Biotechs are still treading water and have not participated in the year-end rally yet. I hardly ever comment on the larger political events since for the most part they impact pharma more than the small cap biotechs. However the current medicare changes will have some major impacts. One group of doctors impacted the most is oncologists. Oncology practices depend on outpatient infusion centers as the major income source and it is the reimbursement for IV oncology drugs that drives the bottom line of these centers. IV drugs have been traditionally reimbursed at 95% AWP (average wholesale price) by medicare but the clinics pay much less to vendors. The more drugs a clinic uses the bigger the discounts. Oncology practices make the difference between the 95% AWP that the government reimburses vs the steeply discounted prices they are actually paying. This income is the margin that makes outpatient oncology viable as a business. All oncologists realize that this is a very distorted pricing system however the reimbursements for nursing time, office care, family consultations and all the work it takes to deal with very sick and dying patients is so minimal that practices have become dependent on this "drug money". All this will now change as of Jan. 1st '04. Drugs that already have codes (which are most drugs) will now be reimbursed at 83 to 85% AWP. The slight bump in reimbursement for services will not offset these big loses. What will happen-smaller oncology offices may close, the larger ones will cut back services and send patients getting the most poorly reimbursed drugs to the hospital outpatient department. The whole system will become much more cumbersome, patients will complain and eventually the law will be changed. The bigger problem is that the law is scheduled to change again in '05 and nobody can figure out what the new formula will be but the sense is it only gets worse. Given all these changes are there any investment decisions that make sense? In this note I will detail a few opportunities.
The opportunity arises for new drugs that are coming onto the market and don't have a current billing code. These drugs will still be reimbursed at 95% of the AWP. Given that they are as good as or better than older competitors oncologist will switch very quickly to the new drug because of the enormous reimbursement differential. One such new drug opportunity is Aloxi (palonosetron), a 5-HT3 receptor antagonist from MGI Pharma (MOGN). Please see archives fro notes on MOGN. This drug was recently approved to treat chemotherapy induced nausea and vomiting. In a nut shell it lasts much longer than competing products, which makes it a better drug. In a normal environment I would expect a slow to moderate uptake by oncology practices perhaps driven by oncology nurses who are always very sensitive to patient discomfort. However this is the "perfect storm" for MOGN. Two currently used drugs in this class, Anzemet and Kytril, are scheduled to be reimbursed at 80% AWP while Zofran is scheduled at 85% of AWP starting Jan. 1. The new medicare pricing will drive oncology practices to Aloxi overnight. They are already signing contracts to convert on Jan 1. The market for this class of drugs in North America is about $850 million/year, which includes the use of both the IV and the oral versions of 5-HT3 inhibitors. Oncologists will usually give the drugs IV in the office at the time of chemotherapy infusions followed by pills to be taken when the patient goes home. Aloxi will be given IV and lasts long enough to eliminate the use of pills. MOGN intends to price Aloxi at about 3 times that of other agents in its class-this premium takes into account the fact that patients will no longer have to pay for pills. The company pays about a 33% royalty to Helsinn (a Swiss company) but this includes cost of goods-MOGN's major cost will be marketing. I got out of most of my MGI Pharma just before the FDA PDUFA date on the fear that some untoward event might delay the drug and crash the price. I wish I had stayed in. MOGN now trades at $40.50 with a market cap of about $1.27 billion (the company has about $100 million in cash). So the question is how much more could the company be worth considering its already lofty market cap. I think the medicare change reflects a change in this company's fortunes. In my estimation it is likely that MGON could get half the market in the first year and maybe even more-considering that most private practices will convert. Hospital use, which makes up about 35%, may be a little slower to follow. Hospital formularies usually take a number of months to make changes but again reimbursement should drive that market as well. MOGN has also recently licensed Aloxi for post-operative nausea and vomiting in NA. Using a conservative metric of 5X sales and estimating an aggressive '04 sales of $400 million you arrive at a valuation of $2 billion which is almost twice where it is now (deducting cash gives a current valuation of about $1.15 billion). I think the trajectory will become apparent after release of 1st quarter '04 sales data. I bought MGI Pharma in my personal account last week at approximately $39/share.
Another company that may benefit from the same type of scenario is Praecis (PRCS). Their drug Plenaxis for prostate cancer was just approved and the new medicare rules will drive sales away from Lupron and other similarly acting agents. However there are some use issues and restrictions that will continue to limit the market in the US. On the other hand I believe the company is underpriced and may get a broader approval in Europe which will impact the valuation story. I have Praecis in my private account and the Model Portfolio (see archives for further details).
