May 29, 2014 - 4:32pm EST by
2014 2015
Price: 103.68 EPS -$2.92 na
Shares Out. (in M): 11 P/E na na
Market Cap (in $M): 1,120 P/FCF na na
Net Debt (in $M): 34 EBIT 0 0
TEV ($): 1,154 TEV/EBIT na na

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  • Pharmaceuticals
  • Acquisition
  • Merger Arbitrage
  • FDA approval


Buy Furiex (FURX)

FURX is a drug development company being taken over by Forest Labs (FRX) for $95 per share ($1.1B) in cash and a non-transferable CVR (contingent Value Right) with value of up to $30 per share  ($360m in aggregate). The exact value of the CVR will depend on the scheduling status of Eluxadoline – FURX’s anti-diarrheal currently in Phase III with expected 2q’14 NDA submission and 1h’15 FDA approval.

Scheduling refers to the designation the DEA (Drug Enforcement Administration) assigns to drugs classified as controlled substances depending on the drug’s acceptable medical use and the drug’s abuse or dependency potential.  This designation obviously has implications on how easily the medicine can be accessed by the consumers, how it can be marketed, prescribed and sold, or even displayed in your local pharmacy.

 Per the DEA website ( http://www.justice.gov/dea/druginfo/ds.shtml):

Schedule I.. drugs with no currently accepted medical use and a high potential for abuse. Schedule I drugs are the most dangerous drugs of all the drug schedules with potentially severe psychological or physical dependence.  (E.g. heroin)

Schedule II.. drugs with a high potential for abuse, less abuse potential than Schedule I drugs, with use potentially leading to severe psychological or physical dependence. These drugs are also considered dangerous. (Methadone, meperidine (Demerol), oxycodone (OxyContin))

Schedule III ..drugs with a moderate to low potential for physical and psychological dependence. Schedule III drugs abuse potential is less than Schedule I and Schedule II drugs but more than Schedule IV. (E.g. combination products with less than 15 milligrams of hydrocodone per dosage unit (Vicodin), Products containing less than 90 milligrams of codeine per dosage unit (Tylenol with codeine), ketamine, anabolic steroids, testosterone

Schedule IV .. drugs with a low potential for abuse and low risk of dependence. (e.g. Xanax, Valium, )

Schedule V .. drugs with lower potential for abuse than Schedule IV and consist of preparations containing limited quantities of certain narcotics. Schedule V drugs are generally used for antidiarrheal, antitussive, and analgesic purposes. (e.g. cough preparations with less than 200 milligrams of codeine or per 100 milliliters (Robitussin AC))

The CVR value will depend on the scheduling as follows

Schedule I-III:    $0
Schedule IV:     $10
Schedule V:      $20
No schedule:     $30

Obviously if Eluxaduline fails to receive the FDA approval at all the CVR expires worthless

To address this scenario, there is a favorable market consensus regarding the available data from the 2 Phase III studies. The only points of concern were the 5 cases of pancreatitis (0.3% of over 1,600 patients). However it appears all the cases were mild, reversible and occurred among the subset of patients with known risk factors for the condition (e.g. heavy alcohol consumption, etc). In fact, a few years ago another anti-diarrheal with a similar mechanism of action, Loperamide, has been associated with pancreatitis. Nonetheless it is still available OTC, while being monitored for any further pancreatitis reports. This is a known issue and the company has reiterated that it could be resolved through labeling and warnings if it became an issue during the NDA review. At the end of the day, FRX clearly assumes a near certain approval since the CVR is contingent on the subsequent scheduling, not the approval itself. In fact, the transaction background section of the S4 filed recently discloses the lengthy evolution of the structure of the bid, where in the earlier stages of negotiations the CVR value was tied to the FDA approval as well, but as confidence in this approval grew, this condition was dropped.

Moving on to the DEA scheduling issue: During the conference call FURX stated that for their internal projections they modeled conservatively and assumed Eluxadoline would receive Schedule III status. We agree that this is a very conservative model and think there is a high probability of attaining Schedule V  or even no scheduling (a possibility clearly seriously contemplated in the merger agreement given the specific 6 month post FDA-approval timeline for the payment in that scenario)

The reason Eluxadoline might be subject to DEA scheduling is because it contains opioids. Opioids affect the central nervous system if they get into the bloodstream. However by design Eluxadoline works locally in the gut and does not get into the bloodstream of a patient, and therefore the nervous system impact is avoided.

