Expert Financial Analysis and Reporting

Investment Opinion

I am recommending purchase of Savient Pharmaceuticals at the current price of $2.35. My recommendation is based on the estimate that Krystexxa sales could reach $209 million in 2015 and my valuation methodology suggests that the stock could sell at $6.40 to $8.50 in 2015. The initial launch of Krystexxa has been slow and has discouraged many investors. I think that sales may rise only modestly until mid-2012, before they begin a significant upward inflection. The price may move in concert with Krystexxa sales so that the price movement could be lackluster until mid-2012. Hence, my recommendation is geared to the long term and is not a call based on short term prospects.

 

Investment Overview

Savient is an emerging biotechnology company that is in the early stages of launching its first product, Krystexxa (pegloticase) for chronic, refractory gout patients. Krystexxa was approved on September 10, 2010. Shortly after approval, the stock hit a high of $21 on the basis of the approval and the announcement that the board had decided to sell the company. However, no buyers surfaced and the company then decided to launch Krystexxa on its own. So far, the launch has been disappointing and the stock has dropped to a recent close of $2.29. The key investment issues are as follows:

1. The disappointing launch has led many investors to conclude that the chronic, refractory gout market is tiny and that patients are difficult to find and treat. Because there have been no drugs approved for chronic, refractory gout, there is no clear understanding of the market size and the skeptics may be proven right. However, the overall size of the gout market is huge with 3.2 million patients being treated and it is reasonable to think that a meaningful number have progressed to chronic, refractory gout. The FDA estimated that there are 50,000 chronic, refractory gout patients and a detailed survey performed by a consulting firm for Savient concluded that there are 120,000 such patients. The US addressable market based on 50,000 patients is over $1 billion.
2. The initial launch was poorly executed and sometimes the initial launch determines the ultimate fate of a product. However, Krystexxa represents a breakthrough for chronic, refractory gout and there is no other effective therapy. I think that most patients with chronic, refractory gout when they become aware of the product will want to try it.
3. The company is burning cash at a prodigious rate as it is on track to burn over $100 million in 2011. It raised $230 million in a convertible note offering in February 2011 which comes due in 2018 and converts at $11.54 per share. At the end of the third quarter, Savient had $203 million of cash on hand. According to management guidance, this cash should last 18 months if the company decides to launch Krystexxa in Europe without a partner. If Krystexxa is partnered in Europe, current cash along with milestone payments will stretch cash out much further, potentially beyond cash flow break even.
4. There is significant new drug development in the treatment of chronic gout with Takeda’s Uloric (febuxostat) which was approved in February of 2009, Ardea’s (RDEA) lesinurad and BioCryst’s (BCRX) BCX4028 leading the way. Beyond 2017 there is the potential that these drugs when combined with the current gold standard drug allopurinol could change the natural history for gout patients, reducing the number entering the chronic, refractory state and limiting the market potential for Krystexxa. However, none of these drugs promise to have the efficacy of Krystexxa; about 3% of gout patients do not respond to are contraindicated or intolerant of allopurinol; and refractory gout takes many years to reverse. Also, lesinurad and BCX4028 won’t be on the market until 2014, 2015 or 2016 and their clinical profile has yet to be defined in phase III trials. If this is a concern, it is for the 2017 and beyond time frame.
5. A combination of factors such as the complexity as the pegloticase molecule, orphan drug status and issued patents makes generic competition to Krystexxa unlikely over the next decade or longer. It has enviable protection from generic competition which sets it apart from many other biopharm companies.
6. Management is guiding investors to expect only modest upward inflection in sales until mid-2012. Hence, investors who buy now may have to wait for a half year before seeing an upward turn in sales that could trigger an upward stock

 

As is almost always the case with emerging companies, there is lots of uncertainty with this stock and in the worst case in which Krystexxa continues to disappoint and the company significantly runs down its cash balance, there could be considerable downside. However, there is very significant upside if the market is as large as 50,000 patients, which is my base case assumption. The bear case is that there are substantially fewer than 50,000 patients and that Savient sales force which is targeted at rheumatologists will only to be able to reach a modest percentage of eligible patients because most are treated by general practitioners.

