ViroPharma's Generic Discount

Did you feel that downdraft? Whoosh! That gale force wind was created by tiny biotech ViroPharma (Nasdaq: VPHM  ) falling off the cliff and plummeting 33% on news that generics may be allowed to enter its antibiotic drug market sooner than expected.

ViroPharma's sole source of revenues is the drug Vancocin, which it bought the rights to in 2004 from Eli Lilly (NYSE: LLY  ) for $120 million. Not a bad deal, really, when you consider that sales in 2005 for ViroPharma were $126 million. Although it was still required to pay some royalties to Lilly, they were relatively negligible.

There's big demand for Vancocin, an antibiotic which treats enterocolitis (an infection and inflammation of the intestine that usually develops in a hospital setting). Sales are expected to continue their expansion -- they've grown at a compounded rate of 65% for the past three years -- since the bacterium already kills thousands of people each year in the U.S., and it's apparently growing more common and deadly. A supervirulent strain -- which generates 20 times more toxins that damage the colon than the typical strain -- has been reported in at least 14 states and several countries.

The fear of this widely spreading bacterium has allowed ViroPharma to raise prices of Vancocin by 80% since it acquired the rights to it. While $800 for the complete regimen compares favorably to other infection antibiotics that cost as much as $2,000, it's expected that ViroPharma could increase the cost by another 65% and still be considered reasonable. That has been fueling the growth in ViroPharma's stock, which has risen by more than 500% over the past year.

Yet it's also possible that the price increases played a role in the FDA's decision to allow generics to move into the market ahead of schedule. The FDA recently informed ViroPharma that the regulatory agency had revised its policy of requiring clinical trials showing the efficacy of possible generic alternatives; in the future it will merely require companies to show that lab tests of generics produce the same rate of dissolving as Vancocin does. Vancocin is the only FDA-approved oral drug of vancomycin that is delivered intravenously and specifically targets the bacterium that causes the infection.

Because of the cost factor, some doctors prescribe off-label treatments using metronidazole, which is less than one-tenth the cost of Vancocin. Yet the off-labels are not nearly as effective, nor can they treat the more severe cases of infection.

While it's difficult to imagine the FDA actually going through with this lesser standard of proof -- especially considering the heat that it's taking over its handling of Merck's (NYSE: MRK  ) Vioxx and Pfizer's (NYSE: PFE  ) Celebrex -- investors were concerned enough about the possible early entry of generics to whack $5 off ViroPharma's share price, which had followed a 9% decline the day before. The stock is more than 55% off its 52-week high, which piques my interest here.

The company has $233 million in cash, no debt, and is trading at a little over two times its book value per share. It has a trailing P/E of only 5 and a forward P/E of just 8, and the company was finally able to become profitable in 2005, on the strength of Vancocin. Generics, if they're ever even approved, will not appear on the market for at least two years, and ViroPharma has announced its intention to vigorously defend its patents. Considering the hypervirulency of the new bacteria, it seems unlikely that the FDA would follow through.

Moreover, while Vancocin is the biotech's sole product right now, it has two other drugs in its pipeline: Maribavir, which it acquired from GlaxoSmithKline (NYSE: GSK  ) in 2003, is used to treat cytomegalovirus, a common virus in the herpes family that is found worldwide; and HCV-796, with which it entered into a partnership with Wyeth (NYSE: WYE  ) in 1999 to target hepatitis C. Considering the amount of cash it has on hand from Vancocin, it could also always buy into another cash-producing drug -- should generics prove formidable.

The sell-off is definitely overwrought here, and investors would do well to look a little closer at this promising biotech.

GlaxoSmithKline, Eli Lilly, and Merck are Motley Fool Income Investorselections. Pfizer is aMotley Fool Inside Valueselection.

Fool contributorRich Dupreydoes not own any of the stocks mentioned in this article. You can see his holdingshere. The Motley Fool has adisclosure policy.


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