In this article, we describe the key issues that investors should understand coming into the Markman hearing decision, to be rendered any day by Judge Sleet of the U.S. District Court in Delaware. The case involves Cubist and patent challenger Hospira, and the outcome will cause sharp volatility in CBST (we anticipate a $3-$4 per share move in either direction). We believe there’s a high probability that Cubist wins the case, but even if the Markman hearing (for patent claims construction or language interpretation) goes against the company, full litigation with Hospira will continue to drag on, and Cubist may decide to settle with this challenger. Thus, we believe that this litigation will be resolved in the company’s favor one way or another, particularly given the impressive economics that Cubist structured in a prior agreement with Teva Pharmaceuticals, which we discuss in detail below. We also describe the opportunity for CXA-201, a much-needed new approach to treating Gram-negative infections that will bear the torch as branded Cubicin loses market share in the next decade. Overall, CBST should begin to appreciate over the next few months as the CXA-201 results approach, and the overhang from the ongoing Cubicin patent challenge provides investors with an entry point in advance of this catalyst later this year.
Markman hearings clarify patent terminology, and this one should favor Cubist. Our expectations for the hearing outcome are geared towards Cubist receiving a favorable ruling on “claims construction” of the 5 Cubicin patents being challenged. However, many investors are waiting for the risk to be reduced or removed, therefore we believe a positive decision will cause the stock to trade immediately higher.
The key issue in this case is the definition of “daptomycin”, the active ingredient in Cubicin. The ambiguity of what “daptomycin” means stems back to an original patent (the RE ‘071 patent) in which the chemical structure of “daptomycin” was disclosed as an image. Because the chemical was characterized in the 1990s, when methods for determining complex chemical structures were more crude, the picture of “daptomycin” in the RE ‘071 patent was incorrect by a minor detail. Instead of an L-asparagine in the structure, Cubist found out years after the patent was issued that the compound actually contained R-asparagine, a very minor difference and one that only modern stereochemistry (3-D) techniques could detect. In fact, stereochemistry mistakes were quite common before the 21st century. Nevertheless, the actual commercial version of “daptomycin” (Cubicin) was different from the original picture in the RE ‘071 patent by one molecule. As a result, Cubist immediately alerted the FDA to reference the updated structure, and also alerted the U.S. Patent Office (PTO), which issued a Certificate of Correction in early 2008.
Patent challenger Hospira, which initiated its challenge in February of 2012, argues that because of this situation, the term “daptomycin” in the patents refers to the erroneous form of Cubicin, and that all of the company’s patents are, hence, invalid. It’s easy to see why it’s so important for the judge to clarify the definition of “daptomycin” in the patents to mean either the marketed drug (favoring Cubist), or the erroneous original image (favoring Hospira’s argument). It’s also pertinent to note that the four most important patents protecting Cubicin (2 dosing patents and 2 purity patents, expiring in 2019 and 2020, respectively) do not refer to any structure of daptomycin, only a verbal description of the drug that does not mention stereochemistry (whether the asparagine moiety in question is “L” or “R”). Legal consultants believe that the definition of “daptomycin” is the commercial drug, especially given the PTO’s acknowledgement of the error and the Certificate of Correction that was issued. Additionally, the dosing and purity patents mentioned above (‘967, ‘689, ‘238, and ‘342 patents) are arguably the most important patents for protecting Cubicin through 2019/2020, and they do not refer to three dimensional structures of the drug. As a result, the probability that Cubist will receive a favorable Markman decision remains high in our view, thus our belief in upside to the stock upon the near-term ruling.
