative for a few quarters as they ramp Xiaflex sales so buying BSTC would definitely require a capital raise or require that AUXL issue stock to pay for the deal.  BSTC isn't bite size the way CPEX is.  And AUXL would still have the capacity to buy BSTC at a future time if they bought CPEX today.

    2.       More than 20% of AUXL shares are sold short based on the market being fairly pessimistic that Xiaflex sales will be $500+mm.  Specifically, AUXL is having issues getting insurance companies to agree on reimbursement rates for Xiaflex.  Testim has been on the market since early 2003 - AUXL knows what Testim sales are.  Buying CPEX is far less risky.

    3.       AUXL stock will be a homerun if Xiaflex sales are $500mm+.  Putting another ~$250mm into Xiaflex by purchasing the BSTC royalty is a pretty risky move.  If Xiaflex achieves $500+mm in sales, it doesn't really matter if AUXL owns BSTC.  To buy BSTC is doubling down on Xiaflex a month after launch.  More than a year ago I communicated to AUXL that they should buy BSTC - I was told by the CFO that he was clearly aware of the value opportunity and nothing happened.  BSTC's stock price was a lot lower at that time.  Moreover, I find that BSTC CEO Tom Wegman gives pretty clear body language.  I've spoken to him within the past month and the body language is that AUXL is not looking to buy BSTC at the current time.

    4.       The Peyronie's Xiaflex data was pretty disappointing.  I spoke with urologists on it and the general feedback was that if a man's penis used to have a 60 degree bend and a few shots of Xiaflex reduces it to a 45 degree bend, it's still not going to allow him to have sex (fair warning to fellow VIC members: the investor presentations on the websites of both AUXL and BSTC include pictures of Peyronie's disease).  Xiaflex for treatment of Peyronie's is unproven and the Peyronie's Phase 2 was at best partially successful.  If you're willing to pay for the option value of Peyronie's you should be willing to pay more for the option value of Serenity given a successful Phase 2.  Also, Serenity has started Phase 3 while AUXL has not started Phase 3 for Peyronie's.

    5.       BSTC has 5 employees.  CPEX has 15 employees - it isn't a big organization.  My opinion is that everyone at CPEX can easily be let go and while senior management of CPEX may want to keep running the company, the value of severance and immediate vesting of stock options is a strong incentive to sell (seems hard for CEO John Sedor to walk away with less than $5 million).

    RBC (John Capano - john.capano@rbccm.com or 212 428 2371) is running the sale process and I would be stunned if he hasn't contacted AUXL.  So AUXL is aware that CPEX is exploring strategic alternatives and needs to decide if they want to do a small, but highly accretive tuck-in acquisition.  Testim sales are pretty clear for the next few years - they know what they're getting.  Peak Xiaflex sales are a big question market. 

    I don't know anyone at Blackhorse and have never spoken with them.  The 13F filed on 5/17 shows that Blackhorse no longer owns BSTC stock, but still owns 93.5k shares of CPEX.


    SubjectRE: Upsher-Smith
    Entry05/19/2010 12:09 AM
    Membersunny118

    Sorry for such a terrible delay in replying.  I don't view Upsher-Smith's attempt to make a generic version of Testim as a significant risk.  On August 26, 2009 the FDA responded to AUXL/CPEX's Citizens Petition and gave Upsher-Smith two options.  Option #1: use CPE-215 as the penetration enhancer for Upsher-Smith's generic version in order to be bioequivalent to Testim.  Upsher-Smith can't do this because it would violate CPEX's patents.  Option #2: If Upsher-Smith doesn't use CPE-215, then Upsher-Smith needs to apply to the FDA with a NDA, rather than ANDA (the "A" stands for Abbreviated rather than New Drug Application).  It's not Upsher-Smith's business model to put a large amount of money into a NDA, particularly when the best possible outcome is that Upsher-Smith's drug is approved, but is not bio-equivalent to Testim.  So to be clear, the only pathway provided by the FDA would leave Upsher-Smith (a generic drug maker) spending a lot on an expensive drug application process for a new drug that is not the generic version of Testim (can't be substituted at the pharmacy level) and would require a big sales force to sell the new drug.  That's not the business model of a generic drug maker.  Therefore, my opinion is the same as the Cowen analyst (pretty good analyst) who titled his note on Sept 8, 2009 "Testim Generics Hit a Major Roadblock."  When the FDA's response was released in late August 2009, I was relatively surprised by how positive it was for Testim.

