What to Learn From the Sonus Blowup

This stock's letdown may hold advice for future biotech trades.
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There's nothing I'd like to do more than forget that

Sonus Pharmaceuticals

(SNUS)

exists, let alone remind readers that I looked favorably upon the company's cancer drug Tocosol paclitaxel in an August

column.

But the disastrous

results from the phase III study released Monday, and the absolute thrashing of the stock -- it plummeted 84% to 70 cents -- requires a review of what went wrong.

There's a lesson or two in this debacle, I hope.

I guess I deserve this to some extent, so I'll start by letting reader Larry K. take a swing at me:

"My goodness, how wrong can an analyst be," he asks (rhetorically, I assume.) "You're off my read list. Terrible analysis up and down."

Well, I actually think my analysis of Tocosol paclitaxel was OK, based on publicly available clinical data from previous studies. The problem was that the phase II data on Tocosol paclitaxel (which I'll call TocP from now on) turned out to be totally unreliable. It's not yet clear why.

So, my big mistake was placing too much faith in those past studies and not factoring in enough risk that the phase III trial could end up in a doomsday scenario of lower efficacy and higher toxicity -- which is what happened precisely.

When investment firms or stock-pickers warn you that past results are not a good predictor of future results, they mean it. The same goes with drug development. It's an old saw in biotech circles:

Phase II results are almost always better than any data from a phase III study

.

All biotech investors should have that bit of wisdom written in bold marker across the top of their computers. (I'm thinking of having it tattooed on my forearm.)

In its key phase II study, the response rate for TocP was 49%. That response rate fell to 37% in the failed phase III study.

I certainly expected some dropoff (I highlighted just such a risk in my previous Sonus column), but not this much. I also didn't expect conventional paclitaxel (the comparator drug in the phase III trial) to perform as well as it did. Historically, response rates for paclitaxel, also known as Taxol, are in the 30%-to-40% range.

In this phase III trial, the Taxol response rate was 45%.

Lesson No. 1: Don't overestimate the applicability of phase II study results to a phase III study. Expect a drug's performance to worsen in a larger, phase III trial.

Corollary to Lesson No. 1: When a phase II study is uncontrolled, be extra-super-careful about overinterpreting the data. The phase II TocP study that filled some of us with optimism ahead of Monday's results was uncontrolled, which means that there wasn't a control arm to provide any comparison data.

Phase II studies lacking control arms are all too common in biotech drug development, mainly because they're cheaper and faster to run. But unfortunately, speed and cost-savings sometimes lead to data that greatly (albeit inadvertently) exaggerate a drug's efficacy or safety.

Why did TocP's efficacy drop so precipitously in the phase III study? Unfortunately, there isn't a good answer yet. One hypothesis being explored is that TocP wasn't tolerated well by the breast cancer patients in the study, forcing doctors to reduce the dose during the trial, according to Sonus CEO Michael Martino, who spoke in a phone interview after the company's conference call Monday.

A lesser amount of TocP given to patients because of tolerability or side-effect problems could explain the lower efficacy, he said. In the older phase II study, about 80% of patients given the 100-milligram dose of TocP were able to tolerate it without requiring a dose reduction.

But in the phase III study, only 26% of TocP patients tolerated the 100-mg dose without requiring dose reduction.

Martino says the company doesn't have enough facts yet to understand the wide disparity in dose reduction between the phase II and phase III studies.

That's what makes Monday's disappointing results so frustrating. The phase II data didn't raise red flags about safety or tolerability of TocP in breast cancer patients. Again, I never expected the phase III results to be as clean as those reported in the phase II study, but I also didn't expect to see toxicity and intolerability to the extent that it would relegate TocP to the biotech trash heap.

Foreign Affairs

Here's another takeaway, call it Lesson No. 2: Be worried when clinical trials are run in Eastern Europe or other non-"Western" countries.

Sonus conducted both its phase II and phase III studies primarily in Russia. While I'm sure there are high-quality clinical trial sites in these locales, there are also many instances where data collected there turns out strange. Sometimes this is due to shabby trial conduct, and sometimes it can result from bad data collection.

Martino says the company doesn't believe that geographical differences played a role in the bad outcome of its TocP trial. But when the data is analyzed further, it won't surprise me to see differences between Western and non-Western clinical trial sites.

Regardless, knowing where a drug company is conducting a clinical trial is an important piece of information to have. If the answer turns out to be Russia, I'd suggest upping the risk factor.

In this case, I was aware that Sonus was working in Russia. It was a worry, but one that I was OK with because both the phase II and phase III studies were conducted over there. In the future, it might be wiser to stick with companies and drugs that are tested in North America and Europe.

Lesson No. 3: When it comes to biotech, don't try to be the smartest guy in the room.

At around $4, Sonus looked cheap going into the phase III TocP data. In my last column, I wrote about some of the reasons why investors seemed to be steering clear of the stock, including a partner, the German drug maker

Bayer

, that seemed to be giving Sonus the cold shoulder.

Well, it turns out that Sonus was cheap for a reason. Sure, the risk/reward ratio looked good, and perhaps Sonus could have been a stock that was simply being overlooked or forgotten by institutional investors. That sounds good, but unfortunately, it's rarely true, and certainly not in this case.

Lastly, Lesson No. 4: Biotech is risky -- assume that something will go wrong and plan accordingly. Diversify and look for stocks that can survive a blowup.

Sonus is now trading below cash. Why? Because investors have discounted Sonus' entire technology platform along with TocP, therefore its cash reserves, if spent progressing a worthless or questionable drug delivery platform, will be squandered.

If Sonus had something else to fall back on -- another drug, another technology -- it might be better suited to weather the inevitable disappointments that come with biotech drug development.

I know many investors love single-digit biotech stocks with the potential to double or triple overnight on news of positive clinical data. But remember, these are also the stocks least likely to survive bad news. High-risk biotech stocks are great fun, but only in moderation.

Investing in

Gilead Sciences

(GILD) - Get Report

at $30 because you think it's worth $40 may not be sexy, but the odds of making money are better -- and the chances of a cataclysmic blowup like Sonus are a lot rarer.

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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