 

I have put together a sales model that results in Krystexxa sales growth as follows: 2011 ($6 million), 2012 ($24 million), 2013 ($55 million), 2014 ($126 million) and 2015 ($209 million). These estimates are based on the following assumptions: (1) 50,000 gout patients in 2011 with annual growth of 4%, (2) a price of $2,300 per infusion, (3) responders receive 18 infusions over nine months, (4) 58% of patients are non-responders who receive only four treatments and drop out, (4) Krystexxa penetrates 12% of the US market in 2015 and (5) European sales ramp comparably to US sales with a lag factor of two years.

 

I prefer to value emerging companies on the basis of sales estimates rather than earnings. Sales are more predictable than earnings for an early stage company and this is what investors pay the most attention to. Based on market capitalization to sales ratios that I have seen with other emerging biopharm companies, I think that Savient’s market capitalization could reach 3 to 4 times 2015 sales of $246 million. This results in a target price of $6.40 to $8.50 in 2015. Needless to say, these estimates are highly subjective.

 

Initial Launch of Krystexxa is Disappointing

The Krystexxa launch has been unimpressive as is seen by quarterly sales results: 4Q, 2010 ($18,000), 1Q, 2011 ($300,000), 2Q, 2011 ($1,400,000) and 3Q, 2011 ($1,900,000). My estimate for 4Q, 2011 is $2,300,000 which would result in full year sales of $5,900,000.

 

Disappointing new product launches have become the norm in biotechnology. The common thread appears to be the delay in obtaining a J code and a general caution on the part of physicians about new drugs. This has played a role in Kystexxa’a slow takeoff, but there are other factors to consider.

 

The launch of Krystexxa by the previous management team could be a Harvard business school case study on how not to launch a new product. Management in late 2010 was focused on selling the entire company instead of Krystexxa. The marketing material for the launch was based only on the package insert and the drug was distributed through a specialty pharmaceutical company.

 

In early 2011, a new management team was brought in that put in place 60 sales representatives and began a full commercial launch on February 28, 2011. Preparation for the launch should have been started long before the approval and the sales force should have been brought on board shortly thereafter.

 

There were a number of other problems that affected the launch.

1. The phase III trials were successfully completed in late 2007. However, a change in pegylation created regulatory issues that delayed approval for nearly three years so that there were no patients available to roll over from the phase III trials into the commercial launch. For the same period, there were almost no physicians working with or prescribing the drug.
2. The results of the phase III clinical trial had not been published in a peer reviewed journal so that the only clinical information available was what was contained in the package insert. The phase III results were finally published in the Journal of the American Medical Association August 17, 2011 issue.
3. Physicians were poorly educated and upon taking a first look at the drug saw a black box in the package insert warning of anaphylaxis. This coupled with lack of familiarity was a major deterrent to writing prescriptions.
4. The company has been operating with a temporary J code that can slow reimbursement sometimes for several months. This can be an issue as Krystexxa is given every two weeks in an infusion that costs $2,300. If reimbursement is slow, there is the potential for a rapid buildup in accounts receivable for a providor. A permanent J code was issued on November 3, 2011 and will become effective in January of 2012. Management estimates that it will take six months for the J-code to be loaded into the entire payer system. This will allow electronic filing of claims, payment in about 30 days and negate the accounts receivable issue.

 

It is difficult for me to sort out the effect of the three potential causes for the disappointing launch: (1) the difficult environment for all new drug launches, (2) the market addressed may be very small and patients hard to locate, and (3) old management bungled the initial launch. However, if the FDA and consulting firm estimates of market size are anywhere near correct, Krystexxa has enormous potential as it is a breakthrough therapy for chronic, refractory gout. My inclination is that the latter and more positive point of view is correct, but this can only be verified over time.

