Expert Financial Analysis and Reporting

Investment Overview

Santarus was founded to commercialize Zegerid for the treatment of gastrointestinal reflux disease (GERD) and ulcers. It competed in the proton pump inhibitor class of drugs, which includes Nexium, Prilosec, Prevacid, Protonix and Aciphex. Despite being up against the sales forces of much larger companies like Astra-Zeneca (AZN), Abbott (ABT), Wyeth and Johnson & Johnson (JNJ) and competing in an area in which usage and prices are closely controlled by managed care; Santarus built Zegerid sales to an impressive $119 million in five years (2009). Then misfortune struck as Zegerid’s patents were challenged and to the surprise of the company and many investors the generic challenger prevailed in court. This allowed generic entry against Zegerid in mid-2010 and led to a sharp decline in sales.

 

Prior to the loss of exclusivity on Zegerid, Santarus had begun to diversify by licensing the anti-diabetic drug Glumetza in 2008 from its developer Depomed (DEPO). At the time, its sales were about $20 million. The anti-diabetes market presents marketing and managed care challenges comparable to the PPI market, but once again management was able to find a successful commercialization strategy. Sales of Glumetza could reach $114 million in 2012 assuming no generic competition.

 

The company’s demonstrated prowess in marketing based on the success of Zegerid and Glumetza has enabled it to strike a number of new licensing deals. As a licensee, Santarus fills an interesting space. It is an attractive partner to small companies that need sales and marketing prowess but are unable to attract the interest of larger companies because the sales potential of their products is too small, the patent position is not solid or some other reason. For example, Santarus was able to in-license and introduce Cycloset, a unique, effective and needed anti-diabetes drug that could make a significant contribution to the treatment of diabetes. However, it is based on the discovery of a new application for an existing drug and will only have three years of patent exclusivity.

 

I project that Santarus will have sales of about $96 million in 2011 from its three marketed products: Zegerid, Glumetza and Cycloset. Glumetza is by far the most important of these products. Unfortunately, all three of these drugs have patent issues. Zegerid is already generic and Cycloset will go generic in early 2015. Glumetza is also the subject of a generic challenger. Under current law, when a generic company issues a challenge to the enforceability of patent(s) of a brand name product, it cannot launch a product for 30 months or until the conclusion of a trial, whichever comes first. The 30 month stay for Glumetza expires in May 2012 and the trial is scheduled for August 2012 so that it could be 2013 before the court decides on the validity of Glumetza’s patents. In May 2012, the generic challenger can choose to launch its product. However, it would do this at great risk for if it then loses the court case, it is liable for treble damages on losses suffered which in the case of Glumetza could be tens or hundreds of millions of dollars. Santarus/ Depomed have what appear to be strong, defendable patents, the first of which expires in 2016. They may, however, choose to reach a settlement with the generic firm in which it would allow a generic to be introduced sometime between May 2012 and 2016. This takes away uncertainty for both companies and I believe that it is the likely outcome of this situation. The question is how long a settlement might protect Glumetza; my best guess is that early 2015 would be a good compromise.

 

For obvious reasons, Santarus is looking to move away from products with short commercial lives. It has turned its focus on specialty markets which require limited numbers of sales reps and are not as tightly watched by managed care. This has led to the in-licensing of a new wave of products which will be the heart of the Santarus product line in the 2015 to 2020 period. First in line is budesonide MMX for treating ulcerative colitis, which could reach the market in 2013; management believes it has peak sales potential of $300+ million. Next up is Rhucin; a specialty product for hereditary angioedema; management believes it has peak sales potential of $200+ million. Following them is Rifamycin SV MMX for travelers’ diarrhea which could reach the market in 2014 and which management believes has peak sales potential of $150+ million. Longer term it is working on SAN-300 an anti-VLA-1 antibody for inflammatory disease. It is also probable that other products will be acquired or in-licensed along the way. These new products should enjoy more predictable and longer commercial lives because of better patent protection coupled with complexities for generics trying to duplicate their action.

