Failure is an inherent risk in the boom-and-bust world of biotech, and InterMune (Nasdaq: ITMN) shareholders saw that risk play out on Wednesday morning. The FDA effectively rejected the company's application for marketing approval of Esbriet (pirfenidone) in the treatment of idiopathic pulmonary fibrosis.


IN PICTURES: Learn To Invest In 10 Steps


Clearly the damage has already been done, but what InterMune investors must decide now is whether there is enough promise in the drug and the company to hang on in the hopes of a rebound.

The Genesis of the Drop
On Tuesday evening, InterMune issued a press release stating that the company received a complete response letter from the FDA concerning its application for marketing approval for the drug Esbriet in the treatment of pulmonary fibrosis. Although this is not exactly a rejection, it has the same effect for now - the FDA has essentially stated that the existing data is not sufficient to motivate them to approve the drug, and that the company needs to do an additional Phase 3 study and re-submit the application with that data. (For more, see The Ups And Downs Of Biotechnology)

Could Investors Have Avoided This?
From where I sit, Esbriet had been seen as something of a long-shot drug for most of its development history, until an FDA panel recommendation of approval in March of this year. Despite somewhat mixed efficacy data for the drug, the panel voted nine to three to recommend that the FDA approve the drug. The FDA generally follows the advice of its panels, but as we all saw on Tuesday there is no requirement or guarantee that the FDA will do so.

Still, it is difficult for me to see where investors should have clearly bailed out ahead of this announcement. The data was not perfectly clean, but the drug had been approved in Japan and there were mitigating factors. The disease that this drug targets, idiopathic pulmonary fibrosis, is rare but awful. Somewhere around 100,000 people in the U.S. have this disease, and the five-year survival rate is 20% - due in part to the fact that there are very few treatment options - and no drugs targeted specifically at the condition. Accordingly, I think it was entirely reasonable for investors to believe the FDA would overlook the less-than-perfect data and allow this orphan drug onto the market. (For related reading, see Measuring The Medicine Makers.)

What now?
InterMune now faces a series of uncomfortable choices. With $178 million in cash and a $41 million convertible bond coming due in 2011, I really question whether the company can fund this potential new trial as-is.

Perhaps the company will surrender some of its development responsibilities for its pipeline drug ITMN-191 and accept a lower royalty from Roche in exchange. Alternatively, the company could elect to partner this drug and surrender a chunk of its future profits. Potential partners with respiratory franchises could include GlaxoSmithKline (NYSE:GSK), Novartis, Merck or AstraZeneca (NYSE:AZN), but InterMune shareholders should prepare for a royalty rate in the teens to 20s should the company go that route.

There are a couple of other options, however. First, the company could file for formal dispute resolution. Gilead (Nasdaq:GILD) has gone this route in the past, but it would still take about 18 months and require some funds - though, if successful, not as much as a new trial. There is also a chance that the FDA could accept Shionogi's Phase 3 study in Japan as supplemental data (Shionogi has rights to this drug in Japan) and/or perhaps grant compassionate-use exemptions while InterMune works on a new trial.

Bottom Line
At the bottom line, I have to tip my hat to Jeffries analyst Eun Yang, who had an "underperform" on the stock and was openly concerned about the risk of the FDA not approving pirfenidone. Again, though, that does not help shareholders today.

I am not very optimistic about the company's hepatitis C drug (partnered with Roche), as I believe Merck and Vertex Pharmaceuticals (Nasdaq: VRTX) could have better drugs on the market before InterMune, and Achillion Pharmaceuticals (Nasdaq: ACHN) and Pharmasset (Nasdaq: VRUS) might have better HepC drugs in their pipelines.

As a result, it is really all about Esbriet for now. I think the odds of FDA approval are minimal at this point, which means I would be flying blind as a shareholder. If the company can assuage the FDA's concerns about risk-benefit, or force the issue through dispute resolution, then this is an orphan drug with billion-dollar potential. If not, then shareholders need to be prepared to take a major loss on this speculation. But that is the nature of the beast with biotech - only the fearless need apply.

Use the Investopedia Stock Simulator to trade the stocks mentioned in this stock analysis, risk free!

Related Articles
  1. Fundamental Analysis

    5 Must-Have Metrics For Value Investors

    Focusing on certain fundamental metrics is the best way for value investors to cash in gains. Here are the most important metrics to know.
  2. Stock Analysis

    Analyzing Altria's Return on Equity (ROE) (MO)

    Learn about Altria Group's return on equity (ROE) and analyze net profit margin, asset turnover and financial leverage to determine what is causing its high ROE.
  3. Investing News

    Icahn's Bet on Cheniere Energy: Should You Follow?

    Investing legend Carl Icahn continues to lose money on Cheniere Energy, but he's increasing his stake. Should you follow his lead?
  4. Stock Analysis

    Analyzing Google's Return on Equity (ROE) (GOOGL)

    Learn about Alphabet's return on equity. How has its ROE changed over time, how does it compare to its peers and what factors are driving ROE for the company?
  5. Investing News

    Is Buffett's Bet on Oil Right for You? (XOM, PSX)

    Oil stocks are getting trounced, but Warren Buffett still likes one of them. Should you follow the leader?
  6. Stock Analysis

    The Top 5 Micro Cap Alternative Energy Stocks for 2016 (AMSC, SLTD)

    Follow a cautious approach when purchasing micro-cap stocks in the alternative energy sector. Learn about five alternative energy micro-caps worth considering.
  7. Stock Analysis

    Analyzing Porter's Five Forces on Under Armour (UA)

    Learn about Under Armour and how it differentiates itself in the competitive athletic apparel industry in light of the Porter's Five Forces Model.
  8. Stock Analysis

    The Biggest Risks of Investing in Qualcomm Stock (QCOM, BRCM)

    Understand the long-term fundamental risks related to investing in Qualcomm stock, and how financial ratios also play into the investment consideration.
  9. Stock Analysis

    The Biggest Risks of Investing in Johnson & Johnson Stock (JNJ)

    Learn the largest risks to investing in Johnson & Johnson through fundamental analysis and other potential risks. Also discover how JNJ compares to its peers.
  10. Investing News

    Chipotle Served with Criminal Probe

    Chipotle's beat muted expectations and got a clear bill from the CDC, but it now appears that an investigation into its E.coli breakout has expanded.
RELATED FAQS
  1. What is the formula for calculating EBITDA?

    When analyzing financial fitness, corporate accountants and investors alike closely examine a company's financial statements ... Read Full Answer >>
  2. How do I calculate the P/E ratio of a company?

    The price-earnings ratio (P/E ratio) is a valuation measure that compares the level of stock prices to the level of corporate ... Read Full Answer >>
  3. How do you calculate return on equity (ROE)?

    Return on equity (ROE) is a ratio that provides investors insight into how efficiently a company (or more specifically, its ... Read Full Answer >>
  4. How do you calculate working capital?

    Working capital represents the difference between a firm’s current assets and current liabilities. The challenge can be determining ... Read Full Answer >>
  5. What is the formula for calculating the current ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
  6. What is the formula for calculating earnings per share (EPS)?

    Earnings per share (EPS) is the portion of a company’s profit that is allocated to each outstanding share of common stock, ... Read Full Answer >>
COMPANIES IN THIS ARTICLE
Trading Center