Macro Tsimmis

intelligently hedged investment

BUY Vertex Pharmaceuticals (VRTX)—Hepatitis C play

Posted by intelledgement on Tue, 17 Apr 07

Vertex Pharmaceuticals is a biotech company with a protease inhibitor drug—telaprevir—just completing Phase II testing that promises dramatic improvement in the treatment of Type 1 hepatitis C, which is both the most prevalent and the most pervasive form of the disease. There are an estimated 170MM people with chronic hepatitis C—meaning they can’t clear their bodies of the virus unaided—in the world, and 3.2MM in the USA; 80% of those in the USA are infected with Type 1. The number of chronic cases in the USA is expected to rise to over 10MM within the next decade or so.

Because hepatitis C is asymptomatic for years—basically until liver function begins to degrade—many infected people don’t know they have it. People infected suffer innocuously mild and brief flu-like symptoms within a few weeks—which are rarely ominous enough to trigger alarm bells—and then nothing…until things get deadly serious. However, a blood test—if the patient happens to have one—can detect the infection.

The current standard of care (SOC) for hepatitis C in the USA requires a 48-week course of treatment with interferon and ribavirin, and it is no walk in the park—many patients experience flu-like symptoms for several days following each weekly interferon injection and some suffer severe adverse events including anemia, cardiovascular distress, and depression. For those able to complete the course of treatment—about half of all those who start it—fewer than 40% appear to be free of any hepatitis C virus (HCV) and, thus, effectively cured. The combination of a year of being more-or-less disabled, the cost, and the 60+% chance of not being cured after all that has discouraged many asymptomatic HCV carriers who know they are infected from undergoing treatment. Currently only about 2% of chronic HCV carriers undergo treatment each year (which means only about half of one percent are cured annually).

In Phase 1 trials, patients dosed with telaprevir in combination with interferon or in combination with interferon and ribavirin for much shorter courses of treatment experienced effective cure rates of around 70%. Currently the company is conducting three Phase 2 trials with a total of 1000 patients testing various combinations of treatment agents and course-of-treatment durations (including 12 and 24 weeks) against a control of the current SOC (48 weeks of interferon and ribavirin). Preliminary data are due to be publicly released this Fall and the company expects to launch Phase 3 testing by the end of the year (presumably the data they already have from Phase 2 are strong and they are working with the FDA to design their Phase 3 trials in light of these data…there was some hope the FDA might be able to approve based on the Phase 2 data, but that seems to have evaporated).

Telaprevir clearly works and a cure rate of 70% in half or one-quarter the time would be a major advance over the current SOC. The cardinal fly in the ointment thus far is a new telaprevir-related side effect that surfaced in some of the early Phase 2 results—a serious rash that contributed to a relatively high 8% early days drop out rate and takes weeks to recover from. Hopefully the Vertex folks will learn enough from these trials about under what circumstances this rash is likely to be a problem to minimize the risk going forward.

Critically, Vertex has a clear shot at being first to market a product that improves materially on the current SOC for hepatitis C. Back when it appeared as if approval from the large Phase 2 trials was likely, they had a huge time advantage (presuming the potential competition all had to go through Phase 3); even now most of the potential competition are in Phase 1 or earlier. The closest potential competitor is boceprevir from Schering Plough (SGP)—who market interferon for hepatitis C, although it is a minor market for that drug—and is early in Phase 2 testing. Unless telaprevir is significantly delayed, it is likely to have established a dramatically shorter course of treatment employing all three agents—telaprevir, interferon, and ribaviron—as the new SOC.

And the market is potentially huge. About $700MM annually is presently spent on interferon/ribaviron for HCV treatment of 2% of the potential patients (of whom only 25% are typically cured—half drop out before completing the 48 weeks…although a few of those are cured never-the-less…and about 35% of those who stick out the full 48 weeks are cured…for some unknown reason, almost 50% of those who stick out the full course in Europe are cured). With a shorter course of treatment and a better chance of success, the number of patients willing to undergo treatment is likely to increase dramatically, while the dropout rate will fall.

Now from a valuation point of view, biotech companies with their first $1B blockbuster potential drug and the earning growth to match—e.g., CELG today and AMGN, BGEN, DNA in the past—typically command multiples of 15x to 20x revenues depending on how The Street regards their pipeline. (Mature healthy pharmas have marketcaps more typically in the 4x to 6x revs range.) Presuming for the sake of argument that the dollars/patient remain constant—the cost of the interferon/ribaviron is less because only half as much is needed but telaprevir takes up the slack—and that the proportion of patients seeking treatment rises from 2% in 2009 (when the FDA approves telaprevir) to 7.4% by 2012, by than telaprevir should be generating over $2B in revenues from the USA alone. By 2014, we are looking at a potential $4.3B in USA telaprevir revenues—and presuming 10% annual dilution through 2012 and 5% thereafter (as the company will be profitable and presumably won’t be so needful of selling shares to raise cash)—the share price at a P/S ratio of 15x sales puts the pps at $287. (Only 15x and not 17.5x as we used for Élan because we feel the pipeline here is not as strong.) Discount that price 25% per annum to reflect the various risk factors and we project a fair price for VRTX of around $38 by the end of 2007 (and much higher in the following years).

And speaking of the USA, Vertex have retained all rights to that market (and, at least for now, the Far East), and have concluded a marketing agreement for telaprevir with Janssen Pharmaceutica N.V., a division of Johnson & Johnson for Europe, Middle East, Africa, and Central and South America. They are due an additional $380 million in milestone payments as telaprevir is tested and brought to market there.

Beyond telaprevir, Vertex’s pipeline is decent but not outstanding. They do have stuff: VX-702, a Phase II clinical trial product for rheumatoid arthritis and other inflammatory diseases, VX-770, a Phase I clinical trial product for cystic fibrosis, and VX-883, a preclinical stage product for bacterial infection. Plus in collaboration with Merck, there are MK-0457 and MK-6592, which are in Phase II clinical trials for the treatment of cancer; in collaboration with Avalon Pharmaceuticals AVN-944, a Phase I clinical trial product for cancer; and in collaboration with GlaxoSmithKline, VX-409 and backup compounds, which are in preclinical stage for the pain management. Currently, they receive revenue for Lexiva/Telzir for the treatment of HIV infection and AIDS, which are marketed/distributed by GlaxoSmithKline. Nothing here that appears to have blockbuster potential as yet…with the potential exception of VX-500, which is their follow-on HCV protease inhibitor drug, currently in pre-human testing. Ideally this would be ready to take over from telaprevir—with better efficacy and milder AEs—around 2013 or so.

Of course, first they have to get telaprevir itself to market…and in that regard, there is always the Dendreon factor. A drug is not approved until it is approved. But here, in contrast to Provenge, we have a drug that has outstanding efficacy credentials, with a 1000-patient Phase 2 already (Provenge had a few hundred in Phase 3…and missed the primary endpoint). So based on where we are now, Vertex look to be giving the FDA an easy decision. There remains a risk of an unanticipated side effect showing up in Phase 3—that is why we do these tests, afterall—or even beyond (as with Tysabri). This is why we discount 25% per annum off our projected fair value. If you don’t think that is a conservative enough discount, then pass this one up. One man’s speculation is another man’s plunge.

Six month’s ago, when it appeared possible the FDA might approve based on the Phase 2 results, this stock was in the $40s. Based on a late-2009 approval and telaprevir revenues starting in 2010, that’s too expensive for us. But down here around $31, we’re good to go.

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