SSB: DOVP: Earnings Uneventful, Triple Reuptake Program Faces
Setback
BUY (1)
Speculative (S)
Mkt Cap: $423 mil.
August 9, 2005
SUMMARY
* DOV Pharmaceutical released their Q2 results today posting a narrower than expected loss of ($0.49 ) versus our ($0.63) and consensus of ($0.57). While expenses were in line, revenue recognized was higher due to amortization of milestone payments from the Merck and Neurocrine collaborations.
* DOV also announced that it will assume development responsibility for DOV 21,947, a triple reuptake inhibitor, that Merck concluded did not meet a prespecified bar for efficacy based on preclinical and phase Ib biomarker data. DOV disagrees and will start a phase Ib study by year-end. The rest of the agreement with Merck was not changed and Merck is seeking to in-license a preclinical compound to the target. Merck has right of first refusal for DOV 102,677 that is currently in phase I testing.
* Despite this setback, DOV has a steady flow of catalysts and we look for release of bicifadine data for acute pain in Sept to drive interest in the stock.
FUNDAMENTALS
SHARE DATA . RECOMMENDATION
Price (8/5/05) $19.78
Rating (Cur/Prev) 1S/1S
52-Week Range $21.20-$12.99
Target Price (Cur/Prev) $27.00/$27.00
Shares Outstanding(a) 21.4 mil.
Expected Share Price Return 36.5%
Div(E) (Cur/Prev) $0.00/$0.00
Expected Dividend Yield 0.0%
Expected Total Return 36.5%
OPINION
DOV released today second quarter earnings results of ($0.63) versus our
($0.59) and consensus ($0.57). Revenues were slightly higher than projected due
to the amortization of a milestone payment from Merck, and the recognition of a
$2 million milestone payment from Neurocrine for the acceptance of the Indiplon
tablet NDA by the FDA.
Overall expenses were $15M mostly in line with our expectations of $16 million.
Higher G&A expense of $3 versus our $2 million offset lower R&D expense. R&D
expense was $12 million versus our expected $14 million. DOV has reiterated its
guidance for end of year R&D spend to be between $60-$65 million. We have
modestly increased G&A and lowered R&D for the rest of 2005 to reflect the Q2
run rate (see changes to our model).
Importantly, DOV also announced that it will assume developmental
responsibility for the triple reuptake inhibitor DOV21,947 for depression since
Merck was disappointed at biomarker data based on preclinical animal models and
phase Ib studies. DOV disagrees with Merck's findings and will start a phase
Ib study by year-end to further characterize the compound. If successful, DOV
will be responsible for conducting two additional phase II studies and will be
reimbursed for its development costs and a premium if these yield positive
results. On its call, management expressed confidence in DOV21,947 given that
its parent compound, DOV216,303 has shown efficacy that is suggestive to be
comparable to the SSRI, citalopram.
Despite the minor setback to DOV21,947, DOV stands to benefit from a steady
flow of news into 2006. In September, DOV will release data from the first
phase III bunionectomy trial that will further define bicifadine's prospects in
acute pain. We note that bicifadine passed a futility analysis in May,
suggesting that there is a reasonable chance that this study could show a
positive result.
By the end of the year, DOV is expected to complete the futility analysis from
the ongoing phase III trial in chronic lower back pain. Final results could be
released during the second half of 2006. If this trial is positive, it will
increase the commercial potential of bicifadine considerably, as none of the
current non-steroidal anti-inflammatories currently on the market have a
chronic back pain indication. A second confirmatory trial will be needed for
registration, however.
We continue to believe that DOV's pipeline represents "multiple shots on goal"
opportunity at a reasonable price.
UPCOMING MILESTONES FOR DOV PHARMACEUTICALS
Source: Company filings and Citigroup Investment Research
TRIPLE REUPTAKE INHIBITOR HAS A SETBACK BUT REST OF PIPELINE INTACT
In a press release today, DOV announced that the triple reuptake inhibitor DOV
21,947 failed to meet a pre-specified bar for efficacy in preclinical and phase
Ib biomarker studies. The lead indication for this program is major depression.
DOV agreed to re-demonstrate the efficacy of this compound in an additional
phase Ib and two phase II trials, with the phase Ib trial starting in 2005, and
the phase II trials starting in 2006. DOV will pay for this development, and if
successful, will receive reimbursed expenses plus a success premium from Merck.
Recall that the first triple reuptake inhibitor, DOV216,303, has shown efficacy
that is suggestive of being similar to the SSRI citalopram in clinical trials
of major depression. As DOV21,947 is the plus isomer of the racemate that
composes DOV216,303, and is therefore structurally almost identical, DOV has
confidence that further studies will demonstrate the efficacy of DOV21,947.
While this is a setback to the compound, Merck remains committed to this class
of molecules and has the rest of the agreement remains unchanged. Merck also
retains the right of first refusal for the follow-on triple reuptake inhibitor
DOV102,677 that is currently in phase I testing. We envision that phase II
testing for this compound will commence by year-end or early 2006.
