To really understand a stock, you just have to get down and dirty, break out your pencil, and really weigh the risk-vs.-reward potential of the company you're following. I propose we take a closer look at the good and the bad at Somaxon Pharmaceuticals (Nasdaq: SOMX) to see if the stock is a good value or a potential money pit.
The good
Somaxon's story begins with the Food and Drug Administration approving its insomnia drug, Silenor, in March. Shortly after the news of Silenor's approval, the company made a secondary stock offering that generated a much-needed $50 million in cash. This cash gives Somaxon the versatility it needs to market Silenor while keeping its balance sheet debt-free.
More recently, the company allied itself with a proven winner in Procter & Gamble (NYSE: PG). P&G will help Somaxon with marketing Silenor in return for undisclosed fees and royalties that Somaxon said should amount to no more than 15% of the net U.S. sales of the drug. What makes this deal particularly intriguing is that Somaxon gets the benefit of an experienced sales staff at P&G, but could keep the vast majority of the revenue stream from Silenor.
The bad
Unfortunately for Somaxon, its marketing partnership with Procter & Gamble isn't perfect. P&G didn't have to make any payment up front, and the agreement runs through only 2012. That limits P&G's risk, but it means that even with the deal, Somaxon needs Silenor to do well and still bears most of the risk if the drug doesn't catch on.
Silenor is also entering a large, but very crowded, insomnia market. Generic versions of Ambien dominate the market, and sanofi-aventis' (NYSE: SNY) Ambien CR, Sepracor's Lunesta, King Pharmaceuticals' (NYSE: KG) Sonata, and Pfizer's (NYSE: PFE) Halcion make up a smaller portion.
The danger here is that Somaxon could wind up throwing nearly all of its cash into marketing Silenor, only to have the drug win just a small fraction of the market. With so many products targeting sleep disorders, Silenor needs to carve out a niche against its competition and vigorously defend it.
The takeaway
In the end, investing in Somaxon depends on whether you think the promise of a new drug outweighs the risks associated with entering a crowded market and building its Silenor franchise from the ground up. Having P&G on its side will help, but only time will tell if Somaxon can successfully market Silenor.
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