As a matter of disclosure I want all readers to know that I own many of the stocks I write about in my personal account and always maintain a long position. I am not a stock broker or a registered investment adviser. I also write about many of these stocks in alerts for BioSpace, which can be found at www.biospace.com. . Biotech Insight is a web-based newsletter published and archived at www.biotechinsight.com. Alerts and newsletters are sent electronically to subscribers. The following is further disclosure: Dr. Garren is a member of Biotech Insight Management, LLC, a California registered investment adviser and the general partner of a hedge fund that invests in biotechnology companies, including many of the companies discussed in this newsletter (www.biotechmgt.com). Garren is a member of the advisory board of New York based InvestBio and their chief biotechnology strategist. I recommend many of these same stocks to the investment funds mentioned above. It should be noted that hedge funds could go both long and short on any particular stock. The information in this column under no circumstances serves as a recommendation to buy or sell stocks. Please also see the disclosure about Biotech Insight archived on BioSpace.
Ronald Garren, M.D.
Click here to learn more about InvestBio
Click here to subscribe to the Biotech Insight Newsletter
Information transmitted via BioSpace has been provided by publishers of the "InvestBio" Investment Newsletter. It is not guaranteed as to completeness or accuracy by BioSpace, the InvestBio publishers, or any person. Such Information is neither an offer to sell nor a solicitation to buy the securities of any company. Opinions expressed are subject to change without notice. The Information and views provided by the InvestBio Newsletter are prepared by Garren Publishing and in no way reflect the views or efforts of BioSpace.com, Inc., any of BioSpace's employees or officers. BioSpace, and BioSpace's employees and officers, as well as Garren Publishing, and Garren Publishing's employees and officers, in no way accept responsibility for any of the Newsletter's content.
While all reasonable care has been taken to ensure that the Information contained herein is presented in good faith, and is not untrue or misleading at the time of publication, BioSpace, and Garren Publishing make no representation as to its accuracy or completeness and it should not be relied upon as such. The Information is supplied on the condition that the reader or any other person receiving the Information will make his or her own determination as to its suitability for any purpose prior to any use of the Information. From time to time, BioSpace and any officers or employees of BioSpace, as well as Garren Publishing, and any officers or employees of Garren Publishing, may, to the extent permitted by law, have a position or otherwise be interested in any transactions, in any investments (including derivatives) directly or indirectly the subject of this report. Also BioSpace and Garren Publishing may, from time to time solicit business from any company mentioned in this report. This report is provided solely for the information of viewers of BioSpace and/or viewers and subscribers of the Newsletters, who are expected to make their own investment decisions without reliance on this report. Neither BioSpace nor any officer or employee of BioSpace, nor Garren Publishing, or any officer or employee of Garren Publishing, accepts any liability whatsoever for any direct, indirect, special or consequential damages or loss arising from any use of this report or their contents. This report may not be reproduced, distributed or published by any recipient for any purpose without the prior express consent of the publishers. Nothing contained herein shall be construed as conferring by implication, estoppel or otherwise any license or right under any patent, trademark or copyright of BioSpace.com, Garren Publishing or any third party.
The value of the investment(s) to which this report relates and their income yield(s) may go up or down. The investment(s) referred to in this report may not be suitable for private investors: if you are in any doubt you should seek advice from your investment advisor. Changes in rates of currency exchange may have an adverse effect on the value, price or income of investments. Statements as to past performance of any investment are not a guide to future performance. The levels and bases of taxation can change, and if you are in doubt you should seek independent professional advice. In some cases it may be difficult for you to sell or realize your investment or to obtain reliable information about its value or the extent of the risks to which you are exposed.
THIS INFORMATION IS PROVIDED "AS IS" AND NO REPRESENTATIONS OR WARRANTIES, EITHER EXPRESS OR IMPLIED OF ACCURACY, MERCHANTIBILITY FITNESS FOR A PARTICULAR PURPOSE OR OF ANY OTHER NATURE ARE MADE WITH RESPECT TO THIS INFORMATION OR TO ANY EXPRESSED VIEWS PRESENTED IN THIS INFORMATION.
Ronald Garren, the editor of InvestBio is also a technical consultant to the Biotech Select Focus Portfolio domiciled at Schwab and managed Capital Management, Joel Smolen RIA.