For many biotechnology investors, there is nothing that matters more than the quality of clinical data. If a company’s data are of quality and the market opportunity compelling, many believe, the rest will take care of itself. It’s simply not always the case, and weighing the strength of a management team and the balance sheet at their disposal are just as important. Led by CEO Adrian Adams, Auxilium Pharmaceuticals (AUXL) presents an opportunity to bet on a proven leader, who, using Auxilium’s strong balance sheet, is prepared to continue a multi-decade track record of creating shareholder value at every biotechnology company he leads.
Over the past 12 months, shares of Auxilium Pharmaceuticals have lost nearly 7%, driven by a confluence of concerns relating to generic competition as well as the lackluster growth of the company’s Xiaflex franchise. Sell-side opinion on Auxilium has been lowered as a result. But, buried within the forward estimates for Auxilium is a paradox. 2012 was Auxilium’s first full year of pro-forma profitability, even after excluding the favorable financial effects of the termination of its European collaboration agreement with Pfizer (PFE). On a pro-forma basis, Auxilium posted $0.04 in EPS when recognition of deferred revenue and costs of the Pfizer collaboration agreement are excluded. For 2013, the company has not released EPS guidance, but has guided for pro forma net income of $20.5 million at the midpoint of guidance. Consensus forecasts, however, call for Auxilium to post a loss of 4 cents per share in 2013, implying very low expectations among the analyst community and institutional investors. As a result, there is likely significant upside to estimates (it’s interesting to note that the current consensus price target for Auxilium stands at $23, over 33% above the company’s current stock price). The table below presents the consensus earnings forecasts for Auxilium through 2016 (P/E multiples are based on the company’s March 28 closing price of $17.29).
Auxilium Earnings Forecasts
| Year | EPS | % Change | P/E Multiple |
| 2012 | $0.04 | N/A | 432.25x |
| 2013 | -$0.04 | N/A | N/A |
| 2014 | $0.56 | N/A | 30.88x |
| 2015 | $1.03 | +83.93% | 16.79x |
| 2016 | $1.33 | +29.13% | 13x |
Testim & Generic Competition
Central to the bearish thesis against Auxilium is the expected erosion of its Testim franchise. Testim is a 1% testosterone gel designed to treat low testosterone, and is set to post sales of $257.5 million at the midpoint of guidance in 2013, versus $237.5 million in 2012 sales, implying 2013 growth of 8.42%. While Testim’s primary competitor is AbbVie’s (ABBV) AndroGel, which holds 62% of the testosterone gel market, competition from AbbVie has not been the real concern. Actavis (ACT) is set to begin selling generic versions of AndroGel in August 2015 (per the company’s settlement with AbbVie), and Auxilium is currently suing Actavis, as well as several other generic pharmaceutical companies to block generic testosterone gel sales. Current Auxilium investors should certainly prepare themselves for generic versions of AndroGel, as they will indeed have an impact on the growth potential of Testim. Once Actavis begins selling generic versions of AndroGel at low prices, health insurance companies are highly likely to mandate that patients be put on generic copies of AndroGel before they will consider providing coverage for Testim. Although clinical studies have shown that Testim offers hypogonadal men increased clinical benefits relative to AndroGel, many men still do well on AndroGel, and a cheaper generic will surely maintain, if not gain, share in the market. Pressuring the Testim story in the near-term, Auxilium noted that it saw an increase in Testim wholesale inventory in Q4 2012 ahead of price increases anticipated and enacted early this year. The company notes that normalized inventory levels are around 25 days, but that in Q4, inventory levels rose to over 30. This implies that Q1 Testim sales may come in weaker than expected, but Auxilium’s management team has incorporated this inventory build into its full-year guidance. Given that these inventory issues were thoroughly discussed on the company’s Q4 earnings call, investor & analyst expectations/estimates for Q1 likely factor in the impact. Testim’s growth will likely be materially pressured once generic sales of AndroGel begin. But, that does not mean that the franchise will be destroyed the same way Lipitor was, where sales fell by around 50% just a week after generic versions were introduced.
