Friday, July 20, 2007

Can Flamel Technologies Deliver?

Flamel Technologies S.A. (FLML-$21.72) is a drug delivery company with expertise in polymer chemistry. In our view, recent price weakness is temporary, and affords investors an inflective buying point.

Industry Overview

Against a background of soaring R&D costs, the onslaught of patent expiries, and increasing consumer—and FDA—demand for improved medications, pharmaceutical companies are relying more heavily on novel ‘Lifecycle Management’ strategies—including Over-the-counter (OTC) switching, combination products, patent litigation, or
advanced drug delivery technologies, to help sustain and extend products' profitable commercial value.

Once the proprietary product patent expires, generic erosion is inevitable, for generic manufacturers usually price their products at a discount to the brand, which encourages switching from the branded product to the cheaper generic.

Once patent protection and periods of marketing exclusivity expire for a branded drug, the price typically plunges about 40 percent during the first six months, followed by another 40% to 50 percent plunge after more authorized generic(s) join the competition. And, a branded product can expect to concede 70% of its market share to generics in a mere four-to-eight weeks.

Prozac, an antidepressant drug with strong product recognition, lost its patent in August 2001. Generics stole 73% of the drug's new prescription volume (Rx) within two weeks, and two years later, Eli Lilly lost more that $ 2.0 billion in annual sales, making just $182 million in U.S. sales of Prozac, less than a third of its generic equivalent, fluoxetine.

Trying to match the price of the generic often is a failed strategy, too. When Merck’s $4.4 billion cholesterol drug Zocor’s patent expired in June 2006, the company sold the pill below the price of the first generic. Nevertheless, data from health care informatics provider Verispan showed a 70 percent reduction in Zocor’s sales in the first full month of generic competition.

Research from Datamonitor, a leading provider of data, analytic and forecasting platforms for key manufacturing sectors, shows the speed and impact of brand erosion can fluctuate, depending on factors such as country-specific prescription, pricing and reimbursement (P&R) regulations, product formulation (e.g., if a product has a short half-life and needs to be administered two or more times daily, reformulating this as an extended-release product will improves odds against generic erosion), success of the targeted brand (e.g., highly prescribed and administered on a chronic basis), and the implementation of lifecycle management (LCM) strategies.

Drugs worth nearly $140 billion in sales are
coming off patent coming off patent by 2016. And, the percentage of prescriptions that are generic is expected to increase to 75% in 2011 from 56% now.

Manufacturers need to develop novel drugs in order to maintain franchise and portfolio revenues in the face of generic intrusion.

Nevertheless, according to a Reuters Business Insights report (2005), Generic Defense Strategies, a high percentage of reformulations fail, due to poor timing, inadequate promotional support, lack of competitive differentiation, or no clinical advantages (such as better efficacy or improved compliance).

This abbreviated assessment of current and future opportunities and threats facing branded drugs should translate into a commercial bonanza for drug delivery companies offering proprietary technology platforms that complement drug makers own internal research activities aimed at stifling generic competition and extending branded life-cycles.

Technologies & Products

Flamel’s drug delivery platforms,
Medusa for therapeutic proteins and peptides, and Micropump for small molecules, have been developed “to improve the therapeutic characteristics, safety profile and ease of use of wide variety of drugs,” (and extend the drugs’ life-spans beyond patent expiry of the active substances).

The design of the Micropump microparticles allows an extended transit time in the small intestine with a plasma mean residence time extended up to 24 hours, which is especially suitable for short-lived drugs known to be absorbed only in the small intestine. The current research pipeline includes the extension of the release of four small molecule drugs, known to be only absorbed in the upper part of the small intestine:
  • Proton pump inhibitors for the treatment of gastroesophageal conditions, including heartburn and other symptoms of gastroesophageal reflux disease (GERD);
  • Genvir, long-acting acyclovir for the treatment of Acute Genital Herpes (positive results in Phase III);
  • Metformin XL, an anti-diabetic for the treatment of type II diabetes (positive results in Phase I);
  • An undisclosed ACE inhibitor co-developed with Servier Monde (confidential); and,
  • Augmentin SR, an antibiotic (confidential).

The 10Q Detective believes the current share price also discounts the commercial viability of the Medusa delivery platform, a versatile nanotechnology that can accommodate the physico-chemical specifications and the delivery therapeutic-requirements of a wide variety of protein drugs. Medusa nano-carrier is also suitable for the efficient delivery of insoluble (i.e., hydrophobic) small molecule drugs and could be applied to peptides.

