Description

Praecis Pharmaceuticals (Nasdaq: PRCS) is a biotech company with a real phase III product for prostate cancer (with published data showing efficacy and safety) in addition to other earlier stage drugs and a drug discovery technology. Praecis has $233 million in net cash and market capitalization of $158 million.

Praecis is a drug discovery and development company, founded in 1993, that has a pipeline of drugs in clinical trials and a proprietary drug discovery technology called Ligand Evolution to Active Pharmaceuticals (LEAP). The basic story is that the company is trading at a discount to cash, and the value of its lead product can be easily justified (i.e., w/o biohype) as $10-12/share without applying any value to its pipeline or basic technology platform. In addition to the lead compound, the pipeline has some early stage candidates that could be valuable and the LEAP technology has produced 3 of the lead compounds (Abarelix, Apan and Apan-CH). The LEAP technology can be used to develop drugs in a variety of additional disease areas. With any value attached to these assets, the company could easily trade into the $20’s or higher (it was north of $40 in late 2000 – with the same product portfolio)

Lead Product - Abarelix
Abarelix (also called Plenaxis – which is the injectible formulation) is a GnRH antagonist that blocks the GnRH receptor and ultimately inhibits the production of testosterone, one of the key drivers of prostate cancer growth (and other diseases/conditions). The current standard of care are GnRH agonists (e.g., Lupron and Zoladex). The ultimate goal of these products is to reduce the testosterone production to reduce the impact of the disease. The agonists (Lupron, Zoladex), however, create an initial surge in the testosterone level prior to reducing the level over the longer term. This surge causes an issue particularly in late stage patients where it could be detrimental to the disease progress, in addition, patients often need to take an anti-androgen product concurrently (very expensive). Abarelix on the other hand, immediately reduces the testosterone level without any surge.

Abarelix completed its initial set of Phase III trials and submitted a New Drug Application (NDA) in Q4 ’00. The drug was slated for expedited review due to the potential importance of the drug. The FDA gave a “non-approvable” letter based on the data citing two primary issues:
1. Safety issues – the drug showed a 0.4% rate of anaphlaxis (out of 1,600 patients), a serious allergic reaction at the injection site.
2. Efficacy issues – Abarelix showed a 10% higher incidence of testosterone breakthrough or “escape” after 6 months as compared to the control arm.

As a result of these concerns PRCS altered its strategy to apply for an “acute” label vs. a “chronic” label that will initially limit the use to 3 months. PRCS would likely then pursue Phase IV studies to extend the label.

Why is Abarelix likely to be approved?
First, there is published data in refereed scientific journals and conference proceedings (The Journal of Urology http://www.jurology.com/ - search for Abarelix, Adult Urology, ASCO 2001, AAPS Pharmaceuitca www.aapspharmaceutica.com ) that clearly lays out the fact that the drug works. The testosterone level is suppressed immediately as compared to the Lupron which can take 1 week or even more (up to 30 days). There is no need for an anti-androgen product either. Clinicians who were involved with the trials clearly see a benefit from this product – specifically saying that they saw an immediate improvement in the patients due to the lack of surge – which is critical for specific patient populations, and beneficial for many others. Additionally the benefit for reduced testosterone levels obviates the need for expensive anti-androgen therapy that is required with Lupron or Zoladex. Abarelix specifically could uniquely benefit patients in several settings including:
• Neoadjuvant therapy – data suggests that abarelix can reduce tumors faster than current agents, allowing the use of additional therapies much sooner in the management of the disease
• Intermittent therapy – this new therapeutic approach could reduce the side effects of the therapy by 6 months on/6 months off treatment. Abarelix would be the drug of choice due to the fast suppression, and recovery of testosterone levels.
• Rescue therapy following Lupron failures – 3-4% of patients with hormone-dependent tumors do not respond to Lupron therapy, but may respond to abarelix
• Stage D patients – These patients cannot handle a large surge of testosterone, and so are not treated by the current drugs, but would be able to use Abarelix due to the lack of surge in testosterone.
The drug was given expedited review, and continues to enjoy that status (i.e., requiring a decision within 6 months of package submission at the FDA).

