A Pain Specialist Buys a Technology Call Option

Endo Health Solutions (NASDAQ: ENDP  ) has not been shy about using M&A to rebuild its growth prospects in the wake of losing patent coverage on Lidoderm and Opana ER. While prior management didn't do well with its M&A, new management has already made some smart (albeit not necessarily cheap) deals for Paladin Labs and Boca Pharmaceutical. Now management is going for for a different sort of deal -- the acquisition of NuPathe (UNKNOWN: PATH.DL  ) is hardly a slam dunk value-adding deal, but the upfront consideration of $105 million excluding deal costs is not a terribly high price to pay for taking a chance.

The deal
Endo Health announced that it had reached an agreement to acquire NuPathe for $2.85 per share in cash upfront (totaling about $105 million) and up to $3.15 more per share in contingent cash payments. NuPathe shareholders will get $2.15 per share if Zecuity sales meet or exceed $100 million in revenue over any four-quarter period in the nine years after launch, and another $1.00 per share if the sales exceed $300 million.

What Endo Health is buying
The key asset at NuPathe is Zecuity, a battery-powered drug patch that was approved in January 2013 for migraine. Zecuity's active ingredient is sumatriptan, the generic form of GlaxoSmithKline's (NYSE: GSK  ) one-time migraine blockbuster Imitrex.

While Imitrex is quite effective in relieving the symptoms of most migraine sufferers, it is not without a significant side effect -- a large percentage of those who take sumatriptan orally experience nausea, and it is severe enough for some to make oral sumatriptan impractical. By avoiding the GI tract, though, Zecuity avoids those elevated levels of nausea in most migraine patients.

That all sounds fine, but it is more complicated than that. Non-oral forms of sumatriptan (Imitrex Nasal Spray and Imitrex Injection) generated only $100 million in revenue in 2008 before going generic. What's more, NuPathe was quite open about wanting a commercial partner for Zecuity but even with the dearth of branded drug growth prospects and the attractiveness of pain management, there we no takers. That inability to find a partner, and the subsequent delay of the commercial launch of Zecuity, goes a long way toward explaining why the $2.85 upfront price for NuPathe is 25% below the price after Zecuity was approved.

What can Endo do?
Endo Health already has a sizable presence in the pain management space, making it arguably an ideal owner for Zecuity. If Endo Health can't make a winner out of Zecuity, I'm reasonably certain that nobody else could.

I do believe that Endo Health will be able to strip out almost all of the operating costs of NuPathe. After Zecuity, all NuPathe has are two preclinical assets (NP 201, NP 202) for Parkinson's and schizophrenia/bipolar disorder. I have my doubts that Endo Health will choose to develop these, and may look instead to sell, license, or abandon them outright (and may develop them to phase 1 just to improve licensing/sale prospects).

I have confidence that Endo Health will succeed in stripping out costs, but I'm still skeptical that the company will have to pay out those sales milestones. Allergan (NYSE: AGN  ) will likely get approval for Levadex in the first half of 2014 and the late-stage data from this drug have been encouraging with respect to Allergan's likelihood of distinguishing this drug in the market. At a minimum, Allergan's Levadex can benefit from patients and doctors looking to try a new drug for patients who haven't responded to triptans.

The bottom line
Endo Health's management has done a very good job of selling the Street on the idea that this is a new company. This deal for NuPathe may bring back some memories of the more speculative deals that the company used to do (and generally frittered away shareholder capital), but I believe the risk-reward balance makes it worth a shot. While I expect Zecuity to be a $50 million to $100 million a year drug at best, I believe Endo Health could earn a double-digit return on this deal with that and if the company ends up having to pay those milestones, that will be a "win win" for everybody.

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