Regeneron, Amgen And The 'Hope Creation Cycle

NEW YORK ( TheStreet) -- At the recent annual meeting of the American College of Cardiology, Regeneron Pharmaceuticals ( REGN) (joined by partner Sanofi ( SNY)) and biotech icon Amgen ( AMGN) separately unveiled impressive data for a new class of molecules to treat hypercholesterolemia, or elevated cholesterol. The two drug candidates -- REGN-727 and AMG-145 -- are monoclonal antibodies that bind to protein convertase subtilisin/kexin 9, a tongue-twisting enzyme that regulates cholesterol and thankfully goes by the acronym PCSK9.

The science behind PCSK9 inhibitors is very cool, but bullish forecasts -- as much as $20 billion for the class -- are way too high. Not that commercial reality matters for Regeneron these days: The company's $11 billion market capitalization belies this year's sales guidance of $250-$300 million for Eylea, an injectable therapy for "wet" age-related macular degeneration (AMD), a common cause of blindness. (Eylea is similar to Roche's Lucentis, which the company inherited when it bought Genentech.)

Regeneron has mastered the "hope creation cycle," a biotech phenomenon in which the promise of the R&D pipeline -- in this case, the PCSK9 inhibitors, Eylea in oncology, and a host of early-stage monoclonal antibodies -- outweighs the albatross of fundamental valuation metrics that usually weigh on commercial-stage enterprises. Regeneron's current valuation is aggressive but it's hard to recommend the stock as a short because I'm not sure what event(s) in the near future would disappoint the bulls and cause them to sell. I certainly wouldn't be a buyer of Regeneron at these stock levels.

Amgen, the other major player in the PCSK9 inhibitor game, has a tough road ahead. Over the next few years, some of Amgen's most important sources of revenue, notably the red blood cell stimulant Epogen and rheumatoid arthritis drug Enbrel, will face competition from new branded drugs and biosimilars. Amgen's pipeline seems unlikely to make up for the predicted revenue shortfall. I think management is struggling against an increasingly inevitable spiral towards the wrong end of the hope creation cycle. Amgen looks like a decent short, but I will save a fuller discussion of the company's prospects for a future column.

For now, let's dig into the PCSK9 inhibitors.

First, the science: PCSK9 is a protein that decreases the number of receptors in the liver responsible for clearing excess low-density lipoprotein cholesterol (LDL-c or so-called "bad" cholesterol) from the blood. Higher concentrations of PCSK9 mean more LDL-c, so antibodies that eliminate PCSK9 should, conversely, lower cholesterol levels.

This is what PCSK9 inhibitors do quite elegantly: Patients receiving injections of REGN-727 and AMG-145 showed dramatic, dose-related declines in cholesterol up to 67% and 81%, respectively, compared to placebo, according to data presented from Regeneron's Phase II and Amgen's Phase I trial. Importantly, although these studies enrolled only 240 patients combined -- tiny by cardiovascular drug study standards -- the results don't suggest any obvious safety signals.

Even though much larger trials will be needed prior to approval to rule out infrequent adverse events, I know good data when I see it. The PCSK9 inhibitors are real. Barring unforeseen side effects in Phase III trials, which for Regeneron start this year, these compounds should reach the market within the next three to four years. (Some bears expect the FDA to require massive cardiovascular outcomes trials prior to approval. I don't share that view.)

However, my enthusiasm for the science behind PCSK9 inhibitors doesn't mean this is a $20 billion drug class. I think the bulls misunderstand the market, and that's going to be a problem.

The gold standard treatment for elevated cholesterol is a statin like Pfizer's ( PFE) Lipitor or Merck's ( MRK) Zocor. Depending on the dose and drug used, statins reduce LDL-c by 25-60% from baseline for most patients. Adding Merck's Zetia -- a drug that blocks cholesterol absorption -- can reduce LDL-c by an additional 15-20%. Most importantly, the clinical outcomes data for statins are unequivocal: Reducing LDL-c meaningfully lowers the risk of a heart attack. (The outcomes data for Zetia are less compelling.)

