Zohydro’s Approval Was the First Step

After a negative vote from the FDA’s Anesthetic and Analgesic Drug Products Advisory Committee (AADPAC) and repeat signals that the regulatory agency was taking a hardline approach to preventing opioid abuse, PropThink suggested that Zogenix’s (ZGNX) pure hydrocodone formulation, Zohydro ER, would not be approved by the FDA for the management of chronic pain.

We were wrong. On Friday, the FDA approved Zohydro ER for the management of pain severe enough to require long-term opioid treatment and for which alternative treatment options are inadequate. Zohydro ER is the first extended-release hydrocodone that does not contain acetaminophen. Clearly the FDA saw value in having an acetaminophen-free hydrocodone on the market, despite that the product lacks abuse-deterrents and will likely become the go-to drug for opioid abusers. Recall that in April, the FDA approved labeling changes to the abuse-deterrent reformulation of OxyContin and simultaneously ruled that original OxyContin (which was widely abused) would be withdrawn from sale.

Zogenix expects to launch Zohydro ER in approximately four months (by the first week of March), and in a conference call on Monday morning said that a partnership or go-it-alone decision would be made in the next 3-4 weeks. Management said that they’ve had significant interest from potential partners (or acquirers, in our view) and would be weighing a decision as final co-promote proposals come in.

But it’s no secret that Zogenix needs capital, particularly if the company sells Zohydro ER on its own. Zogenix ended the second quarter with cash and equivalents of $16 million and long-term debt of more than $36 million. On Monday, management said that they would need a “modest sum” of capital to launch the product alone, and the question now is how much non-dilutive cash a partnership might bring in, or whether a partnership will occur at all. Note that Zogenix put in place a $25 million ATM facility in March, which the company is likely exercising expeditiously and likely was over the last two months into a strong stock. During the second quarter, ZGNX did not make use of the ATM. Over 10 million shares of ZGNX traded hands on Monday. If even a quarter of these were part of the ATM, the company brought in $7.5 million.

The financing overhang is weighing on the stock, but we believe that the partnering decision is more likely than a secondary offering in the near-term given that the ATM should bring in enough cash to back partnering negotiations; a firm balance sheet is critical to quality discussion.

In the $2.00-$3.00 range ZGNX is an intriguing holding, sadly, based in-part on the abuse-ability of this drug and the niche that it might fill. Note that Purdue Pharma, in the two years following the approval of the abuse-resistant reformulation of OxyContin, saw the volume of drug sold decrease by more than 30%. It’s this demand that Zohydro ER will fill. More importantly, it doesn’t take record-breaking sales to justify the current $300 million valuation. We’re cautiously optimistic about ZGNX in the long-term and may nibble at the stock here for the chance to be involved when/if a partnership is announced. Analysts have been raising price targets to the $5-6 level (in pursuit of banking business) and once the company has enough capital on the balance sheet (either through a raise, partnership, or both) to remove the overhang, we expect the stock to trade up to the high $3 or low-$4 level. In addition, we note that as ZGNX tests valuations under $3 a share post-FDA-approval, the chance for an outright acquisition increases.