Phase II and III data to date are strong and portend success in upcoming Phase III trials. IBS-C is a widespread disease affecting mostly women and characterized by constipation and abdominal pain. No drug to date has demonstrated a meaningful impact on abdominal pain, and success for linaclotide on this endpoint could provide a critical point of differentiation and enable greater commercial success. We are optimistic linaclotide will show a clear benefit on pain in Phase III trials as: 1) all data seen to date (Phase IIb IBS-C and Phase III CC) suggest pain improvement (Phase II trial showed 47% reduction in pain score vs. 26% in the placebo arm); 2) we are comfortable with the eleven point scale as prior trials suggest a higher sensitivity than the five point scale; and 3) the drug’s mechanism provides a scientific rationale as to why linaclotide can reduce pain. We believe positive Phase III data in treating both the constipation and the pain associated with IBS-C will be the key catalyst for IRWD in 2010. Targeting large potential markets and even modest penetrations lead to blockbuster sales. Current estimates in the US suggest 11mn people suffer from IBS-C and 30 mn people suffer from CC. We and our consultants believe that IBS-C offers the more compelling commercial opportunity, as the patient suffering is greater and the treatment alternatives offer meaningfully less relief (fiber and laxatives as well as off-label use of anti-depressants often exacerbate bloating and abdominal pain). Our ~$850 mn US peak sales estimate in IBS-C assumes penetration in <5% of the overall IBS-C population
MORGAN STANLEY RESEARCH March 17, 2010 Investment Perspectives — US and the Americas
New Coverage and 40-45% of those patients seeking treatment and not satisfied with current drugs. Though chronic constipation (CC) has more patients, we expect sales in this market to be lower than in IBS-C, as pain and abdominal discomfort are less severe. There are also a number of relatively effective over-the-counter options, so reimbursement and physician acceptance will likely be more challenging. We assume penetration in CC will be limited and that US peak sales will be $400-500mn (<1% of overall CC population and <10% of those seeking care and not satisfied). Solid partnerships with significant economics in place. Ironwood has partnerships in place in the US (Forest; 50/50 profit split), EU (Almirall; royalty where Ironwood has stated the terms approach ~50% of the profits assuming modest sales) and most of Asia (Astellas; we estimate royalty of high-teens/low 20s). Solid IP Estate. Linaclotide has a solid IP estate in place that should allow for substantial cash flow generation over the 15 years. Valuation: Our $19 price target is based on a discounted cash flow (DCF) analysis that uses a WACC of 12.5%, an intermediate growth rate of 8% and a terminal growth rate of 2.5%. This estimate is ~25X 2015 fully-taxed and fully-diluted EPS of $1.27 discounted back to 1Q11 (one year from now) at a rate of 15%. The implied multiple is 18X our actual expected EPS, as the company will not pay taxes for several years given its net operating losses (NOLs). While the primary methodology for our price target is DCF, we believe the discounted earnings methodology provides a sanity check. A 15% discount rate, in our opinion, is consistent with what the market typically demands for drugs with positive Phase III data and a 20-30x multiple (on actual and fully-taxed EPS, respectively) is in line or moderately conservative compared to the multiple awarded to current small-molecule based companies.