May 10, 2011 - 6:13am EST by
2011 2012
Price: 8.44 EPS $0.00 $0.00
Shares Out. (in M): 43 P/E 0.0x 0.0x
Market Cap (in $M): 362 P/FCF 0.0x 0.0x
Net Debt (in $M): -96 EBIT 0 0
TEV ($): 266 TEV/EBIT 0.0x 0.0x

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Pain Therapeutics (PTIE) represents a compelling risk /reward with meaningful upside potential in the next 18 - 24 months.  With a EV of only ~$266mm (Market Cap of $362mm - cash of $96mm) PTIE owns a 15-20% royalty on sales of Pfizer's (PFE) Remoxy (PFE acquired the rights to Remoxy when it acquired King Pharmaceutical in February 2011). Remoxy will be the only competitor to Purdue's Oxycontin which generated $3billion of sales  in the US in 2010 (the 15th largest largest drug  by sales).   In our estimation, the investment  thesis in PTIE can be reduced to two variables / questions: When will Remoxy get approval / launch and how  fast will Remoxy ramp? Under our most conservative / base scenario of Remoxy reaching $500mm in sales in 2014 (14% market share) we think the equity is worth $19/share.   Assuming Remoxy can get to $1billion in sales by 2014 (30% market share), our price target becomes $37.  Rarely does one find such upside in a company that has all of its clinical and financing risk behind it.

For more extensive  background on Remxoy, please reference coda516's writeup of Durect (Durect licensed the drug delivery technology behind Remoxy to  PTIE in 2002 and earns a 5-11% royalty on Remoxy vs. PTIE 15-20% royalty).   To make a long story short, Remoxy is the third entrant in a new class of tamper / abuse  resistant opioids. Illegal diversion of opioids and other drugs  is a huge problem in the US. Oxy, or Hillbilly heroine as it is known, is the most  popular target for addicts because it is a 12 hour, controlled release formulation with a huge drug load.  The FDA estimates that in 2008 there were approximately 500k non-medical users of Oxycontin. The big headline risk for the FDA is the suburban teenager that overdoses on Oxy  and dies which seems to happen a couple of times every  year.   In the context of today's risk averse FDA, which will pull a drug for even the slightest sniff of a safety concern, it is rather puzzling that a drug that has directly contributed to so many deaths has not been pulled (a lot of that has to do with the strong patient advocacy groups, especially in cancer, that lobby for unrestricted usage). The active ingredient in Remoxy is oxycodone (the same as Purdue's Oxycontin) but the surrounding pill / matrix is different. Unlike Oxycontin which is a hard tablet,  Remxoy contains a suspension of oxycodone in a high viscosity fluid matrix . It is this fluid matrix  that resists common methods of chemical and mechanical extraction.   

There's one other unique detail about the long acting oxycodone market that deserves mentioning: there has never been a generic long acting oxycodone and probably will never be one.   Oxycontin was scheduled to go off patent in 2013; however in a stroke of brilliance / good fortune Purdue was able to withdraw its Oxycontin NDA when they released their new tamper / abuse resistant formulation. The implication is that generics cannot reference the  old Oxy NDA  for approval for an ANDA making it impossible to file a generic under current FDA protocol. Even assuming they would approve a generic to the new Oxy, the FDA has yet to decide how to establish "tamper equivalence" since the key properties of the new Oxy  are not demonstrated in standard bio-equivalence  testing.  That is to say, this is never going to be a "quick and dirty" generic play and the barriers to entry will be much higher than is seen in typical markets.

When will Remoxy launch?
After successfully completing a Phase 3 in December 2007 and first submitting its NDA in June of 2008,  PTIE investors were seemingly dealt another set back last week  when PFE CEO Ian Reed announced  on their  May 3 quarterly conference call  that PFE would possibly delay the PDUFA date for Remoxy which is currently set for June 23, 2011.  We have pasted Reed's comments below:

"In terms of anticipated regulatory decisions later this year, the PDUFA date for REMOXY is currently set for June 23, 2011. At this point, we are working to address the specific issue in the manufacturing section of the application as well as to understanding any potential implications for the  FDA'S recent class-wide REMS, announcement for extended-release opioids. These issues could delay the timing of approval or the launch of REMOXY. "

There is no question that whenever a company hedges previous guidance, especially in drug development, there is cause for concern. But we think there are several important mitigating factors in this case:
  1. In the face of the jittery  panic selling that occurred on May 3rd, it has to be emphasized that the  PDUFA date has not been changed yet and  perhaps more importantly PFE's CEO sees the program as important enough to highlight it and referred to it in Q&A as a matter of "when" Remoxy launches and not "if.".
  2. Even if the PDUFA date is pushed out, say three or six months, PFE only  acquired the rights to Remoxy in late February when it closed on its acquisition of King Pharmaceuticals. Minimally it takes 6-9 months to ramp up a product launch like this which will be sold into the highly diffuse primary care channel. On top of that, Remxoy is a Class 2 Opioid and must conform to the FDA's Risk Evaluation & Mitigation Strategy (REMS) which was only released in its final version in mid April 2011.   Obviously in the worst case if Remxoy is pushed out a year or more, the opportunity costs will increase but the most likely scenario is that Remxoy will launch in the  first quarter of 2012.  
  3. This is not an FDA issue but relates to internal manufacturing. That is to say, this is an issue that PFE presumably  knew about  before it acquired King Pharmaceuticals.  The most probable explanation for the delay is that PFE is buying time to make sure it has satisfied all of its REMS requirements.

