Orexo — Update 10 August 2016

Orexo’s Q216 results provided further evidence of positive Zubsolv momentum with encouraging trends in net revenue growth as the 5% price rise had its first full quarter of impact, coupled with decreasing COGS, and a key market access win in the public segment. Costs were in line with guidance, although the split differed: the Mundipharma deal lowered R&D spend, which was offset by higher than expected admin costs incurred in relation to the IP infringement case against Actavis. Uncertainty about the outcome of this litigation, in our view, has dampened recent share price performance. However, Orexo management remains confident on the validity of all the five patents pertaining to Zubsolv, the last of which expires in 2032. With the completion of the court hearing and the expiry of Actavis’s 30-month stay in November, a court decision is expected in H216. We provide further discussion in the Sensitivities section below.

The main body of this report focuses on three important recent developments, which should drive future Zubsolv revenue growth and potentially also market share gains in the US.

In line with guidance for a Q216 deal, in June Orexo out-licensed exclusive global ex-US Zubsolv rights to Mundipharma in exchange for a €7m upfront payment (received in Q216) and further undisclosed economics. Deal terms include regulatory and commercial milestones and up to low double-digit net sales royalties. Orexo will also be reimbursed for specific expenses incurred in relation for preparatory work required ahead of Zubsolv commercialisation ex-US (we assume this includes the cost of the ongoing European bioequivalence trial). Responsibility for filing and launch of Zubsolv now rests with Mundipharma.

Access to the global opioid dependence market is a key growth driver for Orexo; this deal expands access to the Zubsolv market opportunity, which in turn has the potential to significantly grow Orexo’s revenues and also improve gross margins as Zubsolv production volumes increase.

Pain is a key franchise for Mundipharma, a network of independent companies with a presence in 48 countries. Its broad reach, coupled to the fragmented nature of the ex-US market, particularly in Europe, means that Mundipharma is well positioned. Mundipharma has focused significant research resources on opioid dependence, abuse and substitution therapy; hence Zubsolv is a complementary product that also has potential to address the continuing pain opioid dependence market segment.

Mundipharma will work with Orexo to complete the PK bioequivalence study that Orexo began in Q116 and which was previously guided to complete in H216. This study is required to support the EMA filing as Suboxone tablets marketed in Europe differ to those approved in the US. Bioequivalence data from this study, and/or from the US study, which underpinned Zubsolv’s FDA approval, can be used as part of the regulatory package in various other territories. Regulatory filings in additional territories are planned, although no guidance has been provided with respect to timelines. Given that Suboxone tablets have data exclusivity into late 2016 in Europe, the earliest a Zubsolv EMA filing could take place would be around year-end. Consequently, we would anticipate first launches in 2018, although timelines would be contingent on completion of reimbursement decisions, which have varied timelines in different EU member states.

According to the United Nations Office on Drugs and Crime (UNODC) 2015 World Drug Report, global prevalence of opioid use is c 32.4 million users (Exhibit 1), with 16.5 million of these using opiates. Opioids include all compounds (natural and synthetic) that act on opioid receptors, while opiates are the subset of drugs derived from opium. The majority (c 12 million) of opioid users in North America are in the US, but Asia (12 million) and Europe (4.6 million) also represent significant markets in absolute terms, while high prevalence in Oceania suggests unmet need.

Overall, the potential ex-US patient pool is c 5x larger than in the US, with c 20 million individuals afflicted by opioid dependence. International markets lag the US in terms of development, but in common with the US, only a small proportion of dependent individuals are diagnosed internationally, with even a smaller proportion treated. Hence there is opportunity to develop and grow the market for medical-assisted treatment for opioid dependence.

This report focuses on the European opportunity as timelines for Zubsolv are clearest. However, we acknowledge that China and Australia/New Zealand – regions where Mundipharma has a presence – could be important markets for Zubsolv longer term. Addiction is mainly to opiates in China, and in the coming years Indivior is seeking entry into this market; latest disclosures indicate that approval for Suboxone tablets could come in late 2018 with approval of Suboxone film following a year later. In Australia and New Zealand opioid dependence largely results from misuse of prescription opioids; this market opportunity could be nearer term. In September 2013, Suboxone tablets (approved 2005) were discontinued in Australia; US Zubsolv bioequivalence data would apply.

Latest figures from the European Monitoring Centre for Drugs and Drug Addiction (EMCDDA) estimate that there were roughly 1.3 million high risk opioid users, of which, in 2014, 644,000 received substitution treatment in the EU (with Norway and Turkey representing another 36,000), a similar figure to the number receiving buprenorphine treatment in the US. This is a lower number than prior years (c 700,000 in 2013), which continues a downward trend since 2010. Five countries (France, UK, Germany, Italy and Spain) account for c 80% of patients receiving substitution therapy.

Across Europe, methadone remains the most commonly prescribed opioid substitution drug (61%) with buprenorphine, either singly or in combination, accounting for 37% of prescriptions. The share of buprenorphine-derived drugs has been increasing (28% in 2013), reflecting the ability of GPs (office-based physicians) to prescribe buprenorphine as well as specialist substance abuse clinics, which are the primary prescribers of methadone, and potential benefits over methadone. The latter include the longer half-life of buprenorphine, lower dosing frequency and abuse potential, ceiling effects limiting overdose risk and milder withdrawal symptoms.

