Summary: Furiex (FURX) has a market cap of $205M and an annual royalty stream of $25M. The story is currently underappreciated, offers minimal downside and multiple levers to realizing a 100% return on your money. Fred Eshelman, chairman of the company, owns 28.6% of the company most of which was purchased in the open market over the past year and a half. Insider interests are aligned with ours.

Please see bondo119’s write-up of this to get a background on the original spin-off.

Please see mack885’s write-up for some additional background and history.

With many changes having taken place since February of last year, we thought an update was in order.

A bit of recent history: On April 24th, 2012, the FDA issued a CRL to Takeda, which is in partnership with FURX on their drug Nessina for treating diabetes. The FDA requested some additional data that Takeda was able to provide. There is an ongoing cardiac trial and there is some concern that the FDA will want to see the results when the trial concludes in 2014; however, Takeda felt strongly that they had sufficient data from their post marketing studies in Japan to resubmit the drug to the FDA. Takeda received a Class 1 review period for the drug and the PDUFA date is coming up once again on January 25th. Notably, when the CRL came last time around, the stock tanked rapidly from $20 to $12. FURX’s chairman, Fred Eshelman, stepped in and brought his position in the company from 22.6% up to 28.6%. Eshelman owned 9% of the company on the spin from PPDI and was an aggressive purchaser of the company prior to April 2012 as well. Today, Eshelman’s stake is worth $58M. We place the probability of approval at 50/50 this go around as we have no special insight on this leg of the story.

We will discuss the drugs and drivers and then later return to a discussion about valuation.

Growth Drivers: Nessina (Japan, U.S and Europe), Priligy (U.S and Europe), Mu Delta

Nessina in Japan: This drug has been a runaway success in Japan. Introduced just over a year and a half ago, Nessina is a DPP4 inhibitor for diabetes and competes directly with Merck’s blockbuster drug Januvia ($3.6B run rate). Nessina is at a run rate of approximately $400M and, according to partner Takeda, is expected to grow to $475M this year. Ultimately, Takeda thinks this can grow to $600M. FURX collects a 4-8% royalty. The composition of matter patent (strongest type) runs into 2025; but, Merck’s competing drug Januvia loses patent protection in 2019. There is some possibility that Merck will be able to extend their patent; but, for the sake of being conservative, let’s assume the party is over in 2019. Let us also assume that sales of Nessina don’t grow beyond $475M and FURX collects a 6% royalty or $28.5M annually for the next seven years. In total, FURX will collect close to $200M.

Nessina in the US: If the drug is approved in the U.S, FURX is eligible to receive a $25M milestone payment (worth $2.50 per share) and royalties of 7 - 12% on sales. If the drug is marginally successful, and sells just 50% of what it is selling in Japan (in a smaller market), this would bring FURX a $16M - $28M annual royalty (depending on royalty tiers which are unknown) or $.96 to $1.68 a share after tax. The company would collect this royalty for 7 years and collect $112M - $196M in total. Again, this assumes a moderate level of success. Japan is Takeda’s home turf but the U.S is a larger market. Also, the royalty rate for FURX is much higher here than over there (7% - 12% vs. 4% - 8%). A more substantial success could bring $30M - $50M in annual royalties. To be conservative, let’s stick with $200M in sales vs. $400M in Japan (which continues to grow). This compares to Merck’s Januvia which is at a $3.6B (and growing) annual run-rate worldwide with the U.S and Japan being their fastest growing markets. A U.S approval would be a game changer for FURX. However, in the event of a rejection, we believe there is tremendous downside protection coming from the other drugs.

Nessina in Europe: Approval in Europe is expected sometime in 2013. FURX is eligible to receive a royalty of between 4% and 8%. Assuming an approval and modest success of $50M, this drug could be worth $2M annually or $16M over the lifespan of this drug. We believe the ultimate sales value in Europe could exceed this number. Approval of the drug brings a $10M - $20M milestone payment.

