FOOL ON THE HILL
Biotech for Gamblers

Tom Jacobs valued ImClone at $10.67 a share at the end of January, when its future was up in the air. There is plenty of uncertainty left, but its lead drug Erbitux has at least a good shot at approval in the next year, and competitors haven't cornered the market. If all goes well, the company could be worth $15.13 a share -- 72% over its current price -- but it's an absolute gamble.

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By Tom Jacobs (TMF Tom9)
September 26, 2002

[On the day after this article was published, the Wall Street Journal ran a p. 1 story detailing former ImClone CEO Samuel Waksal's history as a scientific researcher of fabricating and manipulating data. While Waksal-era data on ImClone's Erbitux may still be credible, and post-Waksal data may prove more reliable, this major uncertainty is another strong reason to steer clear of the stock.]

Some call biotech investing a lottery -- or worse. Investors in established or upstart biotech drug makers must have strong stomachs. Most drug candidates fail, and even late-stage hopefuls sometimes produce disappointing data after showing initial promise.

A new company riding on one big drug lives or dies on its prospects: If it fails, look out. Even if it does win FDA approval, it still may not be a success in the marketplace.

By now, the name "ImClone" is synonymous with this risk. Last December, the FDA stunned investors and biotech drug maker ImClone Systems (Nasdaq: IMCL) by refusing to accept its application for approval of its colorectal cancer treatment Erbitux.

On the basis of early data and because of the lack of treatments for colorectal cancer patients who were not responding to often-used chemotherapy agent irinotecan, the FDA granted Erbitux fast-track status. This meant it would review the data on a rolling basis. However, it refused the application to do so. Whew.

This is a very big deal for a drug maker, and it was especially so for ImClone, for two reasons: First, Erbitux was the unprofitable, cash-eating company's sole lead product candidate; second, it was the most advanced of a new class of drugs called epidermal growth factor receptor (EGFR) inhibitors, designed to slow or turn off a protein believed to be important in over 50% of certain lung, head and neck, and gastrointestinal cancer tumors.

In drug land, the first of a new treatment through the FDA's gate usually becomes the standard against which subsequent candidates are measured. Kinda like, "So, uh, we've got one of those. What makes yours different and better? Can it dance on the head of a pin?" Merely building an equally good mousetrap doesn't cut it.

Losing your inhibitors
That's why when the FDA dealt ImClone the blow, it did more than slow it down. It gave valuable time to competing EGFR inhibitors Iressa, from AstraZeneca (NYSE: AZN), Tarceva from OSI Pharmaceuticals (Nasdaq: OSIP) and Genentech (NYSE: DNA), and ABX-EGF from Abgenix (Nasdaq: ABGX) and Amgen's (Nasdaq: AMGN) Immunex unit. 

This week has been kinder to ImClone's competitors. Tarceva, already under FDA fast-track status since May, gained another fast-track designation Monday for certain non-small cell (NSC) lung cancer treatment uses. And despite lowered expectations from AstraZeneca management, an FDA advisory panel Tuesday recommended the FDA approve Iressa for the same cancer in advanced stages where other treatments have failed. The FDA usually follows the panel's advice, though not always.

But investors need to scrutinize approval -- or the prospects for approval -- of a cancer drug carefully. Because cancer is so deadly serious and the side effects from standard chemotherapy so severe, the FDA may approve drugs that have little benefit for a small subset of patients.

That appears to be the case with Iressa. AstraZeneca reported mediocre data from Iressa in human trials, preparing the market for disappointment from the FDA panel. Yet the advisory panel recommended approval because of clear benefits for a small subset of patients, even if it isn't widely helpful. That's good for doctors and patients.

But for investors, that approval comes with the probability the drug's limited benefits will mean limited profits. Ditto Tarceva, where the fast-track status is for very limited, late-stage lung cancer when one or even two other standard treatments have failed. Doctors will use these when they have no alternatives. Hardly blockbuster material.

True, these drugs are in trials for other cancers, and they may prove more effective elsewhere. But so far, they haven't raised the bar so high that Erbitux looks like a come-lately loser -- and, in fact, suggest if Erbitux possesses its touted benefits, approval is at least as likely as before, if not more so. The crucial issue for investors will be whether any EGFR inhibitor can extend survival in more than one cancer. Then there's big money.

What we know today
So, at least for now, Erbitux is still in the running. ImClone must conduct more tests to beef up its data and reanalyze existing data before resubmitting its application. The company is now hoping for approval in 2003. Back in January, I valued the company at about $10.67 a share based on probabilities for five different outcomes. We didn't know whether:

  • Allegations of insider trading by the former CEO, Samuel Waksal, were true, and if so, whether other officers were in the soup, too.

  • Bristol-Myers Squibb (NYSE: BMY) would pull out of its $2 billion deal, leaving ImClone without a deep-pocket partner for the rest of Erbitux's development.

  • The FDA's rejection of ImClone's application for consideration of data on a rolling basis was due to inexperience or incompetence. Or worse, whether Erbitux was just plain useless. We didn't know for sure if or when Erbitux would be approved by the FDA, and if approved, with what eventual revenues.

Today, we know more:

  • Samuel Waksal has been indicted and has resigned from ImClone. There is no indication (yet) that other officers acted improperly, though allegations have surfaced about his brother, now CEO Harlan Waksal, ordering a paper shredder. The SEC and Congress continue to investigate the company.

  • Despite saber rattling by both companies, Bristol-Myers renegotiated its deal on slightly more favorable terms. Its ill-starred purchase of over 14 million ImClone shares at $70 is history (ImClone closed yesterday at $8.96), as is the big drug maker's stock price, but it did succeed in reducing its milestone payments by $100 million. Instead of a $500 million payment on FDA approval, Bristol-Myers will pay $250 million each if and when Erbitux is approved for a first and second indication. ImClone will receive 39% of North American revenues.

  • Erbitux's rejection appears to be from ImClone's inexperience and incompetence -- though we'll probably never know the inside truth -- and not because Erbitux is a loser. Subsequent data appear to back up earlier proof that Erbitux does work well in serious cases. [Though the day after this article was published, more questions appeared Samuel Waksal's history of data manipulation. See note at the beginning of the article.] Competitors have not -- for now -- taken over the market. Approval is still more likely than not, which, in the drug game, is not half bad.

Buy ImClone?
I invest in high-risk companies often, but experience over the last few years has taught me to give this opportunity a wide berth. ImClone appears to have enough money to see the rest of the data-gathering process through and resubmit the Erbitux application. The drug appears to have a good shot at approval. Trials of the drug for other indications appear to show potential for efficacy in other cancers besides colorectal. Former management clearly lost investor confidence, and while it appears that the problem is gone, this whole brother thing is a bit weird for me.

That's a lot of appearances. With which we need not keep up.

But there are fewer uncertainties now than in January. Using a 15% discount rate, assuming that Erbitux is approved in 2003 and ramps over a few years to $1 billion in revenue, I compute a value of $15.13 a share. That's assuming no new revenue from other drugs in development.

At $8.96, ImClone shares sell at a substantial discount, but what a risk! Erbitux might not be approved, or it might be approved with limited prospects (like Iressa). Or, sure, it could expand beyond colorectal cancer and be a real blockbuster, billions and billions served. Who knows?

That's a lotta coulds. It's always difficult to write about a company with a new treatment, because you hope it works and patients will be helped. But investing is about your financial future. If you simply must do something about a biotech urge, and unless you have money to light with a match, why not just start a dividend reinvestment plan with Johnson & Johnson (NYSE: JNJ), which buys you its Centocor and Ortho Biotech biotech operations as well as its gold-plated consumer brand? You'll sleep better.

If you're really revved up, tell us your biotech investing ideas on our Biotechnology discussion board.

Tom Jacobs (TMF Tom9) currently causes others to need medication, but takes none himself. At press time, he owned no shares in companies mentioned in this story. To see his stock holdings, view his profile, and check out The Motley Fool's disclosure policy.