     

    Additional thoughts:

    1.       I've spoken with both CPEX and AUXL about the FDA's Aug 26, 2009 ruling (http://www.regulations.gov/search/Regs/home.html#documentDetail?R=0900006480a16487) and both view it very positively.  In a Sept 9, 2009 investor presentation, AUXL highlighted that the FDA stated "The practical effect of this determination is that any application for a testosterone gel product that has different penetration enhancers than the reference listed drug cannot be submitted as an ANDA and, instead, will have to be submitted as an NDA under section 505(b) of the Act."  If one looks at the 11 page document, they'll see that the FDA would require that Upsher-Smith conduct a number of tests related to safety and pharmacokinetics.

    2.       Cowen's note on Sept 8, 2009 noted that "specifically, the FDA concluded that a proposed generic that includes different inactive ingredients (primarily different skin penetration enhancers for the gel) would require several studies to be carried out, in part due to recent concerns around the risk of secondary transfer of testosterone gel products to women and children."  Cowen also states "we now believe there is a high likelihood that Testim will retain its exclusivity for the foreseeable future."   Cowen further noted, "assuming this is the case, it is unclear whether Upsher-Smith would go ahead with such an NDA filing, this given the relatively small market size of the branded testosterone gel market, and the costs of marketing a competitive product (that would not be substitutable at the pharmacy level)."

     

    As alluded by Testim, it's not clear that making a generic version of Testim is a smart economic decision.    Assume a generic version of Testim cuts price by 75%.  And then assume that this generic version wins 100% of Testim sales.  Based on 2010's estimated sales of $190mm, this results in less than $50mm of revenue.  I'm not an expert on generics, but generally generic companies target drugs that can be at least $100mm of sales post the generic price cut.  The CFO of AUXL has described Testim as an old school pharma drug that requires a big sales force (lots of marketing spend) to generate additional prescriptions, which also doesn't fit the generic business model.

     

    Since the August 26, 2009 FDA response, Upsher-Smith has issued no press releases on Testim.  It's possible that they're still working on Testim, but as it has been nearly 9 months, it seems that they've let it die.  A key part of the generic business model is being first to file.  So it may be the case that Upsher-Smith was hoping to get through and now that they haven't, they've let it die.  They're not a public company and therefore they haven't returned my past phone calls inquiring about this.


    SubjectRE: RE: RE: Upsher-Smith
    Entry05/24/2010 08:37 PM
    Membersunny118

    As I'm not a patent expert, I've hired a lawyer to look into this further and will post additional thoughts when the lawyer gets back to me, but my initial thoughts are that it's very unlikely the '968 patent is ruled invalid:

     

    1.       Cowen Healthcare Royalty Partners has a very good reputation for royalty investing so it seems unlikely they would have provided a commitment letter unless they had looked into this and gotten comfortable that it wasn't a killer.  Cowen provided a commitment letter, not contractually financing, and therefore the $40 million is subject to additional due diligence, but it seems unlikely they would have provided a commitment letter if they weren't comfortable with the patent.

    2.       CPEX has the patent so I'd argue they're coming at this from a position of strength.  Upsher-Smith needs to try to get the patent invalidated.

    3.       The '968 main patent was applied for in 2003 and received in 2008. This review took nearly 5 years.  The '968 patent is clearly for the use of CPE-215 with Testosterone - so the patent office knew what they were patenting - no one fooled them.  And while the patent office isn't normally quick, this shows they gave it some good thought.  (patent can be found at www.uspto.gov - search for 7,320,968). 

