The Life Sciences Report: The relative strength of generic drug companies has been weak, even compared to biotech. Since these companies have not performed as well as biotech in the previous years, I was thinking they could have had a softer landing in the recent correction. Do you see it this way? Why are they lagging so dramatically?
Rohit Vanjani: I see it somewhat differently. I would say that generics companies have had a pretty good run over the past couple of years. True, it's not what you might expect with generics, but it's been an unprecedented run largely based on price increases. Generics companies are lagging now because investors think the game will come to an end at some point, and they're waiting to pounce on that short thesis.
TLSR: What events precipitated this situation?
RV: A couple of events have been a drag on the healthcare space in general, and have compressed the multiples. In late March 2014, the House of Representatives issued a letter challenging Gilead Sciences Inc. (GILD:NASDAQ) on pricing for Sovaldi (sofosbuvir) for hepatitis B. That brought down the whole market.
"Generic pricing power has been more widespread in the past couple of years."
Then there have been a couple of events that were more generic-specific. In October 2014, Senator Bernie Sanders of Vermont and Congressman Elijah Cummings of Maryland sent a letter to 14 generic drug companies questioning price increases and asking to provide pricing data. People inside two of the companies on that list of 14 were issued subpoenas to testify. Then, in May 2015, Senator Sanders and Representative Cummings introduced legislation that would require generic drug manufacturers to pay rebates to Medicaid when drug pricing outpaces inflation.
Most recently, there was the issue with Turing Pharmaceuticals AG (private), which raised prices on Daraprim (pyrimethamine) by more than 5,000%. This drug is used to treat toxoplasmosis, a parasitic disease that affects patients with HIV/AIDS. Presidential candidate Hillary Clinton tweeted about it, and then came out with her own plan to target the pricing of generics. She also pushed the FDA and the Federal Trade Commission to investigate the Daraprim price increase. All these factors have been weighing on the generic multiples.
TLSR: Are you implying that, at least for the time being, generic pricing power no longer exists?
RV: It's not that it doesn't exist. It's just that pricing power has been more widespread in the past couple of years. We're now in the second or maybe even third round of price increases by generic companies, and so widespread price increases are probably not going to happen as much. You will see opportunities in pockets by products, rather than across-the-board increases. These increases will result mainly from a lack of competition, which arises from Indian manufacturers getting tripped up with inspections, and also by the backlog at the FDA. But I think the FDA's Office of Generic Drugs is showing signs it will address the backlog by improving the abbreviated new drug application (ANDA) process that generic drugs must clear for approval.
TLSR: I recently spoke to a critical care physician working in a large trauma center about drug pricing. She told me that she goes to the formulary first to see if the cheapest correct drug is available for an indication, usually a generic. What is the investment thesis for generic drugs today, given that physicians want to keep prices as low as they can for their patients and for their institutions?
RV: I think the investment thesis today is what it has always been. It's about taking price or grabbing market share, or both.
"Generics companies are lagging now because investors think the game will come to an end, and they're waiting to pounce on that short thesis."
Generics have been taking price for the last couple of years, but maybe in the future they will be less inclined to do that. Pricing and taking market share could result from a competitor that has run into manufacturing issues or can't source the active pharmaceutical ingredient (API), or the API supply chain itself is challenging, which would lead to interruptions in supply. That kind of situation would lead to a share shift and, potentially, a price increase. That's why generics companies have done well over the past couple of years, and why people have chosen to invest in them.
TLSR: You have some emphasis on the opioid class of drugs in your coverage. What is the investment case for betting on generic narcotics?
RV: One is that they'll always be cheaper than whatever else is out there for the treatment of pain.
There has been a sense of regret within the FDA and among physicians on the pain pathways we've taken, meaning the emphasis on opioids and the nonsteroidal anti-inflammatories (NSAIDs). NSAIDs have gastrointestinal, renal and cardiovascular side effects. Opioids have bad side effects as well, such as constipation and respiratory depression, and they have abuse potential because they are addictive. Long term, people are looking at new pain pathways and for true abuse deterrents.
A lot of companies are working in abuse deterrents, but it may be some time before we see an onslaught of new products addressing this problem. Right now a couple of drugs have abuse-deterrent labeling, and a couple of companies are working on the problem. So the traditional category of generic opioids may yet have shelf life. But longer term, people will be moving away from the opioid and the NSAID pathways and looking to target different pain pathways altogether.
TLSR: Would you go ahead and address some companies in your coverage?
