Expert Financial Analysis and Reporting

Introduction

I recently was invited to attend a broker sponsored conference for biotechnology companies. Altogether, there were 116 companies presenting at the conference and I attended 29 individual company presentations. I regularly attend conferences like this to screen for potential new companies to cover and to get updates on companies that I already have done work on.

When I pick up coverage of a company it usually takes several months to put together a comprehensive report so no one should expect that I would go a conference and immediately become intrigued with a company(as is the case with Cubist) and recommend a buy. I just don’t work that way. I disdain instant stock analyses as is so popular on business news networks like CNBC; I am thinking specifically of their programs Mad Money and Fast Money (I think the latter should be renamed Fast Way to Lose Money). All companies are complicated and biotechnology companies are extremely complicated. It is foolhardy to think that you can listen to a 30 minute presentation and have enough information to make a sound investment decision.

However, most of my subscribers do their own research and don’t rely just on my opinion or analysis of a stock. Some have asked me for leads on stocks that they may choose to follow up on even if I have not done a detailed analysis and have not reached an opinion. This has led me to this report on Cubist (CBST) which is something new and difficult for me.  I am giving my investment impression of the Company without going through a rigorous analysis and this makes me uncomfortable; I don’t know what I don’t know. This report on Cubist is the first report of this sort that I have done.

I have not yet decided on whether I will do more research on Cubist. While I think it is a very interesting company it does not fit into the types of companies on which I choose to focus- small companies that are not well covered. Cubist is a much larger company and is well covered on Wall Street. In short, whatever you decide to do on Cubist you should not count on this report for more than part of the information needed to reach an investment conclusion. I have not done a sales and earnings projection nor have I considered how to value Cubist.

All of these caveats aside, I do like the positioning of the Company. As I explain in this article, all of the stars are aligned for companies involved in antibiotics development. World health organizations have recognized that infections caused by resistant bacterial strains are one of the greatest health threats facing mankind and politicians (especially in the US) are responding by passing or introducing legislation that makes it easier to develop antibiotics and (hold your breath) significantly increase prices. After nearly two decades in which antibiotics research was on the backburner for major drug companies, it is re-emerging as a very hot and promising area.

Cubist is beautifully positioned as the top antibiotics company in the US. This bodes well fundamentally and may make the Company an interesting acquisition candidate. However, at this time I am not issuing an opinion because I don’t feel that I have the understanding of the company that I would need to do so. This is an informational report. Because this is a new approach for me, I would appreciate feedback from subscribers as to whether informational reports like this are valuable.

Company Overview

Cubist is a fascinating company that defied conventional logic to become a huge success. It jumped into the antibiotics drug development in the late 1990s at a time when the major drug companies were jumping out. Industry critics at the time argued vociferously that there were more than enough antibiotics to treat all known bacterial infections. This led to a consensus view that there was no need for expensive new antibiotics. The industry succumbed to this pressure, largely abandoned antibiotic development and moved on to other areas of drug research.

This thinking failed to take into account that bacteria mutate and become resistant to antibiotics. Today, the thinking on antibiotics has gone full circle. World health care agencies are saying that the emergence of bacteria resistant to existing antibiotics is one of the greatest health problems facing mankind and are clamoring for the development of new antibiotics. As I will discuss in a moment, politicians in the US are enacting or trying to enact new laws that make it easier to develop new drugs and (hold your breath) significantly increase price points on important new antibiotics.

Cubist zigged when the industry zagged by putting its total focus on antibiotics. It licensed Cubicin (daptomycin) from Eli Lilly & Company (LLY) in late 1997 and received FDA approval for Cubicin in the U.S. in September 2003 for the treatment of complicated skin and skin structure infections and bacteremia/endocarditis in 2006. In effect, Cubist entered a market that others were exiting with a drug that Eli Lilly had given up on. The conventional wisdom early on was that this was a doomed strategy and Cubist was going against all of the bright thinkers in the pharmaceutical history.

So what happened? Well Cubist against all expectations has built Cubicin into a blockbuster drug that should exceed $1 billion of sales in 2014. Without meaningful competition from major companies, it was able to establish itself as the top antibiotics company in the US in terms of commercial infrastructure and new product development. It now has an exciting new product outlook to go with Cubicin

New Product Outlook is Exciting

Cubist has been very busy on the acquisition front and has added three promising antibiotics to its portfolio through acquisitions:

• ceftolozane/tazobactam for the treatment of certain serious Gram-negative bacterial infections in the hospital was acquired through the acquisition of Calixa in December 2009,
• Sivextro (tedizolid) which is effective against MRSA and other gram positive organisms was acquired through the acquisition of Trius in September 2013.
• Dificid (fidoxomicin) for the treatment of Clostridium difficile-associated diarrhea (CDAD) was acquired through the acquisition of Optimer in October 2013.

Through internal development, Cubist discovered sutromycin. This is an oral lipopeptide (same antibiotic class as vancomycin) that is being developed (like Dificid) for Clostridium difficile-associated diarrhea (CDAD). Phase 3 trials were started in July 2012.

