Acadia Pharmaceuticals - Investing With No Safety Net
Location: MagicDiligence's CAPS Blog
It is one of the fundamental facts of Joel Greenblatt's Magic Formula Investing (MFI) screening methodology: small research pharmaceutical firms almost always show up shortly after receiving one-time windfalls such as hitting development milestones or receiving collaboration payments of some sort. These huge shots of revenue spike profits, causing trailing 12 month returns on capital to skyrocket. At the same time, human investors realize that these payments are non-recurring, keeping the stock price at a reasonable level but creating what looks like a very low valuation (low P/E ratios, or high earnings yields). Bingo, the perfect formula for getting screened by MFI! I believe it is one of the side effects of the simple screening methodology, and it breaks the strategy's core mission of finding "great companies selling at cheap prices".
It is not just an annoyance, either - a significant number of these stocks constitute the current small-cap (top 50 over $50 million) screen. Currently, 8 of the 50 stocks can be classified as small research pharmaceutical firms - a meaningful 16%. Some have approved products that pay royalties, some do not. Some have multiple late-stage drug candidates, some do not have a pipeline past Phase II. One thing they all have in common is that it is extremely difficult to value them due to the inherent uncertainties in drug development. MagicDiligence generally recommends taking a "basket approach" if you want exposure to these names - buy a little of each of them instead of dedicating a full portfolio position to one in particular.
We've looked at several recently (DepoMed (DEPO), Pozen (POZN), and SuperGen (SUPG)), and today we'll add another to the reviewed list: Acadia Pharmaceuticals (ACAD).
Acadia falls on the high-risk side of this group. Unlike any of the aforementioned 3 stocks, Acadia does not have any approved products generating royalties. In fact, the company has *never* had a product approved! Acadia relies on occasional milestone payments, research grants, and issuing new equity to fund its operations. The payment that got the stock into MFI was recognition of about $35 million in deferred revenue from the October 2010 termination of its partnership with Biovail for lead drug candidate Pimavanserin. This occurred after Biovail was merged into Valeant (VRX).
This leaves the development, approval, and marketing of Pimavanserin solely in Acadia's hands as of right now. Pimavanserin is in Phase III trials to treat the psychosis effects of Parkinson's disease, without compromising dopamine co-treatments used to minimize the loss of motor control associated with the disease.
If it can make it to market, Pimavanserin has good potential. Parkinson's is a chronic, degenerative disease affecting over a million people in the U.S. and as many as 5 million worldwide. Currently there are no FDA-approved drugs to treat Parkinson's psychosis, although some anti-psychotics such as Seroquel are used off-label in treatment. Being the first (and presumably only) FDA-approved treatment would be a boon to the drug and allow Acadia to charge higher prices. The Parkinson's drug market is relatively small at just $2.5 billion, but Pimavanserin has several hundred million in sales potential in this indication alone. Follow-on indications for Alzheimer's and schizophrenia are being studied in Phase II trials and could give the drug a significantly higher sales ceiling, if successful.
Getting Pimavanserin through FDA approval is a difficult enough step. It has been in Phase III (last-stage) studies for over 2 years now. Initial Phase III trials failed to meet the drug's primary effectiveness (efficacy) endpoints, although the drug has proven to be very safe and successful in not impairing motor symptom treatments. There are concerns that these earlier trials were poorly designed, with several dosages, a geographically diverse patient population, and unusually frequent physician visits, leading to higher than expected placebo response. Acadia has simplified the current Phase III trials to produce better results (for the full details, check out this excellent write-up). Data is expected by the end of this year, but even in the best case Pimavanserin is probably 2 years away from reaching the market.
FDA approval is not the only hurdle. Losing Biovail has forced Acadia to either produce and market the drug on its own in the U.S., or find a new partner. Partnership will be critical for international sales. Acadia will have to raise a significant amount of money to bring Pimavanserin through approval, hire and train a sales force, and set up distribution. As it is, the company has been surviving mainly on equity offerings. Just this past January, the firm raised $14 million by diluting current shareholders another 31%. It requires a special kind of patience to invest in a company like this - there are no revenues to speak of, cash burn is about $15-20 million a year, dilution has averaged about 12% a year, and the balance sheet provides the only safety with $45 million in cash.
Acadia has a few other drugs in the pipeline. A partnership with Allergan (AGN) is investigating drugs for chronic pain (Phase II trials) and glaucoma (Phase I). Another with Meiji Seika Kaisha is in very early discovery stages for schizophrenia. These are too premature to assign much value to.
As with most dev-stage drug firms, this is a highly risky stock. It is virtually impossible to assign any kind of meaningful price target - there are way too many variables here. Acadia is certainly one of the least attractive of the dev-stage bio-pharmas in MFI right now, however. I prefer DEPO, POZN, or SUPG to this one. Or, better yet, buy a little of each if you want exposure to this group of stocks.
Steve owns no position in any stocks discussed in this article.