From SSB:
OSI Pharmaceuticals (OSIP)
OSIP: Initiation of Coverage 2S (In-line, Speculative)
Stock ratings are relative to analyst's
industry coverage universe
Mkt Cap: $576.2 mil.
September 18, SUMMARY
2002 * We are initiating coverage of OSI Pharmaceuticals with
an In-Line, Speculative, rating and a 12-18 month price
BIOTECHNOLOGY target of $19 per share.
Ilana Fogelman * OSI offers a unique opportunity to invest in a promising
oncology franchise. Tarceva, its lead candidate, belongs
to a new class of anti-cancer agents, the EGF receptor
Elise Wang inhibitors, which could be useful in several types of
cancer.
* Three large phase III trials of Tarceva in lung cancer
and a fourth phase III trial in pancreatic cancer are
underway. Approval could come in mid-2004.
* Negative data from a competitor's trial (AstraZeneca's
Iressa) have increased the risk for OSI's stock. We
believe the stock won't appreciate significantly until
2H03 when data from its phase III trials of Tarceva should
become available. However the stock should move somewhat
next week in response to the FDA advisory committee
recommendation on Iressa.
* We rate biotechnology as an Overweight sector.
FUNDAMENTALS
P/E (9/02E) NA
P/E (9/03E) NA
TEV/EBITDA (9/02E) NA
TEV/EBITDA (9/03E) NA
Book Value/Share (9/02E) NA
Price/Book Value NA
Dividend/Yield (9/02E) NA/NA
Revenue (9/02E) $22.6 mil.
Proj. Long-Term EPS Growth NA
ROE (9/02E) NA
Long-Term Debt to Capital(a) NA
(a) Data as of most recent quarter
SHARE DATA RECOMMENDATION
Price (9/17/02) $15.53 Current Rating 2S
52-Week Range $49.99-$14.05 Prior Rating NA
Shares Outstanding(a) 37.1 mil. Current Target Price $19.00
Convertible No Previous Target Price NA
EARNINGS PER SHARE
FY ends 1Q 2Q 3Q 4Q Full Year
9/01A Actual ($0.10)A $0.04A ($0.14)A ($0.45)A ($0.62)A
9/02E Current ($0.34)A ($0.66)A ($0.81)A ($1.04)E ($2.86)E
Previous NA NA NA NA NA
9/03E Current NA NA NA NA ($3.25)E
Previous NA NA NA NA NA
9/04E Current NA NA NA NA ($1.97)E
Previous NA NA NA NA NA
First Call Consensus EPS: 9/02E ($2.87); 9/03E ($3.43); 9/04E ($1.97)
Calendar Year EPS: 12/01A NA; 12/02E NA; 12/03E NA; 12/04E NA
OPINION
We are initiating coverage of OSI Pharmaceuticals with an In-Line investment
rating and a 12-month price target of $19 per share. We believe OSI offers a
unique opportunity to invest in a biotechnology company with a promising
oncology franchise. Its lead product candidate -- Tarceva -- belongs to a new
class of genetically-targeted cancer therapies, the Epidermal Growth Factor
Receptor (EGFR) inhibitors. Agents in this class block the abnormal EGFR-
mediated signaling that drives the growth, proliferation and survival of
cancer cells. Each year, in the U.S. alone, there are more than 850,000 new
cases and about 320,000 deaths from tumors where EGFR might play a role.
Tarceva is being developed in collaboration with Genentech and Roche, and we
believe it could reach the U.S. market in mid-2004 with an approval in
relapsed/refractory non-small-cell lung cancer (NSCLC). In addition to
Tarceva, OSI has another 5 anti-cancer drug candidates already in clinical
development, and a state-of-the art drug discovery effort with several
product candidates in pre-clinical stages.
