Millions of Americans suffer from depression, and there's a big unmet need for new depression drugs because about one-third of patients don't respond adequately to existing treatment options. To fill that need, Alkermes (NASDAQ:ALKS) developed ALKS-5461, a once-daily pill that combines an opioid with a compound that can prevent addiction. Unfortunately, missteps in ALKS-5461's trial design and less-than-convincing efficacy appear to have dashed the drug's chances of approval because a key Food and Drug Administration (FDA) advisory committee just voted overwhelmingly against approving it.

In this episode of Industry Focus: Healthcare, analyst Shannon Jones and specialist Todd Campbell explain why these experts object to ALKS-5461, and what investors should be watching at Alkermes next. Also, Jones and Campbell explain why Illumina (NASDAQ:ILMN) is expanding into the long-read gene sequencing market through its $1.2 billion acquisition of Pacific Biosciences (NASDAQ:PACB). Will this deal saddle the company with losses or be a boon to its future sales?

A full transcript follows the video.

This video was recorded on Nov. 7, 2018.

Shannon Jones: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today is Wednesday, November 7th. We're talking Healthcare. I'm your host, Shannon Jones, and I am joined via Skype by healthcare specialist and all-around good guy, Todd Campbell. Todd, how are you?

Todd Campbell: I'm doing great, Shannon, thanks. How about yourself? How are you doing, Shannon? 

Jones: I am doing well. I must admit, I'm excited, because we actually now have fall weather. I'm not so excited because it has been raining cats and dogs here in Alexandria for the past two days.

Campbell: I made the mistake of actually trying to mow my lawn this past weekend, [laughs] thinking that maybe I would get through it. I got halfway through and I was sinking into the ground, the ground was so wet. Listeners, don't bother going out and mowing until it's dried out! Public service announcement!

Jones: Always wise words from Todd Campbell. Thank you, Todd, for that.  I'm even more excited because on today's show, we're doing a news roundup. Todd, I'm excited because in the month of November, we started off with a bang. Healthcare got some big news, first of which was Alkermes' big day in court with the FDA last week. Also, finally, some M&A action that happened with Illumina. All around, it's been so quiet on healthcare. Now, we're starting to get some interesting news.

Campbell: You get that big push into the end of the year. Then in early January, when they get together at the JP Morgan conference, we usually get all sorts of exciting news that goes out. And, we've ASH coming in December, too.

Jones: We've got ASH! ASH is one of my favorites. Always big surprises. Big letdowns, too, but, big surprises. This is really my favorite time of the year for more reasons than one.

Campbell: Listeners are going to have lots of great stuff over the coming weeks! Keep tuning in!

Jones: For sure.

Campbell: This past week, we had the FDA smack down of Alkermes. And the really surprising news -- shocked me, anyways -- with Illumina stepping up and buying PacBio.

Jones: Yeah. Let's dig into Alkermes. For our listeners, on November 1st, Alkermes, ticker ALKS, had the opportunity to make its case for its depression drug, ALKS 5461 -- we'll just call it 5461 -- in front of an FDA advisory panel of experts. 5461 has been studied, is still being studied, in treatment-resistant major depressive disorder. But this drug in and of itself has had quite the roller coaster history. Looking at earlier this year, in April, at one point, you had the FDA issuing a refuse to file letter. In the grand scheme of things, a complete response letter is terrible. When the FDA refuses to even look at your drug, because they say it's not complete enough, that is red flag of red flags. But, two weeks later, all of a sudden, the FDA did an about face. Alkermes came out and said that they were able to "clarify" some things with the FDA. 

Todd, what is all the fuss with this drug, 5461?

Campbell: It makes you wonder whether they really clarified things, or if they basically just strong-armed them and said, "We're filing it anyway!" And the FDA said, "Hey, do it at your own risk." I urge everybody to go out and check out the background that that was put together by the FDA for the members of the Advisory Committee. As a refresher, what ends up happening with many of these drugs that go through the FDA process of approval is that the company will make a presentation in front of a panel of experts in that field and try to convince that panel of experts that their drug is both efficacious, it works, and that it's safe, it doesn't harm anybody relative to the efficacy that it delivers. That's what we're talking about. The FDA Advisory Committee panel meeting met to weigh in on 5461. And they voted overwhelmingly against its approval. The vote was 21-2 overall against approving it. 20-3 said that Alkermes did not provide substantial evidence of the drug's effectiveness. That's crazy, they only convinced three people that the drug was approvable for efficacy. And on safety, it squeaked by with safety barely, 13 votes in favor on safety versus 10. And if you read the background that was put together by the FDA for these committee members, you certainly feel a slant against this drug by the FDA. You'd assume that probably factored into the committee members' decision. 

