Description

By Jan 2016 opex, SRPT will either be $75 (90% chance) or $10 (10%), for a NPV of $69.  Utah1009 once wrote he wished there were more cheap option, binary ideas posted to VIC.  For him, the relatively liquid Jan 2016 40 calls offer a probability-weighted return of 640% ($35 upside, $4.7 cost).  The common stock also works. 

SRPT´s main drug helps a segment (13% of total) of DMD (Duchenne Muscular Dystrophy) which first handicaps young boys before they die.  No cure, no treatment.  SRPT has drugs in the pipeline for the other segments, albeit at much earlier stages.  SRPT probably slows progression, which is better than anything else out there.  Everyone wants a drug on the market to help, including Congress, Moms, the FDA, etc.

SRPT has burned VIC before.  Many bad things happened that skeptics predicted.  But, twice call spreads that returned 5x based on solid analysis have been posted in the messages.  While there have been some misses, solid reasoning has led to returns in the past.

Now, while the scars and residual skepticism is keeping the stock price low, the situation has done a 180:  SRPT leadership went from poor to competent, SRPT test methodology as judged by the FDA is now compliant, and the FDA regulatory environment went from unclear to favorable.   Still, for those wanting a single smoking gun guaranteeing conditional drug approval, I can offer none, but the evidence is near overwhelming when taken in totality.

The Bad History

Sarepta did a terribly-designed Phase II trial.  A near complete loss of dystrophin production is a symptom of DMD, and SRPT focused on linking increased dystrophin production with drug effectiveness.  But there has not yet been a provable correlation between the two, and some patients had higher dystrophin yet didn´t improve (not just at SRPT, but elsewhere).  Increasing dystrophin might be like adding horsepower to a car with no wheels, it does no good.  Or some people say it absolutely drives success especially at higher quantities.  We don´t know. Also, the FDA called SRPT´s prior dystrophin testing methods unusable.   

While other test results from SRPT like the six minute walk test (6MWT) have been interesting, the small data set and less-than-perfect results are potentially not persuasive nor statistically significant when excluded (data mined) subjects are reincluded.  You´re also not supposed to change the trial pre-specified endpoint (from dystrophin to 6MWT).  FDA said “come back later.” 

Steps to get to $75 and changes in FDA thinking which enable those steps

Step 1 (mostly done): In May, the FDA changed from “come back later” to “file a NDA" (New Drug Application). Final filing still needs to be done by roughly end of June but is wholy within SRPT´s hands. The FDA required prior dystrophin tests to be rescored by 3 independent labs, which obviously was done to FDA satisfaction so one black mark is gone.

Also, in April 2015: BMRN, with a better designed test but which failed a Phase III and is somewhat unsafe, was given the nod to file a NDA.   If BMRN will go, why not SRPT?

Step 2:  FDA will accept or reject the NDA within 60 days of NDA filing.  The FDA doesn´t normally give the nod to file if they don´t think the application will be likely acceptable.  But this is different - SRPT/FDA interaction has been nearly unprecedented; the last two years have been an unofficial rolling process with constant feedback due to the FDA having public pressure to do something on DMD, or show why it isn´t.  I´m sure all material data produced to date has been seen by the FDA, and SRPT knows what the FDA wants to see.  If the FDA wasn´t okay with what they saw, they wouldn´t have given the okay to file.  SRPT´s NDA is super unlikely to get rejected at this stage.

Step 3:  AdCom Review Sept or Oct 2015, and Non-Binding Reco to the FDA.

Post NDA acceptance, SRPT goes to AdCom (advisory committee), which consists of a panel of experts who simultaneously vote yes or no for safety and effectiveness and risk vs. benefit.   They are not the FDA and can vote independently, but will consider guidance given by the FDA and the FDA will give their thoughts (positive and negative) in a written briefing. 

