Cadence is Tiring Out and Generic Risks Suggest Taking Profit

Shares of Cadence Pharmaceuticals (CADX) have run too high too fast, and although fundamentals have improved significantly in the last year, we believe the stock is due for a pull-back and now is the time to take profits. Patent challenges from generic drugmakers pose a major risk to this one-product business, which, with some near-term clarity on this issue, compounds our view that it’s time for an exit. PropThink recommended Cadence based on improving sales expectations four months ago (see the report), and shares are up 63% since. The company launched Ofirmev, the first FDA-approved IV acetaminophen formulation for the hospital setting, in 2011, and since last year, product sales have been ramping well; the company is guiding for revenue in 2013 to double off of 2012, from $50.1M to $97M at the mid-point of guidance. And, analysts are projecting revenue in 2014 of $162M, suggesting that at 4x forward revenue, CADX is worth just under $650M, or roughly $7.50 per share. CADX’s recent breakout peaked at $6.85 on Thursday the 28th, and with the stock this close to what we consider fair value, technicals suggesting that a correction is imminent, and possible clarity on generic entrants in the next two months, we believe the risks outweigh the rewards.

The value proposition for Ofirmev? Physicians need alternatives to opioids and NSAIDs in pain management, and Ofirmev is a compelling addition in a multimodal approach to perioperative analgesia (Pacira Pharmaceuticals (PCRX) on Wednesday announced supportive findings published in the Journal of Pain and Palliative Care). Research has shown that opioids are overprescribed in the U.S., and physicians are weighing alternatives in the hospital setting due to the addictive qualities of, and adverse reactions to, narcotics. But litigation with generic filers still overhangs CADX. The company goes to court in May with Exela Pharmaceuticals, and barring a settlement prior (Cadence successfully settled with generic-filer Perrigo in November), this ongoing case, and generic challenges from both Sandoz and Fresenius Kabi last December, will weigh on the shares until resolution. The stock is tiring out, and we believe the mid-$6’s make for a good exit point.

Sales growth has been strong, but litigation and/or settlement is a critical near-term event. Ofirmev sales have grown considerably in the last year as physicians both began using the product and, just as importantly, returned to the product. CEO Ted Schroeder said that with access and formulary acceptance out of the way in 2011, growth is occurring due to a “broadening of the number of patients and varieties of procedures where Ofirmev is utilized. As healthcare professionals have positive patient outcomes and gain familiarity with Ofirmev, our experience is that the number of vials they use per patient, as well as their utilization of the product across their patient population as a whole, increases.” As of December 31, 82% of customers had placed multiple orders for Ofirmev, and Cadence increased its customer base as a whole significantly, from 2,260 at year-end 2011 to 3,750 at the end of 2012, a 66% increase year-over-year and an 8% increase over 3Q12. The average number of orders (frequency) per customer climbed 16% from 4Q11 to 4Q12, while the average order size per customer climbed 40%, demonstrating that physicians who have begun using Ofirmev are going back for more.

While hospitals are certainly becoming familiar with Ofirmev and returning to Cadence with greater demand, the company will go to court in just a month for a patent infringement case with Exela Pharmaceuticals, the second generic challenger that Cadence will need to stave off. (Patents aside  Ofirmev’s market exclusivity, granted by the FDA, expires in November of this year.) In 2011, Exela filed an abbreviated NDA containing a Paragraph IV patent certification with the FDA for a generic version of Ofirmev. Cadence alleges that Exela infringed on two patents (‘222 and ‘218) with the filing; Exela asserts non-infringement and invalidity of the patents, and has filed counterclaims.

Cadence faced a similar case with Perrigo (PRGO), but reached a settlement in November of 2012 through which Perrigo receives the right of first refusal to market an authorized generic version of Ofirmev in the U.S. (purchased from Cadence), or will be able to sell its own in December of 2020. A negative court decision and worst case scenario could result in Exela bringing a generic to market as early as 2014, putting considerable pressure on Cadence’s branded version and essentially slashing sales to the bone. Remember, if one company secures a generic product, it opens the floodgates for all developers to follow suit. As a single-product company, it’s a risk that needs to be taken seriously, as generic entrants could put a veritable end to Cadence. Thus, the mid-$6 range, in expectation of a correction in the short-term and this overhang, makes for a nice profit-booking point.

There is a case to be made for a settlement with Exela in advance of the actual trial. Perrigo is a large ($10B+), publicly-traded pharmaceutical, and to see a company with the resources to fight a legal battle agree to a settlement suggests that the Ofirmev patents hold water. It may be in Exela’s best interest to avoid a protracted legal battle and settle now in an arrangement similar to Perrigo’s. In the case of a settlement, we would expect an announcement to come before, or early in, May. It would be a key catalyst for the stock, and seeing a second pharmaceutical company agree to hold off on bringing a generic to market — potentially from 2014 to 2020 — would imply that the possible gains simply aren’t there to support an expensive legal battle. But as a defined and understood near-term event, should a settlement fail to materialize in April or early May, CADX shares will weaken significantly in expectation of a prolonged court case, which could end up having devastating long-term effects on Ofirmev’s sales trajectory if a generic receives the go-ahead. It’s a toss-up, and these risks are further reason to take profit in advance.

Ultimately, demand for and utilization of Ofirmev is growing, demonstrated by the inclined sales ramp thus far, and its greatest threat is a generic entrant in the next two years. Cadence believes that its current cash reserves (~$76M as of January) will last the company until it reaches profitability (given no generic entrants). Bear in mind, a settlement with Exela would be good news for investors, who could re-enter the stock in anticipation of further product growth. However, following gains in the past week, CADX is overbought and should correct in the near-term. And with a binary event of sorts in the form of a settlement/litigation upcoming, scraping profits off the top now makes sense.