Since nearly all of the statins are off patent, drug costs are very low and the benefit-to-cost ratio is obvious for patients at increased risk following a cardiac event. Unfortunately for the PCSK9 bulls, monoclonal antibodies are very expensive to produce. That means the cost of REGN-727 and AMG-145 will likely be in the tens of thousands of dollars. By comparison, a year of generic simvastatin -- the chemical name for Merck's Zocor -- costs well under $1,000. I think this pricing differential will limit the PCSK9 inhibitors potential to patients who can't adequately lower their LDL-c with statin therapy.

Bulls might argue, so what if statin-failure patients are the only customers for PCSK9 inhibitors? Estimates suggest only half of the more than 20 million statin-treated patients in the U.S. reach national LDL-c goals. So, even the treatment failure market is huge. But as is often the case, close inspection tells a different story.

Those with sky-high estimates for PCSK9 inhibitors are ignoring a critical question: Why do so many patients fail to reach LCL-c goals? Formal U.S. guidelines now suggest reducing LDL-c below 100 mg/dL for even patients at moderately increased risk. These same guidelines also recommend increasingly aggressive treatment with each revision. This call for lower and lower LDL-c targets likely creates a "good enough" mentality among physicians, who might not view slightly above-goal cholesterol as a significant health risk for their patients.

Another problem is that most patients don't reach LDL-c lowering goal because they aren't taking their medications. High cholesterol won't kill you immediately and you don't feel it, so there is limited incentive to demand aggressive treatment and maintain diligent habits. I think private payors and the Centers for Medicare and Medicaid Services, or CMS, know this and won't allow the use of PCSK9 inhibitors without clear demonstration of failure on high dose statins.

I think the most likely candidates for the PCSK9 inhibitors are those individuals with familial hypercholesterolemia, or FH, a genetic disorder that leads to markedly elevated cholesterol levels despite lifestyle changes. The severe, homozygous form of the disease, affects only one in a million individuals, but the more common heterozygous form of FH -- heFH -- occurs in one in 500 people. That means there are 600,000 Americans with the disease, and probably a similar number of Europeans.

My review of the literature suggests that untreated heFH patients have baseline LDL-c levels around 300 mg/dL, well above normal and clearly in a range that increases risk of a cardiac event. But does even this group really need an expensive, injectable biologic when far cheaper alternatives exist? I doubt it.

The combination of a high-dose statin and Zetia reduce LDL by up to 75%, enough to get most FH patients to goal. Even if that patient doesn't quite get to goal, the dramatic LDL-c reductions from aggressive conventional therapy will probably satisfy physicians and patients alike.

Let's assume 50% of FH patients will get PCSK9 inhibitors and use a hefty $15,000 per year cost. That implies a U.S. market of $4.5 billion. (The cost-conscious European markets will likely restrict usage even more aggressively; despite a similar number of patients, I suspect the European opportunity 50% that in the U.S.)

Using a 70% market penetration -- generous, given that many heFH patients remain undiagnosed or untreated -- and an even split between Regeneron and Amgen suggests global sales for each company of $3.4 billion. That's a lot, but it's far less than $20 billion and even less exciting given that these sales may not be realized until 2020 or later. Regeneron must also split profits with Sanofi, which further reduces company's share to $1.7 billion. Once we adjust for the still-present clinical trial risks and discount back to the present, future PCSK9 inhibitor sales don't justify Regeneron's valuation or solve Amgen's looming revenue-shortfall problems.

But that's not the point. Regeneron has convinced investors that it can continue to produce exciting drug candidates that will generate future sales. Management has done an excellent job of stoking investor excitement. On the other side of the hope creation cycle, even the exciting science of the PCSK9 inhibitors seems unlikely to keep Amgen's shares aloft over the long-term. That's the thing about cycles: they often persist for longer than you expect, but they never last forever.

Disclosure: Sadeghi has no positions in Regeneron, Amgen or any of the other stocks mentioned in this article.

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Nathan Sadeghi-Nejad has 15 years experience as a professional health-care investor, most recently as a sector head for Highside Capital. He has worked on the sell side (with independent research boutiques Sturza's Medical Research and Avalon Research) and the buyside (at Kilkenny Capital prior to Highside). Sadeghi-Nejad is a graduate of Columbia University and lives in New York. You can follow him on Twitter @natesadeghi.