Testim’s label includes a BX rating (which is assigned by the FDA when the agency has insufficient information to determine therapeutic equivalence), meaning that pharmacists are legally barred from substituting AndroGel (or any future generic) for Testim. The company will not see an instantaneous revenue collapse, as patients currently on Testim cannot simply be given generic AndroGel (of note is the fact that current consensus forecasts imply that Auxilium will coast through the introduction of generic AndroGel, with 2016 EPS growth projected to be over 29%). Auxilium has more than two years to prepare for generic versions of AndroGel, and the company is not sitting still. After seeing share losses in Q4 and 2012 as a whole, Testim’s market share has begun to rise in 2013, with a nearly 20 basis point increase versus AndroGel in January 2013. Thanks to a collaboration & marketing agreement inked with GlaxoSmithKline (GSK) in July 2012, Auxilium has been able to increase its Testim promotional efforts in the United States, and the benefits of this agreement have already begun to be realized. In addition, expanded AndroGel advertising is having a positive impact on Testim as well. Over $125 million was spent on AndroGel advertising in 2012, which is not only driving growth of AndroGel sales, but is expanding the entire market as well, allowing Testim to benefit. As Auxilium’s CFO James Fickenscher stated at Barclays’ 2013 Global Healthcare Conference:
“This is a market that has been growing extremely quickly. Last year, TRT revenues were up 31%, prescriptions were up 32% over the prior year, and the market, the gel market segment of the TRT market, is just under $2 billion as of the end of last year. Within the gel market, we are seeing similar growth that we’re seeing in the overall TRT market, prescriptions are up 31%, and that gel segment represents about just under 90% of the total TRT market by dollars. So when we look at the market dynamics going forward, we want to continue to condition the awareness and diagnosis rates that are definitely improving. We got about 20% and 30%, respectively, among men aged 45 to 64. But that means that there’s still a tremendous number of patients who can come into this market.”
Analysts expect Testim to continue generating meaningful revenue in 2013, 2014, and through most of 2015 before generic AndroGel enters the market. We note that several price increases are expected to also take place between now and then, increasing the profitability of the product. While the entry of generic AndroGel will almost certainly have an impact on the future growth of the Testim franchise, it is not the aspect of the Auxilium “story” that investors should focus on.
Xiaflex: Optionality to the Upside
Auxilium’s 2nd product is Xiaflex, currently approved for the treatment of Dupuytren’s contracture, which causes a contraction of tissues beneath a patient’s palms and fingers, making it difficult or impossible for them to straighten fingers. Auxilium generated $55.2 million in U.S. Xiaflex sales in 2012 and is forecasting ~$70 million in 2013. In a vacuum, revenue growth of nearly 27% in 2013, as well as market share of around 30% (and growing) is positive, yet these results are not that impressive when compared to initial sales forecasts for the product. When Xiaflex was first approved, the drug was estimated to be a franchise worth hundreds of millions of dollars, with peak annual sales estimates approaching $400 million, and 2010 sales of over $70 million. The fact that Auxilium expects to reach that threshold only in 2013 highlights the gap between Xiaflex’s initial promise and its current performance.
Although Auxilium is testing Xiaflex in three additional indications, these markets are unlikely to generate meaningful revenue in the years to come. A PDUFA date of September 6 has been set for Auxilium’s NDA for the use of Xiaflex in treating Peyronie’s Disease (also known as PD), a penile tissue disorder for which Auxilium estimates between 65,000-120,000 cases diagnosed each year in the United States, with most cases treated by either surgery or Verapamil, neither of which are ideal treatments. Xiaflex, however, showed statistically significant improvements in its clinical trials for Peyronie’s disease, in both deformity improvements (p-values of 0.0005 & 0.0059) and psychosocial improvements (p-values of 0.0451 & 0.0496). Auxilium’s estimates for the initial addressable market imply over $109 million in revenue potential, and the company has noted that its revenue guidance for 2013 does not incorporate any potential revenues from sales of Xiaflex in this indication. Given the past performance of the Xiaflex franchise relative to expectations, however, it’s unlikely that these forecasts will be met anytime soon, if indeed Xiaflex does receive approval for the treatment of Peyronie’s disease in September.
