AFFY Poised to Snap Back

A number of factors have come together to create weakness in Affymax, Inc. (NASDAQ:AFFY) providing a buying opportunity. On Wednesday, AFFY closed at $19.51, down 30% from its October high. The high volume down day was most likely precipitated by Piper Jaffray stating that the U.S. Government Accountability Office published a report on December 7 that recommended that congress require the Department of Health and Human Services to rebase the End Stage Renal Disease bundle, as Erythropoiesis Stimulating Agent (ESA) utilization saw a 31% decline from 2007 to 2011, which is the year in which the bundle is based. Piper thinks that a reduction in the bundle has grown more probable, and that dialysis providers will probably require more discounts from drug manufacturers. The statement, combined with a decrease in script data last month and a small amount of insider selling, led to the sell-off. This was an overreaction, as the fundamentals supporting adoption and use of Omontys, AFFY’s lead product, are strong and not significantly changed.

ESA Market Stabilizing. Declining use of ESA’s comes as no surprise, as recent studies have highlighted the dangers associated with their use; target hemoglobin levels have been reduced and iron supplementation has increased, reducing ESA requirement; conversion from intravenous to subcutaneous route of administration reduces Erythropoeitin dosage by two-thirds; and economic pressures have increased with bundle payments. The $2 billion ESA market, however, is unlikely to contract much further, as reduction from 2007 to 2011 is mostly due to the factors mentioned above, and there is an ageing population with increasing need for dialysis.

Omontys differentiation is key to retaining and growing sales. Omontys is a clearly differentiated ESA that needs to be administered only once a month as opposed to thirteen times; it has a cost advantage, convenience advantage, and given a choice, patients prefer it. After 22 years, the Amgen (NASDAQ:AMGN) monopoly has been broken, but it will initially take time for dialysis organizations to change over to Omontys because they will have to gain experience and confidence in the use and monitoring of the drug. This change will take time, and AFFY has a good staged approach and pricing plan. Once providers have converted, they are unlikely to revert back. A blip in the script data is nothing of consequence given the very early stage in Omontys’ product cycle, which received approval in March of this year.

Better economics for Omontys also driving uptake. The unifying guiding principle for adjusting the bundle payment is that Medicare should pay the cost reasonably incurred by an efficient dialysis provider. Any change in bundle payment will affect the overall margins of profitability for an entire treatment, impacting long term financial viability of dialysis facilities, which are largely dependent on Medicare payment. The dialysis market is very concentrated, with two-thirds of the market shared by Fresenius (NYSE:FMS) and DaVita (NYSE:DVA) and the remaining one-third provided by medium and small dialysis companies. If anything, a change in the bundle would accelerate adoption of Omontys by the smaller organizations. DaVita has a seven-year exclusive agreement calling for 90% utilization of ESA’s from Amgen, which will expire in 2018. Importantly, Fresenius makes up 35 percent of the market larger than DaVita. They’ve signed a non-exclusive agreement with Amgen and have commenced a large conversion pilot with AFFY; 10,000 patients have already been treated. AFFY has access to two-thirds of the market, and it is unlikely that the DaVita-Amgen agreement will be renewed.

Script data recovery after Hurricane Sandy impact should be a catalyst for the stock. As far as the weak script (prescription) trends go, let’s not forget that last month, hurricane Sandy put pressure on the market resulting in fewer dialysis procedures over several weeks. We expect a snap back in demand trends for AFFY as December prescriptions should not have this issue, and could show a strong recovery. This represents a nice catalyst for a recovery in AFFY’s stock price.

AFFY’s recent weakness is a buying opportunity. Omontys will gain a large share of the market, but patience is needed as the conversion process is more complex than for a simple drug. It is likely that a high percentage of new patients to dialysis will eventually start on Omontys. Sadly the turnover of the dialysis population is very high, as average life expectancy is worse than for many cancers, being only five years. In the current price range, AFFY represents an opportunity to buy into a long term growth story.