 

About Gout

Gout is a form of inflammatory arthritis caused by excessive blood levels of uric acid, the end product of the metabolic breakdown of certain foods and internal body functions. Uric acid is poorly soluble so that as levels exceed 6.8 mg/dl in the blood, it crystallizes, forming lumpy deposits in tissues that trigger an inflammatory response. These crystalline deposits occur in joints, tendons, and surrounding tissues.

 

Over time, these deposits (larger and more noticeable deposits are known as tophi) can become quite large, unsightly and interfere with the functioning of joints. In over 50% of cases, the first joint affected is the big toe and the popular image of the gout sufferer is an obese person with his foot propped up and bandaged. Gout flares up at unpredictable times and these flares can be painful and debilitating. If not controlled, over several years gout can progress and cause joint deformities that debilitate the patient and put patients at risk for developing kidney stones, kidney damage and heart disease.

 

Diet related factors account for an estimated 12% of gout cases and genetic factors around 60%. It is often associated with metabolic syndrome and can be triggered by physical trauma and surgery.

 

Drugs Used to Treat Gout

Earlier and milder stages of gout can be treated with diet and exercise. As gout progresses, it is treated with two types of drugs. Pain relievers like the non-steroidal anti-inflammatory drug are used to treat the pain associated with acute flares. Colchicine may also be used to break down the urate crystals and keep them from forming deposits. In more severe cases of pain and inflammation, steroids may be used.

 

Another class of drugs is used chronically to reduce the amount of uric acid in the blood with the goal of getting blood levels to 6.0 mg/dl or less. Remember that at levels greater than 6.8 mg/dl, uric acid precipitates out of the blood and forms crystals. The mainstay and gold standard of chronic drug therapy is allopurinol. It inhibits the enzyme xanthine oxidase that is necessary for the body to produce uric acid. Physicians may also use a drug like probenecid that works through a different mechanism of action and causes the kidneys to excrete more uric acid. Alone or in combination, these drugs reduce the concentration of uric acid.

 

For over 40 years, there was no innovation in chronic gout therapy and allopurinol and to a much lesser extent probenecid were routinely prescribed by physicians. The pharmaceutical industry has rediscovered gout and there is frenetic development activity. About three years ago, the FDA approved Uloric (febuxostat). You may have seen the commercials on television that feature a man carrying a green jar that symbolizes uric acid. Uloric is a xanthine oxidase inhibitor like allopurinol.

 

The efficacy of allopurinol and Uloric is comparable and the major differentiation is that febuxostat is primarily excreted from the body through the feces and allopurinol through urine. There are a small, but meaningful percentage of patients that have impaired kidney function and for whom Uloric offers a crucial advantage. Uloric is priced at about 40 times the price level of generic allopurinol and has been able to capture only 5% of the market since its February 2009 approval. There are two other uric acid lowering agents that are nearing phase III development and are being closely watched by investors

 

Ardea’s lesinurad is a once a day oral drug that inhibits the URAT1 transporter in the kidney that regulates uric acid excretion from the body. Lesinurad increases renal excretion of uric acid by moderating URAT1. It is not a xanthine oxidase inhibitor like allopurinol and febuxostat and could potentially be used in combination with them. It is poised to begin phase III trials and if all goes smoothly, it could be approved in the US in late 2014 or 2015. Because lesinurad affects kidney function, any side effects related to the kidney will be closely scrutinized by the regulatory agencies.

 

BioCryst’s BCX4208 is a novel enzyme inhibitor that works upstream of xanthine oxidase. It is an oral drug with potentially once a day dosing. It should be synergistic with allopurinol and febuxostat and used in combination with them. It is nearing the end of phase II development and could enter phase III in 2012. If all goes well, it approved in the US in 2015 or 2016.

 

Beyond 2017 there is the potential that these three drugs when combined with the current gold standard drug allopurinol could change the natural history for gout patients, reducing the number entering the refractory state and limiting the market potential for Krystexxa. However, none of these drugs promise to have the efficacy of Krystexxa and chronic, refractory gout takes many years to reverse. Also, lesinurad and BCX4028 won’t be on the market until 2014, 2015 or 2016 and their clinical profile has yet to be defined in phase III trials. If this is a concern for Krystexxa, it is for the 2017 and beyond time frame.

