I recently had the pleasure of chatting with Flexion Therapeutics (NASDAQ:FLXN) CEO Mike Clayman about the company's plans for Zilretta, a newly approved medicine treating osteoarthritis of the knee. The company is in the midst of launching Zilretta, and if all goes well, it could eventually displace the use of corticosteroid shots in millions of patients. Is now a good time to buy Flexion Therapeutics shares? Read on to learn more about this company's opportunity.

First, some background

Initially, doctors recommend over-the-counter pain medicines for patients who suffer from pain caused by osteoarthritis of the knee. However, when those medicines fail, doctors prescribe opioid pain medications and corticosteroid or hyaluronic acid injections.

Man in athletic attire holding his knee.

Image source: Getty Images.

Apparently, that happens a lot. Roughly 40% of all osteoarthritis pain patients are prescribed opioid medications, 4.3 million patients in the U.S. receive quarterly corticosteroid injections, and 1.1 million patients get hyaluronic acid injections in hope of achieving relief from their knee pain.

Clearly, the use of these treatments is common, but each has significant drawbacks that make this market ripe for disruption. For example, opioids are effective pain relievers, but they expose patients to addiction risk. The life-threatening potential associated with opioid abuse has regulators and doctors eagerly looking for other treatment options. 

Corticosteroid and hyaluronic acid are less risky treatment options, but unfortunately, they really don't work very well. The pain relief provided by corticosteroid shots often wears off long before a patient's next scheduled injection, and the efficacy of hyaluronic acid injections is so uncertain that it's not even recommended for pain relief in the latest American Academy of Orthopedic Surgeons guidelines.   

Management's plans

Zilretta is an extended-release formulation of triamcinolone acetonide, an immediate-release corticosteroid that Flexion Therapeutics has combined with its own microsphere technology. It doesn't have the addiction risks associated with opioids, and unlike corticosteroids and hyaluronic acid, it can provide lasting pain relief. In trials, patients taking Zilretta saw their pain drop by about 50% over the course of a 12-week period.

During our conversation, I asked Clayman how he plans on leveraging that arguably best-in-class efficacy and safety to win market share. He told me that Flexion Therapeutics has hired more than 100 salespeople to call on healthcare providers and that those salespeople will be educating providers on how to use Zilretta (it requires mixing prior to use) and how to make sure they receive reimbursement from payers. 

Corticosteroids don't require pre-mixing, and many of them are cheap generics that are easily reimbursed by Medicare and commercial insurers. They've been used for a long time, which means providers are pretty comfortable with them. Nevertheless, most providers probably won't worry too much about reconstitution. They're likely to worry much more, however, about getting paid. 

Medicare patients account for about half of this market, and Zilretta won't have a distinct Medicare reimbursement code until early in 2019. Until then, it will be paid for under a miscellaneous J-code. Commercial insurers represent about 40% of the market, so getting contracts in place with them for payment will also be important. 

Unlike prescription drugs that can be filled at a pharmacy and taken at home, Zilretta is administered in the healthcare provider's office. That means that the provider has to buy it up front and then file for Medicare payment after it's been administered. Because of the upfront costs associated with stockpiling Zilretta, providers might balk at building up a significant inventory of it until they know for sure that they'll get paid when they use it. Therefore, making sure that reimbursement goes off without a hitch will be important for the company initially. 

Overall, Clayman is confident that the company can address providers' concerns, but he admits that 2018 is likely to be a building year. Instead, it appears that 2019 could be the first big year for Zilretta. At that point, doctors will have built up real-world experience using it, shared those experiences with peers, and ironed out any reimbursement headaches.

What's Flexion Therapeutics worth?

Flexion Therapeutics share price has stumbled since Zilretta's approval. Some of its sell-off is probably due to "buy the rumor, sell the news" activity relating to the FDA decision, but some investors may have sold their shares because of a study earlier this year that showed accelerated cartilage loss in patients given quarterly shots of immediate-release corticosteroids.

The study didn't involve Zilretta, but it did involve the use of the immediate-release corticosteroid that's combined with Flexion Therapeutics' microsphere technology. Some investors may be nervous that the use of quarterly shots declines following the study, but that concern could be misplaced. There simply aren't a lot of options available to these patients other than knee replacement surgery.

About 50% of Americans are expected to develop symptomatic knee osteoarthritis during their lifetime, and diagnoses are occurring at increasingly younger ages. Since a knee replacement only lasts for about 20 years, performing these surgeries when patients are younger exposes them to a greater risk of requiring a second surgery. Surgery is costly and it increases the risk of infection, so it's hard for me to believe that doctors and insurers would prefer going that route until they've tried other options, including Zilretta, first. 

If I'm right, then Flexion Therapeutics shares could be undervalued. Sales of the hyaluronic acid medications Synvisc and Synvisc One clock in at nearly $100 million per quarter, and the corticosteroid and opioid markets are even bigger.  

Currently, there are nearly 8 million corticosteroid and hyaluronic acid injections administered annually, and Clayman says the market can support a net price of $500 per injection for Zilretta. Some quick math suggests that even if Zilretta gets just 10% market share of those injections, it could generate $400 million in annual sales. If we assume a price-to-sales ratio of between three and four, then you could model for a $1.2 billion to $1.6 billion market cap, which is nicely higher than its sub $1 billion market cap now.

Also, investors could be undervaluing the potential to market Zilretta overseas and to expand its use into other osteoarthritis indications. Overall, I think Flexion Therapeutics could be worth owning in growth portfolios. Sure, Zilretta could fall flat, but the indication is ripe for disruption, and Clayman sounds like he's got a good grasp on what needs to be done to tap this opportunity.