Orexo — Update 9 May 2016

Orexo has navigated a challenging quarter when the anticipated effect of the CVS Caremark loss was keenly felt, reducing market share to 5.7% by volume vs 6.5% at end-Q415 (Exhibits 1 and 2). In line with guidance, this change in formulary status had a 15% negative effect on sales; although, positively, c 20-25% of CVS Caremark unrestricted business was retained. Overall, quarter-on-quarter Zubsolv sales fell from to SEK120.3m to SEK98.4m, with the key drivers shown in Exhibit 3. On a year-on-year basis, Zubsolv net sales growth of 4% resulted from the improved gross:net ratio, a price increase (a 5% rise implemented in February 2016) and increased mg/Rx (pricing is linear hence growth on a mg basis outstripped volume growth).

Orexo had positive cash flow from operations in Q116, which was underpinned by the enhanced focus on cost control (down 15% vs Q4). Priorities for management are revenue growth and balancing this with expenditure to achieve profitability. Our current forecasts suggest that the company is adequately financed to sustainability. In Exhibit 4, below, we highlight the key events in 2016 that will have a bearing on this strategy.

Orexo is dynamically managing its investment in its Zubsolv salesforce to ensure that it achieves a positive return. Future investment in promotional activities would rise as opportunities to gain market share become clearer; these include market access on a more localised level and legislative change nationally. Orexo is actively working to expand market access (which is a facilitator of growth) with a particular focus on increasing the number of patients with unrestricted access to Zubsolv (eg fee for service Medicaid) and continuing to grow the profitable cash and commercial segments (including securing restrictive contracts, provided they are profitable). On a federal level, changes to government policy have been proposed (outlined in more detail in the following section), which would represent new growth opportunities by expanding access to opioid dependence treatment through both current and new prescribers.

Access to medically assisted treatment is an important contributing factor to the large treatment gap between the number of individuals diagnosed with opioid dependence and those that actually receive therapy. US policymakers are increasingly focusing on the issue, with three separate proposals to increase access to buprenorphine-based therapies for opioid addiction currently under consideration (Exhibit 5). These proposals outline two key changes to current regulations which would expand access to treatment: increasing the patient cap per physician, and increasing the number of potential prescribers to include nurse practitioners and physician assistants.

At present, physicians are only permitted to prescribe buprenorphine to up to 100 patients after they have been certified for one year (in the first year of post-certification practice, the cap is 30 patients). This, coupled with the fact that only around 6,000 out of 30,000 certified physicians are active in treating opioid dependence, means that access to timely treatment is limited. Resultant waiting lists have serious implications for relapse, overdose or death. Increasing the patient cap from 100 to 200-500 (depending on the proposal) and authorising nurse practitioners and physician assistants to prescribe buprenorphine would reduce waiting lists and potentially provide an improved incentive for physicians to certify and start up addiction clinics. This would increase the overall market for buprenorphine therapies: more patients would be able to be treated, with an expectation that more new patients would seek therapy.

An important question remains with respect to the timing of any formal changes. Implementation of improved HHS guidelines could be imminent (Orexo anticipates that the first effects of this will be seen in H216), although the timetable for legislative change is less well-defined in Edison’s view. In order to change legislation at a federal level, the relevant bills must be passed by both the Senate and the House prior to being signed by the president in order to be enacted in law. While opioid dependence is clearly a high-profile issue and has received bipartisan attention, its chance and timeline of passage are likely to also be determined by political considerations, not least because 2016 is an election year.

Nevertheless, if the goal of improving access to treatment is realised, it could significantly expand the current >$2bn US opioid dependence market. Access to treatment has increased linearly over the past decade; however, these federal initiatives would be an important inflection point in the growth trajectory, and while the impact will not be immediate, they serve to reinforce our long-term Zubsolv sales forecasts. Zubsolv is well-positioned to benefit. Data suggest a general trend towards Zubsolv taking greater share when the market is growing, with prescribing to new patients outweighing switching of existing patients; consequently any initiatives that result in increasing the proportion of new patients seeking treatment may provide Zubsolv with the opportunity to increase market share. Additionally, we note that the HHS proposal requires physicians to implement plans to reduce diversion; preferential prescribing of Zubsolv could form part of this due to its bioequivalence to Suboxone at a lower dose and decreased potential for abuse (lower street value).