    4.       The patent it clearly for Testim: the result of combining CPE-215 and testestrone (and other things like thickening agent) in the correct manner to create Testim.  I'm sure the initial CPE-215 patent is the strongest, but my understanding is that patents get invalidated when they're far more of a stretch than this.  For example, trying to patent "Lipitor extended release" and keep out generic competition because regular Lipitor is going off patent.  The '968 patent is for the initial drug that resulted from CPE-215...doesn't seem crazy to me that it should be allowed to be patented.

    5.       CPEX filed for the patent following the release of Testim in early 2003 (Testim on market in Feb 2003 and patent filed for in April 2008).  I'd be more worried if CPEX filed for the patent in late 2007 as they realized "damn, our patent runs out next year and we need a new patent, we need to pull something together quick."  This doesn't seem to be a situation...there doesn't seem to be anything obviously fishy.

    6.       CPEX received 6 more patents in Q409.  This shows that the patent office reviewed these and found nothing obviously wrong with them.  It seems unlikely the patent office is going to now reverse itself and note "less than a year ago we made the wrong decision."  The 7 patents for Testim can be found at: http://www.accessdata.fda.gov/scripts/cder/ob/docs/patexclnew.cfm?Appl_No=021454&Product_No=001&table1=OB_Rx

    7.       The claim that the '968 patent is invalid is part of the amended claim - if the '968 patent was obviously invalid, seems likely that it would have been part of the initial claim by Upsher-Smith.  When I'm in an argument, I lead with my strongest points.

    8.       When I called the patent lawyer he noted that his quick glance shows the trial date has been postponed.  It's unclear if CPEX/AUXL or Upsher-Smith has asked for the postponement and when I called AUXL they wouldn't say who asked.  The lawyer felt that this was positive for CPEX - if the worst case scenario is that the patent is ruled invalid and Upsher-Smith can make a generic version of CPEX, there's no chance that CPEX is going to be willing to postpone the trial to enter into settlement discussions that result in this outcome (the lawyer was speculating that a reason CPEX would be fine to postpone the trial is to start settlement discussions). 

     

    What would be the worst case scenario? 

    I'll try to get more exact timing with the lawyer, but my inclination is that the process of getting the '968 patent ruled invalid would take many years.  First off, AUXL has stated that Upsher-Smith is only claiming that the '968 patent is invalid and that the additional 6 patents cannot be rolled into this court case.   So if Upsher-Smith wins and the '968 patent is ruled invalid, they'd need to also get the other 6 patents ruled invalid (probably not hard to do if the '968 patent is ruled invalid, but would take time).   And in addition to the time in court, the USPTO would need time to review - it took 5 years for CPEX to receive the '968 patent so my hunch is that it would take quite a long time for the USPTO to reverse itself.   Plus, the USPTO would need to reverse the patents they just issued.

     

    When the patent lawyer gets back to me I will update these thoughts.  Sorry for delay in getting you these initial thoughts.


    SubjectRE: RE: RE: RE: RE: Upsher-Smith
    Entry06/08/2010 03:54 PM
    Membersunny118

    Sorry for the delay in replying - I'd never worked with this lawyer before so I was at the bottom of his to-do list and it took a couple weeks.  Unfortunately he wasn't able to determine a whole lot because a lot of the documents are sealed as they contain financial information, trade secrets, etc.  Lawyer noted this isn't uncommon when there is a public company involved. 

     

    First off, the history of the case:

     

    Dec 2008 - AUXL/CPEX file suit against Upsher-Smith for patent infringement.  7 months later Upsher-Smith included an amended answer to include patent infringement - it's unclear why they waited.  Lawyer's skim of the documents is that Upsher-Smith didn't have a very good invalidity argument so didn't lead with it.  When they got wind that FDA was going to come back and say "you can only make bioequivalent if you use CPE-215" they seemed to change their claim to include that the patent was invalid.  In summary, Upsher-Smith responded to CPEX/AUXL by claiming that the patent was invalid, which the lawyer noted is the standard legal tactic to take. 

     

    March 2010 - Teleconference with judge scheduled to discuss mediation being cancelled.  The lawyer notes that it's unclear if the parties ever went to mediation from court records.  Similarly, on March 3, 2010 there was a letter to the judge asking to settle a motion for summary judgment (this means ask judge to either declare patent valid or invalid), but the motion for summary judgment was never filed. 

