Right on cue last week, the FDA tentatively approved Sepracor's (NASDAQ:SEPR) Estorra, its lead sleeping pill. In response, the company's stock shot up an eye-popping 70% over the past week as investors scrambled to buy shares, despite the decision date for the FDA being known for quite some time.

Investors must be banking that Sepracor's head start will allow the drug maker to establish prescribing habits among the nation's physicians and shut out the competition. And the competition is guaranteed to get fierce.

The competition, as I described last November, includes Neurocrine (NASDAQ:NBIX) and Pfizer's (NYSE:PFE) indiplon. Although it will be hitting the market (pending approval) about a year after Estorra, Pfizer's marketing muscle, two formulations, and broad-based clinical trials could well grind down Estorra's head start. Neurocrine has risen about 10% in sympathy with Sepracor over the past week.

Along with indiplon, Sanofi-Synthelabo's (NYSE:SNY) Ambien will come off patent in 2006, opening up a cheaper generic option for the occasional insomniac. King Pharmaceuticals (NYSE:KG) is also exploring an extended-release formulation for their already-approved drug, Sonata. This new formulation, currently in phase 2 trials, would possibly allow King Pharmaceuticals to avoid one problem associated with current sleeping pills: waking up in the middle of the night. An extended formulation would encourage sleep through the night, along with easing sleepless folks into dreamland at bedtime.

Furthermore, Merck (NYSE:MRK) has licensed a drug from Copenhagen-based H. Lundbeck that is in phase 3 clinical trials. Merck paid $70 million upfront for the U.S. co-marketing privilege and is responsible for up to $200 million more in milestone payments. However, if that drug candidate is successful, it won't likely hit the market until 2008.

I have to admit that I was surprised at investors' reaction to the news. Adding about $1.5 billion in market capitalization to Sepracor, which was already valued near $3 billion seems optimistic to me. While I think that Estorra has the potential to move Sepracor into the black after losing about $135 million last year, given the strength of the competition likely to come, I'm still of the opinion that Sepracor is fully valued.

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Fool contributor David Nierengarten, Ph.D., works with a biotechnology venture capital fund. He is an active member of the TMF community as DavidMN, and enjoys the Biotechnology discussion board. He doesn't own shares of companies listed, but does enjoy a full night's sleep when he can get it.