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Discovery Labs (DSCO) and Surfaxin Approval: How Much is it Worth?

publication date: Mar 9, 2012
 | 
author/source: @SteveJo22

Discovery Labs (DSCO) and Surfaxin Approval: How Much is it Worth?

March 9, 2012
Author: Steve J., 
Twitter: @SteveJo22

After a long wait and five tries Discovery labs has finally received FDA approval for their synthetic lung surfactant (Surfaxin) indicated for infant respiratory distress syndrome (IRDS) in premature infants.

Official PR here: http://www.discoverylabs.com/2012pr/030612-PR.pdf

DSCO stock has had an impressive run from $1.45 in mid December to an after hour high of $6.85 on the day of FDA approval. Traders have been locking in their profits and investors are waiting to step in.

To understand the value we must look at the financial state of the company and the future sales. Since we don’t have all the data yet we will have to estimate some of these numbers.

The first thing we need to look at is the potential US market for Surfaxin. Discovery labs estimated the market size as 90,000 patients. Lets examine that number with data to back it up. The number of births in the US in 2009 was 4,130,665 and 1 in 8 babies are born premature in the US. About 10 percent of premature babies develop RDS each year.

Simple math allows us to calculate the potential market:

Number of premature infants: 4,130,665 / 8 = 516,333

Percent of premature infants with RDS: 516,333 x 10% = 51,633

http://www.cdc.gov/features/prematurebirth/

http://www.cdc.gov/nchs/data/nvsr/nvsr60/nvsr60_01.pdf

http://www.thoracic.org/education/breathing-in-america/resources/chapter-19-respiratory-distress-syndr.pdf

Now that we have an estimate of the market size we need to look at potential pricing for Surfaxin. The company has not disclosed pricing but mentioned on their conference call that they will price it competitively to current therapies.

Let’s examine Curosurf which is an animal based surfactant and one of the market leaders. Curosurf sales in the U.S. in 2008 were $30 million. Its RDS market share is 44 percent in the U.S. Live births in 2008 were 4,247,000 and using similar math as above we can derive the cost per patient.

Estimated Curosurf sales: (4247000 / 8) x 10% x 44% market = 23,359 patients

Cost per patient = $30M / 23,359 = $1284

http://wraltechwire.com/business/tech_wire/biotech/story/5102273/

I spoke with a doctor friend who was able to get me some current pricing. Curosurf is $289, 5 ml (980mg/ml), 100 mg/kg (typically 1-3 doses). These numbers seem to be consistent with our estimate and looks like prices have gone down slightly since 2008.

Estimating the market share for Surfaxin is a little more difficult. We need to look at the FDA label for guidance on how it can be marketed.

http://www.accessdata.fda.gov/scripts/cder/drugsatfda/index.cfm?fuseaction=Search.Label_ApprovalHistory


The FDA states that SURFAXIN demonstrated a statistically significant improvement in both RDS at 24 hours and RDS-related mortality through Day 14 over colfosceril palmitate. (page 11). An important point to note is that colfosceril palmitate (Exosurf) is a synthetic surfactant.

Here is a list of current surfactants and their origin:

http://en.wikipedia.org/wiki/Pulmonary_surfactant

The intent of the trial was to demonstrate superiority over colfosceril palmitate (Exosurf). The FDA did not grant them a superiority claim in the label most likely because the incidence of administration-related adverse reactions was higher in infants who received SURFAXIN compared to other surfactants (page 6, Table 2)

In the non-inferiority trial comparing Surfaxin vs. poractant alfa (Curosurf) the study was terminated early. The FDA made no conclusion from this trial other than safety.

DSCO can not claim superiority over any of the other surfactants in the market since it was not indicated in the label.

Financials:

As of December 31, 2011, the company had cash and cash equivalents of $10.2 million. The current operating costs are ~$6.17M/quarter (24.7M/year), with outstanding shares of 24,499,497.

DSCO has a CEFF worth $3.6M and a Sales Agency Agreement with Lazard Capital Markets LLC (Lazard) for an ATM financing of $15M. (estimate: 14% dilution at $4.25)

There are also existing outstanding warrants:

5M at $2.94 and 5M at 3.20 (40 % dilution)

To make it easy lets assume a 50% dilution from current levels (24,499,497 shares x 1.50 = 36.7M outstanding shares)

For our calculations we are using a gross margin of 40% and P/E ratio of 20.

Lets assume that DSCO hires the best sales force possible and quickly establishes a 60% market share.

51,633 patients x 60% = 30,980 patients

Let’s also assume that DSCO can charge a premium of $2K per patient. I will also give them the benefit of the doubt and assign them a generous gross profit margin of 40%. In 2002, for example, the top 10 drug companies in the United States had a median profit margin of 17%.

http://www.cmaj.ca/content/171/12/1451.full

30,980 patients x $2K = $61.9M in sales x 40 % gross margin = $24.8M gross profit

Subtract $24.7M in operating costs from gross revenue and we get $100K net profit/year.

100K x 20 (P/E) = $2M projected market value.

$2M projected market value / 36.7M outstanding shares = $0.05/share

The point of this exercise was to show that even with extremely generous numbers, Surfaxin approval does not significantly add to the value of Discovery Labs.

 

Disclosure: Long March $5 and $4 puts.