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Hep C Drug Panic! Pharmasset Stumble Ripples Through Sector

Updated with additional information.

PRINCETON, NJ ( TheStreet) -- The discovery of liver toxicity in a Pharmasset (VRUS) hepatitis C drug Friday has investors panicked that similar problems could crop up in competing drugs from Inhibitex (INHX) and Idenix Pharmaceuticals (IDIX).

Pharmasset first spooked investors Friday morning with the announcement that hepatitis C patients were being pulled off treatment with PSI-938 because of laboratory measurements suggesting the experimental drug was negatively affecting liver function.

Importantly, PSI-938 is not the keystone jewel in Pharmasset's hepatitis C pipeline for which Gilead Sciences (GILD - Get Report) is paying $11 billion to acquire. Gilead's main interest is in Pharmasset's drug PSI-7977, which remains untouched by Friday's announcement.

Pharmasset said the safety problem with PSI-938 does not trigger an escape clause written into the Gilead purchase agreement that allows Gilead to walk away if a serious adverse event or safety issue is discovered in a key Pharmasset drug.

Regardless, Pharmasset shares were down 2% to $125.28 Friday, even as the company reaffirmed its belief that the Gilead deal will close in the first quarter of next year. Gilead is acquiring Pharmasset for $137 per share.

The real investor panic took place in Inhibitex, which is developing a hepatitis C drug known as INX-189 that shares similarities in chemical structure with Pharmasset's now-tainted PSI-938. With Pharmasset bought for $11 billion, investors have been betting that Inhibitex could be the next hepatitis C drug company to get gobbled up.

But if PSI-938 was causing liver damage, then perhaps treatment with INX-189 runs the same risk -- not a pleasant thought for a company trading at a high takeover premium already.

No evidence of INX-189 induced liver damage has been reported yet, but just that possibility hit Inhibitex hard with shares plunging almost 50% in Friday's pre-market trading. The stock recovered somewhat when regular trading opened but Inhibitex is still down 21% to $10.29.

Analysts rushed to defend Inhibitex, pulling out their medicinal chemistry textbooks to demonstrate that while INX-189 was similar in some respects to Pharmasset's PSI-938, the two drugs also have structural differences.

For hepatitis C investors, Friday was clearly a day to regret sleeping through your college chemistry classes. Here's what JMP Securities analyst Liisa Bayko had to say to clients about INX-189:

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