On March 25, Auxilium released positive Phase IIa data from its clinical trials of Xiaflex in frozen shoulder syndrome, with patients in the trial seeing statistically significant improvements in both pain and shoulder function at both dosing levels [0.58mg(1mL) and 0.58mg(2mL)]. No patients discontinued treatment due to adverse events, and the most common side effects (bruising, injection site pain and swelling, and hematoma) were resolved on their own. The company will begin new trials for Xiaflex in frozen shoulder in the 2nd half of the year. While this indication could expand the Xiaflex franchise, the market opportunity is not truly meaningful. Auxilium estimates around 300,000 cases of frozen shoulder diagnosed each year, and just 10% are treated with invasive surgery. Working in Auxilium’s favor is the fact that frozen shoulder is more likely to occur in patients with Dupuytren’s contracture, thereby giving Auxilium a higher degree of selling synergies. Auxilium is also set to initiate Phase II trials of Xiaflex in cellulite reduction in the 2nd half of 2013. Data from Auxilium’s Phase Ib cellulite trial was positive, with Xiaflex well-tolerated by patients, and an efficacy profile that supports movement into Phase II trials.
While Xiaflex sales are growing, they are nowhere near initial expectations. At best, Xiaflex and its follow-on indications represent potential optionality to the upside, and we doubt that many of the company’s present investors are expecting Xiaflex to transform Auxilium in a material way. What we have here then, is a company with two franchises, both of which come with their own set of issues. Testim will face headwinds from generic AndroGel in 2015, and Xiaflex’s addressable market has proven to be far smaller than initially estimated. How can this company be a solid investment opportunity? The answer lies not in its current drugs, but in Auxilium’s balance sheet and its CEO, Adrian Adams.
A Strong Balance Sheet with a Strong CEO to Match
The core of the bullish thesis for Auxilium lies in its balance sheet and in Adrian Adams, Auxilium’s CEO. These 2 factors are intertwined, and will both serve to create shareholder value in the long-term. Auxilium ended 2012 with $158.9 million in cash & investments and no debt. While the company did post operating cash burn of $2.3 million in 2012, this was due in large part to changes in deferred revenue relating to the company’s agreement with Pfizer. With Auxilium guiding for positive non-GAAP net income in 2013, we expect the company to see either a continuation of low cash burn or even positive operating cash flow. In January, Auxilium further bolstered its balance sheet with the sale of $350 million ($338.7 million in net proceeds) of 1.5% convertible notes due 2018. Auxilium stated that these notes could be used to finance acquisitions, licensing deals, or other business development opportunities, and addressed this issue on its Q4 call. CEO Adrian Adams openly stated that Auxilium believes that it needs to diversify its revenue base, stating that:
“To build a more robust and a valuable company, we believe that we must augment our portfolio of currently marketed products and pipeline product candidates through corporate development and licensing activities. Our current CD&L focus is on assets that would generate meaningful revenue in 2013 or 2014 and could be accretive to Auxilium in the short term. If we achieve this goal, we may then look to add earlier stage pipeline assets in our areas of focus. We will prioritize opportunities that can leverage our current commercial infrastructure in urology, endocrinology and orthopedics, or which will help us leapfrog the learning curve and bring an established platform to an emerging area of interest such as dermatology. Finally, we will remain opportunistic to other specialty areas like rheumatology, GI or orphan indication. In pursuing our goals in corporate development and licensing, we will continue a dual path of looking for bolt-on products or acquisitions that build out our current franchises or a larger transformative transaction. The most important criteria for us are that the transaction must be fiscally responsible and have the ability to create value for shareholders.”
