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2019-08-14 22:17:48

Supernus pharmaceuticals was founded in 2005 and was previously a subsidiary of Shire PLC. SUPN and its management team have developed and commercialized central nervous system ( CNS ) products for more than 25 years. The company's two commercial products are Oxtellar XR® and Trokendi XR® both originally for the treatment of epilepsy. SUPN drugs are extended-release versions of earlier immediate-release branded products. SUPN found that by using extended-release formulations, these two molecules could achieve smoother blood saturation levels resulting in patients with fewer negative side effects and better disease management. In August 2016, SUPN expanded the label for Trokendi by gaining FDA approval for use with migraines. SUPN then built on that label expansion in April 2017 by gaining further approval for Trokendi for use in children over 12 with migraines. This went extremely well for SUPN and led to the strong stock price from 2016 to mid-2018.

The label expansion playbook that SUPN used with Trokendi has been a big part of the company’s success to date. Recently with their drug Oxtellar, SUPN returned to the same strategy by filing an sNDA to expand the drug's label to include its use as monotherapy treatment for partial onset seizures. The product had previously been approved only as an adjunctive treatment for the same indication. The additional market adds roughly 15M new potential patients for Oxtellar. The chart below shows the increase in TAM provided by the monotherapy approval.

(Source: May 2019 Investor Presentation)

To be clear, there are many drugs available for treating partial onset seizures, so we should not expect Oxtellar to gain more than a low single digit percentage peak market share of this expanded opportunity. While this label expansion comes with a very large market, management has cautioned in the past that growth won’t be as swift as it was for the Trokendi label expansion in migraines. This is because it takes much longer for patients and doctors to switch their epilepsy medication versus migraine medication, among other factors.

Management has guided that Trokendi and Oxtellar have peak sales potential greater than $500M per year combined. For 2019, management's guidance is for revenue between $400-410M, lowered from $435-455M on the Q219 earnings call. That only leaves about 25% growth from the new 2019 mid-point until we hit peak sales for the company's two primary products.

To make matters worse for SUPN, a new class of migraine drugs has recently entered the market called anti-CGRPs. During 2019, the FDA approved at least 3 anti-CGRPs (that I know of) known by the brand names Aimovig, Ajovy, and Emgality. The approval of these anti-CGRP’s has driven significant fear that the Topiramate molecule, used by many migraine sufferers, and of which Trokendi is an extended release version of, would lose market share to this new class of drugs. This has resulted in SUPN having more than $850M in cash on the balance sheet, two drugs on the market and 2 large, late-stage pipeline opportunities, but only valued at a $1.49B market cap.

An Aside: Biotech Valuation For Beginners

If you are a seasoned biotech investor, feel free to skip over this section. However, if you have ever wondered how a company burning millions of dollars per quarter can be worth anything at all keep reading this section.

Biopharma companies are broken down into two broad categories: clinical stage and pre-clinical. The difference between the two is that one has products on the market and the other has a pipeline of drug candidates undergoing clinical trials or pre-clinical development. The companies that have products and revenue are generally more straight forward to understand. Their valuation can be boiled down to some multiple of sales or EBITDA and then a value is ascribed to their pipeline assets, if they have any, to form a sum-of- the parts analysis.

The process of assigning a value to pipeline assets is similar to valuing a clinical stage biotech company because effectively you are doing the same thing. We start this process by looking at the affected patient population size that the drug is attempting to serve. If we have a drug that treats anxiety, how many people suffer from anxiety? For sake of example, let’s say there are 50M cases of anxiety in the US per year.

From here, we then try to determine a reasonable price for the drug. This can be achieved by looking at similar drugs in the same market, similar types of breakthrough drugs in other markets, investor estimates, 3rd party research or management's guidance. Once we approximate the market size and the cost of the drug, we can then make an estimate of the future peak market share for the product. Market share is a function of product differentiation, competitive therapies, exclusivity, generics, number of alternative therapies, pricing and a host of other factors.

Given these three inputs, we can then begin to work backward into the valuation of the pipeline/clinical stage biotech company. Building on our example above in which there are 50M anxious people in the US, management expects they can achieve 5% total market share and sell for $100/month supply. Therefore, peak sales potential for this drug is = 40,000,000 patients x 5% peak market share = 2,000,000 peak patients x ($100 x 12 months) = $2.4B peak sales potential.

Next, there is typically a multiple applied to peak sales of between 1.5-3x. This multiple varies depending on market conditions and the individual product's expectations. For our example, let's use a 2x multiple to give us $4.8B which is then discounted back the number of years until peak sales are expected, generally at a pretty hefty double-digit discount rate. This “present value” of the multiple of peak sales is then divided by shares outstanding to give you a “reasonable expectation” of the value of our anxiety drug for today’s share price assuming approval. For those drugs that aren't already FDA-approved, this “reasonable expectation” is then probability weighted for approval likelihood to arrive at a “more conservative” price target.

So that’s how it is done! As you can see, there is considerable room for grey area in the final estimation of share price for clinical-stage biotech companies. Each of the different assumptions made in the process - peak market share, TAM, sales price, probability of approval and time to approval - all affect the ultimate fair value for the shares today. As you can see valuing these companies and their assets is as much, or maybe even more, art than science but now back to SUPN.

SUPN: The Bear Arguments

The bear arguments on SUPN are related to a few primary points, some more valid than others. First, SUPN is already near peak sales for their two marketed drugs, so what comes next? Second, anti-CGRP’s are going to take considerable market share from Topiramate/Triptans in migraine and thus Trokendi sales will plummet/decline. And finally, arguments around the depth and quality of SUPN's pipeline opportunities.

Migraine Market Landscape

According to Grand View Research: “The global migraine drug market size was valued at USD 1.7 billion in 2017 and is expected to exhibit a CAGR of 18.0% during the forecast period [2017-2025]. Increased uptake of novel drug classes, launch of Calcitonin gene-related peptide (CGRP)-based therapies, and high unmet needs are some of the key factors driving market growth. Majority of the drugs currently available are approved for the acute form of the condition, led by generic triptans as the first-line treatment. The market is witnessing a shift in terms of strong R&D with the introduction of CGRP-based therapies and uptake of novel drug classes such as ditans, gepants, and reformulation of triptans for both chronic and episodic migraine.”

(Source:Migraine Drugs Market Analysis Report By Therapeutic Class By Treatment, By Route of Administration, And Segment Forecasts, 2018 - 2025)

You can see that Triptans currently have about half the market share of prescriptions in the migraine space today. Additionally, they are considered a first line treatment versus anti-CGRPs which are second or even third line treatments. You will also notice that much of the future growth in the migraine market is driven by novel treatments such as anti-CGRPs. This is the point SUPN bears make – anti-CGRPs are going to become the majority of the market.

From a dollar value perspective, this may be true given these drugs have considerably higher prices than Triptans. However, note the second comment that growth is also expected to be driven by reformulated versions of Triptans. An example of a reformulated Triptan is Trokendi XR. What this means is that Trokendi XR and similar products are likely to keep taking share from immediate-release Triptans due to the safety and tolerability profile of extended-release formulations irrespective of what happens in the anti-CGRP market. Management affirmed this supposition on the Q2 2019 earnings call saying “we continue to believe we can still convert immediate release prescriptions to Trokendi XR, nothing has changed here as far as the fundamentals behind the product itself and the benefits of the product delivers even compared to CGRPs.”

The last part of the quote above highlights another important point: anti-CGRP medicines are not a cure all for all migraines and nor do they work for everyone. Even in the most optimistic scenario for this new class of migraine drugs, they are unlikely to completely displace Triptans. In fact, according to the American Migraine Foundation, it is likely that patients will need to fail off two or more oral preventative therapies [such as a Triptans like Trokendi] before they’re able to become eligible for these treatments.

The main point is Trokendi will not likely continue the torrid pace of growth it has seen in recent past, but neither will sales fall back to pre-migraine indication levels any time soon. Especially when you consider the new generation of anti-CGRP’s is roughly twice (or more) the cost of Trokendi XR which itself is much more expensive than traditional Triptans such as generic Topamax. Thus, creating an expensive hurdle for insurers to cover these novel products in a second or even third line setting.

Trokendi And Oxtellar Generic Threats?

SUPN has a strong patent portfolio on both Oxtellar and Trokendi and both have been tested several times by generic challengers. In each case, SUPN proved successful and had their patents upheld. This is certainly a positive, and patent protection for Trokendi extends for some time, expiring no earlier than 2027. Unfortunately, through previous settlements with Zydus and Actavis, those two companies are allowed to sell a generic version of Trokendi beginning Jan 1 2023 which is a looming risk to Trokendi sales. Considering that Trokendi currently represents about 80% of SUPN sales, you can see the relevance of the upcoming generic entrance.

Once generics enter the market, sales won’t go to zero but historically the branded drugs price will decline about 20-30% in the first two years with just two generic competitors. This implies it is prudent to look at Trokendi sales and expect them to start declining in 2023-2024. While the exact trajectory is difficult to predict, a 10-20% per year decline for the first few years doesn’t seem unrealistic given the data below.

According to a study titled The Consequences of Generic Entry: Price, Promotional Effort and Market Share, the authors found that both price and market share decline for branded drugs when generics enter the market. “The dashed light-grey curve in Figure 1 below illustrates the dynamics of mean price, quantity and volume market shares (left) and median values (right) for 123 molecules that lost patent protection in the U.S. during the period 1994-2004. Time is expressed in quarters and we denote as date 0th quarter when {manufacturers] lose exclusivity. We normalize [price] values to 1 at quarter -8 before patent expiration (quarters -8 to 0), the price of the original molecule is slightly increasing. Then, within a year of the Loss of Exclusivity (LoE), mean (respectively, median) prices drop by about 30% (20%). Within three years, the drop reaches about 60% (40%).

While the price drop is to be expected…the genericized molecule [branded drug] actually experiences a steep drop in volumes after LoE (black curves): average and median quantity drop by 20% three years after patent expiry. In other words, after LoE, the combined volumes of the branded and generic producers are substantially below the volume of the single branded drug when it was sold at a price embodying monopoly power. The dashed dark-grey lines show that these molecules experience an even more dramatic decrease in their volume market shares, thus suggesting that generic competition decreases [branded] volumes despite a growing market.”

(Source: The Consequences of Generic Entry: Price, Promotional Effort and Market Share)

The above referenced study provides support that we should begin to see Trokendi sales decline as generic competition enters the market in 2023. However, in SUPN's case, there is the opportunity to stem this decline somewhat by continuing to take share from the large immediate release Topiramate market.

SUPN’s other currently-marketed product, Oxtellar, has patent protection that extends out to April 2027 and they were successfully defended against TWi Pharmaceuticals in 2017. The difference between Oxtellar and Trokendi is there was not a settlement for an authorized generic of Oxtellar with TWi. Meaning, TWi won’t be able to market a generic version of the product until 2027.

Given the longer effective patent protection, we can now understand the importance of growing the Oxtellar franchise to offset a potentially declining Trokendi franchise beginning in 2023. The epilepsy market is slower moving than the migraine market so it is fortunate to have a few years of runway to execute on Oxtellar's label expansion opportunity before Trokendi sales start to decline.

SUPN Pipeline

Remember that SUPN has a proven ability to successfully defend their patents. This is relevant when considering the likelihood of SUPN successfully protecting the revenue stream expected from their pipeline products.

SUPN currently has 5 drugs in their pipeline as shown in the table below. Three drugs are in late stage clinical trials including SPN 604 which is moving into phase III trials in the 2H of 2019. SUPN also has two lead candidates nearing NDA filings addressing large market opportunities in psychiatry. SPN-810 is meant for the treatment of Impulsive Aggression in patients with attention deficit hyperactivity disorder (ADHD) and SPN-812 is a non-stimulant treatment for ADHD.

(Source: May 2019 Investor Presentation)

SPN 812 is a very interesting non-stimulant ADHD medicine that could be quite disruptive to the large ADHD market. Its disruptive potential is a result of the drug's quick onset of action which is similar to stimulant ADHD therapies such as Ritalin but is a non-stimulant like Strattera. Meaning parents can have the best of both worlds - quick onset of action while avoiding giving their children a controlled substance to manage their ADHD symptoms.

The primary difference between Strattera and SPN 812 is the onset of action. According to SUPN’s published studies, SPN 812 has a statistically significant effect on patients within 1-2 weeks versus up to 12 weeks for Strattera. The competitive differentiation between SPN 812 and stimulants (like Ritalin) is that SPN 812 is a non-controlled substance. Many parents would prefer to not have their children prescribed stimulants.

When we first began following SUPN, management consistently stated they expected to achieve a peak market share of 5% with SPN 812. Once all the studies were finished, management increased that assumption to gaining a peak market share of 5-10%. This fact seemed to be lost, or highly questioned, by many sell-side analysts and investors. It appeared that investors became too focused on comparing affect sizes between the Strattera studies run years ago and the SPN 812 studies done recently by SUPN.

The question remains - Why would management increase their expected peak market share expectations unless they believe they can achieve them? It serves them no benefit to increase their own hurdles before launching the product unless they are confident, they will be able to achieve the new goal.

Yet, the market ignored this and chose to fixate on junk statistical analysis. Comparing affect sizes across multiple studies of the same drug is considered poor science let alone comparing it across different drugs and studies.

Drawing meaningful inferences from something as arbitrary as one variable, i.e. affect size, from two different studies and assuming they are comparable is dubious at best. Through our research, we believe this highly-publicized bear point will prove to be a red hearing as this is a case of comparing apples to oranges. From a competitive differentiation standpoint, the more important point is that SPN-812 has a much faster onset of action measured in weeks compared to months for Strattera. The table below shows the market size and potential of SPN 812.

(Source: May 2019 Investor Presentation)

In order to translate management's prescription market size estimate to peak sales potential, we went through the following process. According to GoodRX, the generic price for 30 days of Strattera is ~$70/month retail. The manufacturer likely receives far less than half that price after rebates, etc. are considered. For the sake of argument, let’s say SUPN prices its drug to generate $10/month in sales per prescription. This would imply a peak sales opportunity for the company of between $500M and $2.4B based on management's market share estimates. This is a significant opportunity for a company with a market cap of about $1.5B and $850M+ in cash.

Another way to nail down the potential peak sales opportunity for SUPN is to look at 3rd party research. A recent Grand View Research, Inc. study expects the global ADHD market to grow to “$24.9 billion USD by 2025, exhibiting a 6.4% CAGR during the forecast period. Using management's estimates, 5%-10% of $25 billion is a $1.25-2.5B peak sales opportunity for SPN 812.

The question then becomes – is the clinical data good enough for approval? In our opinion – yes. There is not a concerning amount of serious adverse events that would precipitate safety fears or any black box warnings. Additionally, the molecule was previously marketed outside the US as an antidepressant, underscoring the limited safety concerns. The remaining question is whether or not SPN 812 will become a commercial success. With an experienced management team that has shown their ability to execute, we believe, the odds are favorable. See below for a summary of the 4 clinical trials on SPN 812 provided by the company.

(Source: May 2019 Investor Presentation)

(Source: May 2019 Investor Presentation)

(Source: May 2019 Investor Presentation)

(Source: May 2019 Investor Presentation)

In my best Willie Mays voice - But wait that’s not all! Buy right now and receive a second late stage potential blockbuster drug absolutely free! SUPN also has SPN 810 for the treatment of Impulsive Aggression in patients with attention deficit hyperactivity disorder (ADHD) nearing an NDA filing. It is the first product that has the potential to be approved for Impulsive Aggression which is a significant problem in many psychiatric settings. Between Autism, ADHD, Bipolar Disorder and PTSD, management sees a total addressable market of $6B+ and they anticipate being the first to file in the Impulsive Aggression designation. Additionally, the company has been granted fast track designation by the FDA for SPN 810 speeding up the approval pathway.