This might all  sound like apologetics but at the end of the day this is  the risk one takes investing in between Phase 3 and the PDUFA date.  We think PTIE is easily a $15 stock just upon approval but as value investors we prefer the risk/ reward here given the high chances for approval.  

How fast  will Remoxy ramp?

Abe Lincoln once remarked: "Never speculate. If you are right no one will remember and if you are wrong no one will forget." In this "speculation" we are comforted primarily by the tiny size of PTIE's enterprise value relative to the market size for long acting oxycodone which we think gives us  a good margin of safety . As said above, PFE pays PTIE 15% of US sales up to cumulative sales of $1billion after which the royalty rate increase to 20% (ex US, a much smaller market, is a flat 10% royalty).   We liked PTIE before PFE became their partner but it's hard not have our conviction buttressed  simply based upon PFE's assessment that this is  an attractive asset which is worth their time and effort.   While it is clear that PFE thinks Remoxy has potential to be a billion dollar drug (otherwise why bother), why do we think that they actually can do it as we are traditionally loath to bet on drug launches?
  1. We estimate that PFE's sales force is between 5-7x  the size of Purdue's sale force and the drug should sell itself given it uses the same active pharmaceutical agent as Oxycontin.
  2. More than that,  Remxoy will have one major advantage over Oxycontin.   By way of background, Purdue has had a very strained relationship with the  FDA and at the behest of the FDA has actually been working on  a tamper / abuse resistant formulation of Oxycontin for the last decade.  Purdue apparently never took the FDA seriously and even made an embarrassment of  themselves when they released their first  version at an FDA advisory panel in 2008 without rigorous clinical data. Fast forward to 2010 / 2011 and Purdue has manged to get  its new version of Oxycontin approved and launched in Q3 2010. There's only one  problem: Purdue  never conducted in vivo studies or likability studies to prove the abuse/ tamper resistant nature of the new formulation. As such Purdue was not allowed to make label claims nor can Purdue sales reps speak to the tamper / abuse resistant proprieties of the drug.  This is partly conjecture but it appears that  the reason Purdue did not conduct these  studies is because the new formulation is only marginally better than the old version.   In desperation the FDA let Purdue through because the problem is so rampant but there's broad consensus that Purdue's new version is a joke.  Remoxy, on the other hand, has been tested in 4 in vivo studies that demonstrate its ability to resist rapid extraction through mechanical force and chemical extraction. On top of that King conducted a full scale likability study with subjects with histories of drug abuse that proved they don't prefer  Remoxy. Full data from the study will be presented at the American Pain Society meeting in late May and PFE plans to launch Remoxy with a package insert that highlights this data.   If you are doctor who might now be subject to personal liability if your patient  tampers with or diverts oxy ,which product would you choose assuming they are equally effective and priced the same?

With any other partner we would be skeptical about the bullish claims (heard all the time in biotech) that Remoxy has "blockbuster" potential. But it has to be appreciated that this type of market and this kind of drug  is PFE's bread and butter and such an explosive ramp is not only possible but expected.  By way of comparison,  PFE took Lyrica from $290mm in sales in 2005 to over $1 billion the next year.

How much will the royalties be worth?

For the purposes of calculating the  NPV of the Remoxy royalty  we outline two scenarios. In our base NPV ,  sales begin in Q1 2012 and ramp to $500mm by 2014 at which point PTIE will earns a 20% royalty. We have sales growing between 3-5% until 2021 and we give Remoxy a 5x multiple on year 10  royalties to derive our terminal value.  Discounting the cash flows at 10%   and adding $2/share for the current cash balance gives us a NPV of $19/ share for PTIE  

In the best case we see sales ramping to $1billion by 2014 and growing by 3% afterwards until 2021 and we give Remoxy the same 5x multiple on year 10  royalties to derive our terminal value.  Discounting the cash flows at 10%   and adding $2/share for cash gives us a NPV of $37 for the equity.  It's important to note that this calculation assumes 40% peak market share and no growth in the overall market but it's possible to envision scenarios where PFE supplants Purdue and even garners the majority of the market in which case PTIE would be worth much more, well north of $40/share.  If you don't think PFE can get Remoxy to over $1billion in sales,  it doesn't hurt to mention that  PFE's other pain franchises Celebrex and Lyrica generated  $2.3billion and $3 billion of  sales in 2010, respectively.

PTIE's  deal with King / PFE technically  includes 3 other opioids worth up to $105mm in development milestones but we are giving them no value at this point. In addition  PTIE has 2 early stage drug candidates, one in metastatic melanoma and another in hemophilia,  but CEO Remi Barbier refuses to spend on them and is looking to license them out so the upside is incremental with no additional costs.


Although this is not the basis for our thesis, we all know PFE has a mountain of cash earning  next to nothing and there is no place they could  get leverage like buying out PTIE's royalty stream assuming the product  achieves commercial success but obviously this  doesn't have to happen to make PTIE a home run.  

While we wait for events to play out, we especially like the fact, due to the CEO's 14% ownership interest,  that PTIE is one of the most shareholder friendly companies we have ever invested in: they are incredibly tight with their cash burning less than $10 mm a year and they moved their head quarters to Texas to avoid state sales taxes.  Given the high probability of approval (this is after all a drug that the FDA wants  on the market)  and the high probability of commercial success, we think the the current valuation of PTIE offers a margin of safety  relative to its explosive upside


-approval of Remoxy
-commerical ramp
-possible personal liability for doctors that don't use abuse /tamper resistant drugs
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