Positive Markman decision to send CBST higher, negative outcome less impactful based on Hospira settlement speculation. We think it makes sense to own some CBST now in front of the Markman hearing decision. Hospira’s arguments are centered primarily on the erroneous picture in the original patent, so two major scenarios exist on the Court’s interpretation of daptomycin: 1) Hospira’s argument prevails, and the full trial (scheduled for February 2014) will be the next expected event for the litigation; or 2) Cubist’s argument prevails, and Hospira’s case is significantly weakened. Note that CBST has many options in the event that Hospira’s argument prevails, such as an appeal and/or tactics to delay the trial proceedings next year. Most importantly, if Hospira’s case continues to look threatening, Cubist may ultimately elect to settle, much like it did a few years back with Teva for a license to Cubicin’s remaining patents and manufacturing know-how. Cubicin is so difficult to manufacture that Teva, in fact, negotiated to purchases all of its supply for generic Cubicin from Cubist when it launches in mid-2018 (assuming a pediatric exclusivity extension), and a settlement with Hospira could result in a similar arrangement. Note that Cubist will make money on its sales of daptomycin to Teva, as well as a majority of the profit margin on Teva’s generic sales. This, in our view, demonstrates the strength of Cubist’s IP and manufacturing process for Cubicin, which is also an incentive for Hospira to settle with the company, even if its legal case appears strong. So, priority #1 for Cubist is to knock Hospira out with its existing intellectual property protection, but if Hospira makes it over a few hurdles, a settlement may be the answer. Though unlikely in our view, bad news from the Markman hearing will significantly raise the probability of a settlement with Hospira.
Looking back on the company’s Cubicin litigation settlement with Teva in 2011, CBST shares shot from $25 per share to nearly $40 over a 2-month period given the removal of an imminent generic threat. In the event that the Markman hearing favors Hospira’s argument and the case begins to look more threatening, we believe Cubist management will be smart enough to settle the case, and the market will likely applaud this move much like when the Teva settlement was announced. The two likely scenarios for Cubicin’s long-term revenue streams are: 1) the Teva generic (split with Cubist) + residual Cubicin brand sales; or 2) the Teva and Hospira generics (also split with Cubist) + residual Cubicin brand sales. Note that either of these oligopoly situations are likely to last for several years, particularly given the high barriers to manufacturing daptomycin at commercial scale. As a result, we believe the litigation with HSP is less onerous than the market is factoring in, and once the generic threat is better understood, investors will be able to focus on Cubist’s pipeline and opportunity for upside from current levels.
Poor 1Q13 results cooled enthusiasm, but Cubist remains a top grower in pharma. While Cubist still makes the list of fastest-growing drug companies (2012 revenues were up 23% y/y), investors were unimpressed by the recent quarterly performance, keeping the stock under pressure. The company reported disappointing 1Q 2013 revenue and earnings, largely due to seasonal issues for Cubicin and a one-time $25 million R&D payment to Astellas for remaining international rights to CXA-201. Cubicin revenues came in at $202 million in 1Q, missing consensus expectations of $213 million as a higher number of flu-related pneumonia hospital admissions (patients not eligible for Cubicin) proved to be the trend during the Winter months. As a result, analysts reduced their 2013 estimates for the company, but importantly, the company stood by its prior revenue guidance of $1.0-$1.045 billion, which includes U.S. Cubicin revenue of $900-$925 million (international Cubicin revenue guidance for $53-$58 million). We note that Cubicin still grew 9%, year over year, based on the 1Q results, and company guidance implies 11-14% revenue growth this year, suggesting that the next couple of quarters could feature a catch up in Cubicin sales. The company has cash of $941M and expects to have $1.1B in cash and equivalents on the balance sheet by year-end, unless it acquires more assets.
Operating earnings for Cubist will step up significantly when a patent on Cubicin expires in 2016 (or Hospira invalidates that particular patent in its litigation). Eli-Lilly, the Cubicin inventor, owns that patent and receives about 14% of sales from the company (reported in cost of goods sold, or COGS). As a result, profitability should improve by about $140 million annually in 2016 when the patent is no longer in force (we expect dosing and purity patents to protect the drug through the end of the decade). This profitability windfall adds about $1.08 to annual EPS, and because COGS will go down significantly after the patent expires (or is invalidated), the economics of Cubist’s settlement with TEVA are enhanced.
Teva settlement was smart and captures Cubicin profits for years. In February of 2009, Cubist was notified that Teva Pharmaceuticals had filed an abbreviated NDA (ANDA) for a generic form of Cubicin. Cubist retaliated with a patent infringement lawsuit a month later, but in what we believe was an adaptive and intelligent maneuver two years later, Cubist structured a settlement with Teva that should continue to provide strong economics from Teva’s forthcoming generic Cubicin. Under the agreement, Teva will launch a generic on December 24, 2017 (or June 24, 2018 if Cubist's daptomycin receives pediatric exclusivity, which we believe is likely). Per the agreement (emphasis is our own):
The settlement agreement with Teva also provides that, for the period that the Company's license to Teva is in effect, Teva will purchase its U.S. requirements of daptomycin for injection exclusively from Cubist…. The supply terms provide that the Company will receive payments from Teva for product supplied by Cubist reflecting two components: one based on the cost of goods sold plus a margin, and the other based on a specified percentage of gross margin (referred to as net profit in the supply terms) from Teva's sales of daptomycin supplied by Cubist.