Priligy in Europe: This drug is for premature ejaculation and we believe it to be the most undervalued product by investors. The drug has been a total disappointment; however, a recent event could change FURX’s fortune here. The company left their partner JNJ and re-partnered this asset with an Italian pharmaceutical company called Menarini. This is a 13,000 person company that can best be compared to Forest Pharmaceuticals in the U.S They’ve been around for 135 years or so and target primary care physicians. JNJ had been targeting urologists and they were not focused on Priligy. Menarini’s strategy is to acquire or partner drugs which are late stage or approved where they can utilize their sales force and strategy to improve the asset value. FURX retains U.S and Japanese rights to the drug.

Importantly, in Europe, this drug will be an out of pocket expense to patients. This means there are no insurance issues to deal with here. Consider that Menarini is paying  $15M upfront to FURX (this money will go to JNJ) and another $20M in regulatory milestones which are near certain and will likely begin to come in over the next 6 - 24 months. So, Menarini is putting $35M on the line. They are also in for up to $19M in additional studies. Adding it all up, that’s close to $55M spent on this asset. Our proprietary research leads us to believe Menarini thinks there is some significant value to this compound and could be one of their most important drugs. It is important to consider that this drug is already approved in many European countries and is a shoe-in for the rest. FURX will collect a royalty of mid teens to mid 20’s on sales of this drug. This is an improvement over their deal with JNJ where they were going to collect 10% - 20%. Estimating potential sales for this drug is somewhat more challenging given lack of any comps; but, we believe it to be enormous. Our most conservative estimates assume $100M in annual sales with no competitors in sight. This would generate $15M in annual royalties to FURX. We think these sales begin to ramp up in the next 8-12 months. Ultimately, we think Priligy could be worth at least $1 a share annually. A more bullish outcome could lead to $50 - $100M in annual royalties at the high end of the royalty tree and with $500M in sales. To us it seems entirely plausible that a drug for premature ejaculation could hit these numbers at some point in Europe alone.  

Priligy in the US: In the U.S, the company needs to wait for some studies to finish. There are two ongoing studies. JNJ/FDA was concerned that Priligy may get used alongside other drugs like Viagra. There were also some isolated cases of syncopy (fainting). The first study is finished dosing already and the second should have also been recently wrapped up. Best case, we are looking at a 2013/2014 approval here.

Mu Delta: This is a drug for Irritable Bowel Syndrome. FURX originally partnered this drug with JNJ but they put the drug back to FURX and now FURX is searching for a new partner. There is a reason FURX wants to keep a good deal of the upside on MuDelta. This could be a $300M - $800M drug with a long IP runway. A simple 10% royalty would be worth $30M - $80M a year to FURX or $3 - $8 a share. Depending on the deal structure FURX sets up, their upside could be even greater than this. Plus, the upfront milestone could be in the $50M - $75M range or $5 - $7.50 a share. Depending on when they partner this drug, MuDelta alone could be worth $20 - $50 to FURX. The drug is also on Fast Track status at the FDA. The issue here is that there is a perception that regulatory risk is high as the end points are difficult to meet and a couple of patients developed pancreatitis in Phase 2 trials. The company (and we) believe the pancreatitis issues are overstated.  Most likely, a partner has not materialized due to a combination of trial difficulty and FURX wanting favorable terms (with a preference to out-license ex U.S and keep U.S rights).

MuDelta Science: The FDA came up with a tough end point for Mu Delta and similar drugs. Historically, it was enough to show ‘adequate relief’ - you just had to ask if the patient got some relief; however, there was a large placebo affect. So the FDA came up with a new end point - the Bristol Stool Scale. The patient needs to look at the consistency of his stool and rate it from 1-10 (1 being hard, 10 being soft). The patient must also have a 30% reduction in pain on the day of a diary entry over a 12 week period. Over this period of time, the patient must have recorded for both end points at least 50% of the days. On those days, the patient must report less than 5 on the stool scale and 30% or more on the pain reduction scale. Salix has a competing drug but it appears to have less of an effect on subsequent treatments whereas Mu Delta becomes even more potent. There is a market for both drugs.

