Why Analyst Estimates Could Prove Conservative For Transcept Pharmaceuticals

Transcept Pharmaceuticals (NASDAQ:TSPT) raised about $38 million on May 1st at $9.00 a share, but given the weak market and the “show me” launch of the company’s lead product, Intermezzo, investors have temporarily walked away from the name. Down roughly 26% since the capital raise, TSPT has fortified its balance sheet and now looks interesting on the long side. For starters, TSPT is trading at $6.65 and is expected to end the second quarter with about $4.20 a share in cash. The company spends roughly $5 million per quarter, but as Intermezzo begins to ramp up, the negative cash flow is expected to be offset by royalty income from commercial partner, Purdue Frederick.

With over $90 million in cash after the financing, TSPT has plenty of resources to get to profitability on Intermezzo revenues. Intermezzo is a rapid acting sleep agent that is taken upon a middle of the night awakening (MOTA), a problem that affects an estimated, one-third of Americans. The drug was approved by the FDA in November 2011, but just launched in early April. Patients are expected to leave the medicine by their bedside and dissolve one dose under the tongue while remaining in bed, as long as he or she has 4 hours of sleep time left.

All eyes are on the early prescription trends for the drug, but many agree that it’s too early to tell how successful the launch is, especially because there are a large number of product samples being distributed initially to doctors and patients. Prescriptions are likely to show a clear trend by the early fall, and an indication that the drug is catching on by or before then could send the shares sharply higher. Importantly, Purdue has committed to spend $100 million on Intermezzo sales and marketing for the first 12 months the drug is on the market.

The market for sleep aids is enormous with 79 million prescriptions filled annually in the U.S. The company notes that each 1% share of the market equates to $150 million in Intermezzo sales, for which Transcept receives a tiered double-digit royalty on sales based on its current arrangement with Purdue Frederick (royalty range from the mid-teens to the mid-20s). Analysts expect peak sales for Intermezzo at approximately $500 million annually on average, which translates into just over 3% of the market. Given the ageing population and an increasing percentage of the population that has trouble staying asleep, these estimates could prove conservative. However, even at the expected level of sales, TSPT has the potential to more than double according to analysts, which have an average price target of $19.50 for the stock. Transcept has the option to co-promote the product with its own sales force to psychiatrists, in which a royalty of up to 40% can be realized by the company on related sales (capped at 15% of total Intermezzo sales in the U.S.). This option, and the company’s Phase II product candidate for obsessive compulsive disorder (OCD) have the potential to increase financial expectations and yield additional upside for the stock.

For now, Trancept’s strong balance offers an opportunity for investors to take advantage of the recent dip in the stock price, and get a good night’s rest while Intermezzo penetrates this large and underserved segment of the sleep market. The large difference between the current stock price and analysts’ price target expectations suggests that a bounce in the shares to at least the price of the recent capital raise could take place soon.