Last week, Encysive Pharmaceuticals (NASDAQ:ENCY) announced that it had met with the FDA as a prelude to formally initiating the dispute resolution process with the agency in an attempt to get it to reverse its decision and approve pulmonary arterial hypertension (PAH) drug Thelin.

Mum's not the word anymore
For more than a year after the first approvable letter in March 2006, Encysive refused to reveal what the "matter of judgment" holding up full approval of Thelin was. Finally, after receiving a third approvable letter on the drug last month, Encysive finally dropped the bomb on investors what the one outstanding approvable letter item was.

The last item holding up FDA approval of Thelin centered around the perception that the agency didn't feel that Thelin succeeded on its primary endpoint in a pivotal study, dubbed Stride-2, that made up the main efficacy portion of the compound's New Drug Application (NDA).

What made the Stride-2 trial so important for Encysive was that it had reached an agreement called a Special Protocol Assessment (SPA) with the FDA so that if the study was successful in showing that Thelin improved six-minute walk distances for PAH sufferers, then the agency would be expected to approve the drug if the rest of the NDA checked out OK.

When Encysive reported back in early 2005 that the Stride-2 study was successful on this primary endpoint and that the drug did well in key safety endpoints, many investors eventually thought (me included) that the drug would be able to gain regulatory approval because of the SPA agreement.

Unfortunately, the FDA didn't see the Stride-2 trial as the successful study that Encysive thought it was. What appears to have happened, although Encysive danced around the issue on the approvable letter conference call last month, is that the FDA omitted a number of patients from the Stride-2 study results (probably for protocol violations, as I reported last month).

This post hoc analysis by the FDA, as Encysive called it, turned the successful, statistically significant six-minute walk efficacy endpoint of the Stride-2 study into not statistically significant results and, thus, a failure as per the SPA agreement between Encysive and the FDA.

Once the FDA deemed the six-minute walk improvement not statistically significant, regulatory approval of Thelin wasn't going to happen. None of this explains the strange delay last December in getting an FDA answer to the second approvable letter response, though.

He said, she said
As a result of this disagreement on the success of Thelin in the Stride-2 study, Encysive started the dispute resolution process last week with a preliminary meeting with the FDA.

As Encysive mentioned on the third approvable letter conference call, the dispute resolution process has historically returned mixed results for other drug makers, with some companies having success via this process. If Encysive continues as planned, it would be the first one to file a dispute attempting to enforce the terms of a SPA agreement.

In anything as opaque as drugmaker interactions with the FDA, it's hard to say how the dispute resolution process will work out for Encysive. From the likely perspective of the FDA, its beef with Encysive isn't over the Thelin SPA (a regulatory agreement) but rather the quality of the data coming from the Stride-2 study.

Encysive approaching the dispute by arguing that the SPA should be enforced is, therefore, a straw man argument. I highly doubt it will be successful in turning around the agency's opinion on Thelin if it tries to argue from this point of view.

Does this failure spell the end for Encysive?
Encysive has definitely made some huge mistakes since the first approvable letter last year. Not immediately starting another study to assuage the FDA's efficacy concerns and also retaining the idle U.S. sales force for so long, just to name a couple.

Earlier in the week, Encysive announced that it had hired financial services firm Morgan Stanley to review its "strategic alternatives." This doesn't necessarily mean that a sale of Encysive is in its future (or that it will receive good terms on a deal), but there are several pharmas with complementary drugs on the market that could benefit by being co-promoted with Thelin. It's also hard to ignore that CoTherix, which was in a similar position as Encysive last year with its PAH drug just starting sales, was bought out by Actelion for $420 million in November.

The possibility of a buyout isn't enough to interest me in owning shares of Encysive, but not gaining regulatory approval to market Thelin in the U.S. isn't the end of the world, either. The drug is still approved in numerous countries and does have a lead over Gilead Sciences' (NASDAQ:GILD) and partner GlaxoSmithKline's (NYSE:GSK) Letairis in the European Union, which is still awaiting a regulatory decision.

The next quarterly financial results update detailing how E.U. sales of Thelin are going is just around the corner. Hopefully, the company will also detail how it plans to bring itself to profitability sans U.S. sales of the drug. If profitability won't be possible without U.S. Thelin revenue, investors should think long and hard about whether shares of Encysive are worth holding, considering that the likely result of this dispute resolution process won't be positive.

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Fool contributor Brian Lawler does not own shares of any company mentioned in this article. GlaxoSmithKline is an Income Investor recommendation.