RV: Absolutely. ANI Pharmaceuticals (ANIP:NASDAQ) is a classic generics company that has done really well by taking a significant price increase on a menopause product, esterified estrogens and methyltestosterone (EEMT) tablets, which are used to treat hot flashes. This goes along with the theme of taking share in a limited market. This was a two-competitor market, but one of the competitors, Amneal Pharmaceuticals (private) fell out because it couldn't source the API. In that intervening time, ANI was able to become the lone supplier of EEMT, and it took significant price increases in doing so.
"Investors will see opportunities in pockets by products, rather than across-the-board increases."
However, Seton Pharmaceuticals (private) and Amneal were able to source some third-party API, and they will remain on the market temporarily. That was a blip in ANI's trajectory, but ANI may be able to get that market back. As ANI got this windfall price increase and market share, it has been trying to diversify itself as much as possible. It is actively developing its business to buy products. Now the story is about how quickly it can get newer products to market and what the opportunity is for those products.
TLSR: Rohit, how serious could these temporary competitive pressures be for ANI?
RV: The amount of Seton's and Amneal's third-party API is finite. The supply was supposed to end this past summer, and ANI was supposed to get all the market back. My channel checks indicate that Amneal was able to source what I think is the last bit of third-party API, but it's only enough for one quarter. I think it's even less than last time, when a limited amount of API lasted for a year or a year-and-a-half. [Editor's note: In the company's Q3/15 earning call, ANI confirmed this information.]
TLSR: Why is the API for EEMT so difficult to access?
RV: API companies must section off part of their plants to make the product because it's a hormone. There's an opportunity cost there, because the plant cannot produce other products in that area. That's the problem. Other companies could make it, but they would probably have to be incented with the right margins to make the API.
That's the larger issue for ANI. If it's only a one-quarter blip, during which the competitor is able to come in and then quickly leave the market, it's not that big a deal. But if someone induces someone else to make the API and a more permanent supplier comes into play, that's a larger issue. Yes, it's a hard product to make. Yes, you have to section off certain parts of your plant to make it. But can it be done by other people? Yes, it most certainly can.
TLSR: Would you go to another name?
RV: Insys Therapeutics Inc. (INSY:NASDAQ) has done really well on one product thus far—its fentanyl breakthrough cancer pain product, which offers patients a faster time to onset because it's a transmucosal absorption product, placed underneath the tongue. It's more convenient than the other fentanyl products out there, a buccal tablet and a lollipop.
"The investment thesis is about taking price, or grabbing market share, or both."
Insys is being investigated on how aggressively it may have marketed this product. A lot of how Insys performs will depend on what those investigations reveal and, also, what's in its pipeline and how quickly it can get that pipeline to market. The pipeline includes an ondansetron product for chemotherapy-induced nausea and vomiting (CINV) and a buprenorphine analgesic product. The company is offering the analgesic in a convenient spray device with a faster time to onset.
TLSR: Rohit, let's backtrack to the investigations you mentioned. What's the downside on that?
RV: If Insys has to pay a big fine and can't market in the same way with its lead product, Subsys (fentanyl sublingual spray), that will alter the dynamics of what people expect the company to gain as far as the share grab in those markets.
But the markets Insys is entering with its two pipeline products—ondansetron and buprenorphine—are much bigger than the breakthrough cancer pain indication. Those are multibillion-dollar markets, so even grabbing a small share could be a big win for Insys.
TLSR: Go to the next one, please.
RV: We talked earlier about abuse-deterrent products. That's what KemPharm Inc. (KMPH:NASDAQ) is focused on. Whereas other companies maybe have a formulation change for a pill, KemPharm has an actual platform technology. It's a prodrug technology, where the body's own metabolic processes cleave the active pharmaceutical ingredient, and the effect of the opioid is released.
"Long term, people are looking at new pain pathways and for true abuse deterrents."
KemPharm's first product, a hydrocodone + acetaminophen combination, is an immediate release (IR) product. The company just finished its abuse liability trials, and will submit its application to the FDA by the end of this year. Hopefully, KemPharm can get an expedited review for a six-month timeline, and get approval in mid-2016. If the company gets its abuse-deterrent labeling, it would be the first immediate-release product to get that designation. The rest of the products on the market are all extended-release products.
TLSR: Because this is a prodrug and must be ingested, it cannot be crushed, dissolved, injected or taken intranasally. Is that right?
RV: That's correct. It's an oral-only drug, and hopefully that prevents people from abusing it intranasally or injecting it. It can be crushed, but you won't get the API or its effect.
TLSR: It sounds like there is pricing power in this kind of prodrug technology.