     

    May 3, 2010 - Pretrial and trial cancelled per request of counsel (don't know which side cancelled).  According to lawyer, this generally happens when a case is settled as a judge will generally not take trial dates off unless they're told the case is settled.  Also it's important to note that the trial was cancelled - not delayed.  Lawyer notes that if lawyers tell the judge they're close to a settlement, he'll delay the trial for a couple months.  But, the trial date was cancelled so it means the case was settled.  This was a month ago - lawyer notes that it's not unusual that it takes up to 10 weeks to work out all settlement details.  After all settlement details are worked out, the case is dismissed.  So if this takes up to 10 weeks, we seem to be halfway through the waiting period.  Btw, the trial was scheduled for June 1 start.

     

    I asked the lawyer if he had a sense for what the settlement might be.  He noted that if they're settling now and this is a critical drug for CPEX, they're not going to stipulate that this patent is invalid. 

     

    Lastly, as a reminder CPEX started this lawsuit based on Upsher-Smith infringing the patent.  I asked the lawyer how Upsher-Smith would have infringed the patent if they haven't sold the drug.  He noted that it's infringement if they make the drug (the definition includes "make, use, or sell" - so just making one sample for internal testing is infringement). 

     

    While he acknowledges that he doesn't know a lot of details, his best guess is that Upsher Smith has given up.  His rationale is that if Upsher-Smith knows the FDA won't allow them to make a product without CPE-215, but that would infringe the patent, they've really got no way out.  So he believes Upsher Smith has said "we'll go away."    

     

    Specific to the question about revenue earned in the past, the lawyer noted that it's not possible to make back payments.  So if the patent was ruled invalid (which seems unlikely given that they're settling), CPEX wouldn't owe Upsher-Smith a liability, but Upsher-Smith would be able to make a generic version of Testim going forward.

     

    Lastly, it might be helpful to listen to the AUXL Presentation at Citi Global Health Care in late May - start a little after minute 12.  When asked about the Paragraph IV challenge status, the CFO noted that the FDA responded to AUXL/CPEX citizen petition agreeing with most of what AUXL/CPEX said and most importantly need to use same penetration enhancer for ANDA route.   The '968 patent is primarily based on penetration enhancer.  CFO notes that they're still in litigation, but that there is a public filing regarding counsel requesting that the hearing be cancelled.  CFO wouldn't say if it was AUXL/CPEX or Upsher-Smith counsel that made the request, but he closed his comments saying, "Still feel pretty good about where we are with Testim."  So nothing specific, but to close statements noting that they feel pretty good seems to indicate that draconian scenarios are off the table.  IR gave the same impression when my analyst called - can't comment specifically, but feel good.

     

    Lastly, I also asked the lawyer for his two cents on the strength of the patent.  He noted there are two tests for invalidity is:

    1.       Anticipated - had it been invented before?  So would need to show that this already exists.  That's not applicable in this situation.

    2.       Obviousness - what makes a patent obvious?  Is someone reasonably skilled in the art likely to have already done this?  If someone had CPE-215 would it have been obvious to add testosterone to it?  I asked this to lawyer on the spot so he didn't have deep thoughts...I'm sure he would have been happy to noodle over it for a few hours at $450/hr.  He said that this is what everyone argues about and it's very hard to know if this is obvious or not.  I'm not a drug researcher, but Testim is the first drug to be commercialized with CPE-215.  It seems hard to say that it was obvious to combine CPE-215 with testosterone, particularly as no one had previously commercialized a drug with CPE-215. 

     

    In summary, it seems that we'll find out pretty soon what the settlement is, but that draconian scenarios are off the table.  And again, I've included the commentary from my lawyer, but a lot of these documents are sealed, so it's just his best guess based on his experience.