Two facets, as highlighted above, make this arrangement particularly beneficial to Cubist, despite that fact that branded Cubicin will face generic competition:
- Teva will purchase unlabeled vials of Cubicin exclusively from Cubist at cost plus a small mark-up on drug manufacturing costs.
- Cubist will receive a percentage of Teva’s generic daptomycin gross margin. Cubist management has stated that it will receive the majority share of the gross profits (we and some analysts estimate 55% of the profit to Cubist, but this could be conservative).
Based on our calculations (using a 55% margin split), after Teva begins selling generic daptomycin, Cubist will still capture about 50% of the gross profit that it’s realizing today on Cubicin. With the ability to immediately drop all selling and marketing costs for Cubicin, as well as R&D expenses associated with the drug in the out years, we estimate that Cubist has structured a deal that enables it to keep about 60% of the actual current operating income from this drug until more generics (No just Teva's) enter the market. Analysts expect CXA-201 to achieve peak sales of approximately $1.3B dollars, with CXA-201 sales getting to about half the level of Cubicin by the end of the decade, indicating that the Teva deal economics on generic Cubicin, plus CXA-201’s income, preserve long-term cash flow generation for Cubist. Incremental growth in the out years will come from further CXA-201 growth, other pipeline products (which we detail below), and any additional M&A activity to increase revenue and profits.
CBST to come back in favor ahead of Phase III results for CXA-201. Cubicin has been a major success for Cubist, with guidance for U.S. sales of the drug at $900-$925M this year and sales to the company from ex-U.S. territories expected in the range of $53-$58 million. And while this major drug moves into its final years of patent life, the company is preparing its next blockbuster anti-infective agent, CXA-201, which addresses an even larger market than Cubicin. Cubicin addresses Gram-positive infections, while CXA-201 addresses Gram-negative infections, and like Cubicin, this drug is differentiated in its ability to kill the most difficult to treat pathogens. Importantly, the pursuit of new anti-infective agents has fallen off the radar screen of major pharma companies (mainly because they are not used chronically), and investors have also spent less time on this forgotten drug segment (see Trius Therapeutics (TSRX) for an undervalued antibiotic play). We believe that a lack of focus by the market, and the high unmet medical need for new Gram-negative agents, provides investors with a significant chance for upside. Below, we provide information on the market potential for CXA-201, which is likely to be larger than Cubicin in the U.S. and have a much larger contribution in the EU. CBST will not license the drug in Europe as it did with Cubicin; it plans to retain the economics in that territory, meaning that CXA-201 could be twice as large as Cubicin from a revenue standpoint. Analyst estimates call for CXA-201 to achieve peak sales of $1.3 billion by the 2025 time-frame, however, based on the larger market size vis-à-vis Cubicin, these estimates may prove conservative.
Gram-negative antibiotic market 80% larger than the Gram-positive market. Cubist has calculated the number of days of therapy in the U.S. and Europe for both Gram-negative and Gram-positive antibiotics, and importantly, there are significantly more days of therapy for drugs to treat Gram-negative infections. In the U.S., this difference is apparent in one of Cubist’s investor presentation slides, but the difference in the EU is much more significant, the reason why the company is now planning to expand its marketing presence into Europe (from just the U.S.), while continuing to license its drugs out in other global territories.
The key to potential success of CXA-201 is that it treats several difficult Gram-negative infections, particularly Pseudomonas, Klebsiella, and Escherichia (E-coli). This differentiation should allow premium pricing and a reasonably rapid uptake in the commercial market. The data below indicate just how significant the market need is, and Wall St. tends to miss this from an investment standpoint because most major IV antibiotics represent small percentages of the revenue streams of large-cap drug companies. As a result, this market segment is not a major focus of professional investors, and for now, is under the radar screen.
