Orexigen Therapeutics — Update 19 August 2016

In March, Orexigen announced that it had reacquired the US rights to Contrave from Takeda, with the expectation of a transition period of around six months. On 1 August, it announced that it had been able to take control of Contrave faster than anticipated and from that time would be selling and marketing the product in the US, with the help of a 200+ person US business unit, including 160 sales representatives with an average of 11 years’ experience.

Whenever a drug switches ownership, there is a risk of share loss as the new salesforce needs time to build relationships with prescribing physicians. According to IMS prescription data provided by the company, Contrave’s share of the total obesity market has fallen from around 7% to 6.6% and the company believes it may fall as low as 6% by the end of the year, before climbing again (see Exhibit 1). However, Contrave continues to control more than 40% of the branded obesity market, although Saxenda (injectable liraglutide originally developed for diabetes) from Novo Nordisk has been making some inroads (see Exhibit 2), which are likely to be limited by its $1,000/month price tag for uninsured prescriptions.

With Contrave already controlling a large part of the branded obesity market and Belviq XR (a once-a-day formulation of Belviq, which is currently twice a day) about to be launched by Eisai/Arena this fall, Contrave’s market share will likely have to come from phentermine, which represents around 80% of the total obesity market, rather than from the other branded products. Phentermine is related chemically and pharmacologically to amphetamines and, while efficacious, also carries with it significant abuse potential and risk for anyone with cardiovascular issues. The main driver of this share growth will be increased physician education on the product, as well as greater payer coverage. On the Q216 earnings call, the company said it estimated that around 19% of prescriptions were covered by insurance, up from the 16% it estimated last quarter.

Increased insurance coverage would have a two-pronged positive impact for the company. First, it would reduce the cost of the product for consumers, which would stimulate demand. For participants in the Contrave savings card program, those with a prescription covered by insurance pay no more than a $30 co-pay (approximately in line with the cost of phentermine), while those who do not have a covered prescription pay $90.

Second, it would increase the net realized price for Contrave as there is a much steeper discount for those paying cash compared to those paying with insurance. Right now the gross-to-net discount for Contrave as a whole is around 67%, which means that for every $3 in the gross retail price, the company only realizes $1. Orexigen believes that if insurance covered closer to 30% of prescriptions, the gross-to-net discount might fall to 40-50%. To illustrate the amount of leverage that changes to the gross-to-net discount would have, if the company can move the gross-to-net discount from 67% to 50%, it would increase the net realized price by more than 50% (for every $3 in gross retail price, it would realize $1.50 instead of $1).

The question is: how will Contrave get improved coverage? Historically, obesity medication has not been a covered indication by most insurers due to the perception that it is a “lifestyle” issue. However, due to the comorbidities associated with obesity, there is a pharmacoeconomic argument to be made that coverage of obesity treatments now will help lower costs later on (obesity is thought to cost over $100bn annually1) by reducing comorbidities like diabetes. Also, as obesity is a real national health issue, the possibility for federal and state mandates for medical coverage of obesity treatments exists, which could quickly transform the market by forcing insurance companies to cover drugs like Contrave. According to a survey of stakeholders in the commercial managed care organization (MCO), pharmacy benefit manager (PBM) and integrated healthcare system communities (IHS) communities, broad-based reimbursement of anti-obesity medications is likely by 2018.2

Contrave is a proprietary formulation of two generic drugs, bupropion (aka Wellbutrin) and naltrexone making the strength of the patent estate weaker than that for a completely novel drug. So it came as no surprise when, in April 2015, notice of a Paragraph IV certification regarding an abbreviated new drug application (ANDA), the type of application needed to get a generic approved, was received. The generic company, Actavis, alleged that the patents listed in the FDA’s Orange Book for Contrave were invalid, unenforceable or uninfringed by the Actavis product. Contrave currently has 11 patents listed in the FDA Orange Book, each of which would have to be invalidated, uninfringed or deemed unenforceable for a generic to hit the market (see Exhibit 3).

In June 2016, following a May 2016 claim construction hearing, the court adopted the company’s proposed constructions with regard to the majority of the disputed claim terms in a Markman ruling. While not a definitive victory, adopting one side’s claim terms over the other’s is an indicator of potential success at trial, which is currently scheduled to begin in June 2017. Before the Markman ruling, there was an increased risk that Actavis and/or other generics would be allowed to launch on the loss of Hatch-Waxman exclusivity on the compound in September 2017, at which point Orexigen’s market opportunity in the US would almost completely disappear.

Due to our increased confidence in the patent estate, we are increasing our assumed patent life for Contrave to 2030 from 2024/5. We are not assuming that patent 9,248,123, which expires in 2032, can hold off competition as it is a method of use patent for a subgroup of obese patients.