Second the safety issue was asked to be addressed by analyzing blood samples from the patients who showed a reaction. The FDA apparently wants to see if there is a way to test ahead of time to see who might react. Importantly, the Lupron control arm had the same level of reaction as Abarelix. There is information that suggests the anaphlaxis was due to a poor batch of material. Worst case, this will require a warning label similar to the label carried by Lupron.

Third, regarding efficacy, the FDA has approved a follow-on study that consists of 3 months of Abarelix followed by 2 months of Lupron or Zoladex to show that there is no follow on testosterone surge. This is a very low hurdle for approval, and all the other incidental data (with some patients in Phase I and preclinical trials) suggest this will not be an issue.

The Pipeline
Product Indication Stage
Abarelix Hormonally Responsive Advanced Prostate Cancer NDA Submitted Q4 ’00; additional study and analysis ongoing; additional data complete by Q1 ‘03
Abarelix Endometriosis Phase II/III – Data to be revealed in June
Apan Alzheimer’s Disease Phase I – Data to be revealed mid-summer and Phase Ib study to commence
PPI-2458 Rheumatoid Arthritis/Cancer Research/Preclinical
Apan-CH Alzheimer’s Disease Research/Preclinical
CCR5 Antagonist* AIDS Research/Preclinical
Androgen Receptor Antagonist Hormone-Independent Prostate Cancer Research/Preclinical
Endometriosis Diagnostic Endometriosis Research/Preclinical
* In conjunction with Human Genome Sciences

LEAP Technology
LEAP (Ligand Evolution to Active Pharmaceuticals) is a proprietary method for discovering drug leads, that both identifies compounds and optimizes the compounds using medicinal chemistry. According to the company, this process allows examination of more than a trillion molecules in a few months. The main benefits of this process include the ability for improved ligand selection (evaluation of a larger number of ligands), and then optimization of the ligand through biological evolution that creates potential permutations to be used. Once these potential leads are identified, other techniques are used to select thebest candidates. LEAP was used to develop three of Praecis’ lead compounds (Abarelix, Apan and Apan-CH). This technology can be used in a variety of disease areas. This is essentially a free option, based on the current valuation.

Valuation
Abarelix serves a market that is currently served by Lupron and Zoladex which have combined sales of roughly $1 bill. in the U.S. and $1 bill. outside the U.S. The expectation is that Abarelix, even with the acute label, should have $150-200 million due to its appeal to specific patient populations and the ability to expand its indications (ultimately including endometriosis). There is a probability that the market could be larger if the drug is approved for chronic conditions, or through pricing that is an incentive for urologists to use the product. Using a simplistic DCF analysis this drug alone could be worth about $10/share (and there is no other biotech/pharma products that can be justified using a DCF!!!). Using price/sales (as many of these are valued) of 7x (approximate average for products w/ 80% gross margins) and discounting back using 20% discount rate gives a share value of over $13/share. Needless to say with a bit of bio-hype this could trade to much higher valuations under certain circumstances (it was trading north of $30 early last year). These valuations give no value to the clinical pipeline or the basic technology platform. With almost $4.50/share in net cash, the risk/reward appears to be extremely compelling, particularly with relatively little technical risk as compared to most biotech companies. This stock has been over $45 in late 2000, with essentially the same product portfolio (admittedly a broader initial market potential for the drug). Clearly with even modest expectations, the valuation could be easily north of $20/share and with any excitement it could go north of $30-40/share as progress is made.

Issues
Needless to say, the stock is cheap for a variety of reasons:
1. Management – Management has been notoriously promotional historically. They are supposedly knowledgeable about drug development, but arrogant, egotistical and arguably misleading. This is a general viewpoint held by many people in the industry (and is our single biggest concern in the story), and is clearly a reason the stock has been under pressure. Management has continuously overpromised and underdelivered. They have recently hired a senior executive from Schering Plough, William Heiden. He is now the President and COO, which should bring some big pharma credibility to the organization. He appears to have had a relatively successful/relevant career at Schering.