Tarceva is the key investment thesis for the stock in the near and
intermediate future. It has shown promising anti-tumor activity as a single
agent in three phase II trials in heavily pre-treated patients with NSCLC,
ovarian cancer, and head and neck cancers. Response rates in this difficult-
to-treat population ranged from 6% to 13%. Similar single agent anti-tumor
activity in relapsed and refractory patients in various types of cancer has
been reported with other EGFR inhibitors in development: AstraZeneca's
Iressa, Abgenix' ABX-EGF and Imclone's Erbitux. The collective body of
evidence indicates that this class of agents could be promising therapies for
some of the major solid tumors where important unmet medical needs exist. In
addition to the preliminary evidence of anti-tumor activity, EGFR inhibitors
have the advantage of a very good safety profile. They are well-tolerated and
do not cause the usual limiting toxicities observed with chemotherapy
regimens. Small molecules such as Tarceva and Iressa also offer the
convenience of oral administration.
Despite the consistent data suggesting biologic activity as single agents,
questions now exist regarding the efficacy of EGFR inhibitors in combination
with chemotherapy agents. Two recently-announced large phase III trials
(called INTACT I and II) with AstraZeneca's Iressa in front-line
(chemotherapy-naive) NSCLC failed to demonstrate any survival benefit from
the addition of Iressa to a background chemotherapy regimen. The Iressa plus
chemotherapy results were surprisingly disappointing and in contradiction to
the overall evidence suggesting activity of EGFR inhibitors as monotherapy.
The news had a major negative impact on OSI's stock, which dropped 57% on the
day of the announcement. In addition to the chemical similarities between
Iressa and Tarceva, three of the four ongoing phase III trials of Tarceva
also evaluate the drug in combination with chemotherapy: two in frontline
treatment for NSCLC (same population as the Iressa INTACT trials) and a third
combination trial in pancreatic cancer. Although the negative Iressa results
have increased the clinical development risk for Tarceva, there are still too
many unanswered questions to derive definitive conclusions from the Iressa
trials. It is not known whether the lack of efficacy in combination with
chemotherapy pertains to Iressa alone, or whether it is representative of the
entire EGFR inhibitor class or perhaps just the small molecules (Iressa,
Tarceva, and Pfizer's CI-1033). The type of cancer, the type of chemotherapy
agents being used, and the degree of EGFR overexpression may be other
variables that need to be considered when interpreting and extrapolating the
results from the Iressa trials to other EGFR inhibitors. In addition, there
is some suggestion from pre-clinical pharmacokinetic studies that the Tarceva
dose being used in the NSCLC phase III trials (150mg) may be more potent than
the Iressa doses tested in the two failed INTACT trials (250 mg and 500 mg).
And although Iressa and Tarceva are both small molecule EGFR inhibitors,
there is structural, formulation, pharmacokinetic, and trial design
differences between the products which may lead to a different outcome for
the Tarceva studies.
Even so, the current uncertainty surrounding the combined use of EGFR
inhibitors with chemotherapy does increase the risk for Tarceva's clinical
development program. However, it's important to note that, in addition to its
three combination trials, OSI has a fourth phase III trial in which Tarceva
is tested as a single agent against best supportive care in
relapsed/refractory NSCLC. This study is an international, randomized,
controlled trial with a survival endpoint. If a survival benefit is
demonstrated, this trial alone could support Tarceva's approval as a 2nd or
3rd line therapy in lung cancer. Results should be available by year-end
2003. Given the increasing importance of this trial, we expect OSI to
increase its sample size while the data are still blinded to maximize the
chances of detecting a positive difference in survival.
Until more data from trials testing combinations of EGFR inhibitors and
chemotherapy are available, our working hypothesis is that EGFR inhibitors
are likely to be used as single agents as second or third line therapy (or in
front-line in patients who cannot tolerate chemotherapy). If data become
available from Tarceva or other EGFR inhibitors suggesting that they may also
work in combination with chemotherapy, we will update our model and estimates
accordingly at that time. Considering all the tumors where EGFR may play a
role, we estimate that the market opportunity in the U.S. for EGFR inhibitors
as monotherapy in relapsed/refractory patients could range from $1.5 billion
to $3 billion (the lower end of the range would apply if EGFR overexpression
is required for a response). However, if EGFR inhibitors are also shown to
work in combination with chemotherapy, then the U.S. market opportunity could
be substantially larger, ranging from $3 to $6.5 billion.