    SubjectLink to heart problems... how meaningful?
    Entry07/01/2010 04:04 PM
    Memberbanjo1055

    By Ellen Gibson
         June 30 (Bloomberg) -- More than one-fifth of patients
    using a testosterone gel sold by Auxilium Pharmaceuticals Inc.
    developed heart problems in a study of mobility-impaired men
    aged 65 and older.
         The study found that 23 of 106, or 22 percent, of men
    getting the gel, Testim, had heart-related side effects such as
    chest pain, heart attack, stroke, or elevated blood pressure,
    according to a report published today in the New England Journal
    of Medicine. Of the 103 men who got a placebo, just five, or 5
    percent, had similar adverse effects, the researchers at Boston
    University Medical Center found.
         Testosterone supplements have been shown to boost muscle
    mass and strength in aging men, the report said. This trial was
    designed to see if Testim could improve physical function in men
    with limited mobility. While the testosterone group did show
    improvement in their ability to climb stairs and do leg presses,
    the study was halted early because of concern that the drug may
    be linked to cardiovascular problems.
         "Physicians and patients, especially older men, should

    consider this study's findings on adverse effects along with
    other information on the risks and benefits of testosterone
    therapy," the study authors said in a statement. They urged
    further research "to clarify the safety issues raised by this
    trial."
         Testim had worldwide revenue of $160.5 million last year,
    98 percent of the company's total, according to a regulatory
    filing. Auxilium rose 65 cents, or 2.8 percent, to $23.50 in
    Nasdaq Stock Market composite trading at 4 p.m. New York time.
    The stock has declined 25 percent in the last 12 months.


                            Low Testosterone

         Testim, a skin gel, was approved in October 2002 as a
    testosterone replacement therapy for men with hypogonadism, a
    condition in which the body doesn't produce enough of the
    hormone. Hypogonadism can cause fatigue, infertility, decreased
    sex drive and loss of bone mass. Testim competes with Androgel,
    sold by Abbott Park, Illinois-based Abbott Laboratories.
         The study, which was discontinued in December, was funded
    by a grant to Shalender Bhasin, the chief of endocrinology at
    Boston Medical Center, from the National Institute on Aging,
    part of the U.S. National Institutes of Health. Auxilium donated
    the product and wasn't involved in the study design or
    execution, according to the report.
         Twice as many men in the Testim group had complications
    requiring medical evaluations compared with the placebo group,
    according to the report. Ten men had full-blown cardiac events,
    including two confirmed heart attacks and one death.
         Bhasin and his co-authors said aspects of this study make
    it difficult to draw conclusions about the safety of Testim. The
    main limitations they cited were the small size of the clinical
    trial and the nature of the population being studied.

                                Frail Men

         Patients in the study were frail, had higher rates of
    chronic disease than the general population, and had an average
    age of 74, according to the study. In contrast, 95 percent of
    patients getting Testim in the real world are under 75, said
    Eboo Versi, vice president of drug safety and medical affairs of
    Malvern, Pennsylvania-based Auxilium.
         Another factor that makes the findings not apply to other
    men is that some study participants were given 15 grams of
    Testim a day, while the medicine's label recommends starting
    patients on 5 grams and going up to 10 grams only if needed.
    That dosing was "totally off label," Versi said in a telephone
    interview today.
         Overall in the study, 16 men received the highest dose or
    15 grams of testosterone, while 61 received 10 grams and 29
    received 5 grams, according to the journal report.

                            Earlier Research

         Another study of testosterone gel in men over 65, published
    online Jan. 8 in the Journal of Clinical Endocrinology &
    Metabolism, found no significant difference in cardiac events
    between the treatment group and those who got a placebo gel.
    Auxilium analyzed its Testim registration studies and didn't
    find any increased risk of cardiovascular events, Versi said.
         "We obviously want to get ahold of this data and we will
    analyze it and share with the FDA our findings," he said. "If
    there was a concern, we'd very much want to ensure we have a
    change in our label, but for now this study is looking like the
    odd man out."
         Another study published in the same journal on June 16
    found that low testosterone levels in older men are less common
    than doctors previously thought, with only 2 percent of men from
    40 to 80 suffering from hypogonadism.