2. Loss of major partnerships – Praecis had partnerships with both Amgen and Sanofi that have been terminated in the last few years. The most troubling is the Amgen deal that was a 50/50 split on Abarelix to help fund development of the compound and commercialize the drug in the U.S.. Amgen walked away in Decmber, 2001 after the FDA gave the non-approvable letter to Praecis. The deal was initially structured so that Praecis initially received $10 mill. for signing, $175 mill. of initial development costs (which was used up entirely) and then a split of on-going expenses and profits 50/50 (this ended up being an incremental $30 mill. by the time the deal was terminated). The fact that Amgen walked is troubling, however, there are several reasons that this may not be as bad as it seems at first blush:
a. A totally different sr. mgmt team has been put in place from when they originally signed deal in March, 1999. The initial motivation for Amgen was to focus on Urology as a therapeutic area, with this being the first major product. Since that time they did not license in any other major compounds in this space, making this a relatively small and therefore unattractive (particularly considering the deal terms and the need to create a new sales force).
b. The deal was poorly structured for Amgen with a 50/50 split on the product costs/profits after significant upfront payments (over $210 million), which is not like most biotech deals that are often lower in terms of combined royalty/milestone payments.
c. The data suggested that the broader chronic indication would not be easily achievable without significant additional testing. The acute indication limited the market size (to $150-200 mill. range) and made it a smaller opportunity than initially anticipated.
d. The delay at the FDA was an additional headache for what was going to be a minor drug for them, particularly as they were focusing more on the Immunex acquisition.
e. Finally, Amgen is not well known for its drug development capability, particularly in Urology. (Basically Amgen has developed Epogen and Aranesp – the follow-on product). I would be much more concerned if this was Pfizer or Merck walking away from the deal.

3. Insider Selling – there has been some insider selling late last year. Also, Dean Falb has been selling this year. Dean Falb has left the company and so he is just liquidating his position. The company claims that the other insider selling for tax purposes, but this is always a bit troubling. A director has been buying recently, and the company approved a $3 million buyback (minimal, but still symbolic). The CEO, chief medical officer and a director collectively own over 3.5 million shares.

4. Cash Burn – As always, these biotechs burn significant cash to develop products, particularly in the later stages of development. Company guidance is that they spend $40-50 million/yr in running the company excluding clinical trials. Adding in the trials should be an additional $30 million/yr. So they have ample cash to fund the Phase III trials, and should still have substantial cash left once the FDA decision is made – protecting downside. This would mean worst case they spend about $160 million by the time the decision is made (leaving $115 million on the balance sheet at the end of 2003), but the results of the trial and other catalysts should happen well before that time.

Bottom Line
With $4.50 in net cash, and a drug worth conservatively $10-12/share without attributing any value to their pipeline or technology or general hype, the risk reward is roughly $0.50-1 in downside and almost $9 in upside. Adding in the pipeline, the technology and some excitement around the story could easily propel this into the $30-$40 range where it was trading a year ago.

Catalysts
Several catalysts exist for the stock:
1. Announcing a marketing partner, or marketing plan. Several possibilities exist here (partner with big pharma, partner with a biotech/specialty pharma company, partner with a contract sales organization – CSO, or go it alone). Clearly partnering with a big pharma company would be most attractive, and despite delays, we believe there is a chance that this could occur (or a lesser partner – such as a biotech/specialty pharma company) and be announced in the next few quarters
2. Completion of trials, unveiling of data for abarelix– Q1’03
3. Incremental pipeline news – endometriosis data should be revealed in June, early data on Apan later this summer.
4. Potential target – the large cash position, advanced drug, and basic technology could make this a takeout candidate.

Catalyst

Catalysts
Several catalysts exist for the stock:
1. Announcing a marketing partner, or marketing plan. Several possibilities exist here (partner with big pharma, partner with a biotech/specialty pharma company, partner with a contract sales organization – CSO, or go it alone). Clearly partnering with a big pharma company would be most attractive, and despite delays, we believe there is a chance that this could occur (or a lesser partner – such as a biotech/specialty pharma company) and be announced in the next few quarters
2. Completion of trials, unveiling of data for abarelix– Q1’03
3. Incremental pipeline news – endometriosis data should be revealed in June, early data on Apan later this summer.
4. Potential target – the large cash position, advanced drug, and basic technology could make this a takeout candidate.