JNJ – Q2: FURX also has another Phase 3 ready compound for community-acquired bacterial pneumonia which has some value. This program is on hold as the company focuses on the larger MuDelta opportunity. There is also some difficult at the FDA at the moment getting drugs like this one approved. To be conservative, we assign no value to this program.

What worries some investors: Although FURX is pulling in a $25M royalty from  Nessina, they have been plowing all the money back into a Phase 3 trial of Mu Delta. Investors seem to fear that FURX will blow $140M on development. We find this risk to be overstated. More likely, the company will spend somewhere between $50M and $75M. Nessina is a huge drug in Japan and as mentioned is up for approval in the U.S. If this gets approved, there is a possibility that FURX will spend the full $140M but it will be a mute point because a U.S approval would be a homerun.  If Nessina does not get approved in the U.S, FURX will likely be forced to partner Mu Delta albeit at less than optimal terms. Although potential partners do not seem to be knocking down the door, we believe FURX would like to see the outcome on Nessina in the U.S before partnering as this would strengthen their position. With a U.S approval, the company could complete the trial themselves or gain more favorable terms from a partner as the financial position of the company would be much improved. If we are wrong and Nessina does not get approved in the U.S and FURX chooses to spend $140M on Mu Delta development, we think there is still tremendous value in the company’s other drug Priligy that has been entirely discounted by the market.

Valuation: We believe the market unfairly values the underlying pieces of FURX because of the perceived (and actual) reinvestment risk of Mu Delta. Although it may cost FURX $50M - $75M to develop Mu delta before signing with a partner, this can easily be paid for with 3-4 years of royalty income from Nessina in Japan. After that, the remaining royalties accrue to shareholders. In addition, there remains tremendous potential upside from the royalties of Nessina internationally and from Priligy + Mu Delta. Cash of $47m nets our against debt of $40M and the company keeps a tight lid on SG&A which runs $8M - 10M a year. The company also stands to collect another several milestones discussed previously which could add up to another $30M - $40M.

Nessina Japan Royalties: $200M

Nessina U.S Royalties: $112M - $196M

Nessina Europe: $16M - $50M

Priligy Europe: $150M - $500M

Priligy US: $300M - $2000M

Mu Delta: $300M - $800M

Lifetime value of portfolio: $1B - $3B

We can (and have) run all sorts of discount rates on these royalty streams based on probabilistic outcomes and varying rates. We find this to be an inexact science. Accurately handicapping outcomes and choosing appropriate discount rates is fraught with error. Valuation is an inexact science and in the case of biotech extraordinarily imprecise. The bottom line is that we believe if each of FURX’s drugs were to be trading as a separate entity, the value accorded to each would come close to the company’s current market cap. The fact that Menarini just plunked down $35M - $55M on Priligy indicates that the value of this drug alone should be multiples of that given FURX’s high royalty share (15% - 25%). Ultimately, what you have here is a basket of binary outcomes each of which could generate a value much great than the current $200M market cap. There are multiple ways to win including:

1)  Better than expected Nessina sales in Japan (ongoing)

2)  Approval of Nessina in the U.S (January 25th)

3)  Approval of Nessina in Europe (2013)

4)  Better than expected sales of Priligy in Europe (ongoing)

5)  Positive study outcomes for Priligy in the US and approval (2013/2014)

6)  Positive Phase 3 trials for MuDelta (Q3/Q4)

7)  A partner for MuDelta

Only one of the above 7 catalysts need to hit for the stock to work out well. If all the catalysts hit, you are looking at a company that could be generating well over $50M- $100M in annual royalties and be worth more than 2X – 5X its current value. In all likelihood, success comes from some combination of the above catalysts. The endgame is probably a sale of the company as Mr. Eshelman will need to monetize his investment and we have precedent in the sale of PPDI for $3B.

1)  Better than expected Nessina sales in Japan (ongoing)

2)  Approval of Nessina in the U.S (January 25th)

3)  Approval of Nessina in Europe (2013)

4)  Better than expected sales of Priligy in Europe (ongoing)

5)  Positive study outcomes for Priligy in the US and approval (2013/2014)

6)  Positive Phase 3 trials for MuDelta (Q3/Q4)

7)  A partner for MuDelta