In 2016, Contrave, which is known as Mysimba in most international markets, is in the process of launching or will be launched in about a dozen countries. In June, Contrave was launched in South Korea through partner Kwangdong after just a seven-month approval process, which was faster than expected. According to the company, the Korean anti-obesity market had $71m in sales in 2015, up 21% compared to 2014. Orexigen is responsible for providing product to Kwangdong and reported net sales for the Korean market of $2.9m in the quarter, which is likely an initial inventory build-up.

Orexigen’s partner Valeant will be launching Mysimba in Q416 in 11 different countries in central and eastern Europe, namely Slovenia, Slovakia, the Czech Republic, Hungary, Croatia, Lithuania, Latvia, Estonia, Poland, Bulgaria and Romania. Launch in Greece and Cyprus is expected in Q117. Additionally, the company’s local partner, Laboratorios Farmaceuticos Rovi (ROVI), will be launching Mysimba in Spain by the end of the year.

We are lowering our value to $70m ($4.80/share) from $213m ($14.70/share, 1:10 reverse split adjusted) due to increased spending assumptions and lower net cash, although this is mitigated partly as a result of the assumption of a longer patent life, thanks to the positive Markman ruling, improved gross-to-net discount forecasts and rolling forward our forecasts.

We have increased our expense assumptions due to increased spending guidance from the company since we last published in April. Full year 2016 operating expense guidance now totals $160-180m, with expenses averaging between $180 and $200m between 2017 and 2019.

Changes that positively affected valuation (adding $368m to the US Contrave NPV) were the previously mentioned extension of our assumed patent life from 2024/25 to 2030 based on the positive Markman ruling and an analysis of Orexigen’s FDA Orange Book-listed patents. We have also increased the ramp-up of its net effective price through lower gross-to-net discounts over time, while keeping the gross retail price the same. Hence, we now estimate the gross-to-net discount will go from 67% this year down to 46% in 2019 and 17% in 2030. The near-term improvement should come from company negotiations with individual payers using pharmacoeconomic arguments to gain coverage, while long-term federal and state mandates for coverage of medical therapy for obesity should help lower the gross-to-net discount further. A positive long-term cardiovascular outcomes trial (expected by 2022) may also help Contrave gain further coverage.

However, it is important to note that small changes to assumptions in our model could have relatively large impacts on the valuation, with the number of prescriptions, the gross-to-net discount and expenses being extremely important variables. If the trajectory of the gross-to-net discount leads it to be 58% in 2019 and 36% in 2030, both improvements on today, the value of the company would be wiped out. The same is true if market share grows by 10% a year on a relative basis over the next three years instead of the 20% we currently project.

Conversely, if Orexigen can add additional products for its salesforce to sell (generally, it does not make sense from a business model point of view for a company to have a salesforce that exclusively sells one product), it could capitalize on tremendous operating leverage as it already has a 160-person salesforce and so may not need much additional spend to sell another product. Also, if Orexigen can execute on its plan, its value to an acquirer with an existing salesforce, if we assume 50% synergies on SG&A and nowhere else, would put the value of the stock at $513m or $35.25 per share.

For Q216, the last full quarter in which Takeda was in control of selling Contrave, Orexigen reported revenue of $7.8m, including $2.5m in royalties on $12.3m in US Contrave sales, $2.4m in collaborative income and $2.9m in sales to Kwangdong, its partner in South Korea. Total operating expenses were $39.2m and it had a net loss of $25.2m. It exited the quarter with $264.4m in cash, restricted cash and marketable securities and $206.4m in debt. The restricted cash is associated with the convertible senior secured notes due in 2020, which require $165m in restricted cash until year-end, then $100m until the end of Q117 and $50m until the end of Q217.

With the closure of the reacquisition agreement with Takeda, Orexigen will be recognizing the deferred revenues associated with the original Takeda licensing agreement. At the end of Q2, these deferred revenues totalled $81m. However, the company has also stated that there will be other non-cash charges associated with the acquisition, although the exact nature and size of these charges is unknown at this time (we have assumed $30m).

Due to the fall in US market share for Contrave in 2016, which we had not previously expected, we have lowered our full year US Contrave market sales forecasts from $94m to $51.0m and from $107.9m to $79.4m in 2017.

The company has stated that it expects to become profitable in 2019 without additional capital. We are more conservative in our assumptions than in our previous model and now project 2020 profitability (from 2019, mainly due to the increase in operating expenses), with $70m in additional capital necessary before the company turns cash flow positive. The main point of divergence from company guidance is US Contrave sales (we expect $160m in 2019 compared to guidance of $160-260m). We also believe we are also more conservative with regard to the potential of Contrave outside the US.