Why Depomed Shares Were Dumped

On Tuesday, shares of specialty drug developer Depomed (NASDAQ:DEPO) were down nearly 60% after it announced negative results in a clinical trial for its lead drug, painkiller gabapentin GR.

Gabapentin GR is a reformulated version of Pfizer's (NYSE:PFE) former blockbuster gabapentin (whose brand name is Neurontin), and it was supposed to be as effective as the now-off-patent compound, but with fewer side effects, using fewer doses.

Besides gabapentin GR, the rest of Depomed's pipeline is uninspiring, with one other compound set to begin mid-stage clinical trials. So Depomed is almost completely reliant on the drug for its future. No wonder shares tanked so much Tuesday after results of the phase 3 study were announced.

Timeline
Depomed's GR version of the drug did well in phase 2 testing last year, showing it was effective in reducing pain for in patients with post-herpetic neuralgia, or nerve pain following a case of the shingles. Based on these positive results, Depomed initiated a phase 3 study to try to get a foothold in this market, which is dominated by compounds like Endo Pharmaceuticals' (NASDAQ:ENDP) Lidoderm.

As was announced Tuesday, in comparison with the placebo in this phase 3 study, gabapentin GR didn't improve patients' average daily pain scores in a statistically significant manner (i.e., the drug was no better at controlling a patient's pain).

Depomed inferred that this failure could be a result of a strong placebo effect among the non-gabapentin patients in the last four weeks of the study. But all pain studies suffer from such an effect to some degree, so the company should have accounted for this effect beforehand, when it had enough patients to detect any benefit there might be from a drug.

A weak defense
Also, the placebo patients performed nearly the same on the average daily pain score scale in this phase 3 study as they did in the phase 2 study. To this analyst, then, the "high placebo effect that persisted throughout the trial" argument from Depomed's management doesn't jive so much, and the real story from the phase 3 trial is that the gabapentin GR's effectiveness just wasn't as strong as in the earlier trial.    

The one bright spot from the study was that when comparing historical data of the already approved gabapentin against Depomed's GR formulation, GR continued to show improved side effects when those effects involve nervous system disorders. So if Depomed can rectify the concerns about gabapentin GR's effectiveness (a big if), then it may have this advantage over gabapentin, although a head-to-head safety study would be needed to confirm this finding.

Depomed didn't say whether it would continue developing gabapentin GR for post-herpetic pain and other pain indications. The compound is also undergoing phase 2 testing as a treatment for menopausal hot flashes, and Depomed did say that this testing would continue.

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Fool contributor Brian Lawler does not own shares of any company mentioned in this article. Pfizer is an Inside Value recommendation. The Fool has a disclosure policy.