This column was originally published on RealMoney on Oct. 28 at 2:59 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

Trimeris ( TRMS) was founded in 1993 with the goal of developing a novel treatment for HIV. Designed to inhibit the virus' fusion to cells, and thus its ability to enter and infect new cells, the drug Fuzeon appeared to have the potential to be a powerful new weapon in the HIV drug armamentarium.

Roche saw the drug's promise and in 1999 signed an agreement whereby it would share development and profits in the U.S. and Canada with Trimeris, and Roche would conduct development in the rest of world and pay Trimeris a royalty on sales.

The FDA approved Fuzeon in March 2003 on strong clinical data in HIV patients who had developed resistance to other drugs. Trimeris sported nearly a $900 million market cap upon approval and it seemed deserved considering it shared the profits of a drug that could have annual sales in the hundreds of millions of dollars in North America and would receive close to a 10% royalty on sales outside North America.

Unfortunately, the drug's high price and cumbersome delivery method led to lower sales than expected. Since hitting an all-time high north of $53 in June 2003, Trimeris shares have dropped precipitously, trading below $12.50 this week.

Nonetheless, there have been some signs of life recently. Fuzeon has slowly and surely gained market share, and though Trimeris itself is still unprofitable, the Roche/Trimeris joint venture has made money for two quarters and the international royalties from Roche should exceed $12 million in 2006.

On top of this, a fellow hedgie and member of the Trimeris board of directors, Kevin Tang of Tang Capital Management, bought nearly 200,000 shares in September 2005. The disclosure sent the shares up nearly $4 over the course of September, but nearly 2 million more shares were sold short in the hoopla from September to October.

There is no question that Trimeris has the potential for incredible operating leverage, and in fact I have no doubt that if the stars aligned, the company could easily earn more than $1 per share in the next few years. Fundamentals will prevail with Trimeris in the end though, and I believe the stock represents a rental opportunity at best. It's not attractive to me as a long-term investment because the drug and business plan, and ultimately the terminal value of the entity, look to be worth less than expected.

Fuzeon's Flaws

Fuzeon's approval was based on excellent data among patients who have resistance to multiple HIV drugs, a group that desperately needs new therapies. There's also a strong clinical rationale for patients who haven't developed treatment resistance to start Fuzeon as well to help battle the virus more effectively. Nevertheless, Fuzeon hasn't caught on.

The crux of the problem stems from the Fuzeon molecule itself. Fuzeon is a large-molecule drug that is delivered via injection twice daily. Manufacturing it is difficult and expensive, requiring more than 100 synthetic steps that produce low yields. As a result, Fuzeon costs nearly three times as much as the next most expensive HIV therapy, approaching $20,000 per year of treatment.

For the patient, cost is just one of the problems. Patients are required to inject themselves twice a day after preparing the drug, which takes 30-45 minutes per injection. Injection site reactions (ISRs), nodules underneath the skin, are common, forcing patients to find new areas on their bodies to inject the drug. The burden of twice-daily injections and ISRs has exasperated patients -- between 20% and 40% of those who start the drug stop taking it within the first few months, by my estimates. Taking Fuzeon is not quality living for them.

As a result of the cost and compliance problems, physicians are only willing to prescribe Fuzeon to incredibly motivated patients.

On the Margins

Exacerbating the problem for Trimeris is the fact that the drug has poor margins by any metric. Gross margins are in the low- to mid-50% range, and with Fuzeon annualizing just more than $100 million a year, the Fuzeon JV has only just started to generate profits.

And these gross margins are artificially inflated. As a result of renegotiations between Roche and Trimeris, Roche no longer includes depreciation in the cost of goods sold at the JV level for Fuzeon, but Trimeris is responsible for directly contributing to capital investments expected to total $14 million over time. This is disclosed in the most recent 10-Q under "Roche Collaboration."

A small dose of accounting gimmickry, for sure. No matter which way you cut this, whether Fuzeon is less profitable because maintenance capital expenditures are required for upkeep or Trimeris is carrying a new liability due to Roche paid via investing cash flows, the economic value of Fuzeon is lower than Trimeris' income statement will have you believe.