However, with Cubist, the leverage from CXA-201 could be huge. According to IMS Health, approximately $41 billion was spent on antibiotic drugs globally in 2011, with $9 billion spent in the U.S. The widespread use of antibiotics has resulted in a rapid increase in bacterial infections, which are resistant to multiple antibacterial agents. With the rise in multi-drug resistant (MDR) bacteria, several antibiotics have become highly successful targeting difficult-to-treat pathogens, such as Pfizer’s (PFE) Zyvox (peak sales of $1.3B), Johnson & Johnson’s (JNJ) Levaquin (peak sales of $1.4B), AstraZeneca’s (AZN) Merrem (peak sales of $800M), and Cubicin (expected 2013 sales of $975M). Reducing methicillin-resistant Staph aureus (MRSA), a Gram-positive bacterium, continues to be a high priority of government agencies, and this created the opportunity for Cubicin to become the blockbuster drug that it is today.
The more acute focus of the Centers for Disease Control (CDC), however, is the need for new drugs to treat multi-drug resistant Gram-negative bacteria. Currently approved products such as Merrem and Levaquin are becoming increasingly ineffective against these bacteria due to increasing drug resistance, and physician options are now quite limited. A survey of infectious disease specialists published in Clinical Infectious Disease (June 2012) rated MDR Gram-negative infections as the most important unmet clinical need in current practice, significantly outranking infections caused by MRSA and MDR Mycobacterium tuberculosis. In the survey, 63% of physicians reported treating a patient in the past year whose Gram-negative infection was resistant to all available antibacterial agents. Further, in 2011, the Clinical Center of the National Institutes of Health had an outbreak of Gram-negative Klebsiella pneumoniae bacteria strains that were resistant to all available antibiotics. The outbreak resulted in eleven deaths, six from the superbug. In addition, there have been numerous reports recently that physicians have resorted to prescribing colistin for Gram-negative bacteria resistant to all other drugs. Colistin is a drug from the 1940s, and has not been widely used for decades because of serious toxicities. In September 2012, the FDA announced the formation of an internal task force to support the development of new antibacterial drugs, and noted that this task force is “a critical public health care goal and a priority for the agency.”
When confronted with a new patient suffering from a serious infection caused by an unknown pathogen, a physician may be required to quickly initiate first-line empiric antibiotic treatment to stabilize the patient prior to definitively diagnosing the particular bacterial infection. However, current antibiotics for first-line empiric treatment of serious bacterial infections suffer from significant limitations, primarily, the potential for drug resistance. Given CXA-201’s ability to cover several strains of MDR Gram-negative bacteria, the drug, if approved, could prove useful as first- line empiric therapy, and certainly has the opportunity to help fill the void of treatments for MDR Gram-negative infections.
CXA-201 safety and efficacy strong thus far and suggest positive Phase III results. Cubist acquired the rights to CXA-201 (ceftolozane/tazobactam) in its purchase of Calixa in late 2009. A combination of CXA-101 (ceftolozane), an anti-pseudomonal cephalosporin, and the beta-lactamase inhibitor tazobactam, CXA-201 is being developed as a treatment for certain infections caused by Gram-negative bacteria, including Pseudomonas aeruginosa. Cubist initiated two Phase III trials in 2011 for complicated intra-abdominal infections (cIAI) and complicated Urinary Tract Infections (cUTI), both of which should read out top-line data later this year. Thus far, the combination therapy has proven safe and well tolerated in patients, and given the long-standing safety profile of the cephalosporin drug class, and tazobactam (contained in the blockbuster antibiotic Zosyn), we do not expect the safety of CXA-201 to be an issue. We count no less than 22 cephalosporins in use as antibiotics since 1964, when the first agent, cephalothin (cefalotin,) was launched by Eli Lilly -- four generations of stronger and less-resistant cephalosporin agents have since made it to market. Tazobactam, meanwhile, has been used for years as part of Zosyn (piperacillin/tazobactam), and is the second part of CXA-201’s combination formulation. Cubist expects tazobactam to help broaden the efficacy range of ceftolozane against certain bacterial strains like Klebsiella and Escherichia.
