Pick Pleasurable Side of Pure Pain Play

Penwest carries less of the launch-risk burden but will enjoy royalties from Endo's potential blockbuster.
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This column was originally published on RealMoney on Oct. 4 at 2:37 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

Two companies stand to benefit from a new pain medication that has the potential to be a blockbuster. But one has more issues clouding the short-term outlook, which makes deciding between the two easy.

Endo Pharmaceuticals

(ENDP) - Get Report

and

Penwest Pharmaceuticals

have collaborated on new drug Opana ER. The brunt of post-launch issues fall to an already challenged Endo, while Penwest remains shielded from the bulk of those problems -- and stands to benefit from royalties on the drug.

High-Potency Product

The most significant opportunity and near-term risk for Endo relates to its most recent addition to its pain product lineup. Opana ER is a third-generation opoid pain medication that is believed to be more potent than prior treatments like morphine and oxycodone.

It's been reformulated from oxymorphone IV, which was used for post-operative pain in the hospital setting, to an extended-release oral medication. Penwest Pharmaceuticals' TIMERx technology provided the time-released and abuse-resistant delivery mechanism that transformed oxymorphone into the extended-release, oral Opana ER.

The opportunity for a continuity of treatment from the hospital to the home and the added efficacy benefit make this a very attractive new product opportunity in the pain segment.

Troubles at Endo

Endo Pharmaceuticals guided third-quarter revenue expectations lower this week due to some additional inventory disruptions for its large-selling pain drug, Lidoderm. The company had hinted on last quarter's earnings call that a new inventory management agreement might cause some revenue volatility. Although prescriptions continue to grow at a healthy pace for Lidoderm, these inventory adjustments have kept investors cautious on Endo shares in recent quarters.

In my view, this uneven earnings record is just one of the issues that cloud the investment case for Endo shares. Another is the uncertain impact of the recent legal settlement with Purdue Pharma. This ends the company's marketing of the generic OxyContin (oxycodone) product line by year-end and brings new competition for Endo's pain-relief products from Purdue's relaunch of the brand.

Contractual, Legal Disputes Increase Endo's Burden

The recent settlement with Purdue to cease marketing generic Oxycontin by year-end makes the near-term progress of Opana a crucial driver for Endo shares. As a result, Endo has beefed up its salesforce with 220 new reps, bringing the total up to 590 for the company.

Penwest participates in the Opana ER product line through an intended 50/50 profit split. Unfortunately for Endo, Penwest is disputing its contractual obligation to fund post-launch development expenses. This has saddled Endo with about $30 million in additional launch costs. This case is currently in arbitration, and Endo expects to recoup these costs through lower royalty payments to Penwest in the future. Although Penwest may be giving away some of the future upside on Opana ER sales, it still will be highly leveraged to the long-term success of this product with even a 30% to 40% profit split.

In the meantime, Endo has the added execution risks of fully funding the Opana ER launch and getting a sizeable new salesforce up to speed. The company's statement this week did mention a slower-than-expected ramp-up in early Opana sales since its launch in the middle of the third quarter.

By early '07, Endo will also have to contend with Purdue's relaunch of branded OxyContin in the pain segment. I view these execution risks and marketing challenges, as well as other product issues, such as Lidoderm, to provide greater near-term uncertainty for Endo shares than development partner Penwest.

Penwest Participates in Longer-Term Upside

Penwest will participate in the longer-term growth of this potential blockbuster through its royalty arrangement, but remains somewhat insulated from the cost and execution of this key product launch in the very near term. I believe this limits the downside exposure for Penwest and makes the shares a better play than Endo on this high-potential pain medication.

Penwest shares have also had their problems, primarily due to the ongoing development funding dispute with Endo on Opana ER. The stock has been hit hard, off about 27% since the Food and Drug Administration approval of Opana ER in late June, with downgrades to royalty expectations by investors. The shares are now flirting with the low end of their recent trading range, near the $16 level.

I expect the stock to hold at this level, and begin to reap the benefits from Endo's upcoming marketing efforts for the Opana ER franchise. I'm targeting a return toward the $20 level for Penwest shares, which is near resistance at the 200-day moving average. Conversely, I expect Endo shares to be bogged down with near-term inventory and spending worries, with little upside from the low $30s. Investors looking to avoid unnecessary pain should consider participating in the upside potential of Opana ER through Penwest shares.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Penwest Pharmaceuticals to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

At the time of publication, Michael Latwis had no positions in the stocks mentioned, although positions may change at any time.

Michael Latwis has directed health care content at TheStreet.com Professional Products. He also has worked at Barclays Wealth management division and was previously associated with Lazard Freres and Fiduciary Trust. Latwis covered companies in the pharmaceutical and specialty pharmaceutical sectors as well as biotech, medical technology, healthcare services, retail and media stocks. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Latwis appreciates your feedback;

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