Based on this statement, we believe that Auxilium is looking for assets that are accretive to earnings in the short-term, with the goal of diversifying its revenue base, and won’t focus on development-stage assets until earnings and cash flow are at attractive levels. Admittedly, with a new infusion of over $300 million in capital, investors may worry that Auxilium will have an “itchy trigger finger.” It’s true that until a deal is announced this adds incremental uncertainty, and it’s possible that shares of Auxilium may fall if any deal that the company announces is not accretive. Any such near-term decline should be seen as a buying opportunity, as Adrian Adams is a shrewd CEO. Since being appointed to his the position on December 8, 2011, shares of the company have fallen just 1%. We expect far better for the company’s future share performance.
Adrian Adams has been CEO of multiple biotechnology companies, and his tenure seems to almost always lead to one outcome: a sale of the company that creates value for investors. The only meaningful exception was Adams’ job prior to joining Auxilium. Before his appointment as Auxilium’s CEO, Adams served as Chairman & CEO of Neurologix. But, Adams held that post for only 2 months, having been appointed in September 2011, and resigning in late November, most likely in order to become CEO of Auxilium. Before that, Adams serves as CEO of Inspire Pharmaceuticals, which was sold to Merck (MRK) in May 2011 for a 26% premium to market price. Prior to that, Adams served as CEO of Sepracor from December 2006 to February 2010. Sepracor was sold to Dainippon Sumitomo in December 2009 for a 28% premium to its trading price at the time. And prior to his role at Sepracor, Adams was CEO of Kos Pharmaceuticals from December 2002 until December 2006 when the company was sold to Abbot Laboratories (ABT) for $3.7 billion, which represented a 58% premium. Adams has made a habit of molding flagging companies into something more attractive. While not as notable, it is also interesting that prior to his role at Kos Pharmaceuticals, Adams held senior positions at ICI, whose pharmaceutical division merged with Astra to form AstraZeneca, and SmithKline Beecham, which merged with Glaxo to form GlaxoSmithKline.
Adrian Adams has already begun imposing fiscal discipline on Auxilium, preparing it for a more aggressive stance towards value creation and a potential buyout in the long-run. The table below shows the reduction in Auxilium’s costs as a percentage of revenues, adjusted for the impact of the termination of the Pfizer deal, which increased revenues and expenses by $92 million and $8.3 million respectively.
Auxilium Cost Structure, 2011 vs. 2012 (in Millions of Dollars)
| 2012 | 2012 Adjusted | 2011 | |
| Revenue | $395.3 | $303.3 | $264.3 |
| Operating Expenses | $309.8 | $301.5 | $297.5 |
| Operating Expenses as a % of Revenue | 78.37% | 99.41% | 112.56% |
Adrian Adams has been CEO of Auxilium for around 15 months, and in 2012 (his first full year as CEO) he has reduced operating expenses as a percentage of revenue by over 1,300 basis points (when adjusted for the effects of the Pfizer collaboration deal), and we expect this reduction to continue during the course of 2013 and beyond. This will further strengthen Auxilium’s cash flow and balance sheet, allowing the company to invest more in expanding its revenue base and pipeline.
Conclusions
With Adrian Adams at the helm, Auxilium Pharmaceuticals is well positioned to create shareholder value. A CEO with a proven track record, who has a clear pattern of positioning companies as takeover targets, leads the company, and Auxilium may very well continue that trend. The company has a clean balance sheet, expects either minimal or no cash burn in 2013, is set up to beat earnings estimates, and has made it clear that it’s looking to expand its revenue base beyond Testim and Xiaflex. With shares trading under $18, investors should consider adding Auxilium to their portfolios. Adrian Adams’ long history in the biotechnology sector has shown that more often than not, his investors will be rewarded.
