Bedside Biotechs

Ever have trouble sleeping? You're not alone -- up to 30% of women and 20% of men (which would lead me to think that's about 25% of the population) take medicine to help them sleep. About half of these medicines are over-the-counter pills that are usually just repackaged anti-histamines -- you know, the same medicines that make you sleepy when you're sniffly.

Other medicines include benzodiazepines, which are related to Valium, and are usually available only by prescription. Both classes of medications have problems that include daytime drowsiness (the "hangover" effect) and disruption in normal sleep rhythms ("rebound insomnia").

Sometimes anti-depressants are prescribed, but they, too, have side effects that leave many avoiding the medicines and suffering in silence -- or at least hitting new high scores at 4:00 a.m. on their favorite video games.

Meet the new sleeping pills
Enter the new anti-insomniacs. The new drugs like Ambien (Sanofi-Synthelabo (NYSE: SNY  ) ) and Sonata (King Pharmaceuticals (NYSE: KG  ) ) are neither old-fashioned benzodiazepines nor anti-histamines, so they do not have the same side effects associated with those medicines. They act specifically on a subunit of a particular brain protein to induce drowsiness and maintain uninterrupted sleep.

Ambien is a true blockbuster drug, with $1.3 billion projected sales in 2003. Sonata is not as popular but still will likely rake in about $100 million. And like moths to your nightlight, success attracts competitors.

The challengers
There are two big biotechnology competitors trying to grab a share of the insomnia market. Sepracor's (Nasdaq: SEPR  ) Estorra is poised to launch shortly, while Neurocrine Biosciences's (Nasdaq: NBIX  ) indiplon will be launched (assuming Food and Drug Administration approval) by 2005. Both of these companies aim to receive FDA approval for long-term use of the drugs, something that Ambien does not have.

Both also have fewer side effects than Ambien. But with Ambien coming off patent in 2006, these new insomnia medicines will need significant competitive advantages to justify a higher price than a generic version of Ambien.

Both Estorra and indiplon work on the same brain protein as Ambien. Estorra is a pure isomer (an isolation of a drug's active chemical) of Imovane, a sleeping pill sold by Aventis (NYSE: AVE  ) in Europe for many years. Sepracor plans to market Estorra using its own sales force.

Indiplon is licensed from DOV Pharmaceuticals (Nasdaq: DOVP  ) , and Neurocrine Biosciences has a marketing and development agreement with Pfizer (NYSE: PFE  ) , where payments to Neurocrine could total $400 million in addition to a share of U.S. revenues. The first $100 million payment was received this year.

Can they beat Ambien?
The trial data for the two newcomers actually look pretty similar to me. Indiplon cut the time it took to fall asleep by 50% in its trial, and it decreased waking episodes during sleep by 40%. Patients averaged about 45 minutes more sleep during the night.

Participants in the Estorra trial tended to have less severe insomnia, so it's difficult to compare the two directly. Still, patients also increased their sleep time by about 45 minutes and decreased awakenings by more than 50%. The Estorra patients took the drug for six months and experienced no significant build-up of tolerance or sleep disruptions. The drug leaves an unpleasant aftertaste, but that did not seem to cause patients to discontinue treatment.

One issue with the Estorra trial is that they measured subjects' alertness nine and a half hours after taking it, rather than the usual eight hours. The difference could obscure any hangover effect Estorra might have. Additionally, Estorra remains in the body longer than Ambien or indiplon.

Another significant difference between the trials is that the Estorra patients took the drugs for six months and experienced no significant buildup of tolerance or sleep disruptions, while indiplon's study lasted only two weeks. As such, the potential efficacy of indiplon over long-term use remains unclear. Indiplon will be studied over the longer-term in the coming year, however.

Right now it seems from the trial results that neither indiplon nor Estorra demonstrates significant improvement over Ambien. Therefore, sales and marketing efforts will be key to convincing physicians and patients that the new drugs are better. In that case, Estorra has first-mover advantage because it will come to market at least a year before indiplon. On the other hand, Neurocrine has the marketing muscle of Pfizer's legendary sales team behind it -- albeit at a cost of some of the revenues indiplon generates.