 

The investment outlook for Santarus in the period beyond 2015 looks very promising as budesonide MMX, Rhucin, Rifamycin SV MMX and the likelihood of other in-licensed products should lead to strong sales growth. The period from now to 2015 is muddled by the patent situation on currently marketed products, Zegerid, Glumetza and Cycloset. Because of its dominance, Glumetza is the most important to assess. There are two extreme scenarios to consider. The first is that the Glumetza patents are successfully defended and the product enjoys exclusivity through and beyond 2016. In this case, Santarus would be an extremely attractive stock. The second extreme would be that the generic company does launch at risk in May 2012 leading to a sharp decline in Glumetza sales. In this case, investors would probably see a decline, probably significant, in the stock. There are then a number of in-between scenarios that could come about if a settlement were reached between Santarus and the generic challenger. My most likely case calls for a settlement that results in generic competition in early 2015. I present sales scenarios for my best case, worst case and most probable case in the following table.

 

 

Best Case, Worst Case and Most Likely Case Scenarios for Sales 2009-2017
Sales ($000)
		2011	2012	2013	2014	2015	2016	2017
Best Case
Zegerid		44,975	33,000	8,000	2,000	1,000	1,000	0
Cycloset		5,700	13,200	17,600	4,000	1,000	1,000	0
Glumetza		45,389	113,677	125,044	137,549	151,304	166,434	183,077
Budesonide MMX				5,000	20,000	40,000	75,000	100,000
Rhucin					10,000	22,000	30,000	40,000
Rifaxin MMX						10,000	15,000	22,500
Total Sales		96,064	159,877	155,644	173,549	225,304	288,434	345,577
Worst Case
Glumetza		45,389	73,890	8000	5,000	3,000	1,000	0
Other Products		50,675	46,200	30,600	36,000	74,000	122,000	162,500
Total Sales		96,064	120,090	38,600	41,000	77,000	123,000	162,500
Most Likely
Glumetza		45,389	113,677	125,044	137,549	41,265	5000	0
Other Products		50,675	46,200	30,600	36,000	74,000	122,000	162,500
Total Sales		96,064	159,877	155,644	173,549	115,265	127,000	162,500

 

Source: SmithOnStocks.com estimates

 

Investment Opinion

I think that Santarus has the potential to be a very good investment over the next five to ten years, but I do not own the stock and I am not actively recommending it. There are two principal reasons for this. The first is the uncertainty of the Glumetza generic situation with the potential (probably small) of generic competition in mid-2012. The second is that my investment outlook is very dependent on a very promising pipeline led by budesonide MMX. Erratic and risk adverse decision making by the FDA makes it difficult to have confidence that new products will be approved in a timely manner even when clinical results are positive.

 

In order for me to aggressively recommend the stock, I would want to see a de-risking of these two issues. A favorable settlement with the generic challenger to Glumetza might resolve one of my concerns. While clinical results look excellent, making a decision on whether budesonide MMX and other pipeline candidates will move smoothly through the FDA regulatory process is more difficult. Adding to short term uncertainty, the company is awaiting the outcome of an important 12 month safety study on budesonide MMX, results of which could be released at any time. Weighing the uncertainties against the promise of the new pipeline keeps me in a neutral position at this point in time.

 

In looking at Santarus, I have tried to determine a potential price target for the company for the scenarios shown in the previous table. I have chosen to use price to sales to determine the potential market capitalization under each scenario in 2016. I believe that this is more accurate that trying to value the company on an earnings basis as sales are much more predictable than earnings. Generally, specialty pharmaceutical firms sell at roughly 3 time’s sales although this can vary widely and is highly dependent the growth prospects for key products and the intellectual property position.

 

Under the best case sales scenario in 2016, I would assign a price to sales ratio of 3.5 if investor consensus is that the Glumetza patents will provide protection through 2020. If there is concern about the patents, I would use a price to sales multiplier of 2.0. Moving on to the most likely scenario and worst case scenarios, my 2016 sales estimates for both are about the same at $123 million and $127 million. I think that the market would place a 4.0 times sales value on 2016 sales in both cases as sales would be driven by budesonide MMX and Rhucin that should not be subject to generic challenges for some time. This results in a 2016 price target of $7.56 for the worst case and $7.81 for the most likely scenario. This is shown in the following table.