Given the increased clinical development risk for Tarceva, we believe OSI's
stock price is unlikely to appreciate substantially in the next 12 months or
until positive data for any of the four ongoing phase III Tarceva trials
become available. These trials should be completed in 2H 2003. However, the
stock could experience some fluctuation beforehand in response to the news
flow from other EGFR inhibitors in development. Key events with other
products include the upcoming FDA's Oncologic Drugs Advisory Committee (ODAC)
review of Iressa on September 24th (see below) and FDA's decision on the
Iressa NDA (by year-end), results for Merck-KGaA's Erbitux trial in
colorectal cancer by year end and data for Abgenix' ABX-EGF in colorectal
cancer (year-end) and kidney cancer (time-to-progression data) in early 2003.
Near-term catalyst: the FDA advisory committee's recommendation on Iressa
On September 24th, FDA's ODAC will be meeting to discuss Iressa's new drug
application (NDA) in relapsed/refractory NSCLC. OSI's stock is likely to move
according to the outcome of this meeting. Iressa was recently approved in
Japan for relapsed/refractory NSCLC, and a new drug application (NDA) for the
same indication is currently under review by FDA. The NDA submission is based
on two uncontrolled trials in relapsed/refractory NSCLC where tumor response
rates and symptom improvement are co-primary endpoints. Both studies were
positive with response rates of 11.8% (U.S. trial) and 18.7% (EU/Japan trial)
that correlated with symptom improvement. An approval recommendation for
Iressa is possible given the positive tumor responses and the lack of
treatment alternatives for the targeted patient population. However, there
are some important hurdles that would have to be overcome for Iressa's
approval at this point, such as: the lack of control groups in the two
studies supporting the NDA (particularly with the subjective co-primary
endpoint), the lack of survival data in these two studies, and the absence of
a survival benefit in the two phase III studies (i.e., the INTACT studies) of
Iressa in combination with chemotherapy in front-line NSCLC. The failed
combination trials were expected to provide critical survival data FDA is
likely to require. In our opinion, ODAC will recommend (and FDA is likely to
follow ODAC's recommendation) that AstraZeneca conduct a controlled trial in
relapsed/refractory NSCLC with survival as the primary endpoint. The key
question is whether or not such study will need to be completed prior to
Iressa's approval. This is a complicated question which depends on the
regulatory pathway that FDA will consider applicable to the NDA.
From the regulatory point of view, traditional (full) drug approval requires
demonstration of clinical benefit. In oncology, the prime clinical benefit
endpoint is survival, however symptom improvement or quality of life may also
be acceptable in certain circumstances, such as in the relapsed/refractory
setting. The difficulty AstraZeneca will face is that symptomatic improvement
and quality of life are subjective endpoints, hence prone to bias (patients
are likely to feel better if they know their tumors have responded to
treatment) in open label uncontrolled trials such as the ones supporting the
Iressa NDA. But even if full approval was not granted to Iressa because of
the difficulties in interpreting the subjective endpoints, the drug could
still be considered for an accelerated (conditional) approval based on a
surrogate marker such as tumor response rates. The problem with that approach
for AstraZeneca is that for an accelerated approval to be granted, a
confirmatory study with clinical endpoints -- survival - has to be underway
at the time of approval. And as we know, the trials AstraZeneca conducted
that could confirm the survival benefit of Iressa have already failed.
Hence, the committee and FDA will have to be sufficiently impressed with the
level of tumor responses to overlook the negative front-line survival results
and allow AstraZeneca another opportunity at demonstrating survival, but this
time in the relapsed/refractory setting as a single agent. There is an
important caveat: for an accelerated approval to be granted, such study will
have to be off the ground prior to Iressa's PDUFA date, which is by year-end
2002.
