A New FDA Approval Sends Small Cap Flexion Soaring

This week, small-cap biotech company Flexion (NASDAQ: FLXN) received its first FDA approval for Zilretta, a non-opioid sustained-release steroid injection for knee pain. In this week's episode of Industry Focus: Healthcare, analysts Kristine Harjes and Michael Douglass explain why this approval is so exciting for patients and investors, where Flexion could go from here, and the most important things for owners and investors who are interested in the company to look out for in the next few quarters. The hosts also talk about Mylan (NASDAQ: MYL) and Teva Pharmaceutical's (NYSE: TEVA) legal battle over Copaxone, and what it means for both companies that the FDA has now approved Mylan's biosimilar of the drug before the lawsuits have wrapped up.

A full transcript follows the video.

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This video was recorded on Oct. 11, 2017.

Kristine Harjes: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. It's Wednesday, Oct. [11]. I'm your host, Kristine Harjes, and I'm joined today by my esteemed colleague and good friend, healthcare analyst Michael Douglass. Welcome back to the show, Michael!

Michael Douglass: Thanks, Kristine! It's great to be back!

Harjes: I'm very excited to have you here with me today. We have two topics on deck. The first one relates to biosimilars, and the second one is about a new drug approval for a company called Flexion Therapeutics, which we will get to after we first cover biosimilars. Do you want to kick us off with that first topic, Michael?

Douglass: Sure. It's a long story.

Harjes: So settle in.

Douglass: Yeah, exactly. This is going to be a long episode -- no. Teva Pharmaceuticals has a drug called Copaxone. It's the market share leader in multiple sclerosis. It's very popular and pretty expensive, and it makes Teva a lot of money, about $4 billion a year. Now, Copaxone is about 20% of Teva's sales, but because it's such a high-margin drug, it actually makes up a much bigger percentage of their overall profit. Copaxone is formulated in both 20 mg and 40 mg doses. The 20 mg dose basically meant once-per-day dosing. Teva moved over to the 40 mg dose once the patents for the 20 mg dose expired, allowing generic competition to come in. So essentially, what they did was they took this drug that could be dosed once a day and changed it to a drug that could be dosed every two days. So, suddenly, there was a difference, and a lot of patients converted over, and they used this to protect their market share.

This is something that you see a lot of different pharmaceutical companies doing for a lot of different drugs and in a lot of different ways -- either dosing, safety issues, in some way trying to make the drug a little bit better so they can protect themselves from market share reductions by generic competition. However, Teva's 40 mg Copaxone dose is now in peril, because Mylan has a biosimilar that has been approved.

Harjes: Right. Just a little bit of background on biosimilars -- this is something that we talk about all the time on the show, so if you're a regular listener, feel free to tune out for the next 20 seconds. But just in case we have any newer listeners with us, biosimilars are essentially really complex generic drugs. Traditionally, if you have a small-molecule drug, you can make a generic version of it very easily. It's just a chemical formula that you repeat, whereas, if you have a more complex biologic drug like Copaxone, it's more difficult to duplicate, so then you get the word "biosimilar" because it's actually not an exact replica. It's merely similar. It functions exactly the same, and you do have to prove that. There's a whole set of safety regulations that the FDA has set up. So that's what we're talking about here when we say biosimilar.

Mylan is deciding to do something that is called launching at risk. This is an interesting choice of strategy. I can't say that I disagree with it. What it means is, they are currently tied up in court with Teva about whether or not they are allowed to launch this 40 mg dose. Mylan's argument is that, "Hey, your patent shouldn't renew just because you made a longer-lasting dose of this exact same drug." So they think they should be able to launch their generic version of it, their biosimilar. Teva is obviously on the opposite side of that. They don't want to just hand over all of their sales to some generic copycat version that can come and undercut them on price and steal all of their market share.

They're currently still in court duking this out, but the FDA gave Mylan the green light for both the 20 mg and the 40 mg versions of their biosimilar, meaning that they're now allowed to launch it, and they just have to accept the potential risk of, if they lose the lawsuit, if Teva wins their appeal, they might have to pay up a bunch in damages to Teva.

Douglass: Yes. And just to give you a bit of background, AstraZeneca sued Apotex after Apotex did an at-risk launch of a generic form of Prilosec from 2003 to 2007. The district court in 2015 awarded AstraZeneca 50% of Apotex's gross margin on the generic form of that drug as damages. So that gives you a bit of a sense as to how much Mylan might end up having to pay up.

Now, things are a little bit different here. Prilosec was a small-molecule drug. So the generic form of it was a lot easier to formulate, as we've already discussed. For a biosimilar, even if Mylan lost -- and of course, there's no guarantee of that -- it's a much more complicated bit of pricing because there's so much more R&D that has to go into creating that biosimilar drug. So I think even if this plays out against Mylan, we could see a very different sort of result in terms of damages from the legal challenge. But of course, we're not lawyers, and we're not very good at predicting the future, so it's hard to say from here.

Harjes: Unfortunately. I wish we were.

Douglass: I do, too.

Harjes: It'd make our jobs a lot easier if we were just right every single time.

Douglass: [laughs] How do they do that?

