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) 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: