Discovery Labs Awaits FDA Word on Surfaxin
Discovery Labs (DSCO) expects to learn Thursday, May 1, whether U.S. drug regulators will approve its lung surfactant Surfaxin as a treatment for premature infants suffering from respiratory distress.
This is the third time Discovery has brought Surfaxin to the Food and Drug Administration. Manufacturing and quality control issues have stymied the previous stabs at approval.
In recent public forums and conference calls, Discovery management has sounded confident that it's solved all FDA concerns this time around. The stock, long battered due to the Surfaxin delays, has started to rebound as investors anticipate better news from the FDA this time around.
From an investor angle, the ugly truth about Discovery, however, is that the commercial opportunity for Surfaxin right now is relatively small, and with well over 90 million shares outstanding, it's going to be hard for the company to generate much value from an approval.
Discovery is currently trading around $2.82 a share. An approval Thursday might pop the stock to about $5, but it's not really worth much more than that until the company can meaningfully expand Surfaxin use or make progress on its drug development pipeline.
Two analysts covering the company -- Jon Aschoff at Brean Murray Carret and Adam Walsh at Jefferies -- both have $5 price targets on Discovery, assuming that Surfaxin gets approved this week.
How Surfaxin Works
A surfactant is like lubrication for the lungs. Think of it as a slick goo that surrounds and coats the air sacs in the lungs, making them flexible and allowing them to absorb oxygen.
We all have natural surfactant in our lungs, but some premature babies are born with lungs that aren't fully formed and lack natural surfactant. In the worst of these cases, preemies suffer from respiratory distress syndrome so severe that doctors must insert breathing tubes to deliver artificial surfactant to their lungs.
There are a couple of animal-derived lung surfactants on the market today, made from chopped up and refined cow and pig lungs. These work, but given the source of the material and the manufacturing process, the quality of animal-derived surfactants can vary from one batch to another.
Discovery solves this problem by manufacturing an entirely synthetic surfactant, Surfaxin, that is more consistent and better mimics the precise mix of lipids and proteins contained in natural surfactant.
Market Potential
If Surfaxin is approved, it should displace much of the animal-derived surfactant in use today.
The problem is that the premature infant respiratory distress syndrome (RDS) market is fairly small. According to Discovery, RDS afflicts about 120,000 premature infants in the U.S. each year. Of these, about 75,000 RDS infants are treated with the currently approved surfactants.
Brean Murray's Aschoff says the total U.S. RDS market opportunity for Surfaxin is about $100 million, based on projected pricing of around $1,200 per treatment.
Even if you assume (very optimistically) that Discovery can treat all of these infants and take 100% market share from the animal-derived surfactants, $100 million in peak Surfaxin revenue in 2011 (roughly three years from launch) still only gets you a net present value of about $59 million.
Assuming a six-times sales multiple, that comes to an enterprise value of $359 million for Discovery, or about $3.70 a share. (You see where the 90 million-plus shares outstanding hurts the company's valuation.)
Discovery doesn't have much cash on hand, so that doesn't help with the valuation much. In fact, expect the company to raise cash soon (perhaps diluting shareholders even more) if Surfaxin is approved.
The European market is a growth opportunity for Discovery, about the same size of the U.S., but the company has not yet sought approval there for the treatment.
Discovery also intends to expand Surfaxin's use into other respiratory diseases, and further develop its pipeline, which includes a synthetic surfactant that can be inhaled without the use of an intubation tube. All of these projects are potential value-expanders for Discovery, but they remain relatively long-term and risky, so investors aren't going to afford them much value today.
The best long-term plan for Discovery might just be to put the company up for sale, or find a partner willing to fork over big money on a bet that Surfaxin's long-term potential is worth much more.
Know What You Own
: FDA decisions can swing a small-cap health stock like Discovery Lab severely to the up or downside. Just yesterday, micro-cap medical-device company
NeuroMetrix
(NURO) - Get Report
on marketing clearance for a nerve conduction product. The same day shares of small-cap biotech
Medarex
(MEDX)
traded to a new 52-week low on news of regulatory delays for ipilimumab, an investigational immunotherapy it's developing with
Bristol-Myers Squibb
(BMY) - Get Report
for patients with advanced metastatic melanoma.
But even shares of larger drugmakers are often at the mercy of regulatory rulings. Just today,
Merck
(MRK) - Get Report
shares were
after the FDA rejected MK-0524A, the company's proposed new cholesterol treatment.
Adam Feuerstein writes regularly for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. Feuerstein appreciates your feedback;
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