RV: That's the idea. It's very hard, when you're creating abuse-deterrent formulations, to prevent pill-popping behavior or to prevent people from taking multiple pills. Some doctors will tell you that people don't like to abuse that way. They'd rather inject it or snort it, thereby getting a faster, better high. I'm not sure this formulation will get a claim to prevent pill popping, and I don't know that any oral product can. But I think this does a good job of preventing other forms of abuse, as the studies thus far indicate.
TLSR: Would this be attractive to clinicians who are paranoid about prescribing narcotics?
RV: Yes. If you're eliminating all other pathways of abuse, this should be good enough to make the clinician comfortable. If all the products in the marketplace can eventually be replaced by abuse-deterrent formulations, then, ideally, there will be less abuse.
TLSR: Another name, please?
RV: Marinus Pharmaceuticals Inc. (MRNS:NASDAQ) has a promising technology, but it's still early stage. Its epilepsy product ganaxolone is in Phase 3, and the study still needs to be borne out. We will get data results in H1/16 hopefully, and the company will start its second Phase 3 trial after that. The product may also have indications in rare genetic disorders, fragile X syndrome and PCDH19 female pediatric epilepsy.
TLSR: Are these orphan genetic disorders in your model?
RV: I don't value either fragile X or PCDH19 in my model; I'm leaving them as potential upside. The key indication here will be for epilepsy, for which ganaxolone therapy would represent a new mechanism of action. Between 30-40% of epilepsy patients end up being refractory to existing therapies, so clinicians are always looking for new drugs with new mechanisms of action. There will always be a place for newer drugs that work.
TLSR: Did you have another name you wanted to mention?
RV: Zynerba Pharmaceuticals Inc. (ZYNE:NASDAQ) is at a very early stage, and the company is also targeting an epilepsy indication. Instead of using traditional formulations, it's using a cannabinoid, something from the cannabis plant called cannabidiol. We've seen GW Pharmaceuticals Plc (GWPH:NASDAQ) do this in a liquid form, but Zynerba is changing the formulation to a topical application.
TLSR: Rohit, you follow more than generics and specialty pharmas. You also follow an interesting fertility play.
RV: You're talking about OvaScience (OVAS:NASDAQ), which recently had a bit of a blowup in terms of the stock. The company pulled guidance on its treatment procedure called AUGMENT (autologous germ-line mitochondrial energy transfer), which is based on its egg precursor cell (EggPC) technology. The technology still has some merit, but I think investors reassessed the launch of the product and took down numbers. Still, if the technology works, OvaScience could be a stock that ends up working.
TLSR: I'm not clear on why OvaScience pulled its guidance on AUGMENT. You wrote a note that fertility clinics are reorganizing, or something like that?
RV: That's right. AUGMENT is launched in three regions right now—the United Arab Emirates, Turkey and Canada. It is supposed to launch in Japan by the end of the year. But in those three regions, the company stated that all three of its clinics were undergoing simultaneous mergers. OvaScience either had to move its facilities, or the physicians may have had to shut down the AUGMENT procedures for a short time. The AUGMENT trajectory was interrupted, and that would inhibit the 1,000 cycles of therapy the company had guided investors on. That's when OvaScience decided to pull the guidance.
TLSR: I know the company has a couple of technologies, but please refresh me on AUGMENT. It has something to do with improving in vitro fertilization with the patient's mitochondria. Is that right?
RV: That's exactly right. With what's called intracytoplasmic sperm injection, you take the sperm outside the father's body, inject it into the egg, and then put the fertilized embryo back in the mother's body. With AUGMENT, OvaScience's procedure, in addition to the sperm you add the mother's own fresh mitochondria, which is isolated from her EggPCs on the outer cortex of the ovary. The idea is that if you add these mitochondria, which are the "battery packs" of cells, you improve the energy of the egg, its division process, and the correction process, and you might get an improved fertility rate.
TLSR: Of these five names you've mentioned today, what's your best idea?
RV: KemPharm is my favorite name, and my target price for it is $28/share.
TLSR: Rohit, thanks for your time.
Rohit Vanjani is executive director and senior analyst covering generics and specialty pharmaceuticals at Oppenheimer & Co. He has been with the firm since 2011, initially working on the Healthcare Services Team (healthcare IT, PBMs, and labs). Prior to Oppenheimer, Vanjani worked at Jefferies, UBS, and Leerink Swann, helping to cover the biotechnology, managed care and hospitals, and specialty pharmaceuticals verticals. He has also worked as an assistant economist at the Federal Reserve Bank of New York and as an economics associate at Stanford University, helping to conduct healthcare economic research. Prior to those roles, Vanjani worked as a laboratory associate researching enzyme active site residues and animal mitochondrial DNA. He holds a bachelor's degree in biochemistry and economics from the University of Michigan, and a master's degree in business administration from New York University's Stern School of Business.
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