It's Time to Get Out of the New River

Numerous what-ifs surrounding its ADHD drug make shares very risky at these levels.
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Just three months ago, I espoused the positives of New River Pharmaceuticals (NRPH) , expecting the stock to jump if its attention deficit hyperactivity disorder drug, NRP104, received approval and if it was granted a schedule III or IV designation by the Drug Enforcement Agency.

After the stock rocketed 82% on an approvable letter from the Food and Drug Administration, I quoted Dr. Harry Tracy, president of NI Research, who compared the mania to the demand for

Dutch tulips in 17th century Holland. But the frenzy hasn't abated, as the stock has continued higher in the three weeks since that last column.

At these levels I believe the stock price is unsustainable, considering that a schedule II classification, which is what the FDA recommended, essentially means there is little incentive for patients and their doctors to switch from

Shire's

(SHPGY)

Adderall XR to New River's NRP104.

There are many bears on the stock, as evidenced by the 7.4 million shares (27% of the float) that have been sold short. That's up from 5.9 million shares on Oct. 10, but given that that was just one day after the stock's spike, it's possible that some shorts have been unable to take the pain and have covered.

The skeptics generally have a few interrelated main points: Revenue expectations for NRP104 are too high, and Shire has no motivation to promote the drug and may renegotiate the terms of the current deal with New River.

It's All About the Label

If the DEA goes against the FDA's recommendation and gives NRP104 the looser scheduling, break out the noisemakers and confetti -- NRP104 becomes a blockbuster drug. But it is fairly unlikely that the agency is going to go against the FDA's suggestion. What remains to be seen is if NRP104 can make anti-abuse claims on the label if it receives a schedule II. If not, there is nothing to differentiate the drug from Adderall XR, Shire's top-selling product.

So far, Shire's management has been saying all the right things. Spokesman Matt Cabrey says, "We do believe that NRP104 has the potential to be at least as successful as Adderall XR." Some on the Street believe Adderall will be a $1 billion drug this calendar year. Shire CEO Matthew Emmens declares, "We will stop promoting Adderall XR, assuming that the

NRP104's label is superior."

Shire hopes to gain an important foothold with NRP104 before Adderall's patent expiration on April 1, 2009. But if the label is not superior, it's unlikely that physicians will switch to a new drug with no added benefit. It's also difficult to fathom why Shire would put much marketing muscle behind the drug, considering that it may pocket less than 40% of the profits if certain sales thresholds are met. Meanwhile, the company keeps 100% of the profits of its other ADHD drugs.

One hedge fund manager, who is short New River's stock and asked to remain anonymous, expects that Shire's marketing efforts will result in a new drug launch, not a conversion strategy. That is a possibility because Adderall XR is a mixture of amphetamine salts, while NRP104's active ingredient is d-amphetamine. In some circles, NRP104 is believed to be just like Adderall XR, with an amino acid that makes abuse more difficult.

However, because the two drugs are not exactly alike, the companies will have to educate physicians and their patients to the benefits of NRP104 (if the FDA allows them to market the advantages). Furthermore, a study by Summer Street Research earlier in the year showed that polled physicians indicate that NRP104 could capture 23% of Adderall sales with a schedule II. Interestingly, that number only increases to 43% assuming a looser schedule IV classification.

Let's Make a Deal

According to New River's 8-K filed with the

Securities and Exchange Commission

in early October, the agreement between New River and Shire calls for New River to retain 25% of the profits from NRP104 for the first two years and 50% of the profits thereafter -- if the drug receives a schedule III or IV. A schedule II ruling means the companies split the profits according to a complex formula.

In the example given in the filing, if NRP104 achieved sales of $312.5 million in 2010, New River would keep 58% of the profits and Shire 42%. But keep in mind, this is a drug that some have said would be a $1 billion seller by 2010 -- in which case, Shire's portion of the profits would be even less.

The manager who is short New River states, "The people at Shire are not dumb." He asks and answers his own question, "Why would Shire structure the deal that way, where they give up more profits as sales go higher? It makes sense if it's a niche drug, not if it's a blockbuster."

In Shire's conference call last week, Emmens defended the deal, saying that at the time the agreement was made, it was believed that generic-drug competition would emerge in 2006,

Cephalon's

(CEPH)

Sparlon for ADHD was expected to be on the market shortly, and all of the data on NRP104 were not yet available. In other words, it was a different environment. Sparlon was rejected by the FDA earlier this year.

Credit Suisse First Boston speculates that Shire may seek to restructure its agreement with New River (and not in New River's favor). On the conference call, Emmens stated, "We look at anything else that might happen every single day in light of other options that we could do to invest in our money and renegotiate things."

When I directly asked Emmens whether he would try to alter the deal with New River, he wouldn't deny or confirm the idea. "Any deal or renegotiation with New River would be balanced against other opportunities that are presented to the company," he said.

Within 18 months, it's possible that Shire will have five ADHD products on the market, including NRP104. If the feds don't allow the companies to market NRP104 with the clear benefit of abuse resistance, it's hard to imagine Shire putting too much effort into marketing the joint venture at the expense of its other solely owned products, especially if it will be a tough sell to doctors.

Unless the DEA rejects the FDA's advice, New River's stock is likely teetering on a precipice. Investors have already ignored the schedule II recommendation, so if NRP104 does receive the schedule II as expected, who knows if that will be enough to send the stock reeling? But the events to follow, such as a renegotiated agreement with Shire and disappointing sales, make New River's shares very risky at these levels.

In keeping with TSC's editorial policy, Lichtenfeld doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships.

Marc Lichtenfeld was previously an analyst at Avalon Research Group and The Weiss Group and a trader at Carlin Equities. He holds NASD 86, 87, 7 and 63 licenses. His prior journalism experience includes being a reporter/anchor for On24 in San Francisco and a managing editor of InvestorsObserver, a personal finance Web site. He is a graduate of the State University of New York at Albany. He appreciates your feedback;

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