 

Price Target for Santarus For Several Scenarios
	2016 sales (millions)	Estimated Price to Sales Ratio	Market Capitalization (milions)	Shares Outstanding (millions)	2016 Price Target
Best case
Glumetza patents good until 2021	$288	3.5	$1,008	65	$15.51
Glumetza patents look vulnerable	$288	2.0	$576	65	$8.86
Worst case	$123	4.0	$492	80	$6.15
Most likely case	$127	4.0	$508	65	$7.82

 

There is a wild card in the investment scenario that could only be very positive for Santarus. The company is challenging the court ruling that the Zegerid patents are invalid. The chance of this winning is very small, but if it did it would be a windfall for the company. They would regain perhaps $30 million or more of sales that are now being achieved by the generic competitor and Zegerid would be patent protected for several more years. If this were to happen, I think the stock could increase quickly to $5.00. Again, I think that the chance of the decision being overturned is very small.

 

Zegerid (omeprazole, sodium bicarbonate)

Zegerid combines omeprazole which was marketed by Astra Zeneca as Prilosec with baking soda. The problem with omeprazole is that it is destroyed by acid in the stomach and has to be given as an enteric tablet that is resistant to stomach acid, passes through the stomach and releases the drug in the small intestine. This process takes an hour or two for the product to be effective. Baking soda has two attributes. It is a quick acting effective agent in and of itself as it reduces stomach acidity and relieves the symptoms of GERD and ulcers. It also allows omeprazole to be absorbed in the stomach as it reduces acidity. Based on personal experience, I consider it as more effective than other PPIs.

 

When the generic competitor to Zegerid entered the market, Santarus countered with an authorized generic. Because no other generic companies have filed ANDAs, the two companies are splitting the market between them and this could continue for some time. In addition, Santarus licensed Zegerid to Schering-Plough (now part of Merck) for over the counter use in the US and to Glaxo for sales in emerging markets. These should provide modest royalty streams for some time. Sales of Zegerid are running at about $40 million per year, but I expect new generic companies to enter the market and significantly erode this sales base.

 

Glumetza (metformin)

The major classes of oral drugs for type II diabetes work through stimulating the production of insulin, making cells more sensitive to insulin or reducing the output of glucose produced by the liver. The intent is to delay the use of or the amount of insulin required to treat diabetes. Metformin is the cornerstone of type II diabetes therapy. Most patients are started on metformin and drugs from other product classes- sulfonylureas, DPP-IV inhibitors, thiazalidones, etc. -are added as needed.

 

Metformin is viewed as the essential first line therapy for the treatment of type II diabetes. There is a low risk of hypoglycemia and it causes few side effects with the most common being gastrointestinal upset. Lactic acidosis (a buildup of lactate in the blood) can be a serious concern if metformin is overdosed. Metformin helps to reduce LDL cholesterol and triglyceride levels, and is not associated with weight gain. It and Cycloset are the only anti-diabetic drugs that have been shown to prevent the cardiovascular complications of diabetes.

 

Metformin was first found to reduce blood sugar in the 1920s, but was forgotten for the next six decades as research shifted to insulin and other anti-diabetic drugs. It was re-discovered and introduced to United States in 1995. Metformin is now believed to be the most widely prescribed anti-diabetic drug in the world; in the United States alone, more than 48 million prescriptions were filled in 2010.

 

Glumetza offers improved deliverability over immediate release metformin. Its tablets are retained longer in the in the upper GI track and release metformin more slowly than immediate release products. Dose-related gastrointestinal or GI side effects may occur in up to 50% of metformin treated patients with the generic immediate release dosages. Glumetza often allows physicians to titrate dosing to reach up to 2,000 mg per day without a significant increase in GI side effects compared with 1,500 mg per day of immediate release metformin. Doctors are able to push the dose much faster and get patients up to the 2,000 mg desired level.