Jones: There were so many interesting things. I would encourage any healthcare investor, if you are investing in the biotech space, I would say this is just as important as reviewing SEC filings -- reviewing the advisory committee briefing documents, to your point, Todd, is crucial. Oftentimes, a company may issue a press release, or they'll say, "We had very successful talks with the FDA and we're both on the same page." Really, I think what this panel demonstrated and highlighted is that that's not always the case. 

Looking at this drug, it was novel, not just the drug itself, but even from a study design perspective. Todd, what can you tell us about the drug itself? This is not your typical antidepressant. 

Campbell: Alkermes, I think, was thinking that because there's such a big need for new therapies that can address depression, they could push this over the finish line. There are about 15 million people in America who suffer from major depression. About 3 million new cases of major depression are diagnosed per year. Unfortunately, 60-70% of people with depression fail to respond to the existing antidepressant therapies that are on the market, and less than 30% achieve remission in depression on the first line of therapy that they try. So, what ends up happening is that they go through multiple lines of trying and failing on different antidepressants, hoping to find the right one that will work for them. Part of that is because we don't fully understand the cause of depression. We can make some assumptions about biology. We know that the environment can factor into causing it, as well. Most of the antidepressants, what they try to do manipulate the amount of chemicals that are in your brain, things like serotonin, to try and improve mood. This was going to be an entirely novel approach, an entirely new approach. 

What they were doing at Alkermes was combining together an opiate and a second compound that was designed to prevent you from becoming addicted to the opiate. You had buprenorphine, which is the opiate part of 5461, and samidorphan, which was the new entity that was trying to counteract the risks associated with taking buprenorphine. The idea here was "We know that opiates can improve mood. Is there a way that we can make them less addictive?"

We look at the trial design, the way that Alkermes set up the trials to try and win approval ... [laughs] again, reading this background, wow. They actually said in the background at one point, the FDA wrote that there was a "lack of alignment between the applicant and the FDA on this new drug application." A lack of alignment. It's really weird when you're being told by the FDA, "Hey, these are the things that you should probably do if you want to come in front of us and win approval," and you're basically ignoring them and saying, "No. We're going to do these things. We're just going to hope that you give us approval."

Jones: Yeah. That's what's been the big head scratcher here. You sometimes expect to see this with really small, very early stage biotechs. You don't expect to see it with a company like Alkermes. They're about a $6 billion market cap company, with approved products already on the market. That was a bit of a head scratcher. 

Going back to that trial design, it's something called sequential parallel comparison design, or SPCD. The reason that Alkermes was attempting to use this novel study design that the FDA didn't think had much merit was trying to get after one of the major problems that they see with depression trials, and that's the placebo effect. You see this consistently with drug companies that attempt to go after this depression indication. Oftentimes, when a patient is exposed to placebo, they have improvements. It makes it much harder to see the actual effect of the drug in the trial. Alkermes was attempting to mitigate this with this study design. Uh ... basically, they failed. [laughs] I'm trying to think of a nice way to say it. They failed! [laughs] 

Campbell: Downright failed! I mean, you think about the people who will enroll in a trial, it's going to be the ones who are most motivated to want to see an improvement. I think that's probably why you see the placebo effect typically being high in these trials. Historically, that's been a big problem for drug developers. Failure rates in depression and related disorders are much higher than they are in other disorders where maybe you can connect the dots little bit more easily to treatment versus outcome. This two-stage trial design approach, basically what they did is they randomized for the drug and for placebo, then they took the non-responders, and that's from that stage one that were in the placebo group, and then randomized again into either the placebo or the drug. And the FDA basically said, "We've never really considered this for any trial. We would need to see a lot more evidence to be convinced that this is a good way to design it." And, apparently, obviously, Alkermes did not deliver that.

That wasn't the only problem. They also designed the trial to take an average of outcomes over multiple weeks. Historically, when trials are designed for this indication, they use a fixed endpoint, so, the improvement at the six-week mark or the four-week mark or the five-week mark, whatever. In this case, Alkermes was trying to convince them, "No, use an average." They actually wrote in this background, "The division did not prospectively agree on this approach." [laughs] So, they already had told Alkermes, "Listen, we're not really comfortable with this."

And the third problem that Alkermes had, the third decision that they made that went against what the FDA was hoping that they would do, is that they used entirely new rating scale that they crafted. The Montgomery-Asberg Depression Scale rating is commonly used, but it's a ten-item questionnaire. And they cherry picked it. They created their own six-item version of it that excluded some pretty important stuff like suicidal thoughts.