    --Editors: Donna Alvarado, Jeffrey Tannenbaum

    To contact the reporter on this story:
    Ellen Gibson in New York at 1-212-617-5462 or
    Egibson9@bloomberg.net;


    SubjectRE: Link to heart problems... how meaningful?
    Entry07/26/2010 02:00 AM
    Membersunny118
    Sorry to just notice this question.  This is not meaningful.  As noted by an LP of my fund that is a cardiologist "I was taught this 45 years ago in med school in India...everyone knows not to give testosterone to someone with heart problems...this is nothing new."  If you'd like me to elaborate further, I can (AUXL IR has supplied a lot of good information).  Probably most important data point is that the weekly sales data for Testim shows that hasn't had an impact. 

    SubjectRE: Link to heart problems... how meaningful?
    Entry07/26/2010 11:20 AM
    Membersunny118

    I have no insight - as you note, it's possible to argue both for and against.  The obvious reason to argue "for" is that it's very accretive and it helps balance the company relative to Xiaflex, which isn't starting well.  The obvious reason "against" is that they want to keep all their cash for further investment in Xiaflex. 

     

    While AUXL is the most likely pharma buyer, it's possible they're not the only pharma buyer.  A pharma company that likes the CPE-215 technology could be a buyer.  For example, Allergan could be very optimistic about Ser-120, the Serenity Pharmaceutical drug focused on treatment of Nocturia.  Or a pharma company could believe that CPE-215 may be a novel way to administer a number of their drugs. 

     

    A shareholder that lives in New England drove to CPEX's annual meeting and was given the impression that the board was meeting with RBC in late June to discuss the status of the strategic review and that final, binding bids were due a couple weeks afterwards.  So an estimate of the timeframe would be that the board met on Wed, June 30th, bids were due two weeks later on Wed, July 14th and the entire process should be complete within about one month (by Monday, August 16th).  Shortly after CPEX announced it had engaged RBC, I spoke with John Capano, the RBC investment banker running the strategic review, and he noted that he'd like to have this process complete in early Q3, which I took to mine the 1st half of Q3.  Therefore, completion of the review by mid-August seems to be in-line with his goal.  On the other hand, mid-August assumes all goes according to schedule.  I was an i-banker 10 years ago and most of the time the process was a few weeks longer than our initial timeframe.


    SubjectRE: Link to heart problems... how meaningful?
    Entry08/25/2010 02:56 PM
    Membersunny118
    I know of nothing that would change my thoughts and I would agree that we're pretty close to the final stretch.  The August 9th Q2 press release stated again that they expect to announce the results of the strategic review in Q3. 

    Subject9/29/2010 "Continuation" Press Release
    Entry09/29/2010 02:48 PM
    Membersunny118
     

    While I try not to read too much into these announcements (they're intentionally written to give no clue of what's actually going on), my take is that it's a mild positive.  If they were near the end of the road and felt that it was likely they weren't going to announce a transaction, I doubt they would have put this out.  The release does say "we remain actively engaged in discussions regarding potential strategic transactions."  Also, as it has been nearly 5 months, if they were planning to conclude strategic alternatives and remain a standalone company, I think that they would have determined that by now.  There is nothing that I've uncovered that makes me believe the company isn't sincerely exploring strategic alternatives.  Everything I've diligence shows that the management/board are committed to change so the value of CPEX will be realized and released to shareholders.    

     

    In a very painful period of my life, I worked in banking and PE.  Oftentimes deals took much longer than we imagined: documentation took months to finalize or we had a hard time completing diligence (a buyer would want to speak with Auxilium, Serenity, Allergan, and others - none of these companies are obligated to speak in a timely fashion).  Or if we assume that the board is pursuing a complete sale of CPEX, perhaps it's the case that there is not one buyer for all of CPEX.  If a royalty fund is bidding for the Testim royalty, would they want to pay for the potential royalty & milestone payments associated with Serenity given these are very speculative?  Or would Serenity or Allergan want to buy this back themselves?  In a similar fashion, I doubt that a royalty fund would ascribe value to the CPE-215 molecule, but perhaps a pharma company wants to buy it and see if it has use on other drugs in their portfolio.  And there are other assets such as the corp HQ.  I have no insight into what is going on in the sale process, but I could imagine that there are lots of moving pieces.  However, despite these moving pieces I've been surprised that it has taken 5 months.

