Expert Financial Analysis and Reporting

Investment Opinion

I believe that the Ofirmev approval is a game changer that can propel Cadence into a successful, medium tier, earnings driven bio-pharmaceutical company. While I am recommending purchase of Cadence, I think that it important for investors to understand the risks and uncertainties of the investment outlook. This note discusses the patent challenge to Ofirmev that was revealed on June 30, 2011. It is inevitable that Ofirmev will be genericized, the question is when. I think the timing for the first generic launch is most likely to be in early 2018.

Some investors believe that the current valuation of Cadence accurately discounts the value of Ofirmev. However, I think that valuing the company only on the basis of Ofirmev’s potential is not correct; it is only part of the investment equation. Ofirmev may enable Cadence to build a powerful hospital sales force that will allow the company to acquire and co-market other products. I would not be surprised to see the company add a new important product each year. I also think that erosion of sales after generics come to market may be less onerous for an intravenous product like Ofirmev than what is usually seen for oral drugs. Instead of a precipitous drop immediately after the launch of a generic, I would look for a more orderly, measured decline.

The nearly ten years of marketing experience with Perfalgan (Ofirmev) in Europe provides a good roadmap for estimating US sales. Extrapolating market penetration seen in Europe and taking into account a higher US price results in potential sales of $325 million to $500 million. Street expectations for Ofirmev sales in 2011 are about $25 million and for 2012 the average is about $125 million.

ANDA Filed Against Ofirmev

On June 30, the FDA website revealed that an as yet unidentified generic company filed an ANDA against Ofirmev. Although this was a little quicker than expected coming just five months after launch, most analysts and investors were expecting the filing. The news was taken in stride as the stock price increased on the next trading day. It has become routine for generics to file quickly after a launch in order to claim the coveted 180 days of exclusivity accorded to the first generic company to file against a patent. Investors have come to expect this.

The intellectual property protection (patents) for Cadence’s Ofirmev (intravenous acetaminophen) is not based on composition of matter claims which are the most rigorous of patents. The key inventions underlying and allowing for the commercialization of Ofirmev were developing a viable formulation and stable manufacturing process. Acetaminophen has been on the market for more than 60 years as an oral product. However, attempts to produce an intravenous formulation repeatedly failed because acetaminophen readily breaks down when exposed to oxygen or water

Ofirmev is protected by two key patents. Management believes that the strongest patent is a formulation patent that expires in August of 2017. However, a pediatric extension adds six months of exclusivity until February 2018. There is also a process patent that extends until June of 2001. It was not disclosed which patent the generic company is challenging, but it is almost certainly the formulation patent and possibly both.

Cadence and Bristol-Myers maintain that Ofirmev’s patents are so broad that it would be very difficult for a generic company to around. They believe that the formulation patent covers all excipients needed to produce the Ofirmev formulation. They maintain that in order to bring a generic form of intravenous acetaminophen to market without infringing their patents, the generic company would have to develop an entirely new formulation and manufacturing process.

The Bristol-Myers/ Cadence process is the only one that has ever resulted in a stable intravenous formulation of acetaminophen. It seems unlikely that a generic firm has suddenly discovered an entirely new formulation and manufacturing process that doesn’t infringe when others have failed for decades. Had anyone else identified a suitable process for stabilizing IV acetaminophen, they would have used that technology to create an intravenous acetaminophen long ago.

Possible Scenarios

I believe that the probability that this generic challenge will infringe the BMY/ CADX patents and block its introduction is very high. However, nothing is for sure when it comes to patent litigation and I have laid out a number of possible scenarios that could unfold. The Waxman Hatch Act governs the challenge of a patent and it specifies that Cadence has 45 days to sue the generic firm for patent infringement. Following this, the generic company is barred from launching a product for 30 months or until a trial concludes, whichever is shorter. It is almost always the case that a trial takes longer to conclude.

Worst case scenario is an “at risk” launch:

A generic company could choose to launch its generic after 30 months and before the case is decided at trial. This would be January of 2014. However, if the generic company then lost the case, it would be subject to treble damages and this could be several hundreds of million dollars in the case of Ofirmev.

Next to worst case:

It is unlikely that a generic company would go with an “at risk” launch because of the apparent strength of the Ofirmev patent position. If it waited for the conclusion of the trial before launching and assuming that it won the trial, it might be able to launch sometime in mid-2014 to mid-2015. I don’t think Cadence would lose a trial, but one can never be sure.

Most likely case:

If the formulation patent is as solid as management believes, there would be no launch until February of 2018.

Best case:

If the process patent also holds up, there would be no generic launch until June of 2021.

In between case:

There is another possibility. Cadence and the as yet undetermined generic filer could agree to a settlement. Both companies would agree to a time when the generic product could be brought to market. I think that this would be no earlier than mid-2016 and no later than mid-2017 although this is a subjective judgment on my part.

Here is how I rank the probabilities of each event occurring.

Injectable Generic Launches Are Different From Oral Dosage Forms

Investors have come to expect rapid sales declines when a generic to an oral dosage form comes to market. It is frequently the case that a brand name drug loses 90% of its sales volume in 18 months. There is reason to believe that this could be different for an injectable product like Ofirmev.

For another company to manufacture this product, they would need specialized equipment beyond what they would already have in place. Manufacturing capacity for injectables is more difficult to find than with solid oral dosage forms because of its greater complexity. Worldwide, the capacity for injectables is dramatically less than for solid dosage forms. Generally it takes several years for capacity to be built up and for generics to gain significant share. Moreover, the two largest suppliers of intravenous acetaminophen, Baxter (BAX) and Bristol-Myers Squibb (BMY), are barred from providing product to a generic company in the US. Because of these factors, generic penetration post entry of the first generic should be much slower than with solids; there is not likely to be 90% erosion in the first year and one half. As a guess, sales might erode at a 20% to 30% rate over the first three years.

Disclosure: The author of this article owned shares of Cadence at the time this note was written. This should be taken into account as it may introduce bias into the conclusions and interpretations that are made. In reading this note, you acknowledge that you have not used it as the sole basis of your decision making and that all investment decisions are based on your own analysis. An investment in Cadence carries substantial risk and investors could potentially lose much of their investment. The reader acknowledges that he/she has carefully read the Investment Approach, Terms/Conditions and Disclosures sections in the About Us section of the website. The reader acknowledges that he/she will not hold SmithOnStocks accountable for any investment loss that may be incurred if a decision is made to invest in Cadence.