Using its Medusa nanoparticles, Flamel is developing second-generation formulations of native protein drugs with better performance (i.e. long time of action, high bioavailability and efficacy, reduced side effects and improved compliance) compared with first-generation proteins. The reduced side-effect profile should allow for increased dosage of some proteins, thus extending their efficacy and potential applications.

Flamel's most advanced products are Basulin, a second-generation formulation of long-acting native insulin—however, in September 2004, Bristol-Myers pulled out of its partnership for this drug; IFN alpha-2b XL is a long-acting native interferon alpha-2b for the treatment of Hepatitis B and C and some cancers; and IL-2 XL, a second-generation long-acting interleukin-2.

Business Strategy

The Company’s business model is to leverage its proprietary technology platforms through
partnership agreements. Flamel applies this strategy to its own drug candidates as well as to the re-formulation of already marketed drugs and the development of new chemical entities with partner companies.

Recent Developments

The share price of Flamel is trading near an eight-month low, on investors’ worries that the Company’s near-term fortunes remain too dependent on the ultimate scale and market acceptance of GlaxoSmithKline’s (GSK-$52.97)
COREG CR, launched on March 22nd.

For the first quarter of 2007, Flamel reported total revenues of $9.6 million, with COREG CR sales accounting for 67 percent: $5.4 million in microparticle shipments to GSK and $1.0 million in GSK milestone payments.

GSK chose to defend its $1.4 billion COREG (carvedilol) franchise by partnering with Flamel. COREG CR utilizes Flamel's proprietary Micropump technology, which controls the delivery of carvedilol helping to maintain appropriate amounts of medicine in the body over a 24-hour span. This technology allows COREG CR to be dosed once daily, in contrast to immediate-release COREG tablets, which patients must take twice daily.

Buy Thesis

In our view, the controlled-release formulation will be a success, for the once-daily formulation of COREG CR offers key advantages to patients. According to Stephen H. Willard, Flamel's Chief Executive Officer, “Physicians understand that once-daily medications lead to greater patient compliance; non-compliance is one of the leading causes of hospitalization in heart failure patients. COREG CR delivers substantially the same peak and trough levels of carvedilol as the twice-a-day drug, but with a smoother release profile. Moreover, COREG CR has been observed to result in 24% fewer adverse events than immediate release Coreg in a crossover study conducted in hypertension.

COREG CR is approved to treat the same conditions as twice-a-day COREG, which has established a significant role in the treatment of heart disease (the only beta-blocker agent approved by the FDA to improve survival in mild-to-severe heart failure).

Moreover, the growth driver behind twice-a-day COREG was its CHF labeling. The reformulation of COREG opens new marketing opportunities, including patients with high-blood pressure or post-MI patients where beta-blocker therapy is appropriate.

Another catalyst for growth is combination therapy. For example, clinical trials are being conducted to examine the benefits of combining COREG CR with lisinopril, an ACE Inhibitor, for the treatment of hypertension.

Determining COREG CR’s intrinsic potential for share retention—and (other approved labeling) growth—is critical to Flamel’s share valuation.

Referencing the foregoing growth drivers, we believe that the Company can easily hit the consensus 2008 share-net target of $1.40.

A short ratio of 13.9 days and a forward 12-month P/E of 15.5 times, in our view, justify the current price as a good inflection point for growth-oriented investors.

The loss of patent protection for key products is increasingly significant in assessing the future performance of major pharmaceutical companies, including GSK.
In our opinion, the successful identification and exploitation of the opportunities afforded by patent expirations provides a major growth driver for drug delivery companies, such as Flamel, who focus their business on extending the life cycle of branded products.

Given an enterprise value of only $471.8 million, the commercial success of COREG CR might make Flamel an attractive acquisition for big pharma and/or biotech companies facing the loss of blockbuster drugs in coming years. Three logical buyers would be (1) GSK (shingles & genital herpes medicines, Augmentin, and COREG CR); (2) AstraZeneca (first patent for Nexium expires March 1, 2008); and, (3) Bristol-Myers Squibb (diabetes franchise).

Investment Risks and Considerations

Flamel remains highly dependent on the commercial success of COREG CR. The Company has no new products coming through its pipeline over the next few years. If sales of COREG CR are not successful or delayed, it would have a material impact on revenue, results of operations, and financial condition. Conversely, we believe the successful launch of COREG CR will validate the Micropump drug delivery platform.

Despite trailing-twelve-month operating cash flow of $(26.89) million, finances remain healthy, with total debt/equity under 5 percent and a current ratio of 3.45 times.

Since May 2007, technical indicators for Flamel have been in a weak downward trend, with the share price breaking below resistance of $23.91 and the 50 day moving average of $23.64.

Editor David J. Phillips is long Flamel Technologies. The 10Q Detective has a Full Disclosure Policy.

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