     

    Regarding someone knowing something, I don't know if I'd agree with that statement.  In nanocap/microcap land I've seen a lot of crazy stock moves and I feel that most of the time they're random.  Perhaps someone has more insight than that, but if they're trading on insider information they also risk going to jail.

     

    Similar to you, a friend of mine recently had a 1on1 with the CFO of AUXL and received similar comments: they will evaluate whether to put more $ into sales/marketing for Xiaflex, buy either CPEX or BSTC, or buy a 3rd drug.  AUXL was certainly aware that CPEX was exploring strategic alternatives - the CFO noted that CPEX CEO John Sedor used to be his boss at a prior job.  Financially it would be a great deal for AUXL.  The issue is that many life science companies have an understanding of corporate finance similar to most Japanese companies.  I believe that Buffett once observed that life science companies are run by scientists and focused on creating and growing new drugs, not benefitting shareholders.  So we'll see if AUXL makes the logical financial decision. 

     

    It's possible that they're waiting to settle with Upsher-Smith, but my best guess is that Upsher-Smith walked away.  When I had a patent lawyer review the case a few months ago, he thought that it could take up to 10 weeks beyond the May 3rd cancellation of the trial dates to finalize the legal language of a settlement.  However, his best guess at the time was that Upsher-Smith opted to walk away.  The fact that it has been more than 20 weeks since the May 3rd cancellation of the trial dates, seems to give credence to the theory that Upsher-Smith has walked away.  There was been nothing posted to the legal docket for nearly 4 months.  My friend asked AUXL's CFO about Upsher-Smith and was told that they haven't heard anything in months from Upsher-Smith so while they don't want to jinx themselves, they believe Upsher-Smith has let this die. 

     

    Regarding what will happen to Testim when Androgel goes generic, normally I would agree that generic competition will have a big impact.  However, a few things to note:

    • 1. Generic testosterone is already available (although only in injectable form). An injectable isn't an exact competitor, but it is much cheaper than Androgel or Testim. It doesn't seem that this has had serious impact on sales of Androgel or Testim.
    • 2. Historically Androgel and Testim have pushed price pretty aggressively with no significant impact on sales.
    • 3. AUXL has talked about Testim as an "old school pharma drug that requires the push of a big sales force." And while it may be AUXL being overly bullish about the outlook for their drug, I think that there is some truth to this. The branded versions of Androgel and Testim may continue to do reasonably well because of the push of their sales forces.
    • 4. Endo and Eli Lilly are working to bring branded testosterone products to market in the next few years. If they thought generic Androgel would destroy the market for branded products, they wouldn't be doing this.
    • 5. There's going to be inertia by both doctors and patients. Either or both may think "You used to feel terrible, now you feel better, don't mess this up - pay the higher co-pay."

     

    But lets assume you're right and estimate what a royalty fund can pay:

    • 1. Testim sales after 12/31/2015 go to zero.
    • 2. From 1/1/2011 - 12/31/2015, total Testim royalties are $135.9mm. This assumes sales forecasts that I've noted previously in the Q&A. While it's not formal guidance, AUXL talks about 2011 Testim sales continuing to grow double digits through a combination of growing prescriptions and continued price increases.
    • 3. Annual operating expense is $1mm/yr, although I think a royalty fund would have far lower costs.
    • 4. The cash tax rate paid is 25%. In looking at past deals (e.g., Rofe's $16/sh bid or other past purchases of royalties) debt is used to finance much of the purchase so the tax rate is less than the full 35% given the shield provided by interest expense.
    • 5. Discount rate of 15% - between the debt & equity financing, royalty funds tend to target a 14-15% IRR, which is consistent with other private equity firms.
    • 6. 2.8mm FD S/O

     

    These assumptions arrive at $23/sh of value for the Testim royalty.  My initial write-up ascribed $7/sh of value to the remaining net assets (net liquid assets remaining after severance payouts, Serenity royalty, CPE-215 molecule, and corp HQ).  To be conservative, knock $2/sh off and assume there is $5/sh of value in the remaining net assets.  So $23/sh of value for Testim + $5/sh of value for other net assets = $28/sh.  So my downside is slightly below your estimate of $30/sh, but I think we're on the same page.  And I think these are reasonably conservative estimates - as you note, AUXL could pay more because they have no operating expenses and wouldn't pay cash taxes.