I would like to point out another important addendum to the Roche agreement. Trimeris and Roche now negotiate at the beginning of each year how much selling, general and administrative expenses will be allocated to support Fuzeon. Whatever Roche decides to spend above and beyond the agreed commitment, Trimeris carries as a long-term liability payable far into the future. This has two meaningful consequences: It preserves critically important cash reserves while Trimeris is unprofitable, and if Fuzeon is ever profitable enough on a sustained basis, Trimeris will be able to pay it back. On the positive side, Trimeris is getting very cheap financing that may ultimately be forgiven or renegotiated altogether again. However, this is nonetheless a mounting liability that is reducing shareholder equity.

Can Fuzeon Be Fixed?

While Fuzeon has had a tough start for sure, the companies are trying to improve delivery in order to increase patient compliance, and thus, revenues. There are three programs that may reduce patient turnover: a once-a-day dosing regimen, the Biojector 2000 delivery system, and a small-gauge needle.

I'm highly skeptical about the once-a-day treatment. This involves delivering two doses at the same time on the premise that it will have similar effectiveness to the twice-a-day regimen. Based on the drug label's notes on virus mutation, I believe that moving to once a day will stretch the pharmacokinetic profile of the drug, facilitating virus mutation.

The Biojector device and the small-gauge needle are intended to lower the ISR rate. The Biojector is likely to be approved by the FDA by the end of the year. I believe this will increase patient compliance and turnover to a certain extent.

Expectations about the relative success of these three initiatives must be at the foundation of any Trimeris investor's thesis for owning the stock. Unfortunately, regardless of whether they succeed or not, Fuzeon will still carry an extremely high price and require injection.

Other fusion and entry inhibitors lie on the horizon, including oral drugs that could be on the market by the end of the decade. A drug that's easier to take will likely take patients away from Fuzeon.

Earlier this week, Tanox ( TNOX) announced that its entry inhibitor antibody showed a clinically meaningful response for HIV treatment-experienced patients. While the drug is also delivered in a cumbersome fashion (30-minute intravenous injection every other week), it certainly could compete for the small slice of the market Fuzeon has carved out.

While Fuzeon will likely serve some subset of the population for quite some time, its low profitability and delivery characteristics put its terminal value into question.

What's Next

With only $40 million in cash in the bank and the next drug in development still in animal testing, the prospect of roughly $12 million in international royalties from Fuzeon in 2006 must have some value that Trimeris could monetize from Roche. Furthermore, it could offset any proceeds with more than $300 million in net operating losses tax-free.

Management believes the international royalty has some strategic business value. This makes no sense to me. I believe that one of three scenarios explains this:
  • Management does not fully grasp their situation;
  • I am insanely incorrect about the international market, and the royalty will grow to be much much bigger than it is now; or
  • Roche's purchase price basically ascribes such a small terminal value to the royalty stream that it exposes the ultimate (negligible) market value of Fuzeon.

  • Unfortunately for the renters, I suspect the answer is the latter.

    Management's objective now is to generate sustainable profits based on Fuzeon and to develop other HIV drugs. While these next-generation drugs may enter human testing soon, there is a highly competitive environment for HIV therapies and the value of these at this stage of development must be near zero.

    I believe that the sum of these factors results in a best-case value for Trimeris in the $10- to $15-a-share range. I do expect increasing profits over the next couple of years; by 2008, if Trimeris can earn 70 cents to 80 cents per share, a generous multiple could put the stock in the high teens to low $20s. However, I doubt that its profitability would be sustainable.

    I called Tang a couple of times to see what I may be missing with this thesis, as I am very open-minded, particularly with a case such as this in which there are matters that can be interpreted quite differently. I suppose as a member of the board he didn't want to be conflicted. Without a return call or satisfactory answers from management, I am left to believe that Trimeris must undergo a dramatic metamorphosis to create meaningful returns for shareholders based on its current price.

    Please note that due to factors including low market capitalization and/or insufficient public float, we consider Trimeris 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.

    P.S. from TheStreet.com Editor-in-Chief, Dave Morrow:
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    Justin Ferayorni, CFA, is the founder and principal of Tamarack Capital Management and was an analyst and portfolio manager at Bricoleur Capital. At the time of publication, Ferayorni had no positions in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Ferayorni appreciates your feedback; click here to send him an email.

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