Typically, at the time of the FDA approval, the FDA provides the DEA with a recommendation whether to schedule the drug and which schedule to assign. A dedicated group within the FDA conducts this analysis during the NDA review. The DEA does not conduct its own study and usually within a couple of months the it comes out with the scheduling based on the FDA’s recommendation. It may take longer depending on DEA’s workload. In rare cases when the DEA wants to get more information they communicate with the FDA, not the company. The recommendation (even on whether or not to subject the drug to a schedule) is not disclosed by the agencies to the public until the final decision is made. That is the nature of the 6 month waiting period between the FDA approval and the CVR payout in the “no scheduling” scenario.

In order to formulate a recommendation, the FDA asks the drug companies to provide it with data addressing various forms of abuse a drug could take: oral, IV, snorting/inhaling and smoking. There is also a test of extractability. 

We know from the company’s 3/12/13 earnings call that the FDA agreed with the company’s assessment of low potential for IV abuse given the low solubility. Similarly, per the company’s statements the FDA agreed on the low risk of oral abuse, but the company still provided the FDA with the data from its studies. All these comments are recorded in the minutes of the company’s discussions with the FDA regarding the design of the entire trial when they decided what data the FDA needs to see and which it doesn’t.

The smoking study will be unnecessary/impossible because the drug was demonstrated to be unstable at high temperatures and simply disintegrates. So that leaves us with testing for inhaling/snorting and extractability.

Regarding inhaling, the company indicated that in its studies the drug was associated with difficult insufflation, nasal irritation and significant disliking by recreational drug users compared to placebo or oxycodone.

As for extractability (which was partially addressed in the IV abuse discussion with the FDA) the company reported its tests showed the drug to be non-extractable by readily accessible solvents or, under more extreme conditions, resulting in impure product difficult to manipulate, thus deterring tampering.

In order to be subject to scheduling, the DEA would have to demonstrate how the drug can be abused if it cannot be smoked, inhaled or injected.

In addition, no psychoactive effects, drug dependence or withdrawal symptoms were reported in animal or clinical studies (including the large Phase III trials)

Finally loperamide, which we mentioned above in the pancreotitis discussion, also can act on opioid receptors, yet, again, it is a widely available OTC drug.

We therefore expect the DEA to conclude that abuse potential for eluxadoline is low and expect it to be classified as a Schedule V drug or not a controlled substance.

The CVR will pay as soon as the DEA schedule is assigned. The time between the FDA approval and the scheduling can range up to 6 months. If the FDA does not recommend that the drug be a controlled substance and the DEA does not initiate scheduling, the CVR holders will have to wait 6 months post the FDA approval to receive the $30 payment.

Currently, FURX is trading under $104 which reflects (after accounting for the risk-arb spread of about 1%) a blended rate of probabilities for all 4 payment outcomes, and amounts to $10 expected value for the CVR. This corresponds to the “expected scheduling” of IV for Eluxadoline. The market assigns a relatively low chance for the V or no-schedule scenario, which we find overly conservative, and leaving $10 or $20 of upside on the table. Even assuming equal probabilities for the $10, $20 and $30 scenarios, with $95 coming in the next ~3 months, FURX shareholder will end up paying under $9 for the CVR with the expected value of $20 in a year’s time. Of course that assumes 100% chance of the FDA approval, but even taking a conservative (given above considerations) 15% haircut on that we still end up with an excellent risk-reward.

Why does the opportunity exist? Besides the misallocation of relative weights of the CVR payment outcomes, the other reason is that since the CVR’s will not be listed, most brokerage statements will show a loss of $9 at current prices between the time the $95 is paid out and the time the CVR is paid out.

Lastly, FRX, the parent in this transaction, is in turn subject to a takeover by ACT. However this is not a risk factor in the FURX transaction as ACT consented to the FRX/FRUX deal.



I do not hold a position of employment, directorship, or consultancy with the issuer.

I and/or others I advise hold a material investment in the issuer's securities.

This investment may change at any time.


I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.


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