In a 64-patient double-blind placebo-controlled Phase I safety and tolerability trial, ceftolozane was well tolerated, with only infrequent and mild drug-related systemic adverse events. Following that, ceftolozane went through a Phase II cUTI study that proved the compound’s similar microbiologic and clinical efficacy vs. ceftazadime: clinical response rates were 91% and 92% with ceftolozane and ceftazidime, respectively, and sustained clinical cure rates at the late follow- up visit (3 to 4 weeks after therapy) were 98% for ceftolozane vs. 93% for ceftazidime. Both drugs were well tolerated in this study. CXA-201 (the ceftolozane/tazobactam combination) met both safety and efficacy endpoints in a Phase II multicenter, double-blind, randomized study in 122 patients with cIAI, demonstrating a clinical cure rate of 91% in the clinically evaluable population. The clinical cure rate for the study comparator, meropenem, was 94%. In the microbiologically evaluable population, the CXA-201 treatment arm demonstrated a clinical cure rate of 89% and the meropenem arm demonstrated a clinical cure rate of 96%, again demonstrating similar efficacy to existing treatments. Most importantly, clinical cure rates for the CXA-201 treatment arm were observed across identified baseline pathogens, which included Escherichia coli, Klebsiella pneumonia and Pseudomonas aeruginosa.
Currently, Cubist has four Phase III trials ongoing for CXA-201 (in early 2013 the FDA allowed Cubist to pool the results of these trials and changed patient requirements - see associated FDA guidance). Two pivotal trials evaluate the drug in cUTI patients. Both are multicenter, randomized, double-blind, double-dummy studies, each targeting enrollment of 776 patients and evaluating CXA-201 versus a comparator drug, levofloxacin. The endpoint in both studies is non-inferiority to levofloxacin, which will be measured 5-9 days after the last doses of the study drugs are administered. The primary endpoints are the proportion of subjects who have both microbiological eradication and a clinical cure, and results are expected in 2H 2013 (clinicaltrials.gov cites a September 2013 conclusion). Additionally, the company is conducting two global 905-patient multicenter, randomized, double-blind, double dummy study of CXA-201 plus metronidazole versus meropenem for the treatment of cIAI. The trials are designed to demonstrate non-inferiority to meropenem, with a primary endpoint of the proportion of subjects who have a clinical cure 26-30 days after the start of treatment. Cubist also plans to initiate a Hospital acquired/ventilator-associated bacterial pneumonia (HABP/VABP) trial by mid-2013 -- a Phase I study demonstrated that ceftolozane penetrates the lung well to fight bacterial infections in compromised patients.
What’s important to note about anti-infectives is that pre-clinical efficacy is largely indicative of a compound’s efficacy in the clinic. Essentially, these compounds are “just killing bugs”, and as long as they demonstrate safety and tolerability in human subjects, and the ability to combat strains that are resistant to current treatments, the antibiotic has a strong chance of being approvable, as well as commercially significant. Completed clinical trials aside, it’s the depth of in vitro and in vivo results that make CXA-201 a compelling asset coming into late-stage studies. We believe that CXA-201 will demonstrate a benefit in Gram-negative infections, and these late-stage studies should lead to the company filing a New Drug Application by mid-2014. Interestingly, the FDA granted CXA-201 a Qualified Infectious Disease Product (QIDP) designation last December, qualifying it for priority review and fast-track status which should accelerate the approval process to a 6-8-month turnaround. As a result, if clinical trials for CXA-201 prove positive, this new antibiotic could be on the market by or before mid-2015. And because of the QIDP designation, CXA-201 is eligible for a 5 year exclusivity extension under the Hatch Waxman Act, if the drug is approved.
Other products and pipeline candidates given little credit by the Street. CBST’s full development program offers a deeper backdrop to the near-term events for Cubicin and CXA-201, and due to the leverage capabilities of the company’s existing hospital sales infrastructure and expertise, we expect new, development-stage anti-infective products to be nicely accretive to the bottom line once approved. CXA-201 aside, the Street and investors have yet to focus in detail on Cubists’ full pipeline, and while we find CXA-201 to be the most exciting of its development programs, two more treatments in late-stage development could generate long-term EPS upside.
