Exactly one year ago, analysts at Merrill Lynch raised their price target on little-known Intercept Pharmaceuticals (Nasdaq: ICPT) from $29 to $42, due to "an increased conviction that the company's lead drug OCA will be approved by the FDA."
They were right to be bullish -- but they missed on the magnitude of this stock's potential upside.
Bullish feedback from the FDA pushed this stock from under $75 on Jan. 8 to $445 on Jan. 10. It's hard to recall the last time a stock went vertical like that.
But the bloom is already off the rose, and shares opened trading this week with a more than $50 plunge. As the dust settles, it's time to see if the pullback is just a bump in the road, or signs of more weakness to come.
An Unmet Need
Any biotech company that aims for glory should target an unmet medical need and a large patient population. It's a swing-for-the-fences opportunity that rarely pays off, but Intercept appears to have succeeded with its key drug: obeticholic acid (OCA). OCA is derived from naturally occurring chemicals in the bile duct, which aids in digestion and ensures that the liver is functioning well.
People with blocked bile ducts tend to develop chronic liver disease (known as nonalcoholic steatohepatitis, or NASH). Remarkably, nearly 10% of the U.S. population has some form of NASH, and many of those people remain unaware of the disease's presence and progression until it has advanced to a late stage. Breaking down those numbers, roughly 22 million Americans have NASH, and 8 million of them are at an advanced stage. There are no current treatments for NASH.
Intercept's OCA proved to be so effective in Phase II clinical testing that the FDA took the unusual move of halting that trial. Thoughts quickly turned to possible fast-track approval for OCA, and the potential annual sales in the billions for the U.S., and a similarly-sized opportunity in the rest of the world, began to be speculated upon by analysts.
The end of the honeymoon?
But shares of this high-flier hit an air pocket on Monday trading, falling nearly 20%, as several concerns emerged. For starters, an article that appeared on WSJ.com on Friday night noting that Intercept's Phase II patients had abnormally high levels of cholesterol.
To its credit, the company wasn't hiding the news. A third party is conducting the clinical trials, and management only heard about the cholesterol concerns after the market closed on Friday.
In response to the cholesterol news, the company issued a press release on Sunday noting that "since lipid abnormalities are common in NASH, all of the patients will be followed for the 24-week period to help determine whether lipids return to pre-treatment levels."
Also, investors shouldn't assume that the FDA's sudden blessing for Phase II trials means that the company can go straight to the finish line. Full-scale Phase III trials are still quite likely to be required, so approval for OCA may come in several years, not several quarters, as initially euphoric investors may have assumed. The National Institute of Health (NIH), which is conducting the trials, won't have a deeper set of data to analyze for another 10 to 12 months.
Moreover, Intercept maintains a lean internal stuff and will likely seek out a Big Pharma partner to assist with sales. That will cut into the company's profit margins, though they are likely to remain considerable. Though the company has more than $100 million in cash on hand, the stock surge may tempt management to conduct a secondary offering. Selling just 3 million shares would raise $1 billion, but new share offerings tend to spook investors.
Lastly, Conatus Pharmaceuticals (Nasdaq: CNAT), Gilead Sciences (Nasdaq: GILD), Galectin Therapeutics (Nasdaq: GALT), Raptor Pharmaceuticals (Nasdaq: RPTP) and Isis Pharmaceuticals (Nasdaq: ISIS) are all working on their own NASH treatments in clinical trials. Several of those stocks surged far higher late last week as investors focused on these rival approaches.
Even with those concerns, and the fresh share price pullback on Monday, some analysts still see huge upside ahead.
BMO Capital's Jim Birchenough predicts shares will rise to $515 (representing nearly 50% upside). Despite the Friday release of those cholesterol concerns, the analysts thinks that future data will show that OCA has a "net beneficial effect on both liver health and cardiovascular health." They predict that the drug will be launched in 2018 (assuming a 70% likelihood of success), with peak sales of $5 billion annually by 2025.
Merrill Lynch's new $872 price target, which represents 130% upside from current levels, is predicated on the notion that the NASH market "has the potential to be as big or bigger than the hepatitis C market." They see peak sales of $4 billion, but concede that a "risk of a (Phase III) trial start beyond (the second quarter of 2014) is possible since ICPT does not yet have formal FDA feedback."
Risks to Consider: The NASH market is so big that it is likely to be met with several drugs, and Intercept is unlikely to end up with 100% control of the market. Moreover, if the start date for Phase III drags on beyond the first half of this year, some investors will grow bored and sell their stakes. Shares could easily drift lower in the absence of further near-term catalysts.
Action to Take --> This is a truly exciting opportunity, as we are rarely treated to new drug discoveries that could yield $4 billion or more in annual revenue. The company's Phase II data quickly shifted the chance for OCA's success from improbable to probable. And if all went according to plan, this company could end up with a market value in excess of $10 billion. (Intercept will be speaking to investors on Jan. 15 at J.P. Morgan's health care conference; you can listen to management's comments by clicking here.)