Jones: The actual important things, and particularly more so, the things that really have not just a long-term impact, but, to your point, suicide, concentration difficulties, reduced appetite, reduced sleep, these are all things that are important for someone who suffers from depression.

In terms of what's next for the company... To back up a little for our listeners the FDA Advisory Committee makes a recommendation to the FDA whether or not to approve a drug. The FDA doesn't have to follow those recommendations. Sometimes, you've even seen the FDA be a little more lenient when it comes to psychotic therapies. But, right now, Alkermes is still running a Phase IIIb study. Not a lot of hope, especially given the trial results that we've already seen, but they have an approval date of January 31st. We could find out before then whether or not the FDA gives the green light. Thankfully, it sounds like this isn't the only thing that Alkermes has in the pipeline. Right, Todd?

Campbell: Yeah, it's not a one trick pony. It already generates about $250 million in sales per quarter. If you look at last quarter, sales were up about 14%. It markets a drug, Vivitrol, that's used to help prevent relapses for people who are addicted to alcohol or that use drugs. Sales of that drug were $80 million last quarter, up 15% year over year. It also has an atypical anti-psychotic drug, Aristada, that's approved and generating revenue growth for the company. It also collects royalties on a bunch of different anti-psychotic drugs that are on the market already and marketed by some of the largest companies in the world. 

This is definitely a company that generates revenue on an adjusted basis. It turns a profit. But this is obviously a disappointing failure because it's a multibillion dollar marketplace, and it could have turned this 5461 into a billion-dollar blockbuster for them. 

Their next thing that investors are going to want to keep an eye out for is results from a drug called 3831 that's being evaluated in schizophrenia. Basically, it's a version of Zyprexa, which is commonly used but its patent expired, so they can manipulate it if they want, and they are. They're manipulating it so that it doesn't result in weight gain, which has been a big drawback of Zyprexa. Phase III results are expected before the end of this year. If they're positive, they could file for FDA approval next year. Zyprexa's peak sales were above $2 billion, so theoretically, this could add nicely to its sales in the future.

Jones: Absolutely. Also, what's really interesting is, Alkermes also has an early immuno oncology asset in their pipeline now. It'll be interesting to see this traditionally CNS-focused company pivot into immuno oncology. Certainly something to keep an eye on. 

Let's turn the tables here. We've been talking about things that are novel. Things that are actually novel and are having a true impact here is a company called Illumina -- our listeners will recognize them as the gene sequencing giant -- ticker ILMN.. They made big news on the M&A front also last week, announcing a big deal to acquire a smaller competitor. I'm excited, Todd. We're finally starting to see the M&A ramp up. It has been really quiet, especially after so much hype went into 2018 with the impacts of tax reform, that all the biotechs and pharmaceutical companies would do M&A. We're finally getting some noteworthy deals here. 

Campbell: Yeah. To me, this was a very surprising deal. Pacific Biosciences has been around a long time, Illumina has been around a long time, but they operate in slightly different parts of the gene sequencing market. PacBio has really been ... I don't want to say an afterthought company, but it's a much smaller company than Illumina. Illumina makes gene sequencers that represent about 90% of all of the gene sequencing that's been done since the Human Genome Project in the 1990s. It's absolutely, 100% a Goliath. It has over 11,000 of its gene sequencing machines installed globally, and its sales are estimated to eclipse $3 billion this year. When you put that in perspective, PacBio's sales last quarter were $18 million. They have less than a $100 million run rate, compared to a $3 billion run rate. They have a fraction of the penetration that Illumina has within these researchers and these drug companies and these academic institutions and such that are doing all this fascinating, next-generation work in evaluating the genes in our body, figuring out how to apply those lessons learned to things like medications that could really move the needle on outcomes.

Jones: This was a surprising deal, but if you think about it, it makes strategic sense when you look at the different tech behind the two companies. Illumina has been dominant on short-read sequencing. For PacBio, it's been long-reads. If you think about genomic sequencing, to use a metaphor that one of our colleagues used, it's like a jigsaw puzzle. Long-reads allow researchers to have fewer puzzle pieces that they have to put together. So, for Illumina, it actually makes a lot of sense to not only dominate in the short-reads, but now be able to take these complex pieces of genomic sequencing data, put them together, and hopefully solve some of the more complex gene therapy issues that we've been seeing, as well.