 

Glumetza is dosed once daily which also increases patient compliance. The immediate release dosage forms of generic metformin are started as 500 mg given twice a day for one week and are then titrated to 500 mg given at breakfast and 1000 mg given at dinner in the second week. Glumetza is as effective as immediate release metformin and has the advantage of a once a day dosage. The principal advantage may be the greater tolerability and ease in getting patients to the desired dosage.

 

Glumetza competes in the branded segment of the metformin market which is based on improved drug delivery. Approximately 80% of the 50 million annual prescriptions in the single agent metformin market are written for immediate release generic metformin products which are taken twice daily. The major competitors to Glumetza in the branded product segment are Fortamet and Glucophage XL, which are also once daily extended release forms of metformin available in 500 mg and 1000 mg tablets.

 

Santarus is recovering from a supply issue that resulted in a recall of the 500 mg dose and which was only resolved in early January of 2011. This was a problem because many physicians like to titrate by starting with a dose of 500 mg. With the 500 mg not being available for a fairly extended period of time, some physicians developed other habits. Santarus is now beginning to win back some of those patients. Fortamet seems to be having some difficulty supplying, or meeting, their demand and Glumetza is also benefiting from this.

 

To increase filling of prescriptions being written for Glumetza but not dispensed at the pharmacy, Santarus is introducing a new e-voucher and savings card programs that will reduce out-of-pocket costs for patients with commercial insurance. There are estimates that 25% and perhaps as high as 50% of Glumetza prescriptions written are not filled because the patient doesn’t get the prescription filled or the pharmacist talks him into a less expensive generic. This program could reduce the co-pay for Glumetza to the approximate level of a generic.

 

Santarus and Depomed just announced a change in their agreement in which Santarus will assume will assume broad commercial, manufacturing and regulatory responsibilities to replace a promotion agreement that the companies entered into in July 2008. Under the new agreement, Santarus will record all revenue from Glumetza sales in the U.S. effective September 1, 2011. Depomed will receive a percent of net sales that starts at 26.5% in 2011, increasing to 29.5% in 2012, 32.0% in 2013 and 2014 and 34.5% in 2015 and beyond. Over the next few months Depomed will transition most U.S. commercial activities for Glumetza to Santarus including managed care contracting, pricing, certain manufacturing activities and distribution.

 

Importantly, Santarus has announced that it is increasing the price of Glumetza to be roughly in line with Fortamet. This is effectively a 60% price increase. Part of this price increase will be negated by absorbing the cost of reducing the co-pay to make Glumetza more affordable. The price increase most importantly along with other factors should lead to a sharp increase in sales as was shown in the earlier table.

 

Cycloset (bromocriptine)

Cycloset is a quick-release formulation of bromocriptine mesylate, a dopamine 2 receptor agonist. No other drugs approved for type II diabetes have this mechanism of action, which targets central dopamine activity. It improves postprandial glucose levels without increasing insulin release by acting as an insulin sensitizer that improves responsiveness to insulin. Cycloset works well in combination with metformin and other oral anti-diabetic products. It will be used possibly as a first but more likely as a second add-on to metformin.

 

The clinical trials supporting approval enrolled 3,723 patients in four randomized, double-blind placebo-controlled clinical studies. Reductions in hemoglobin A1c ranged from 0.4% to 0.9% in adjusted mean relative to placebo, and the percent of patients reaching a hemoglobin A1c level of less than or equal to 7.0% improved from 10% seen with placebo to more than 35% with Cycloset. These results are roughly in line with those seen with Merck’s Januvia which has emerged as the favorite drug as an add-on to metformin and is currently on track to record sales of over $4 billion in 2011.

 

Patients on Cycloset are started with 0.8mg dose and then titrated with a goal to reach a daily dose of 4.8 mg per day or at least a dose of 1.6 mg daily. Nausea is the most troubling side effect requiring the titration followed by fatigue, vomiting, headache, hypotension and dizziness. These side effects were usually reported during the titration period and lasted about two weeks. After the titration period, the rate of nausea was similar between Cycloset and placebo. Importantly, hypoglycemia rates with Cycloset were similar to placebo.