While we believe that the triple reuptake inhibitor family is promising and are
important for long-term stock success, near-term drivers of DOV include release
of phase III bicifadine data in acute pain in September and Science Day in the
fall. In 2006, we expect release of data from the ongoing phase III study of
bicifadine in chronic lower back pain. In addition to this late stage
catalysts, we expect that Neurocrine/Pfizer's Indiplon will receive approval
and launch in mid-2006, thereby further driving interest in the stock.
CHANGES TO OUR MODEL
We have modestly decreased our R&D expense and increased our G&A for the rest
of 2005 in line with this quarter's numbers. We are not making any changes to
our estimates in the out-years.
Source Citigroup Investment Research
VALUATION
Our $27 target price is based on an average of two different valuation metrics:
analysis of the enterprise value based on comparable emerging small-to-mid cap
biotechnology companies, and sum of pipeline candidates' option values.
VALUATION BY PIPELINE OPTION METHOD
DOV has a portfolio of four major assets including Indiplon for insomnia,
bicifadine for pain, ocinaplon and DOV 51,892 for generalized anxiety disorder,
and the triple reuptake inhibitor program for depression (DOV 216,303 and DOV
21,947). We calculated an option value for each to obtain the value of the
company.
We analyzed the net present value of the future cash flow stream of DOV's
pipeline candidates and adjusted each by the probability of advancing into the
next phase of development towards obtaining FDA approval. As a guide, we used
the historical probability of success figures from the Tufts Center for the
Study of Drug Development. However, in the case of DOV 51,892 and DOV 21,947,
we used a 50% probability of success in Phase II (vs. historical rate of 41%)
since these products are second-generation version of products that have
succeeded in Phase II previously.
We also used a lower probability of garnering FDA approval once an application
is filed since the FDA has been particularly tough in the recent past on drugs
for analgesia and generalized anxiety disorder. In our analysis, we attribute a
90% chance that Indiplon would be approved since the product has shown positive
Phase III results. We attributed an 80% probability to the remaining programs
since they are earlier in development. Historically, 95% of applications that
were filed with the FDA ultimately received approval according to the study by
Tufts.
FIGURE 1. PROBABILITY OF SUCCESS BY DRUG DEVELOPMENT PHASE
Source: DiMasi et al, Clin Pharmacol Ther 2001; 69:297-307 (Tufts Center for
Study of Drug Development)
In our valuation analysis, we forecasted sales for each program taking into
account the projected patents expiration dates. We then adjusted the
contribution that each product may have once DOV partners the program in
exchange for royalties and milestone payments. We then made adjustments to
these revenue streams to calculate expected cash flows assuming that DOV pays
for all development expenses until a partnership is signed. Thereafter, our
analysis projects that the partner pays for all development and
commercialization costs.
As a result, once the initial development costs are paid by DOV, the revenue
stream of each product has modest administrative overhead, depreciable assets,
or need for capital expenditures. Since we also assume that the company will
continue to be financed through equity, interest expense will continue to be
negligible. Instead, the majority of adjustments to these revenue streams are
related to the 35% corporate income tax once the initial net operating losses
carry forwards are exhausted.
We then discounted these revenue streams to derive our 12-months target price.
A cost of equity of 15% was calculated using CAPM and an average five-year
weekly-adjusted beta from DOVs comparable companies (see chart below).
To derive the option values, the net present value (NPV) of the cash flows for
each product were deducted from the probability-weighted expenses. The sum of
the values of the four pipeline projects were adjusted by DOV's cash and debt,
and the results were divided by the expected shares outstanding at the end of
2005. The inputs of the pipeline option value analysis are summarized in the
table following, and imply a $20 target price. This valuation method is
unchanged.
OPTION VALUE ANALYSIS
Source Citigroup Investment Research
COMPARABLE COMPANY VALUATION ANALYSIS
In valuing DOV, we also used a comparable group enterprise value analysis. We
chose seven small-to-mid cap biotech companies that are comparable to DOV since
they are all in late stage clinical testing. Since the breadth and depth of
DOV's pipeline is unique, we chose companies that, for the most part, also have
several products in development. In addition, similarly to DOV, some of these
companies have partnered some of their products but also retained rights to
others.
Our analysis suggests that the market is not attributing equivalent value to
DOV's pipeline when compared to its peer group. This is despite DOV's having a
more diverse and deeper pipeline than most of its comps and stands to benefit
from a royalty stream on sales of Indiplon starting in 2006. DOV's enterprise
value is significantly lower than the average calculated for the cohort, and
its technology value is among the lowest in the group.
This differential is likely due to investor skepticism concerning the outlook
of DOV's pipeline due to recent tough FDA stance on analgesic and anxiety
products. However, we believe that the value of this pipeline could be
appreciated over time has clinical data is released.
We argue that DOV should receive a similar enterprise value as that of its peer
group ($914 million versus its $570 million value on July 17th, when we last
changed our target price). Given DOV's cash ($112 million) and debt ($84.0
million) positions, we calculate that DOV's imputed market cap should be $942
million, yielding a 12-months target price of $35 per share.