Finally, anti-insomnia medications are a lot like anti-depressants in that they affect individuals differently. If Ambien doesn't help a patient, indiplon or Estorra might, so the market could be expanded like it was for anti-depressants when they entered the pharmacies.

Despite the apparent similarities between Estorra and indiplon (and Ambien), the two companies developing the new drugs are quite different.

Sepracor
Sepracor was founded to isolate isomers of approved drugs, with the expectation that these pure formulations would be more effective and have fewer side effects than the mixed, or racemic, formulae. Fruits of this research include several well-known drugs licensed to Big Pharma, including Allegra and Clarinex. Royalty revenues from such drugs rang up $27 million for Sepracor in the first half of this year.

More valuable, however, has been Sepracor's development of Xopenex, a drug for asthma that accounted for $133 million in first-half sales this year, an increase of 63% over last year. Xopenex is a form of albuterol, a generic drug, so Sepracor's marketing success shows that it has been able to compete against a generic using its own sales force. The corporate experience gained from the Xopenex sales staff will help Sepracor compete against a future generic Ambien, not to mention indiplon.

However, Sepracor still isn't profitable. It has lost $63 million so far this year and accumulated nearly a billion dollars in convertible debt issuances. The payments on these debts total nearly $55 million in annual expenses through 2006. With $300 million in the bank, Sepracor should be able to cover its costs, but the company will need to ramp up revenue from Estorra quickly to generate cash.

Sepracor also has another formulation of Xopenex in Phase III trials, along with a different drug for chronic obstructive pulmonary disease (COPD) and an incontinence drug. Finally, Sepracor is trying to salvage Soltara, a drug that received a thumbs-down by the FDA in 2002 and sent the company's stock price tumbling 60% in a single day, triggering the inevitable shareholder lawsuits. Just a reminder that biotechnology investing is not for the faint of heart.

That adds up to one launched drug, two under review by the FDA, and three more in Phase III trials, with one of those being a reformulation of Xopenex. Sepracor's market capitalization is $2.4 billion, with an enterprise value of nearly $3 billion.

Neurocrine Biosciences
Neurocrine Biosciences is a company, as its name indicates, that has been concentrating its efforts in developing drugs for both the brain (the "neuro" part) and the endocrine (the "crine" part) systems. It is a smaller company by market cap than Sepracor, being valued at approximately $1.5 billion, with an enterprise value of about $1.2 billion.

However, Neurocrine does not have any products on the market. Indiplon is the one drug closest to market, but that's still more than a year away. Unlike Sepracor, the company does not have an experienced sales staff, but the partnership with Pfizer -- the best in the business -- should lend all the experience needed to market indiplon successfully.

With the payments from Pfizer, Neurocrine has cut its losses significantly, to just under $12.5 million last quarter, compared to $22 million for the second quarter last year. It has nearly $35 million in cash and another $238 million in short-term investments, comprising an impressive hoard with minimal debt.

The downside is that Neurocrine does not have the revenues of Sepracor, making it a riskier investment. In addition to indiplon, Neurocrine has one other drug in Phase III trials for glioblastoma, a type of brain cancer, and a drug in Phase II for multiple sclerosis. Additionally, Neurocrine will have to share revenues from indiplon with Pfizer.

Considering most risk-valuation arguments agree that a billion dollar drug in Phase III is worth about $500 million to $800 million, it appears that both companies are priced pretty fairly, with perhaps Sepracor being a better value.

I believe debt and Soltara's rejection continue to weigh on Sepracor shares. But with prudent cash management and with effective marketing of Estorra, Sepracor should begin to turn a profit. Still, neither of these companies is screaming "buy" to me at the current valuations. They are, however, worth watching in case a buying opportunity emerges.

More by David Nierengarten: "Biotech Pain Killer," Oct. 28, 2003.

Like exploring small-cap opportunities like these biotechs? Then you might like Tom Gardner's Motley Fool Hidden Gems newsletter.

David Nierengarten, Ph.D., works with a biotechnology venture capital fund. He often contributes to Fool.com and is an active member of the TMF community as DavidMN. He does not own shares of any of the companies mentioned in this article. He appreciates your comments at davidnierengarten@mac.com and on the Biotechnology discussion board.


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