A fundamental rule of poker is that you have to play the hand you're dealt.
Forest Labs announced that the FDA had rejected its application for approval to market Lexapro for social anxiety disorder. In rejecting the application, the FDA raised questions about the reliability of data from one of the study centers in the second pivotal trial. When that data was stripped out, the remaining data was insufficient to prove efficacy.
Forest Labs has had a run of bad luck lately. In addition to this most recent rebuff, the company's request to market Lexapro for panic disorder was rejected earlier this month. Going back a little further, shareholders also had to absorb a phase 3 trial failure of the company's promising neramexane drug for Alzheimer's and disappointing clinical results for lercanidipine in hypertension.
Despite this latest setback, though, sales of Lexapro won't likely be affected all that much. Social anxiety disorder is notoriously difficult to diagnose, and the market potential for this add-on indication was pretty modest. What's more, Lexapro already is and will continue to be prescribed for unapproved indications like panic disorder and social anxiety disorder.
See, once the FDA approves a drug, physicians can prescribe a drug for anything they see fit. This practice is known as "off-label" usage and is extremely common -- cancer drugs approved in treating one type of cancer are routinely used off-label in other cancers, and many depression drugs are routinely tried with anxiety/panic patients. The only catch is that Forest Labs cannot explicitly market the drug for these unapproved indications, so that means no TV ads or any other direct-to-consumer advertising.
No doubt Lexapro is critical to Forest Labs -- it accounted for more than 50% of revenue in the last quarter -- and that's both good news and bad news. While Lexapro is a good drug and is patent-protected for several more years, Forest Labs needs to become a more well-rounded company. To that end, the company has become more aggressive in pursuing development partnerships, but investors must remember that drug development doesn't happen overnight, so Forest Labs will likely remain highly dependent upon Lexapro for at least a few more years.
Apart from the risk of being a nearly one-product company, Forest Labs has an enticing valuation. Not only is the P/E low, but so is the enterprise value-to-free cash flow ratio, and this company has all of the other hallmarks of a pharmaceutical company -- that is, high margins and return on assets and equity. Although growth potential may be modest in the short run, investors should take a careful look at Forest Labs and make sure they don't lose this one amongst the trees.
For other pharmaceutical Foolishness:
- Eli Lilly Turns to Japan
- Nice of You to Notice Novartis
- Glaxo Stays Above the Fray
- Lots of Profits in This Forest
Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).