 

Cycloset is the first and only anti-diabetes drug approved subsequent to the FDA cardiovascular risk guidance issued in December 2008 which required safety studies for both new and existing drugs to demonstrate that they do not increase cardiovascular. This followed reports that the widely used drug Avandia might lead to increased cardiovascular events. Cycloset enrolled 3,070 patients in a one year safety study in which 2,054 received Cycloset and 1,016 received placebo. There was a 42% reduction in a prespecified composite cardiovascular endpoint with Cycloset relative to placebo even though the majority of study patients were receiving other drugs control blood pressure, glucose and lipids, and one-third of these studies' patients had pre-existing cardiovascular disease.

 

Cycloset and Glumetza are highly complementary and are promoted to the same physician audience by 110 sales representatives. The target physician market is the 12,000 physicians who account for 25% of prescribing of type II anti-diabetes drugs. They should be able to easily add Cycloset as a second detail to the same physician group. Managed care is very much aware that treatment of type II diabetes agents can reduce complications and reduce costs. Experience with Glumetza suggests that managed care is more open to placing anti-diabetic drugs on formulary and to placing fewer restrictions on access.

Santarus believes that combined, peak sales for Glumetza and Cycloset could reach $300 million to $400 million. Santarus will receive about 60% of the gross margin on Cycloset

 

The primary patents expire in 2014 or early 2015. This is the reason why larger pharma companies had no interest in the product. Santarus feels like they can get four or five years of exclusivity on the product which makes it worthwhile.

 

The launch of Cycloset to date has been somewhat disappointing. Throughout biotechnology, product launches have been slower than expected owing to a variety of factors with the most important being the need to cross payor hurdles to get on formulary and an aversion to new drug products on the part of physicians until the product profile is firmed up in post marketing. I attribute this in large part to the issues with Vioxx and Avandia.

 

Budesonide MMX (budesonide)

Please refer to a previous article “Santarus' Late Stage Pipeline Product Budesonide MMX Is Critical to Future Growth” for an in-depth discussion of budesonide MMX and its role in ulcerative colitis.

 

Rhucin (recombinant C1 esterase inhibitor)

Please refer to a previous article “Key Companies and Products in the Market to Treat the Orphan Disease Hereditary Angioedema” for an in-depth discussion of Rhucin and its role in treating hereditary angioedema.

 

Rifamycin SV MMX

This product was also in-licensed from Cosmos in December 2008. It uses Cosmos’ drug delivery technology to target the broad spectrum antibiotic Rifamycin to the intestine. It is being developed to treat traveler’s diarrhea and could reach the US market in 2013. The company estimates that peak US sales could reach $150 million to $250 million.

 

Rifamycin is a broad spectrum antibiotic that has been used in Europe for over 20 years. The MMX drug delivery technology leads to negligible system absorption and no clinically relevant bacterial resistance has been seen to date. Activity appears similar to Salix’s Xifaxin (rifaximin) which had sales of $250 million in 2010. Xifaxin is indicated for hepatic encephalopathy and traveler’s diarrhea. I don’t have a breakdown of sales from the two indications.

 

The company is currently enrolling patients in a phase III study using twice a day dosing for three days to treat traveler’s diarrhea; Xifaxin requires three times per day dosing for three days. Santarus expects to complete enrollment in 1H, 2012.

 

SAN-300 (anti-VLA-1 antibody)

VLA is a type of integrin which are adhesive molecules that mediate interactions between cells and between cells and the extracellular matrix. They have an effect on the migration, retention and proliferation of activated T-cells at the sites of chronic inflammation. Animal studies of antibodies against VLA-1 have shown activity against rheumatoid arthritis, psoriasis, inflammatory bowel disease and psoriasis.

 

This product was initially created as a humanized antibody by Biogen Idec. A phase I trial will begin in March 2011. Santarus, data permitting, will develop the product through phase IIb and then license it.

 

 

 

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