Evaluating a One-Trick Pony

There is no doubt that we all should have bought Onyx Pharmaceuticals (NASDAQ:ONXX) at its lows last December: The stock has tripled since then. But hindsight is always 20/20. The more important question is, what should you do now? Let's take a look at where Onyx is going.

Onyx's only drug, Nexavar, which it markets with Bayer (NYSE:BAY), was approved in December 2005 to treat advanced kidney cancer. It experienced remarkable sales growth until last quarter, when it reached market saturation and ran into competition from Pfizer's (NYSE:PFE) Sutent.

So what's all the hubbub about?
Onyx has found an effective treatment that extends patients' lives. It's far from a cure, but when a patient's median survival is only eight months, an extra three months is precious.

Onyx and Bayer may experience a bump in sales as early as this quarter, thanks to the clinical trial data presented at the American Society of Clinical Oncology meeting recently. This data has probably convinced many oncologists that Nexavar is effective enough to be prescribed to treat liver cancer, even though it hasn't been approved for use in that disease. The Food and Drug Administration will review this data later this year.

To infinity and beyond
Nexavar is a multiple kinase inhibitor that stalls cellular growth of a tumor and cuts off its blood supply. Because its mechanism of action isn't cell-type specific, it can be used to treat a wide variety of cancers. Onyx and Bayer now have it in late-stage clinical trials for lung cancer and are continuing kidney cancer trials to try to expand its labeling indications.

As with many other drug companies, Onyx's and Bayer's strategy has been to start with an underserved cancer market and gain orphan drug status. They can then use the profits from the first label indications to fund the clinical trials for cancer types that have larger populations -- and more competition.

Since Nexavar works through a different mechanism than many chemotherapeutic compounds, it can be combined with other drugs to produce a synergistic killing of tumor cells. For effective chemotherapies, like the highly toxic cisplatin, the addition of Nexavar might allow doctors to prescribe a lower dose of cisplatin, thereby lessening the horrible side effects. Clinical trials -- most of which aren't company-sponsored -- are testing the effectiveness of different drugs with Nexavar.

Not everything has been perfect for Nexavar. It recently failed a phase 3 clinical trial for the hard-to-treat melanoma. It didn't meet its primary endpoint of progression-free survival, possibly because skin tumors require less blood support, and because of that, the anti-angiogenesis properties of Nexavar may not be as useful.

Pipeline? We don't need no stinking pipeline
Onyx's pipeline is mysteriously missing. Its website's pipeline page contains a brief mention of a cyclin-dependent kinase 4 inhibitor named PD 332991, which Onyx licensed to Warner-Lambert, now a subsidiary of Pfizer. It went into phase 1 trials in 2004, and Onyx could reap a milestone payment and single-digit royalty payments if the drug is commercialized, but Pfizer still lists it as in phase 1 trials, so any payments are years away and shouldn't be counted on.

Other than that, all of Onyx's clinical trials are for expanding Nexavar's label. The company's most recent annual report looks more like an advertisement for Nexavar than an update for investors. Onyx fits the definition of a one-trick pony perfectly.

Valuation
The lack of a pipeline makes it a little easier to evaluate where Onyx's stock is headed. Its value will be directly proportional to the amount of Nexavar it sells, which will be determined by how it does in future clinical trials.

According to Onyx, each year nearly 208,000 people worldwide are diagnosed with renal cell carcinoma, the most common form of kidney cancer. It also reports that there are 600,000 cases of hepatocellular carcinoma, the most common form of liver cancer, each year. With three times the potential number of patients and less competition, because Sutent isn't approved for use in liver cancer -- yet -- Onyx should be able to increase Nexavar sales substantially.

Those sales should bring Onyx into the black for the first time. With many expensive clinical trials planned for well into the future, it's likely that Onyx's P/E will be inflated for quite a while. At this point, purchasing Onyx stock is a bet on the company getting future label indications for Nexavar. As good as Nexavar appears to be, I'm a pipeline kind of guy, and I'm not sure I want to have all my eggs in one basket.

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Fool contributor Brian Orelli, Ph.D., doesn't own shares of any companies mentioned in this article. He blogs about start-up biotech companies at Babybiotechs.com. Pfizer is an Inside Value recommendation. The Fool has an ironclad disclosure policy.