Is This Marijuana Stock GW Pharmaceuticals' Biggest Risk?

Often "build-it-and-they'll-come" drug development doesn't pan out as predicted. According to a McKinsey study last year, analysts are often way off target in forecasting peak sales for drugs making their way through trials.

If analysts' sketchy track record proves true for GW Pharmaceuticals' (NASDAQ: GWPH  ) Sativex, investors may be left holding an overpriced stock worth a great deal less than its current $1.5 billion market cap.

Source: GW Pharma.

Less than stellar record
McKinsey's study looked at 260 drugs that were launched between 2002 and 2011 and discovered that 60% of analysts' predictions heading into their approvals were not only off, but off by as much as 40%. In many cases, McKinsey found that analysts' overly bullish stance overstated the potential market by as much as 160%.

Predicting sales for drugs launched by small companies like GW Pharma was one area where analysts did particularly poorly. Whether analysts' failure to accurately estimate the sales potential for small companies is due to a lack of corporate history or an overly optimistic view of emerging biotechnology as a group is unknown, but their troubles could mean that investors counting on Sativex to rack up hundreds of millions in sales from potential approvals for MS spasticity and cancer pain in the U.S. may end up disappointed.

Source: GW Pharma

Sativex struggles to grow
Sativex won approval for MS spasticity, or muscle stiffness and spasms, in Europe and is on the market in more than a dozen countries overseas, but that's failed to translate into big-time sales.

Revenue from the drug amounted to just $13 million in the first quarter, and despite potential launches in new markets, payer pushback may mean bigger price cuts.

Last month, the UK's top price watch dog rejected paying for Sativex claiming that its benefit didn't justify its cost. That's not the first time the regulator has taken such a stance, but other companies that have endured its scrutiny, including Novartis, have had to offer big price concessions to win them over.

The drug may end up winning approval in the U.S., but that won't guarantee a rapid uptake by doctors. Investors should be similarly concerned over Sativex's opportunity in the indication, given that Europe's MS population is as large as that in the United States. If that's true and GW Pharma is able to double its sales for the indication with a launch in the U.S., we're still only talking about roughly $100 million in annual sales.

That suggests that the company is going to need an approval in cancer pain if it hopes to lower its sky-high valuation of more than 20 times forward sales.

GWPH PS Ratio (Forward 1y) Chart

GWPH PS Ratio (Forward 1y) data by YCharts

But even if Sativex does win over FDA regulators, it's unknown whether market demand in cancer pain will be big or small.

GW Pharma's filing is for approval as a second-line treatment after the more commonly prescribed opioids like Insys' (NASDAQ: INSY  ) Subsys, Teva's Actiq, or Mallinckrodt's Xartemis. That means it's likely to be prescribed only for patients where opioids don't adequately control pain, and while opioids carry risks of dependency, new variations are making them longer lasting, less easily tampered with, and less addictive.

Mallinckrodt's XartemisXR long-lasting oxycodone tablets, for example, have lower levels of oxycodone per tablet and more inactive ingredients that dissuade abusers, and they possess an inactive ingredient that gels and makes nasal and IV abuse difficult.

Counting on its pipeline
If cancer pain and MS spasticity fail to move the needle, investors will need to hope that GW Pharma's pipeline can deliver more winners.

Investors are already excited over the company's potential in epilepsy, and GW Pharma did have pre-clinical success in diabetes, too.

In 27 patients receiving the company's Epidiolex and who were resistant to existing therapies, the mean frequency of seizures fell by 44%. GW Pharma has won FDA fast-track status for the rare indication and is moving the drug into phase 3, but the form of epilepsy for which Epidiolex received fast-track and orphan status is fairly uncommon, with just 5,400 patients in the U.S. and 6,700 in Europe.

Additionally, GW Pharma's Epidiolex isn't the only epilepsy drug making its way toward regulators. On July 2, Insys received FDA orphan designation for its cannibidiol for Dravet Syndrome, too, and Insys expects to launch trials in the indication later this year.

Fool-worthy final thoughts
GW Pharma is an intriguing company operating in a white-hot market. As a result, investors have set the hurdle high for the company. Whether GW Pharma can live up to its billing is a question only history will answer, but for my money I'm content to sit on the sidelines until the company can prove that market demand will be great enough to justify its lofty valuation. 

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Todd Campbell

Todd has been helping buy side portfolio managers as an independent researcher for over a decade. In 2003, Todd founded E.B. Capital Markets, LLC, a research firm providing action oriented ideas to professional investors. Todd has provided insight to a variety of publications, including SmartMoney, Barron's, and CNN/fn.

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