Step 4:  Early 2016.  The FDA will nearly certainly go with the vote of the AdCom as long as the vote is reasonably clear.  The market will price this acceptance (or rejection) in post AdCom.

AdCom decision criteria and likely result

1)   Safety.  Sarpeta has been unusually safe.  SRPT has provided all requested data.  And, any interim safety issue would need to be large since the new FDA guidance said “patients and caregivers may be willing to tolerate substantial risk of harm if a drug may delay loss of important abilities such as walking.” 

2)   Effectiveness/Efficacy:  The vote will be whether it is reasonably likely it has any benefit.  The downside with SRPT, and the old bear case, is I actually don´t believe any individual tests proves efficacy from a scientific (e.g. non data mined) standpoint.  The gold standard test is the 6MWT, and while results I think are quite good due to trial length, which greatly reduces the bias charge, I´d bet the adjusted p-value will not be low (e.g. bad) once the two excluded patients are likely included, given the small sample size and wide standard deviation.  However, in totality – good dystrophin production, good pulmonary production, and good 6MWT test results when taken as a whole seem to easily pass the “reasonably likely to have any benefit” hurdle.  Finally, remember that many patients will be brought in for the AdCom as witnesses, there will be no lack of moms tearing up that will say this drug has made a big difference.

How do we know the regulatory environment is now more favorable?

A.     June 2015:  An AdCom voted 18 to 6 to allow Female Viagra.  Before it had failed, twice.  The FDA wrote it had “challenging benefit/risk assessment”, and myriad risks such as interaction with alcohol.  (Consuming alcohol and Viagra at the same time, say it ain´t so.)  Worse, maybe the drug doesn´t work.  But the FDA cited “long standing unmet medical need” and wrote in their briefing they had been accused of being anti woman (see June 4, 2015 Flibanserin FDA briefing).  Shows that the approval environment is favorable.

B.     June 2015 FDA DMD Draft Guidance:  Released draft guidance for what is needed for conditional approval.  Which addressed many if not all of the prior deficiencies in Sarepta´s approach.  These are:

1)   Before, the FDA said small to medium changes in dystrophin production, which SRPT has and uses as evidence of efficacy, doesn´t necessarily correlate to increased strength.  There is reasonable evidence that large changes do, but no one knows for sure and the FDA likes to approve based on hard evidence.  Now, the FDA says we can get around that now by correlating dystrophin with pulmonary performance, which was positive for SRPT.

2)   Trial sizes and type (placebo vs. not).  The recent FDA guidance doesn´t state SRPT´s design (small N, poor placebo design) to be a show stopper by itself, and says longer 18-24 month trials help a lot (which we are well past now with Phase II results).    The longer trial really helps with bias since if the parents think the kid is on the drug (or not), they may coach them to try harder, which helps short term, but over a long enough trial coaching can´t help as the disease takes over.  Still, a placebo trial is strongly encouraged.

3)   Risk vs. reward.  The FDA would be concerned if “effect is modest for a drug with substantial risks.”  With no SRPT side effects to date, SRPT has room to incur some.

4)   A renewed focus on dystrophin. SRPT is the only DMD drug that makes it. “Baseline dystrophin expression can be a marker of a patient´s prognosis… even if it cannot be concluded that a given biomarker (like dystrophin) can serve as a surrogate endpoint, positive findings based on a biomarker may help….support the validity of findings on other endpoints.” There are specialists that believe dystrophin production in larger quantities will arrest the disease, so it´s possible.  The FDA acknowledging that is helpful.

Source: http://www.fda.gov/downloads/Drugs/GuidanceComplianceRegulatoryInformation/Guidances/UCM450229.pdf

Seems unlikely the FDA would guidelines if they didn´t intend to follow them.

Sarepta Leadership Change for the Better: 

Former CEO through March 2015:

1)   Publicly argued with the FDA.  Wanted to use Dystrophin as a surrogate endpoint (the FDA was right), and accused the FDA of changing their position (which the FDA denied).  They hated each other.