Our Orexo valuation has been updated to SEK4.31bn or SEK125/share (from SEK4.24bn or SEK123/share). Orexo’s enhanced focus on cost control has prompted us to revise our 2016 expense expectations downwards; we also moderate our Zubsolv sales expectations in US dollar terms for the remainder of 2016 in anticipation of future legislative change and the impact that an election year may have on the timing of implementation. We maintain our Zubsolv forecasts (Exhibit 6) in US dollar terms for 2017 and beyond; however, the SEK value of these has altered due to updating our model with the current rate of SEK8.00/US$ (from SEK8.39/US$ when we last published our forecasts). We also roll forward our model to reflect the passage of time.

Our explicit DCF-based valuation out to 2030 assumes a WACC of 10%, a long-term tax rate of 30% after 2016 and no terminal value. We estimate a long-term gross margin of 85% on Zubsolv by 2025, with the operating margin gradually trending to 50% in the long term. We include a modest revenue contribution from global Abstral and Edluar royalties until 2020, at which point we assume for simplicity that all revenues relate to Zubsolv.

Evidence of a growth step-up or the implementation of government plans to increase access to treatment could lead us to positively revise our Zubsolv forecasts. In addition, before securing partnerships that should clarify timelines, we do not explicitly value the ex-US Zubsolv opportunity (a partnering update is expected during Q215), nor OX51, which could both provide upside to our forecasts. Pipeline expansion would also represent a source of additional currently unquantified valuation upside.

Orexo’s Q116 net revenues of SEK151m were up marginally on the same period in 2015 (Q115: SEK149m), but this masked a change in the revenue mix. Exhibit 7 details Orexo’s Q116 revenue breakdown and our full-year per product estimates. Zubsolv revenues were the main contributor to revenues in both periods; in Q115, one-off Abstral milestones of c SEK35m were recognised, while in Q116, Orexo received a $5m (SEK40.8m) milestone from AstraZeneca in relation to option exercise to OX-CLI rights. Zubsolv Q116 net revenues were SEK98.4, up 4.1% compared to Q115 (SEK94.5m) and down 18.2% on Q415 (SEK120.3m).

Core operating costs (excluding FX gains/losses) for Q116 were SEK140.9m, down 17% on Q415 (SEK169.9m), due to cost control across all line items. R&D spending fell from SEK56.1m to SEK45.0m as the RESOLV study nears conclusion and Zubsolv-related costs have fallen. Future Zubsolv R&D spending is expected in connection with ensuring the ex-US data package meets regulatory requirements. Other project-based R&D costs will be incurred in relation to new development programmes that will be disclosed once IP is secured. Adjustment of the field force to reflect Zubsolv’s market access position helped reduced selling expenses by 15% to SEK60.8m vs SEK71.9m; Orexo will on an ongoing basis optimise sales force deployment and investment based on market conditions. Consequently, we believe that there could be more meaningful movement in future sales expenditure as legislative change would provide a market opportunity for Orexo to increase Zubsolv revenues, at which point we would expect further investment in sales infrastructure. Admin expenses, which include investment in the maintenance and protection of IP, were also lower at SEK35.1m vs SEK41.9m.

Management has provided cost guidance for Q216, but not for the second half of the year as Orexo is maintaining flexibility given the potential for increased investment in order to benefit from the impact of legislative change. Guidance for Q216 is for R&D spend of c SEK40m, sales expenses to remain broadly at the same level as Q116 (ie c SEK60m) and admin costs in the region of SEK35-40m. We have updated our model in line with new guidance; a summary is provided in Exhibit 9 overleaf, with the main changes to our forecasts presented in Exhibit 8.

Orexo’s net debt at end March 2016 stood at SEK261.9m, with SEK233m of cash and equivalents. The company maintains a solid cash position, which has benefited from positive operating cash flow in Q116. Significant Zubsolv inventory (SEK382.5m in raw material and finished product) as well as expected business development income (which is not included in our forecasts) will contribute to improving future cash flow generation from operations.