 

Krystexxa Is a Breakthrough for Chronic, Refractory Gout

Krystexxa was approved for patients who have the most severe cases of gout and have failed to respond to allopurinol. These patients have high levels of uncontrolled uric acid and usually present with a number of disfiguring tophi.

 

The type of patient that Krystexxa is effective for was described at the Krystexxa FDA advisory committee by a physician. He said Mr. L, a 46-year-old engineer, came to him with the most severe case of gout that he had ever seen. Due to knee involvement, Mr. L had not walked in more than four years and got about in a motorized scooter. Mr. L sought out the doctor when he learned that he was participating in the phase III clinical trial of Krystexxa. Unfortunately, he was randomized to placebo and endured six months of ineffective therapy and pain without any results. However, he was eligible at the end of the trial to switch over to the open label phase of the program in which he could receive Krystexxa. After a few months on therapy, Mr. L walked for the first time in four years and made great progress toward becoming fully ambulatory. Striking, draining, crusted tophi on his hands resolved over a nine-month period.

 

The experts on the FDA advisory committee were also convinced of the efficacy of Krystexxa in refractory gout. One was a rheumatologist with a large gout patient population. He said that this was the first drug he had seen that could dissolve tophi. Another said that this was the most exciting data that he had ever seen in terms of resolving chronic gout. Of the 15 members of the committee, all were convinced that Krystexxa is uniquely effective in treating refractory gout. Only one member voted not to approve Krystexxa and this was due to concerns about safety.

 

Krystexxa Has Administration and Side Effect Issues

The efficacy of Krystexxa in some patients is extraordinary. However, its efficacy must be weighed against other issues. The development of Krystexxa was based on a novel biological observation by scientists at Duke University that mammals with the exception of humans and great apes have an enzyme called urate oxidase that is produced by the body to break down uric acid. Humans and great apes over the course of evolution have lost the ability to produce urate oxidase and rely on excreting uric acid in urine to maintain balance in the blood.

 

Krystexxa is a recombinantly produced version of pig urate oxidase that is pegylated to allow for longer circulation time in the body and to reduce the immune response. Because it is essentially a foreign (pig) protein, the body can create antibodies against it. These antibodies can lead to troubling side effects and can also inactivate the product. This sounds daunting, but bear in mind that for decades diabetics were treated effectively with pig and cow insulin.

 

The disadvantages of Krystexxa are its side effect profile and its administration requirements. Drug administration requires a two hour infusion every two weeks until uric acid levels reach targeted levels and in the clinical trials this could take 6 to 18 months. About 80% of patients experience a gout flare when starting on the drug; this is common for all uric acid lowering therapies. Infusion related side effects require prophylaxis with the antihistamine fexofenadine and a steroid to reduce inflammatory reactions. In phase III clinical trials, 157 of 212 patients (on intent to treat basis) or 74% of patients completed therapy despite the administration and side effect issues.

 

Phase III Clinical Trial Data

Two phase III pivotal, placebo controlled registration trials were conducted for Krystexxa. The average patient enrolled was in their mid-50s and had suffered from gout for 15 years. In order to enter the trial, they had to have a baseline blood level of 8.0 mg/dl of uric acid, to have had 3 or more gout flares over the prior 18 months, to have 1 or more tophi and to be suffering from joint damage. Allopurinol was contraindicated in 82% of these patients.

 

The primary endpoint of the trial was to lower uric acid levels in the blood to <6.0 mg/dl for ≥ 80% of the time when uric acid was measured during the third month and then again in the sixth month of the trial. Krystexxa easily met this endpoint with a highly statistically significant p value of <0.001. On the important secondary endpoint of elimination at least 1 tophi, the p value was again an impressive 0.005. Clearly Krystexxa works very well relative to placebo.

