If you followed the biotech IPO class of 2003-2004, you probably remember that it was generally a disappointing affair. With the exception of a few hot companies such as Eyetech (NASDAQ:EYET) and Pharmion (NASDAQ:PHRM), most of the biotech debutantes rose only tepidly, treaded water, or fared even worse.

One of the first companies to go out in the recent biotech IPO window, way back in November 2003, was NitroMed (NASDAQ:NTMD). It followed the same pattern most of the other new biotechs did, going out at $11 per share and then proceeding to drop more than 15% the first day. It wasn't until last July that the stock finally got its head above water -- to the tune of a 278% rise in 11 trading days.

Reason for the rise
The catalyst for that turbocharged turnaround was a phase 3 study on NitroMed's heart failure drug BiDil, which was halted early because of a significant survival benefit in the treatment arm. All patients in the study were subsequently given the option to receive BiDil, and NitroMed submitted a marketing application to the FDA in December 2004.

The moment of truth is approaching. The FDA gave BiDil fast-track designation; an approval decision is due by June 23. Given the performance of the drug in the pivotal trial -- a 43% improvement in survival over a placebo, a 33% reduction in first hospitalization for heart failure, and an improvement in quality of life -- it looks to have a very good chance of getting the green light.

Is now a good time to invest, or has this ship sailed?

You might think that good trial results and an approaching potential launch has sent NitroMed shares into the stratosphere, but you'd be wrong. Even after a big run-up in share price, the company currently has a market cap of $578 million and an enterprise value of just $453 million. That looks pretty tasty for a company about to launch a new drug in an area as significant as heart failure.

But there are a couple of catches. The first is that BiDil appears to work only in people of African descent. After earlier studies showed that other populations did not appear to benefit from the treatment, the phase 3 program was conducted only in African-Americans. That limits the market, certainly, but it is still a huge opportunity for a company of NitroMed's size. The estimated target population is about 750,000 patients in the United States, according to the company, and that number is expected to grow substantially over the coming decade.

The second and more significant issue surrounding BiDil is that it is a formulation of isosorbide dinitrate and hydralazine -- two commonly used generic heart drugs. BiDil is a convenient combination of the two, but it's certainly not clear that it offers benefits that can't be gained from taking the two generic drugs separately.

So the real question facing NitroMed investors is: Will doctors prescribe the Reese's Cup when they could just prescribe peanut butter and chocolate? And will insurers pay for it?

Greater than the sum of its parts
It looks to me like NitroMed has a winner on its hands. Yes, doctors could prescribe two generics to avoid extra expense, but since the results of NitroMed's phase 3 study have been out for almost a year, what's to stop cardiologists from using the generics now? NitroMed management says it has seen a less than 20% uptick in the use of hydralazine since study results were announced last July. What that number means is open to interpretation -- there is no indication as to how much of that rise is associated with African-Americans getting a new treatment regimen pursuant to the BiDil study and how much is just organic growth. You could regard the response as a sign that many physicians aren't convinced about the combo, but it seems more likely to me that many doctors either aren't aware of the study's findings or don't want to assume that the use of two generics will equal results seen with BiDil.

That leaves a pretty decent opportunity for the company, particularly if physicians hear about the combo for the first time from a NitroMed sales rep who shows them the data and hands out BiDil samples. Better yet, the company can talk to insurers about cost-effectiveness -- an important issue in heart failure, where medication is far cheaper than hospital-based interventions. The convenience of BiDil over two generics could translate to important improvements in patient compliance -- and fewer hospitalizations.

Formidable formularies
Nevertheless, the company will face some challenges. If approved, most payers will cover BiDil, but it will likely be put on formularies as a "Tier 3" drug -- that is, with the highest co-pays in a given program, likely in the $30 to $50 range. NitroMed's task will be to convince insurers to move the drug up to Tier 2, where the co-pays will be roughly comparable with the co-pays involved in getting two generic prescriptions.

Approval is not a done deal, either. The FDA's Cardiovascular and Renal Drugs Advisory Committee will review BiDil at its June 16 meeting. That fact in itself has worried some investors because it appeared for a while that the FDA wouldn't ask for a committee hearing. Panel meetings raise concern that there are questions about a drug application, and the agency wants guidance.

I don't believe that the mere fact of a panel meeting is much cause for concern, however. When BiDil was first brought to the FDA on the basis of a multiracial patient population in 1997, an FDA advisory panel rejected it. The agency may want a second panel meeting to get the public blessing of a group that previously asked for further study. In addition, it may want some guidance on the severity of heart failure in which the drug should be used -- that is, Class 3 and 4 heart failure, the groups that included the most study patients, or Class 2 as well.

Indeed, the trading in NitroMed options indicates that there is more concern about what will happen to BiDil after approval, rather than about approval itself. The time value on June $17.50 calls, which expire the day after the panel meeting, is only 7% more than the price of the underlying stock. (By that I mean the difference between the cost of the option and its intrinsic value, compared with the current price of the stock.) Even the September $17.50 calls, which would reflect the outcome of FDA's approval decision, have a time value (on the same basis) of about 16%. That may seem like a lot, but drugs facing real regulatory uncertainty can see time premiums twice that high.

To me, the most concerning issue may be patent coverage. Two key patents cover BiDil, one expiring in 2007 and one in 2020. Management insists that BiDil will have exclusivity through 2020, but you can bet that, with the composition of matter patents already expired on the two active ingredients, generic manufacturers will be chomping at the bit to make a competitive combo pill. The 2020 patent appears to cover BiDil for the applications that will most likely be approved, but if a generic drugmaker can get a court to let it make a combo pill in 2007, NitroMed will be hurt badly.

The pipeline
Although NitroMed has other research programs -- a collaboration with Boston Scientific (NYSE:BSX) on stents coated with nitric oxide drugs, for instance -- its pipeline is virtually nonexistent. A collaboration with Merck (NYSE:MRK) on nitric-oxide-enhancing COX-2 inhibitors was canceled after Vioxx was pulled from the market. NitroMed retained all rights to a phase 2 compound, but the program is in limbo at best. There is nothing else in clinical development.

Nevertheless, I like this company's near-term prospects, although to be a long-term winner, it will either have to beef up its pipeline or look to get bought out. BiDil is not currently partnered, so NitroMed won't have to share what could become substantial revenues. The 12% short interest could be the icing on the cake come June 23.

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Karl Thiel does not own shares of any companies mentioned in this article. Merck is a Motley Fool Income Investor recommendation. The Motley Fool has adisclosure policy.