2)   Data mined two kids out of the Phase 2 trial for press releases knowing that data will be likely included in FDA applications, trying to manipulate public opinion.  Upset the FDA, made SRPT look shady.

New CEO as of April 2015:

1)   SRPT former chief scientist.  Very likely to relate better to the FDA

2)   Talks to FDA in private.  Doesn´t publicly air the discussions.  Avoids antagonizing

3)   Gives the FDA what they want.  Three independent labs to confirm instead of one?  Will do!  Want Phase III underway?  Yes, sir!

4)   Puts FDA relations back on track.  Per Bloomberg re the May 2015 FDA/SRPT meeting, “Rather than arguing with them on what they needed, we made sure we gave them exactly what they asked for….the FDA said this was the best meeting they’ve had with Sarepta.”

Finally, a large shareholder Richard Berry joined the Board two weeks ago.  He once ran a generalist hedge fund.  The Board really needed improvement.

Valuation:

The prior SRPT writeup had a bottoms up valuation.  I also think the below top-down sign points point to $75.  Really, there is a wide range around $75 given that many things could happen - could be $60, could be $100 by option expiration in a buyout.  Either way, money is made.  Also, note that we will have a secondary in the next few months, which I factor in.

1) When people thought SRPT was close to a go-ahead by the FDA to file a NDA (not really close though) the stock traded at $50+.

2) BRMN is estimated by analysts to have a $4B valuation embedded in their stock for their DMD drug, which has yet to get conditional approval like SRPT.  $4B would be $80/share for SRPT, post secondary and option dilution.  Their drug doesn´t work near well, will get killed by SRPT in marketing (ours is safe, theirs is not!), but does get a royalty from SRPT for SRPT sales, so no reason for SRPT to be a lower valuation.

Finally, as Majic has pointed out, this may get sold.  Old CEO was adamant in not selling, but he´s gone.  New CEO is interim, and a big shareholder and former activist investor Richard Berry is on the board.   The whole platform could be worth hundreds of dollars eventually, a $100 takeout could happen.

BMRN/Competition:

It´s probable BMRN´s competitive DMD drug also gets conditional approval, so two drugs DMD will be on the market. Yes their Phase 3 trial failed, but those same relaxed FDA requirements that help SRPT also help BMRN.  And their drug may help in some instances.

SRPT has a better drug by all accounts. BMRN´s drug has had serious safety issues so I´d strongly guess their AdCom vote is not as strong as SRPT´s, and the market will likely realize that the majority of volume will go SRPT´s way.   My $75 PT reflects that market split, but if BMRN fails there is more upside.

Red Flags: 

The short interest (36% of float) and no biotech fund involved is a huge red flag.  Even if some very good generalists are long (PointState, Point72).

However, there could be a good reason.  Under the prior CEO/FDA, the drug was unlikely to succeed soon.  Being experts they recognized that. And, the changes in the FDA´s stance, SRPT´s new CEO, and SRPT´s now being relatively compliant with FDA advice all came in Q2 and we don´t have Q2 reporting till mid August, so we haven´t had time to see if we have new holders.

Also, short interest declined 1M shares a week after the FDA gave the nod to file the NDA, and we don´t know what happened post the new FDA draft guidance. We may get a green flag by Q2 fund reporting, but by then I expect share prices to be north of 30 and the options could be significantly higher as vols increase.  The shorts won´t all cover, or perhaps even the majority, but the trend should be down. 

Finally, remember that sometimes change take time to sink in, especially when scars run very deep.

Risks:

This is still a human-driven approval process with various personalities. Who knows the exact odds.  But a 7.4x to 1 option payout suggests 13% odds of $75(ish), and that is way too underpriced. 

I exclude from risks that the Phase III trial is not successful because I will be closing this position one way or the other before the first Phase III readouts.

Catalyst

NDA filing June 30th or early July

AdCom approval October 2015