 

In the final product label, physicians are urged to discontinue therapy if Krystexxa does not lower uric acid. This suggests that only patients who respond to the drug will continue of therapy. In looking at the two phase III trials, 20 of 43 patients in one trial were deemed responders when given two doses per month; this is the approved dosage schedule. In the second phase III trial, 16 of 42 were deemed responders. This suggests that 36 of 85 patients treated (42%) may respond to the drug and remain on therapy.

 

The safety profile of Krystexxa is not benign. Over the six month trial, 26% of patients on Krystexxa discontinued therapy as compared to 9% of placebo patients. Nearly 80% of patients experienced a gout flare and 33% reported infusion reactions of which 11% were severe. Anaphylaxis was reported to have occurred in 4 of 169 patients (2.4%) treated with Krystexxa. There was a troubling imbalance of serious cardiovascular events with 8 patients on Krystexxa and only 1 on placebo. However, the FDA, consultants and members of the advisory committee did not conclude that Krystexxa led to an elevated cardiovascular risk.

 

The Approval of Krystexxa

The FDA approved Krystexxa in September of 2010 as an 8mg IV infusion given every two weeks. The label requires pre-medication with antihistamines as prophylaxis against infusion reactions. There is a black box warning about anaphylaxis that also states that the infusion must also be given in a setting in which there is competent medical care to treat anaphylaxis if it should occur.

 

Many experts feel that the 4 patients who were judged to have incurred anaphylaxis really only suffered severe infusion reactions and that this is an overly cautious stance by the FDA. The black box also advises physicians to monitor uric acid levels before infusions and if the level is above 6.0 mg/dl on two consecutive infusions that the drug should be stopped. A REMS program and a 500 patient, twelve month post-market study was also required.

 

Krystexxa Has Exceptional Protection from Generic Competition

The Savient investment thesis is driven by the prospects for Krystexxa as there is currently no meaningful product pipeline. However, the intellectual property position is excellent. Krystexxa has orphan drug exclusivity through September 2017 and a broad portfolio of patents could provide protection through 2026. Perhaps more importantly, I think that it would be extremely difficult or next to impossible to create a generic to Krystexxa which is a highly complex recombinant, pegylated biological product. I believe that any potential competitor \ would have to go through a complete development process and not be accorded generic status. As a consequence, I look for an exceptionally long period of exclusivity lasting well past 2020 even if there were no patent protection. In my mind, this more than compensates for the current absence of a pipeline.

 

Size of the Refractory Gout Market

The size of the gout market has been a concern to investors and some believe that the slow takeoff of Krystexxa post launch signals that this is a very small patient population.

 

Savient has spent a great deal of time trying to size the patient population and has come up with some interesting data. The company starts with the NHANES survey performed by the Center for Disease Control that did a detailed study of the entire gout market. NHANES questioned some 50,000 health care professionals and also made on-site visits in an attempt to estimate the size of the gout market. Based on this survey they concluded that there are 8.0 million people in the US with gout and the market is growing at 3% to 5% per year. Of this group, 3.2 million patients are currently seeking treatment.

 

The NHANES data provides an insight into the size of the gout market as a whole, but no specific information on the size of the refractory gout market that Krystexxa serves. To answer this question, Savient hired a research firm to try to answer the question of the size of the refractory gout market; Savient played no role in the survey. The firm spoke to 500 physicians who evaluated data on 3,000 gout patients. They asked doctors to look at the charts of all of their gout patients and ask if they met certain key criteria for refractory gout as defined in Kystexxa’a package insert. These were: (1) had the patients’ failed previous therapy with allopurinol and febuxostat and (2) was the uric acid concentration above 8 mg/dl?

 

The consulting group took the results of the survey and extrapolated them to the entire gout universe to estimate the incidence of refractory gout in the patient population. They arrived at an estimate of 120,000 refractory gout patients in the US. Savient will not reveal the methodology used to make the extrapolation citing this as proprietary information that it did not want current or prospective competitors to have. I think that the number for refractory gout patients was probably arrived at by taking the incidence of refractory gout in this 5,000 patient population and extrapolating it to the prevalence of gout in the 3.2 million patients currently being treated for gout.