Harjes: One more detail that I want to throw out about this story before we move on is, there actually already is a different company here that has a 20 mg biosimilar of Copaxone. This is a company called Momenta (NASDAQ: MNTA), which is partnered with Novartis on the biosimilar. So that's another thing to consider. It's not hugely important, because Momenta only reported under $20 million in revenue from their 20 mg dosage in the last quarter. So, not huge. But it's still something worth watching, because if Mylan does get their 40 mg biosimilar out there -- and by all means, they're going to do that -- that'll probably steal a bunch of market share from the 20 mg dose.

When you think about the type of patients who will start on a biosimilar as opposed to the brand-name version, it's usually your newer patient starts. Those are the ones that are directly competing here. It's the drug from Momenta, the 20 mg version, versus now this new Mylan 40 mg version. If you have the choice between taking something once every three days versus every day, the patient's convenience is going to win every time.

Douglass: And I think it's important as well to take a step even further back and really consider that this issue with biosimilars with Mylan and Teva and also with Pfizer and J&J, as Todd and I discussed a couple of weeks ago, is really highlighting how different, in a lot of ways, the market dynamics are with biosimilars versus traditional small-molecule generics. This is really a new approval pathway in the United States. There's a lot of litigation going on because it's still so new. And also, frankly, because the difference in price isn't, so far, as substantial. We're not talking 90% off or more. It's playing out differently. I think this is going to really help all of us as investors better understand how each of these companies, when they lose patent protection on a brand-new product, what that trajectory is going to be and how it's going to be different from traditional small-molecule generics.

It's a really interesting time to be in healthcare because of all this transition, but it also means there's a lot less understanding of what that means today. In a year or two years, I think we'll have a much better sense, and we can, all of us as investors, much better model out what we think will happen to each of these companies as they lose patent protection on their drugs.

Harjes: Absolutely. Bottom line for investors: This is good news for Mylan. Their shares soared about 16% on the news of the FDA green light. This happened on Oct. 4. Shares of Teva, on the other hand, were down about 17%. So, not so good news for Teva, which is kind of a bummer, because that's not a company that's doing well lately. So, more bad news for Teva, and a little bit of good news for Mylan, which could certainly use it after their EpiPen scandal that's still plaguing them a decent bit.

Before we move on to our second topic of the day, Flexion Therapeutics, a couple of times through this episode I have had a sip of the water in my mug, and I could hear the bubbles, and I'm not sure if you could actually hear them through the microphone, but it reminded me that I wanted to talk a little bit about what this water is, because it's not just any water. This sounds like an ad read, but it's not.

Douglass: [laughs] To be clear, we are talking.

Harjes: I believe Vince on his Consumer Goods show a couple of weeks ago mentioned that a company called Topo Chico was bought out by Coca-Cola. So Dylan Lewis, the Tech show host, bought us a bunch of Topo Chico to try out. Michael, you had it. What did you think?

Douglass: It tasted like Perrier, but better. And I struggle to say that, because I have a lot of really positive memories of Perrier, drinking it in Paris while my wife and I were there. It was very romantic; it was very nice. But this had a little something extra. I can't quite quantify what it was. It certainly wasn't my expectations going in that it would be materially different. I figured mineral water is mineral water. But there was something different about the flavor, even though, when I look at the ingredients, they're exactly the same, or as far as I can tell, they are.

Harjes: The ingredients are water and bubbles.

Douglass: [laughs] Right. It doesn't get much more vanilla, if you will, than that.

Harjes: I mean, I really liked it. That's why I'm still drinking it while we film this. It's so bubbly. That, to me, is what distinguishes it from the other fizzy waters that I've had, and also why I felt the need to apologize for the bubbly noises that I'm not sure might be emanating through the speakers. [laughs] Anyway.

Douglass: [laughs] Moving on to Flexion.

Harjes: This is when the Healthcare show tries to talk about consumer goods, this is what happens. Back to healthcare, our wheelhouse. A company called Flexion Therapeutics, which is a fairly small-cap stock -- I believe their market cap is around $880 million when I checked this morning. Their ticker is FLXN, if you're looking to find them. We talked about them on July 25, as one of our three stocks trading under $30. And they were well under $30 at that point, but they're actually getting pretty darn close to their $30 mark after they announced an FDA approval for Zilretta, a non-opioid sustained-release steroid injection for knee pain.

Douglass: Right. I think a little bit of background, two different areas, is important here. The last time is, last time they hit a market cap this big, or even particularly close to this big, there was a lot of talk about Sanofi (NYSE: SNY) buying them out. Now, of course, your question is probably, why would Sanofi want to buy them out? Well, in part because Sanofi has a competitor drug called Synvisc-One, which brings us, actually, to the second piece, which is, knee-pain treatment generally starts with ibuprofen or aspirin. That's what happens when you have an ache and you don't quite know what to do with it. Then you go to corticosteroid injections, and then ultimately opioids. This is a non-opioid drug, so it gives an alternative treatment, which, for anyone concerned about painkillers in general, is really of interest, both as consumers and investors.