The company has 2 trials for SPN 810 expected to read out in the 2H of 2019 and one in 2020. Positive trial results could be a very significant catalyst for a company of this size. As shown below, the $6B market is spread across 4 indications, the first opportunity being the ADHD market which represents about half the Impulsive Aggression market.

(Source: May 2019 Investor Presentation)

We expect SUPN management to return to their old playbook of obtaining approval of the drug and then filing for additional label expansions into other indications providing multiple growth catalysts along the way. SUPN is expecting to file the NDA for SPN 810 in the 2H of 2020 with eventual FDA approval targeted for 2H2021. Since there are several data read out studies for this drug planned for the 2H19, more is to come about this opportunity for the company soon. Even with the limited information available today, we can see the enormous potential for SUPN with this drug.

It is also an encouraging sign for SPN 810 that, on the Q42018 call, management stated that “Supernus continues to observe enrollment in the open label extension study for SPN-810 at 90% or higher. On average a patient in the open label study remains on SPN-810 treatment for 10 months which we believe is an encouraging sign of the tolerability and efficacy profile of SPN-810.” Why would a patient stay on a drug willingly after the trial if it didn’t work/were serious adverse events? See the table below for the data readout schedule.

(Source: May 2019 Investor Presentation)

Why do we like SUPN now?

SUPN is a great bargain given that the company has a track record of solid execution, a strong management team and two large upcoming FDA approval decisions. As we dug into the company and learned more about the pipeline opportunities, we only got more excited about the future of SUPN. While we do agree with the complaint that beyond SPN 810 and 812, the pipeline does look a little sparse. However, it is worth noting that the company has SPN 604 for bi-polar disorder in Phase III trials, SPN 809 for depression ready for phase II and recently acquired SPN 817 for severe epilepsy through their Biscayne Therapeutics deal announced on Sept 13 2018 (but this product is only in phase I trials).

Management has long stated their interest in refilling the pipeline with additional late stage psychiatric products and even raised money via a $350M convertible debt offering in March 2018. This was done to build a warchest supporting upcoming drug launches and to replenish the pipeline. To date we have yet to see any meaningful M&A but management continues to search for the right opportunity.

Valuation

As part of SUPN’s $1.49B market cap, the company has $852.3M in cash and short-term investments on the balance sheet up $75M from Dec 31 2018. Meaning this company is also generating significant cash flow on the current base business while also running multiple clinical trials. The $852M in cash equates to almost $16/share on 53.9M shares outstanding and SUPN is on track to generate an additional ~$2.75/share in cash this year. At today's price (~$27), you are paying a bargain 2.25x 2020 EV/sales for a profitable biotech company, generating cash, with two large late stage pipeline opportunities.

The market is currently valuing SUPN shares at 2.25x 2020 EV/sales (EV of $1004.8M / expected 2020 sales of $445.9M = 2.25x), compared to their peer group being valued with an average multiple of about 6.3x 2020 EV/sales. When calculating our target price for SUPN we choose to apply a more conservative multiple of 4.5x 2020 EV/sales rather than using the peer mean multiple of 6.3x to account for the headwinds facing Trokendi sales and the light pipeline beyond SPN 810.

Using a conservative 4.5x EV/sales multiple we arrive at a share price for SUPN of about $55 versus a market price of roughly $27, as of writing. This implies SUPN is roughly a double from here without including the potential value associated with their two large upcoming pipeline opportunities.

(Source: Authors Calculations, Seeking Alpha data)

Conclusion

Given that management lowered sales guidance in Q2, we are a little cautious to enter this name immediately but will look for a market driven sell off or stability in price to begin an initial position. In order for our investment to play out as we expect, we will need to see continued sales execution on the two currently marketed product, which will be increasingly driven by Oxtellar sales going forward. We would also like to see Trokendi revenues show stability to slight declines pushing back against the idea that anti-CGRPs will eat into Trokendi market share. On the pipeline, positive study data on SPN 810 in the 2H19 would go a long way toward people reevaluating the pipeline potential of the company. Additionally, approval of SPN 812 would help alleviate the concern of what is next for SUPN. Finally, SUPN could get revalued if they execute on a M&A deal that replenishes the pipeline with more products.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in SUPN over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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