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Thursday brought depressing news to

Eli Lilly

(LLY) - Get Eli Lilly and Company Report




investors: The companies dropped plans for an improved, patented version of the top-selling drug Prozac, punishing their shares.

Sepracor's sharp Thursday drop

In announcing unsurprising third-quarter

earnings, Lilly talked up the bright prospects of other depression drugs it's developing in a bid to protect its multibillion-dollar franchise. But Sepracor, which specializes in chopping up drug molecules to create more-refined versions of existing drugs, faces the more sobering prospect that the Prozac episode could play out all over again with its other planned drugs.

The news punished Sepracor particularly hard, sending shares down $40.75, or 34%, to $80.06. Lilly shares also dropped, recently trading down $4.93, or 5.5%, at $84.31.

Summertime Blues

Lilly faced a major setback last August, when

Barr Labs


won the right to

market a generic version of the popular antidepressant starting next year. But Indianapolis-based Lilly held out hopes that r-fluoxetine, dubbed a "cleaner" version of the drug, could supplant some of those lost sales.

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Now Lilly says it's dropping r-fluoxetine, a compound being developed by Sepracor. Lilly said Thursday that some patients developed cardiovascular side effects using r-fluoxetine, although some analysts suspect Lilly dropped the drug mainly for commercial reasons. Sepracor expected royalties of $50 million to $100 million in 2003 for r-fluxoetine; Sepracor's product revenue for the six months ended June 30 totaled $23.5 million.

Some Sepracor bulls said the stock's fall was a massive overreaction, since Sepracor has several other drugs close to the market, including a refined version of Claritin,



multibillion-dollar allergy drug. But not everyone is persuaded.

Sepracor shares soar above Lilly's

Hemant Shah, an independent drug analyst, said the main success story for so-called single isomer drugs was Allegra from



, a refined version of Seldane, a drug that was pulled from the market over toxic side effects. However, such side effects aren't as much of an issue for either Prozac or Claritin, making a single-isomer version less commercially viable, says Shah.

"If the isomer versions offer no advantage, it isn't going to be successful," says Shah, who rates Lilly attractive and does no underwriting. "This is indicative of what may happen to desloratadine," or the refined Claritin.

Others denounced that view. "That's like saying because one book is bad, then all books are bad," says Robert Hazlett, analyst with

Robertson Stephens

, who has a buy on Sepracor and high expectations for coming Sepracor products outside of r-fluoxetine. "We think this is an overreaction." Robertson Stephens hasn't underwritten for Sepracor.

Looking for an Advantage

Lilly, whose shares were pummeled in August when it lost its court case against Barr, isn't giving up on the depression market, even while it continues to press its increasingly remote legal challenge against Barr.

There's room for better depression drugs, analysts say. Prozac and other competitors in the SSRI class don't work in at least a quarter of all patients. Furthermore, depressed sexual appetites and other side effects are common for the drugs.

Lilly says it's now bringing another depression drug called duloxetine into phase 3, or late-stage, clinical trials and could seek approval for that drug in early 2002.

In addition, Lilly just launched a Prozac formulation called Sarafem for premenstrual syndrome. And it's also developing a combination drug with Prozac and its best-selling schizophrenia drug, Zyprexa, for patients who stay depressed even after taking drugs.

The Color of Money

While Lilly officials insisted they had seen cardiovascular side effects at higher doses for Sepracor's Prozac version, some analysts suspect that the earlier-than-expected Barr patent challenge caused Lilly to lose interest in marketing an improved version of Prozac, since it would be likely be launched after a flood of generics hit the market in 2002.

"It may have been a side-effect situation that they could have dealt with if they had wanted to," said Mario Corso, analyst with

ABN Amro

, which has a hold rating on Lilly and does no underwriting for it. "But the timing of generics next year changes the landscape."