Campbell: Yeah. Whenever you research anything or do anything, a lot of times, you can get the gist of it by spending less time on it. That would be like short-read. It's functional, quick, and in the case of Illumina's sequencing, it's a lot cheaper than long-read. Long-read is like doing a deep dive into a subject matter and finding out absolutely everything that you can possibly find out about it. In the past, you haven't needed to have that level of granularity in gene sequencing. However, as we get more and more involved in things like gene editing and really sophisticated gene therapies that are extremely targeted, it's becoming more and more important to have as thorough a look at the DNA and RNA as possible, to make sure that you're not suffering any off-target events or anything else. I think what Illumina is saying is, "We absolutely dominate the short-read space. By buying PacBio, we're going to get a really big footprint in the long-read space." If you think about Illumina's business model, they're so heavily embedded worldwide. Their market teams have 22 offices globally. Many times, one of their clients will have a bunch of their own Illumina machines and then one or two PacBio machines. This is going to give them an opportunity to introduce PacBio to a lot more people, right ahead of some really interesting technology that PacBio was about to launch. Next year, they were planning on launching a brand-new chip that could significantly increase throughput for long-read while also decreasing prices, making them far more competitive with short-read.

Jones: You've got them now expanding on the technology front and trying to get ahead of the competition. Speaking of competition, this is a field that's increasingly becoming more crowded. In addition to PacBio -- thankfully, they've now acquired them -- you've also got Chinese company BGI, you've got Oxford Nanopore Technologies, Roche, Thermo Fisher Scientific. They're already offering sequencing and molecular diagnostic products and services. Amgen actually took out a recent equity stake in privately held Oxford as well, so they're now getting into the game. It's interesting to see a big biotech jumping up to the playing field. Also, focusing on BGI, they plan to offer a human whole genome sample sequencing in less than 24 hours, and it costs less than $300, by 2020. BGI can already perform next generation sequencing for close to $600. 

Again, Illumina, as many of our listeners will know, is trying to continue to bring down the cost of gene sequencing, but they're competitors are right on their heels. I think this makes a really smart and strategic move to try to stay ahead of the competition.

Campbell: Another thing that's important is, there are drawbacks to both short-read and long-read. Long-read is not perfect by any stretch or measure. A lot of times, when you'll do long-read, you'll also do short-read to fill in the gaps for where the long-read doesn't come up with the information you need. The idea now of being able now to have a one-stop solution, where you're able to get my long-read done by Illumina and my short-read done, may give it a competitive advantage against some of those other companies that you were just talking about. That could become increasingly important because, by PacBio's estimates, the market they were targeting is going to grow from about $660 million last year to $2.5 billion by 2022. That's significant growth, especially when you consider that Illumina's sales are tracking about $3 billion. This could be almost equal to where they are today just in additional long-read sales.

Jones: Todd, I'm going to use the word. I'm going to use the word synergies here. [laughs] I hate that word when it comes to M&A, but this is actually one instance where I think the synergies could actually happen, for a change, and actually make sense. What else should investors be watching, especially when it comes to PacBio?

Campbell: PacBio has had some delays in product launches in the past, and some stumbles. It'd be really important to see how that progresses. This deal won't close until 2019. It does have to still get approval for this combination. Like I said, Illumina is the market share leader. Illumina was asked on their conference call, "Do you think you can get this through regulators?" From Illumina's perspective, the answer is yes, because they're a short-read company and PacBio is a long-read company. It'll be interesting to see if regulars agree with that assessment. 

You're also going to want to see, once the combination is done, can they deliver on the timeline of releasing this new technology from PacBio that will, indeed, drive down the cost and increase the speed, making it more useful to researchers? You mentioned synergies. I think most of the synergies are going to come from scale and manufacturing, that type of thing. They're not saying, at this point, what the impact could be on the bottom line in 2019. But investors should know that PacBio is losing money. Integrating it will create some sort of a headwind that's going to have to be offset, either by increased sales growth because of greater penetration in the future from these new products, or from some cost cutting somewhere along the way. 

Jones: Lots to look forward to in 2019. It's really setting up to be a crucial year, not just for biotechs but also on the gene sequencing end, as well.

That's it for this week's Industry Focus: Healthcare show. Thanks so much for tuning in. Be sure to check us out on iTunes, Spotify, and now our own YouTube channel. Just go to youtube.com/user/themotleyfool to check us out. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. This show is produced by Ann Henry. For Todd Campbell, I'm Shannon Jones, thanks for listening and Fool on!

Shannon Jones has no position in any of the stocks mentioned. Todd Campbell owns shares of Amgen. The Motley Fool owns shares of and recommends Alkermes and Illumina. The Motley Fool recommends Amgen and Pacific Biosciences of California. The Motley Fool has a disclosure policy.