 

Krystexxa Sales Model; 2011-2015

I have put together a model for projecting sales of Krystexxa using the following assumptions which are consistent with the analysis of this report:

1. Savient estimates the number of refractory gout patients at 120,000 and the FDA estimates 50,000. I am using the lower estimate of 50,000 in an attempt to build some conservatism into my model.
2. I am estimating modestly building penetration rates of this 50,000 patient universe that starts at 0.4% in 2011 (260 patients) and builds to 12.0% in 2015 (7,019 patients). I am assuming that the difficult infusion schedule and troubling side effects will limit penetration of the severe gout market to a modest level.
3. I assume that 58% of patients started on Krystexxa drop therapy after two months because their uric acid levels do not drop and that during this time they receive four infusions.
4. I assume that 42% of patients do respond to the drug and remain on therapy for nine months receiving 18 infusions. In the phase III and a follow-up safety study, patients remained on drug for six to eighteen months.
5. I assume that each infusion is priced at $2,300 and does not increase.
6. .I estimate that the European market is the same size as the US market and follows the same sales trajectory. However, the launch in the EU is assumed to start in 2013

 

The results are shown below:

 

Worldwide Revenue Model for Krystexxa
	2011	2012	2013	2014	2015
Number of patients with refractory gout	50,000	52,000	54,080	56,243	58,493
% who are prescribed Kyrstexxa	0.5%	2.0%	4.0%	8.0%	12.0%
Number of new patients who are prescribed Krystexxa	260	1,040	2,163	4,499	7,019
% who don't respond to Kyrstexxa	58.0%	58.0%	58.0%	58.0%	58.0%
Non-responders who stop therapy at two months	151	603	1,255	2,610	4,071
Patients who remain on therapy for nine months	109	437	909	1,890	2,948
Number of infusions of non-responders	603	2,413	5,019	10,439	16,284
Number of infusions for responders	1,966	7,862	16,354	34,016	53,065
Total infusions	2,569	10,275	21,372	44,455	69,349
Price of each infusion	$2,300	$2,300	$2,300	$2,300	$2,300
US revenues (millions)	$5.9	$23.6	$49.2	$102.2	$159.5
European revenues (millions)	$0.0	$0.0	$5.9	$23.6	$49.2
Worldwide revenues (millions)	$5.9	$23.6	$55.1	$125.9	$208.7
Source: SmithOnStocks estimates

 

Financial Position

With the initiation of its commercial operation in February of 2011, Savient has been spending cash at a prodigious rate. The quarterly cash burn increased from $20 million in 1Q, 2011 to $28 million in 3Q and $38 million in 4Q. The company ended the 3Q, with $203 million. According to management guidance, this cash should last 18 months if the company decides to launch Krystexxa in Europe without a partner. If Krystexxa is partnered in Europe, current cash along with milestone payments will stretch cash out much further, potentially beyond cash flow break even.

 

The company built its cash position with a $230 million convertible note offering in February 2011. This note comes due in 2018 and will convert into common at $11.54. If converted, it would add about 20 million shares. The current share base is 70 million shares.

 

Estimating a Price Target

I prefer to value emerging companies on the basis of sales estimates rather than earnings. Sales are more predictable than earnings for an early stage company and this is what investors pay the most attention to. Based on market capitalization to sales ratios that I have seen with other emerging biopharm companies, I think that Savient’s market capitalization could reach 3 to 5 times 2015 sales of $246 million. This results in a target price of $7.50 to $12.50 in 2015. Needless to say, these estimates are highly subjective. Calculations for these price targets are shown below:

 

Valuation Model for Savient
	2014	2015
Market valuation @4X sales (millions)	$504	$835
Total Shares Outstanding (millions)	95.1	98.1
Estimated Stock Price	$5.29	$8.51
	2014	2015
Market valuation @3X sales (millions)	$378	$626
Total Shares Outstanding (millions)	95.1	98.1
Estimated Stock Price	$3.97	$6.38

 

Disclosure: The author of this article owned shares of Savient 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 Savient 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 Savient.

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