The High Rewards of Sharing Risk

When investors evaluate a pharmaceutical or biotech company, the first thing they usually check is its drug pipeline. The more compounds a company has in development, the more attractive it is because each compound represents a new revenue opportunity and there’s less risk if one fails to reach market.

But drug development can be an arduous process, taking as long as a decade and costing as much as $5 billion. That prompts many pharmaceutical companies, even giants like Pfizer (NYSE: PFE) and Bristol-Myers Squibb (NYSE: BMY), to out-license drug development to share both the cost and the risk that a new drug might fail. It also allows them to take advantage of the expertise that other companies might have in a particular field.

In 2011, Pfizer out-licensed the development of neratinib to Puma Biotechnology (NYSE: PBYI), giving the company exclusive global rights to the drug.

In early stage testing, neratinib had shown potential as a treatment for several concerns, including the particularly aggressive HER2 breast cancer variant and gastric cancer. Despite that early promise, cancer drug trials have become incredibly expensive as the Food and Drug Administration (FDA) has begun demanding deeper patient pools to verify safety and efficacy data. At the same time, the market is demanding greater differentiation between new cancer drugs and older ones to fetch higher prices.

While Pfizer obviously believed that it had more promising candidates, it didn’t want the compound to sit idly on the shelf given how much it had already invested.

In 2012, Puma raised more than $129 million in an initial public offering to fund itself through late-stage development of neratinib.

The company reported in December that top-line data from phase II trials already underway showed that that neratinib in combination with three other drugs was on track to achieve a high success rate in its later ! stage trials in patients with newly diagnosed stage 2 or higher HER2-positive cancers. The data also showed a high likelihood that the combination would yield better results than current treatment standards, a better performance than expected.

Late last year, Puma launched a multi-arm study of the drug in patients suffering from several types of cancer: urinary tract, colorectal, endometrial, ovarian, gastric/esophageal, and all other solid tumors.

The study follows seven patients in each of the cancer groups and they all have what is known as an activating HER2 mutation. If a provable response rate is shown, additional patients will be added to the study.
In the second quarter of last year, the company also launched a phase III study of neratinib in patients with HER2-positive metastatic breast cancer who didn’t respond to two or more prior treatments.

If the data from late-stage trials is as positive as that which is already in hand, neratinib has the potential to be a blockbuster. That’s because Roche’s (OYC: RHHBY) Herceptin, a current treatment of choice in HER2-positive breast cancers, faces a headwind with about 70 percent of patients showing an initial resistance to the drug. A significant number of patients also developed a secondary resistance after treatment, limiting the option for additional treatment if there is a recurrence.

While neratinib is showing great potential, it’s important to keep in mind that Puma Biotechnology is still a development stage company and is burning through its cash. At the end of 2012, the company had $137 million of cash on its balance sheet and by the third quarter of last year that total had fallen to $96 million.

The cash concern isn’t as significant in this case, though, thanks to the company’s founder, Alan Auerbach. He sold his previous drug development company, Cougar Biotechnology, which developed the prostate cancer drug Zytiga to Johnson & Johnson (NYSE: JNJ) for $1 billion in! 2009. Gi! ven his prior success, Auerback was able to launch Puma with the backing of several health care venture capital firms which will likely provide fall-back financing if the company ends up in a cash crunch.

If for some reason neratinib doesn’t continue to turn in solid data or the FDA requires additional trials, there is the risk that the company could run out of money within about two years. And it’s not unusual for new oncology drugs to show initial promise in mid-stage trials and then fizzle out down the road. And while the company has said that it aims to in-license additional oncology drugs, so far neratinib is its only drug in development.

Right now, assuming that neratinib continues to deliver positive trial results, the most likely endpoint is that Puma Biotechnology will be acquired. In fact, I wouldn’t be at all surprised if Pfizer were to step up and fold neratinib back into its lineup of oncology drugs. Otherwise, Puma would likely partner with another major pharmaceutical company to ultimately bring neratinib to market.

While there is always risk associated with development stage companies, Puma Biotechnology is a speculative buy up to 125 thanks to its promising new drug and experienced management.

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