Expert Financial Analysis and Reporting

Investment View

I believe that Transcept’s (TSPT) Intermezzo is an important new drug for insomnia and will be a commercial success. I am anticipating that Transcept’s marketing partner Purdue Pharmaceuticals will launch the product in mid-2012. There was a time when new product approvals and launches produced investor exuberance. Now they seem to be met with dread. Managed care has emerged as a major factor impeding launches as gaining formulary acceptance is a time consuming process. Last year, new product launches of Human Genome Sciences (HGSI) Benlysta, Auxilium’s (AUXL) Xiaflex and Cadence’s (CADX) Ofirmev did not meet investor expectations and the stocks of these companies performed poorly. I believe that most investors are extrapolating this experience to Transcept’s Intermezzo in 2012 and 2013 and are expecting modest sales and poor stock performance.

I share the concerns about the slow takeoff and have only estimated Intermezzo sales of $1.5 million in the second half of 2012. Thereafter, I look for significant growth as my model projects sales of $40 million in 2013, $140 million in 2014, and $235 million in 2015. Corresponding EPS estimates are a loss of $0.80 in 2013 followed by profits of $0.80 in 2014 and $2.29 in 2015. Clearly, if my estimates are met, this can be a very good long term investment. Simply applying a 10x P/E ratio to the $2.29 estimate would result in a $23 stock in 2015.

I think that the view that the launch will be slow and will result in poor stock performance is pervasive in the market and well discounted in the current stock price. This gloomy sentiment creates lots of potential for upside surprise in the coming year. This along with the my belief in the long term potential of Intermezzo causes me to lean against what I believe to be the consensus view that the stock of Transcept will not do well in 2012 and recommend purchase.

Intermezzo’s Unique Role in Insomnia

Insomnia encompasses several syndromes: (1) difficulty falling asleep, (2) difficulty staying asleep (middle of the night awakening or MOTN), (3) waking too early and (4) poor quality of sleep. The most widely used drugs currently are the GABA A receptor agonists Ambien, Ambien CR and Lunesta, which produce an eight to nine hour drug sedative effect. They are taken at bedtime to produce sleep onset and to then prevent waking too early. Because of their long half-lives, they are not appropriate to take for MOTN and they are not approved for this indication. The FDA is particularly uncomfortable with their potential for next day residual effects such as grogginess and disorientation.

Intermezzo is the first product to receive an indication for MOTN because of three highly desirable characteristics: (1) it needs to be used only if MOTN occurs, (2) it quickly returns people to sleep and (3) its low dosage of active drug avoids or minimizes next day residual affect. Intermezzo is a low dose, sub-lingual formulation of the generic drug zolpidem, the active ingredient in Ambien and Ambien CR, the most widely prescribed insomnia agents in the U.S.

Ambien, Ambien CR and Lunesta are not approved for MOTN because they have sedation effects that last for eight to 10 hours. If a patient wakes up during the night and takes one of these drugs, physical performance could be seriously impaired the next day. Another drawback of long acting drugs is that they must be taken prophylactically in anticipation of a middle of the night awakening. Intermezzo is only used when needed. This reduces the exposure to drugs and reduces pills taken, which potentially provides an important safety advantage.

Intermezzo’s novel sub-lingual formulation allows about 25% of the dosage to be quickly absorbed through the tissues of the mouth, producing a rapid onset of effect. The