Potential Impact of ODAC's recommendation on the stock
A favorable recommendation for Iressa from ODAC on September 24th (followed
by FDA approval by the year-end PDUFA date) we believe would be a positive
catalyst for OSI's stock. It would provide validation for the EGFR class of
agents and for Tarceva, in particular, given the chemical similarities
between the drugs. We believe the stock could appreciate 15% to 20% on such
positive news. A negative recommendation for Iressa from ODAC due to the lack
of survival data could be of mixed impact to OSI's stock. On the one hand,
the negative recommendation would fail to provide the validation for the
class of agents which is most needed at this point. In our opinion, OSI's
stock could react to the negative news with an additional 10% decline. On the
other hand, a negative outcome for the Iressa NDA could significantly delay
Iressa's entry into the U.S. market, which would be advantageous to OSI. If
Iressa is delayed, Tarceva will be competing with Imclone's Erbitux for the
first-to-market position among EGFR inhibitors. But it could be the first
small molecule in the class to enter the U.S. market (assuming the Tarceva
trials are positive). Of note, in contrast to the Iressa trials in the NDA,
Tarceva's phase III trial in relapsed/refractory NSCLC is a controlled study
with a survival endpoint. Therefore, if Iressa's approval is delayed, Tarceva
will have the opportunity to get to the market first with a robust data
package which would include survival data. That would grant OSI a very strong
market position, which AstraZeneca would have to face when it eventually
reached the U.S. market.
VALUATION
In order to value the company, we performed a discounted earnings analysis
utilizing parameters that we deem representative of a high growth
biotechnology company. Our financial model assumes the company will turn
profitable in fiscal 2005 and it will achieve an EPS of approximately $2.36
in fiscal 2007. Consequently, we arrived at a 12-month price target of $19
per share based by applying a P/E multiple of 40x and a 45% discount rate to
our 2007 EPS estimate. We believe this multiple is appropriate when one
examines historically what investors have been willing to pay for shares of
biotechnology companies following product launches.
KEY POSITIVE POINTS
* Tarceva belongs to a new class of anti-cancer agents which could be used in
a variety of tumor types
Tarceva belongs to a new class of gene-targeted anti-cancer agents, the EGFR
inhibitors. This class of agents has shown preliminary anti-tumor activity in
several types of cancer. There are approximately 850,000 new cases, and
313,000 deaths, per year from cancers where EGFR might play a role.
* Tarceva is in late stages of development
Tarceva is currently in phase III trials in non-small cell lung cancer (alone
and in combination with chemotherapy agents) and in pancreatic cancer (in
combination with chemotherapy). We expect it to reach the U.S. market in mid-
2004. European approvals should follow 6 to 9 months after U.S. approvals.
Tarceva should be the second or third EGFR-inhibitor to reach the market.
However, depending on the outcome of Iressa's NDA currently under review by
FDA, Tarceva may even do better than our expectations.
* Roche and Genentech collaboration for the global co-development of Tarceva
OSI has an agreement with Genentech and Roche for the global co-development
and commercialization of Tarceva. Such an agreement with two companies with
an established presence, know-how and sales infrastructure in oncology are
important assets in the competitive EGFR field. Genentech and OSI have a 50-
50 cost and profit sharing agreement for commercialization in the U.S., and
Roche will market Tarceva internationally and will pay OSI royalties on
sales. We estimate these royalties to be approximately 22%.
* Balanced Product Pipeline
As a means to balance risk, OSI has chosen to pursue the development of two
types of anti-cancer drugs: genetically-targeted therapies and next-
generation cytotoxics. By pursuing both approaches, OSI's pipeline offers
products with different risk profiles regarding their chances of getting to
the market. Genetically-targeted therapies such as Tarceva and two other drug
candidates are a novel direction in cancer treatment and therefore are
associated with greater risks and rewards. Next generation cytotoxics, such
as the 3 drugs OSI acquired from Gilead, are improved versions of existing
chemotherapy agents. This approach involves less risk since the product
candidates are newer versions of chemotherapy drugs with an established track
record in cancer therapeutics and a clear development pathway.
KEY NEGATIVES
* Clinical Development Risk
The recent failures with AstraZeneca's two phase III trials for Iressa in
front-line NSCLC in combination with chemotherapy increases the drug
development failure risk for all EGFR inhibitors and Tarceva -in particular-
given the chemical similarities between the two molecules.
* Dependence on Tarceva in the near to medium future
Tarceva represents the core investment thesis for the stock in the near and
medium future. Hence any possible adverse outcome in Tarceva's clinical
development or approval may significantly impact the stock. If the ongoing
phase III trials for Tarceva are negative or weak, if the completion of the
trials is significantly delayed, if approval is delayed or denied, then the
prospects for the company and the stock will be negatively affected. Although
OSI has 5 other products in clinical development, they are in much earlier
stages of development and are not expected to reach the market before 2006. |