Trius was a stock which I first recommended in May of 2012, a little over one year before it was taken over by Cubist. In a series of reports that are available on my website, I projected that Sivextro could achieve worldwide sales of $1 billion in 2020. The FDA approved Sivextro on June 20, 2014 for the treatment of complicated skin and soft tissue infections (cSSTI). A Marketing Authorization Application (MAA) was filed with the European Medicines Agency seeking approval for the same indication and approval could come in 1H, 2015.

Cubist has publicly said that ceftolozane/tazobactam will achieve greater peak sales than Cubicin. It is a combination of the cephalosporin antibiotic ceftolozane and the beta lactamase inhibitor tazobactam. It is particularly active against dangerous strains of gram negative bacteria such as Pseudomonas aeruginosa, Actinobacter and extended-spectrum beta-lactamase producing Escherichia coli and Klebsiella strains that have become resistant to the current mainstays of therapy, the carbapenems.

The FDA has assigned a Prescription Drug User Fee Act (PDUFA) action date of December 21, 2014 for ceftolozane/tazobactam. Cubist expects to submit an MAA in 2H, 2014 to the EMA. If approved, I would expect marketing to begin in the US in mid-2015 and in Europe in early 2016.

Legislative Developments Could Be Very Favorable for Antibiotics Developers

Antibiotics provide striking health and economic benefits. A ten day course of antibiotics used in life threatening infections can save patients’ lives. However, the pricing of antibiotics does not reflect this value. Cubicin is priced at about $2,500 per course of therapy or roughly $250 per day. Let’s compare this to oncology drugs in which an improvement of four months in median overall survival is considered a major advance and routinely bring prices of $70,000 to $100,000 per course of therapy. With this prevailing price structure, it is much easier to come up with blockbuster commercial successes (if not clinical successes) in oncology and very difficult in antibiotics.

There is now a bill in Congress to address this pricing issue. On May 11, the Developing an Innovative Strategy for Antimicrobial Resistant Microorganisms (DISARM) Act was introduced. This bipartisan legislation addresses the critical shortage of research and development for the production of advanced antibiotics that can treat resistant bacterial infections. Among other things, it addresses the payment and delivery systems that currently make it undesirable for companies to pursue new antibiotic treatments; the legislation is intended to encourage a renewed interest in rebuilding the antibiotic arsenal.

The problem with pricing a new antibiotic is that because it is only used for ten days, the price per day seems very high. Cubicin is currently priced at about $250 per day. To achieve the same economic return as cancer therapies it would have to be priced at $6,000 or more per day. Because antibiotics used in hospitals are usually covered by DRGs, this is just not possible as the price of the drug could be larger than the DRG. The DRG is a mechanism developed by Medicare that establishes a fixed price for a medical procedure in which the drug, other products and health care professional fees are lumped.

Most infections in the hospital can be treated with older generic antibiotics and it is not appropriate to use new antibiotics if older ones work. This is not only because of price but because over-exposure to bacteria can result in the emergence of resistant strains. It is important to limit the use of new antibiotics to delay as long as possible the emergence of resistant strains. They should only be used when older antibiotics are not effective or when in the opinion of the physician they are not likely to be effective.

The bottom line is that appropriate usage of antibiotics restricts their use to small patient populations not adequately treated by generic antibiotics. However, it is extremely important to understand that when used in this population, they have enormous benefit. They absolutely save lives. There needs to be a mechanism that allows pricing in the thousands of dollars per day range instead of the current hundreds of dollars per day price level that now prevails so that there is the same commercial payoff for success as now prevails in oncology. If this occurs, it will be an enormous benefit for Cubist and other antibiotic developers.

The introduction of DISARM follows the passage of a very positive piece of legislation in October, 2012 called the Generating Antibiotics Incentives Now Act or GAIN. This was intended to spur development of new antibiotics through streamlining a regulatory process which has been oppressive for much of the last decade. Responding to the prompting of Congress, FDA is beginning to approach regulatory approval of new antibiotics with the same sense of urgency as drugs for cancer. The end result will be quicker approval for both new drugs and new indications for existing antibiotics.

Cubicin has About Four Years of Remaining Patent Life

The most important negative issue for Cubist is that the composition of matter patent has expired on Cubicin. However, Cubist developed a portfolio of patents covering other patentable features such as use, formulation and manufacturing. The patent portfolio was challenged by Teva (TEVA) and rather than going to trial a settlement was reached which allows Teva to introduce a generic formulation of Cubicin in June 2018.

There have been a number of other ANDA filers in addition to Teva that have challenged the Cubicin patents. This led to Markman hearings on the patent challenge of one other company that is preparatory to a trial. Based on this Markman hearing, many investors concluded that Cubicin’s patent position is stronger than previously thought so that further generic competition won’t arise until 2020. If this is true, Teva will be the only other company producing daptomycin in the period from med-2018 to 2020. This would result in a gradual erosion of sales following Teva’s entry, not a meltdown. This makes it easier for Cubist to handle the patent expiry through having more time to establish Sivextro and ceftolozane/tazobactam as well as to acquire new products through acquisition or internal discovery.