FIGURE 3. COMPARABLE COMPANY ENTERPRISE VALUE ANALYSIS
Source: Factset
VALUATION ANALYSIS
SourceCitigroup Investment Research
The average of the two methods was used to produce our target price of $27 a
share.
RISKS
We rate the stock as Speculative due to the risk inherent in clinical
development among other factors as detailed below:
CNS DRUG DEVELOPMENT IS FRAUGHT WITH RISK
Developing drugs for central nervous system disorders has the potential for
attractive returns because of the large populations affected by these illness
and high levels of unmet need. Nevertheless, because the CNS is the most
complicated and organ in the body, developing successful therapeutics is
challenging and fraught with unexpected side effects that are often missed in
clinical trials and may only be uncovered once used by large audiences.
DEVELOPING PAIN PRODUCTS CAN BE CHALLENGING
The recent withdrawal of Merck's Vioxx, COX-2 inhibitor, from the market due to
increased cardiovascular risk has likely raised the bar for approval of new
analgesics that can be used broadly. This may affect the degree of scrutiny
that bicifadine may face. In addition, while the FDA has not issued new
guidelines for approval of pain drugs, the types of pain studies that are
accepted to prove efficacy and safety have been changed from dental to post-
surgical pain studies. As a result, there is limited experience of drug
development using several of these pain models.
RECENT REGULATORY PROBLEMS MAY NOT BE OVER
In 2004, DOV's ocinaplon came off an FDA mandated clinical hold that was due to
a case of elevated liver function tests in a single female patient. While it
appears that this event was due to a pre-existing condition, the FDA has
required that patients treated with ocinaplon in a Phase III study will undergo
twice weekly blood testing to ensure that liver enzymes remain in check. This
onerous requirement appears to be impacting the enrollment rate in this study.
DOV'S INTELLECTUAL PROPERTY IS NOT COMPLETELY PROTECTED
Since several of DOV's development candidates were originally developed by
Wyeth in the 1990's, certain products are facing patents expirations. DOV is
pursuing a strategy that involves patenting specific molecular conformations,
called "polymorphs", as well as more conventional production process and use
patents. At this time, only several of these patents have been awarded. More
so, polymorph patents have not been adequately challenged in courts to
ascertain the extent of protection afforded. Nevertheless, polymorph patents
are accepted by the FDA and are listed in the Orange Book.
DOV'S NEAR-TERM FINANCIAL PROSPECTS REST ON INDIPLON
Over the next few years, DOV's financial condition will depend on global sales
of Pfizer/Neurocrine's Indiplon from which DOV receives a 3.5% royalty. Given
that these royalties would not be of sufficient size to fund DOV's clinical
programs, the company will likely be dependent on further capital financings in
the future.
If the risk factors prove to be greater than we anticipate, then the stock
might not reach our target price.
INVESTMENT THESIS
We believe DOV has been overlooked by investors due to investor prejudice
against the CNS drug development space. We believe that investors correctly
appreciate the risks of CNS drug development, but underestimate the unmet
medical needs and therefore the size of the potential financial rewards.
Investor sentiment has not been helped by the withdrawals of COX-2's Vioxx and
Bextra, and the recent tightening of FDA standards with regard to side effects
in widely used therapies. We believe that these issues are short term, and will
not be as much of an issue in 2008 and later when bicifadine and the triple
reuptake inhibitors submit NDA's. Furthermore the FDA's safety issues with
ocinaplon can be circumvented by switching development to DOV 51,892, which is
only 2 years behind ocinaplon and has better intellectual property protection.
We believe these issues create a good entry point into this stock for risk
tolerant investors who have longer investment horizons.
COMPANY DESCRIPTION
DOV Pharmaceuticals is dedicated to the discovery, development, and
commercialization of drugs for central nervous system disorders (CNS). DOV s
most advanced candidates, Indiplon, bicifadine, ocinaplon, and DOV 21,947 and
DOV 216,303 were licensed from Wyeth in 1998. DOV has out-licensed Indiplon for
the treatment of insomnia to Pfizer/Neurocrine Biosciences. Indiplon has best-
in-class potential and we forecast $922 million in sales by 2010 following
approval in the second quarter of 2006. In August 2004, DOV entered into a
development and commercialization partnership for the triple reuptake
inhibitors (DOV 21,947 and DOV 216,303) with Merck for depression. Apart from
these partnerships, DOV also has an interesting late-stage pipeline. Bicifadine
is in Phase III studies for acute and chronic pain. Due to encouraging activity
in earlier studies, we expect positive data in ongoing studies over the next 12
months and approval for acute pain in 2008. Due to previous safety issues, we
view success in the ongoing ocinaplon Phase III as an upside scenario.
DOV PHARMACEUTICALS QUARTERLY P&L
SourceCitigroup Investment Research
DOV PHARMACEUTICALS ANNUAL P&L
SourceCitigroup Investment Research
ANALYST CERTIFICATION APPENDIX A-1
I,Yaron Werber, the author of this report, hereby certify |