Now, Sanofi's competing drug, Synvisc-One, brought in 116 million euros last quarter for Sanofi. So there's certainly some opportunity here. When you see, most analysts are saying that they think Zilretta could be worth $500 [million] to $600 million a year in peak annual sales, which would put it about on part with what Synvisc-One is bringing in now, plus or minus.

Harjes: Yeah. So, you can see Sanofi being a little bit nervous here. Whether or not Sanofi would now buy up Flexion, that remains to be seen. My hunch would be probably not. They looked at the data from this drug and decided they weren't going to make the acquisition. If they wanted to make it now just because the FDA has now green-lighted this drug, they would have to pay up a heck of a lot more. On the old buyout speculation, the stock was rising to about its current levels of just under a billion dollars. So given that now it's trading on its own merits at nearly a billion dollars, Sanofi would probably have to pay quite a bit more than that to acquire this drug and the company with it. So it remains to be seen whether Sanofi actually will actually suffer a hit due to the new competition.

But the drug did perform pretty well in trials. It reduced pain in patients with osteoarthritis of the knee by a median of 50%, which is a lot, at the 12-week mark. It's set at a fairly reasonable price. I don't have in front of me what Synvisc-One is priced at, but Zilretta will be priced at wholesale of $570 a dose, which, of course, in healthcare, that doesn't mean that's the final price.

Douglass: That's doesn't mean that much.

Harjes: It translates to a net price of about $500 per dose, which ends up being about $2,000 per year. And this is a huge indication. When you look at that price, it's not the price that you would see for some rare-disease drug, or a lot of your oncology drugs. But this is a condition that about 14 million Americans suffer from, and about 5 million of them receive treatment via injections -- words are getting difficult -- every single year.

Douglass: It's all those bubbles.

Harjes: That's what it is. So when you also consider that there's a potential for off-label usage, Flexion is studying this same drug in use in hips and shoulders, which you could probably see doctors already starting to prescribe in the off-label setting, particularly as the trials continue and we start to get positive data there.

Douglass: Hopefully.

Harjes: Yeah, fingers crossed. But regardless, it's absolutely expected to become the standard of care in osteoarthritis knee pain and achieve blockbuster status.

Douglass: Yeah. So this is a big deal for Flexion. For Sanofi, it's not necessarily that big of a deal -- 116 million euros per quarter is a lot of money, to be clear, but if you're the size of Sanofi, it's not really that big. This is definitely really good news for Flexion. It's potentially some bad news for Sanofi. But not in any big, material kind of way. Also, it's important to note, Flexion has a bunch of former Sanofi execs in places in management, so you can probably feel pretty good that they have some sense of what Sanofi's mindset could be. At least that's what I would hope and expect.

Harjes: Yeah, and those sorts of connections will also be really important now that they have the approval, they can go out into the field and market this drug, hopefully with some relationships that have already existed. Of course, it'll take time to mobilize the sales force. So the first few quarters of sales won't be terribly exciting. But it'll be something that we watch as this drug ramps up to its full potential.

Particularly because of how devastating the opioid epidemic has been, to see news like this of a non-opioid drug get approval and hopefully start to do really well, that's good news from a human perspective, from an investing perspective. It's definitely all good stuff here.

As far as the company goes, they look like they have a pretty good balance sheet. They have $360 million in cash as of June 30, last time they reported. They have a little bit of debt, $150 million in debt. It's definitely one that I'll be watching. I think it's worth monitoring those first couple of quarters, seeing how it does competing against Synvisc-One. But it's still a pretty small company working in a huge indication. So it's definitely a watch-list item for me.

Douglass: Yeah. When a company is trading at, let's say roughly 2 times peak sales, it starts getting interesting. And I would also throw out there, for anyone who's currently invested in Flexion or plans to be watching it in the next couple of quarters, keep in mind, sales force isn't supposed to be in the field until some time in November. So this first quarter is going to look bad. Not because they're doing anything wrong, necessarily, just because it takes time.

And even so, it takes a few quarters for that ramp to really happen, so even if this becomes the new standard of care and even if it knocks Synvisc-One out of the park, which we don't necessarily expect it to demolish it or anything like that, that still takes time. So make sure that you have patience, that you're watching cash burn in terms of how much all that extra marketing expense starts draining that cash balance that Kristine just talked about, and remember that we're long-term investors here. We're not looking for this quarter or the next quarter or the quarter after sales. We're looking for what that can tell us about a couple of years down the road.

Harjes: That's a great takeaway. Thank you, Michael. And thank you for being here with me today.

Douglass: Thanks for having me.

Harjes: As always, people on the program may have interests in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. Today's show was produced by Taylor Harris, who's filling in for Austin Morgan. And we really did not make it easy on him, so thank you, Taylor. Austin, hope all is well with you. We miss you. For Michael Douglass, I'm Kristine Harjes. Thanks for listening, and Fool on!

Kristine Harjes owns shares of Johnson & Johnson. Michael Douglass owns shares of Johnson & Johnson. The Motley Fool owns shares of and recommends Johnson & Johnson. The Motley Fool recommends Momenta Pharmaceuticals and Mylan. The Motley Fool has a disclosure policy.