Investors can't fault the ambition of Aerie Pharmaceuticals (NASDAQ:AERI). The company aspires to consolidate a fragmented market for glaucoma treatments and grab a combined 40% market share with its two drug products, Rhopressa and Rocklatan. However, those efforts are off to a frustratingly slow start. The drug duo held a combined 2% market share at the end of 2019.
While it's still relatively early in the trajectory of the franchise, Wall Street has adopted a less than enthusiastic stance on the portfolio. On the one hand, that might be the most realistic approach given the obstacles encountered to date. On the other hand, investors with a long-term mindset might find an opportunity at a sub-$700 million market valuation.
Is this small-cap stock a buy?
The argument in favor
Slow start notwithstanding, the glaucoma market is a $3 billion per year opportunity in the United States alone -- and Rhopressa and Rocklatan have the clinical data to support widespread use. Both drugs lower intraocular pressure (IOP) in the eye, which is the cause of glaucoma. Rhopressa is a Rho kinase (ROCK) inhibitor called netarsudil. Rocklatan is a combination of netarsudil and latanoprost, the most commonly prescribed drug compound for glaucoma.
In a phase 3 clinical trial called MOST, glaucoma patients were given latanoprost, Rhopressa, or Rocklatan. Whereas 12% of individuals taking latanoprost achieved the lowest IOP reading after 12 months of treatment, 27% of individuals taking Rocklatan could say the same. In fact, Rocklatan bested latanoprost in all five IOP groupings measured in the study with statistical significance.
Rhopressa held its own against latanoprost, too, although the information presented by Aerie Pharmaceuticals doesn't make it clear if the results were statistically significant. Either way, considering latanoprost owns a commanding 43% of the U.S. glaucoma market, the head-to-head results suggest Rocklatan really could become the go-to glaucoma treatment.
So, what's been driving sluggish sales of the ROCK inhibitor franchise? The initial obstacle appeared to be a combination of low levels of awareness among doctors (the glaucoma market is highly fragmented) and low rates of coverage from major government insurance programs (making it difficult for doctors aware of the drug franchise to burden patients with high treatment costs given the plethora of other options). But it could be subsiding.
In May, Aerie Pharmaceuticals gained formulary coverage for both of its products from one of the largest Medicare Part D payers in the United States. That increased the number of Medicare Part D recipients with access to Rhopressa from 70% to 90% and the percentage with access to Rocklatan from 38% to 55%. Government-run insurance programs account for an estimated 68% of all glaucoma prescriptions, which makes high coverage rates paramount to market success.
That could help Aerie Pharmaceuticals rebound from the declining numbers of new prescriptions caused by the coronavirus pandemic from late March to late May. Meanwhile, there are expected market approvals on tap in Europe and Japan that could provide a steady source of international sales. Simply put, one could argue Rhopressa and Rocklatan are on the path to achieving combined annual revenue in the hundreds of millions of dollars this decade.
The argument against
Being on the path to achieving annual revenue in the hundreds of millions of dollars is not the same thing as actually achieving it. Aerie Pharmaceuticals is a great example of an unfortunate reality for investors: success in clinical trials doesn't guarantee success on the market.
Investors have to entertain the possibility that management's vision for displacing latanoprost and grabbing 40% of the glaucoma market was perhaps a bit too ambitious. Even if the company succeeds, investors must acknowledge the process could take a pretty long time due to the inherent cannibalization of the ROCK inhibitor franchise.
Consider how prescriptions have been playing out to date. Many doctors prescribe Rhopressa, either as a monotherapy or in addition to a patient's current treatment option, to get introduced to the product. Ironically, one of the most common pairings has been Rhopressa with latanoprost -- the formulation of Rocklatan -- which forces patients to take two products each day.
Despite the added convenience of Rocklatan, doctors have hesitated to prescribe it due to low coverage rates among Medicare Part D recipients. Now that the insurance obstacle is subsiding, investors might expect prescriptions of Rocklatan to increase. Early prescription data from May and early June suggest that's occurring.
Of course, what's good for Rocklatan is bad for Rhopressa. Switching patients from Rhopressa to Rocklatan results in a net increase in revenue for Aerie Pharmaceuticals, as the advanced formulation sells for a premium price, but the strategy (that was always the strategy, mind you) could result in frustratingly slow total revenue growth. This simply isn't the usual situation of a company having two approved drug products.
A few more quarters of sales data would help
Aerie Pharmaceuticals has slogged through a rough market launch for Rhopressa and Rocklatan. The two products combined for just $20 million in revenue in the first quarter of 2020, which makes it easy for Wall Street to remain bearish on the small-cap stock. But the company might be putting the pieces together to realize the potential of its ROCK inhibitor franchise.
The results from the MOST study could convince doctors to prescribe Rhopressa and Rocklatan, which might be easier to do given the increasing rates of coverage among government-run insurance programs. If that drives significant prescription growth, then Aerie Pharmaceuticals could position itself to begin chipping away at the 43% market share of latanoprost in glaucoma treatments.
The primary problem is one of timing. The coronavirus pandemic has thrown all prior projections (and the company's full-year 2020 guidance) for prescriptions out the window. Considering the business ended March with about $260 million in cash and was on pace to cough up roughly $160 million in operating cash outflow in 2020, individual investors would be wise to wait for another quarter or three of sales data before getting too carried away. Those with a long-term mindset and above-average appetite for risk might stake a small position in the company, but it remains a risky investment with the information at hand.