Triumph of Hope Over Reason

Some silliness: Yesterday a SunTrust (NYSE: STI  ) analyst reiterated a "neutral" rating on biotechnology company ImClone (Nasdaq: IMCL  ) , placing a price target on the company of $66. Naturally, we Fools don't pay too much attention to analysts' price targets -- there's just no profit in doing so. But ImClone closed yesterday at a hair less than $52 per share, so my question is, on what planet is a 27% annual gain (the difference between the current price and the price target) "neutral"?

Want more? Standard & Poor's reiterated its "buy" rating of ImClone, but S&P notes that investor expectations on the company "have been too high." Huh? Again, nothing that we find that compelling, but the logic is puzzling. It's as if they're saying, "Yes, we've kept a buy on this company as its stock rocketed up and then tanked. We still have one, but we think folks have been a little aggressive with this."

Unbelievable. At least SunTrust called expectations "lofty" to go along with its neutral rating.

ImClone, at the moment, is a one-drug company. Its colon cancer therapy Erbitux is its only revenue generator. So when drug data provider IMS Health (NYSE: RX  ) noted that July sales for Erbitux were dramatically lower than expectations and, more importantly, than the previous month's numbers -- $25 million vs. $30 million in June -- that gets investors in a bit of a lather. I fail to understand the logic from either analyst above, but let's just blame that on the lather. If you drop down to a weekly revenue number for July (to account for the fact that it was a four-week month), its numbers compared with June's are better. But when ImClone's CEO Daniel Lynch remarked in advance that he thought sales were going well in July, this was not the result many had in mind.

The Food and Drug Administration has approved Erbitux for use in late-stage colon cancer patients, either in combination with chemotherapy in cases where chemo alone hasn't worked or by itself for patients who can't handle chemotherapy. These are desperately sick patients for whom nothing else has worked. The annual cost (should a patient need it for this length of time) for Erbitux treatments can run much higher than $100,000. It has competition from Genentech's (NYSE: DNA  ) Avastin, a similar therapy that also treats tumors by attacking certain proteins that promote growth, though Avastin's therapy is for earlier-stage cancer.

I have to admit having been blown away by the annual cost of Erbitux. But from the February launch date, it seems that the proof was in the pudding, as Erbitux sales rocketed out of the gate. Now that the numbers have backtracked, there is some discussion that its initial strong numbers were actually poor predictors of future demand, that they represented a pent-up demand rush of people desperate to gain access to treatment for their conditions. This makes some sense, though it must be noted that the backlog of end-stage colon cancer sufferers, by definition, couldn't be much more than a few months long. We're not talking about a long-awaited cure for psoriasis.

Upon its approval, some analysts were claiming that Erbitux would be a blockbuster drug, with the potential for $2 billion in annual global revenues. This would, of course, be a home run for ImClone, which gets 39% of all revenues under a marketing deal with Bristol-Myers Squibb (NYSE: BMY  ) . Erbitux sales outside of the U.S. (except Japan) are controlled by German drugmaker Merck KGaA (OTC BB: MKGAF.PK), and ImClone's benefit from such sales will be minimal.

But some oncology researchers shared with me their fairly disconcerting views on Erbitux. The FDA rejected the drug in 2001, only to approve its fast-track application in 2003. They remarked that while they were glad that Erbitux addresses late-stage colorectal cancer, some thought the FDA process was the sloppiest they'd ever seen for a drug approval. One noted that oncologists were balking at the price of the drug, given that they believe that its efficacy is marginal. (As fellow Fool Charly Travers explained, the FDA approved Erbitux based on the fact that the tumors responded to the therapy and not based upon observable improvements in survival rates.) One researcher said that not even many of his oncology colleagues knew how the drug was supposed to be used -- whether it would have to be taken forever, or whether there were some shorter cycles. There was also plenty of confusion as to whether Erbitux would work better as part of a cocktail -- with Avastin, for example -- than it would when used alone. Still, given Erbitux's cost, he believes that doctors are unlikely to use it in any way other than what it is labeled to do: to treat what is known as 3-line colorectal cancer.

ImClone can overcome many of these challenges, of course. You just can't make up the genuine enthusiasm for Erbitux among some premiere researchers, including Drs. John Mendelsohn and Leonard Saltz of the Anderson Cancer Center and Memorial Sloan-Kettering Cancer Center, respectively. In the choice between a drug that offers some efficacy versus nothing, many doctors are going to roll the dice in cases where there is a chance of success. ImClone and Bristol-Myers have plenty of educational outreach to do, and it seems to me, based on these conversations, a different pricing regime might convince doctors to be more aggressive in prescribing the drug.

But the thing that gets me about ImClone is that the company is valued as though Erbitux has already been a smashing success, as if it has already received approval for other therapies currently in trial such as earlier-stage colorectal cancers and head and neck cancers, extending its on-label marketing reach. At an enterprise value of $4.1 billion, ImClone has grossly improved both its operating and financial positions from the days of scorn and scandal when Sam Waksal ran the show. Even if the annual domestic sales for Erbitux hit the $1 billion mark -- blockbuster status, if you will -- ImClone garners only 39% of that amount, or $390 million. That's revenues, and yet the company's stock is priced 10 times that high today. Those are some huge assumptions. Charly Travers got an earful when he wondered what investors were thinking buying ImClone at a $5.2 billion market cap. Well, it's down some 20%, and I'm still wondering.

And given that there has been no statistical proof that Erbitux extends life among the population of patients for which it currently has approval, the assumption of continued rapid growth should not be taken for granted. You see companies like this, and you just hope that they're unleashing miracles of science. You want desperately for them to succeed, to bring life back to the terminally ill.

That doesn't necessarily make them good investments, though. Not at just any price.

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Bill Mann owns none of the companies mentioned in this story. He didn't fall for the whole "pirin" tablet thing, either. The Motley Fool is investors writing for investors .