First, it’s worth noting that Cubist markets two additional FDA approved products: Cubists’ own Entereg (alvimopan), and Optimer’s (OPTR) Dificid (fidaxomicin). Cubist picked up Entereg with the acquisition of Adolor in 2011, and the product did $40.2M in sales in 2012; Entereg is not central to the CBST story, but it’s an incremental bonus to cash flow. Cubist and Optimer entered into a co-promotion agreement for Dificid, an antibiotic for the treatment of clostridium difficile (C. diff)-associated diarrhea, in 2011, shortly before the drug received FDA approval. Under the agreement with Optimer, Cubist co-promotes Dificid and receives a quarterly service fee of $3.8 million plus a portion of Dificid gross profits. The co-promotion agreement expires in July of 2013, and CBST will use the experience it gained with Dificid for its own late-stage C-diff drug candidate, surotomycin. Surotomycin (CB-315) is an antibacterial lipopeptide (same class as Cubicin) being developed as a treatment for patients with C-diff associated diarrhea (CDAD), just like Optimer’s Dificid. In July, Cubist enrolled its first patient in Phase III trials to evaluate the difference in clinical response rates in patients treated with surotomycin compared with oral vancomycin, a generic CDAD treatment that is the most widely prescribed agent in the C. dif. space. Surotomycin demonstrated a 50% reduction in the rate of recurrence in a Phase II study in June 2011, and if the drug performs similarly in Phase III trials, it could become a $150M-$200M product annually. Assuming approval, surotomycin should be on the market in 2016. Bear in mind, Cubist’s existing sales activities and experience with Dificid make this an easy addition to the commercial effort, but more importantly, imply that surotomycin revenue will drop straight to the bottom line. Phase III trials should read out next year, and unlike Optimer’s Dificid, we expect CBST to price this novel treatment for strong market adoption, if approved.
Bevenopran (CB-5945) is a mid-stage mu-opioid receptor antagonist being studied as a potential treatment for chronic opioid-induced constipation (OIC). Cubist initiated a long-term safety trial of bevenopran last October and plans to begin three Phase III efficacy trials in the first half of 2013. OIC is an immense market, yet enthusiasm for bevenopran, at this point, is tempered due to the FDA’s concerns with the potential for cardiovascular risks in this class of drugs and the large number of competitors in late-stage trials. Salix Pharmaceuticals’ (SLXP) Relistor, another mu-opioid receptor antagonist, received a complete response letter upon filing with the FDA, although Nektar’s (NKTR) Naloxegol didn’t appear to demonstrate any increase in CV effects in its long-term safety study. Still it remains to be seen whether the FDA will accept a long-term safety study like Cubist’s ongoing program in place of a CV outcomes study. Cubist believes its program will be sufficient, but until we have some clarity from FDA, or see positive safety results next year, we don’t consider the asset a key part of the Cubist story. The trial results for bevenopran should read out late next year. Finally, Cubist develops with Hydra Biosciences CB-625, a non-opioid small molecule antagonist of the human TRPA1 channel being studied as a potential treatment for post-surgical pain. The product is still in early-stage development and is not a part of most models for CBST’s valuation.
Scaling into a CBST position makes sense. Analysts’ price targets for CBST range from $40 to $69, with most in the $60 range based on discounted cash flow (DCF) estimates for Cubicin and the company’s pipeline candidates, including CXA-201. We agree with these targets, but to get to the high end of the valuation range (up to $70 per share), Cubist needs a favorable Markman decision and strong Phase III results from the cUTI and cIAI trials. As noted above, the next catalyst for the stock is the claims construction decision from Judge Sleet on the Markman hearing, and if positive, we believe CBST shares should cross previous resistance at $49.86 and may continue into the low $50-range as institutional investors begin taking a harder look at CXA-201 with the Markman decision out of the way. Overall, Cubist holds long-term appeal for investors based on both its lead product and lead pipeline candidate, and we anticipate that this mid-cap stock offers 30%-40% upside for investors taking a leap of faith in front of the Markman hearing outcome. Because this is a binary event, however, investors would do well to keep some dry powder by taking a partial position and adding following and regardless of the Markman hearing outcome. One thing is for sure: there will be strong interest in the Phase III results for CXA-201, and once the Cubicin litigation noise fades away, the focus on this drug and its commercial potential should drive shares in the second half of the year. Expect volatility around the Markman hearing decision (anticipated any day) and watch for CBST to begin running into the CXA-201 Phase III results this Fall.
In addition, see PropThink's latest report on Trius Therapeutics (TSRX), which we consider a fellow undervalued antibiotics developer.