     

    Lastly I just noticed your CYPB question.  Sorry to just get back - I've taken a quick look at it, but haven't dug in deep.  I recall that for me to be interested in CYPB, I'd need to think that Savella was worth $3.50+/sh.  To get that valuation takes some pretty significant growth assumptions: perhaps they'll achieve that growth (~50% CAGR from 2011-2013), but it would have taken me a lot of work to determine it so it's a backburner idea.  If I refresh I'll be happy to share deeper thoughts.


    SubjectAllergan comments on Phase III test of Ser-120
    Entry11/02/2010 08:09 PM
    Membersunny118
     

    Yesterday on Allergan's quarterly conference call they noted:

    "Concerning our cooperation with Serenity with their Nocturia product, Ser-120, the Phase III trials have been completed. The conclusion is that these trials are not sufficient for successful registration. Allergan and Serenity are in the process of reviewing the complete trial data to determine what additional trials are indicated to support the development of the program."

     

    There were no questions asked on the call about Ser-120 and Allergan IR had no additional details that could be shared. 

     

    This is a negative data point and therefore my probability weighted estimate of $1.75/sh of value for Ser-120 is too high as the probability of success is now likely lower than 20% and/or the timing of approval is longer.

     

    If I'm able to speak with Serenity's CEO Sam Herschkowitz, I will update VIC.


    SubjectRE: Allergan comments on Phase III test of Ser-120
    Entry11/03/2010 08:08 AM
    Membergocanucks97
    thanks for the update, sunny. do you think that event has anything to do with the fact we are still waiting?
    i realize this is an almost impossible question to answer. is there any event you are watching before you conclude the auction may have failed? the auction process has gone on for 6 months. AUXL reports tomorrow, and CPEX is due to report next week.
    the value is clearly there, but if the auction fails, stock could take a big hit at least in the short term.
    thanks in advance.

    SubjectUpdate?
    Entry12/26/2010 10:02 PM
    Memberruby831
    Sunny,
     
    Do you have any updated thoughts on the timeline of sale of CPEX?
     
    Thanks in advance.

    SubjectRE: sunny/pretium re: AUXL
    Entry12/08/2011 10:58 AM
    Memberpretium
    To quote Cowen's note this morning after talking to AUXL:
    1. Auxilium believes change will help unlock value. Auxilium views Xiaflex and Testim as tremendous assets with value that has not been fully realized.
    2. The managerial change has nothing to do with near term events or trends.
    This search process has been ongoing for some time, allowing the Board to identify a high caliber replacement for Mr. Anido.
    3. Mr. Adams is not coming to AUXL to sell the company. Mr. Adams is coming to AUXL for the long haul (5-year contract) to build shareholder value. There are things he believes he can control (commercial execution, business strategy, financial performance) and things he cannot (interest from third parties in acquiring AUXL).
     
    My take: Adrian is good. At this valuation you are getting Xiaflex for free. People forget that Testim has IP protection through 2025 - this is a very long tailed asset with very good regulatory protection - unusual for a 505b2 product. Also Xiaflex is not yet being marketed in the EU. I'd expect them to push sales harder across the board (perhaps new sales force comp scheme? perhaps a primary care partnership to market Testim with PFE?), particularly with Xiaflex after the new CPT code is effective Jan 1. The stock will now likely run into the Pyronies data. Also on the Collins Stewart marketing trip in mid-Nov old management laid out expectations for a good Xiaflex quarter due to seasonal affects (not sure what drives that but its what they said) and the launch of a DTC marketing campaign. The company sale, however, will likely be a long term issue where a buyer is going to want to see Xiaflex ramp - if someone wanted AUXL for Testim it would have already been taken out most likely. PFE is obviously a logical buyer here given the EU Xiaflex partnership, existing men's health franchise and a stated desire to get into orphan diseases.
     
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