The EMCDDA (European Drug Report 2016: Trends and Developments) estimates that overall around 50% of high risk users received substitution therapy in Europe. However, there are important geographic differences between countries in the preferred drug for substitution treatment (Exhibit 2) and the percentage of opioid users receiving substitution treatment (Exhibit 3).

Europe is a heterogeneous market with differences in the prevalence of opioid users and opioid dependent individuals, access to substitution therapy (at the extreme end, it is illegal in Russia) and the preferred treatment modality. Nevertheless, with a significant unrecognised and undertreated patient population, there is an opportunity to increase penetration of substitution therapy through increasing awareness. At this stage, the key uncertainties relevant to Zubsolv are:

For example, administrative/labour costs represent a significant proportion of the cost of treatment, so a fast dissolve time could minimise the supervision time needed for a nurse to administer a buprenorphine/naloxone tablet. This may also support a price premium under value-based pricing as it would be offset by significant operational efficiency improvements of treatment clinics (ie savings in labour costs and time, allowing more patients to be treated).

The US Department of Health and Human Services (HHS) has officially increased the patient cap that limits the number of patients to which certified physicians can prescribe buprenorphine from 100 to 275, effective 1 August. Currently, approximately 33,600 physicians are waivered to prescribe buprenorphine. Of these, two-thirds are in the first year of post-certification practice and thus are limited to treating 30 patients; the remaining third are permitted to treat 100 patients, which will rise to 275 from August. However, only around 6,000 of these certified physicians are active in treating opioid dependence.

According to data from the HHS and the White House Office of National Drug Control Policy c 650,000 individuals were prescribed buprenorphine in the US in 2014; the increased cap potentially enables an additional 90,000 patients to gain access to treatment. This is a welcome move by the HHS which has a number of immediate and longer-term impacts, including:

The increased cap is a first step towards legislative changes at the federal level to increase access to medically assisted treatment of opioid dependence: other initiatives are summarised in our May 2016 Update note Putting CVS Caremark in the past. Since then, Congress has passed the Comprehensive Addiction and Recovery Act of 2016, which is now pending signature by the US president to become law. A key feature of CARA 2016 is the expansion of prescribing authority to nurse practitioners and physicians’ assistants; coupled with the increase in the patient cap to 275 this should reduce waiting lists and potentially provide an improved incentive for physicians to certify and start up addiction clinics. These initiatives would increase the overall market for buprenorphine therapies: more patients would be able to be treated, with an expectation that more new patients would seek therapy.

We expect the initial impact of the HHS change to be felt from end-Q316 reflecting the administrative lead time for physicians to receive sign off to increase their patient cap; however, this should have increasing momentum, especially once CARA 2016 is enacted into law. These changes should support the continued growth in sales and market share of Zubsolv.

The Maryland FFS (fee-for-service) Medicaid agreement makes Zubsolv the exclusive preferred product on the Maryland state formulary from 1 July, which should help boost Zubsolv’s penetration of the public market segment. To date, Zubsolv penetration into the more profitable commercial (41% of total market and 57% of Zubsolv business in June) and cash segments (17% and 16% respectively) has been higher, with the public segment lagging by comparison (42% of total market, 27% of Zubsolv business).

Securing this agreement is significant as Maryland is the largest FFS Medicaid state in the US with c 1.3% overall market share by value, and this decision reflects the Maryland Pharmaceutical and Therapeutics Committee favourable assessment of Zubsolv’s clinical characteristics and supporting data as well as the competitive rebate offered. As this same data will be presented as part of RFPs at other Medicaid providers, additional FFS agreements may be forthcoming in the near to medium term. We note that these public payer agreements are typically reviewed annually (vs the two-year contracts that are common in the commercial segment) and there is an opportunity cost to the payer to switching preferred products regularly.

In June 2016, Orexo had access to 39% of business in the public segment; the Maryland FFS deal should increase this. Nevertheless, from prior experience and the fact that other opioid dependence products will remain available (requiring prior authorisation), Orexo does not expect to capture all of the Maryland business. Any incremental market share gains will be important in driving volumes (with corresponding COGS improvements) and while increased rebates will decrease the overall gross:net ratio, implementation investment is limited.

Orexo is subject to various sensitivities common to speciality pharmaceutical companies, including commercialisation, manufacturing and financing risks. Execution risk is a key sensitivity in relation to Zubsolv: the outcome of reimbursement discussions, impact of physician education initiatives and the evolving competitive landscape could have a significant bearing on Zubsolv’s US sales trajectory, peak sales potential and ultimate market share gains. Various factors could affect our valuation, either through their influence on Zubsolv’s market penetration (eg reimbursement, pricing and competition) or on operating margins (cost of promotion, revenue split between commercial and public plans, level of rebates).

The key near-term sensitivity is the outcome of the Actavis patent infringement suit with respect to Zubsolv. Actavis is the first and so far only company to file an ANDA for Zubsolv generic, submitted to the FDA in June 2014; Orexo subsequently sued for patent infringement, covering the five patents listed in the Orange Book (the earliest and latest expiries of which are in September 2019 and September 2032 respectively). The 30-month Hatch-Waxman stay expires in November 2016 and the court ruling is pending following completion of the trial in June 2016. The worst-case scenario, assuming all patents are deemed invalid, could see imminent launch of an Actavis generic, whereby Orexo’s marketing strategy would need to shift to that of a branded generic product: Zubsolv’s peak sales opportunity may be lower, but this would be offset by a lower cost of promotion. The best-case scenario would preclude Actavis from launching its product until expiry of the last of the Zubsolv patents upheld by the court; a favourable ruling would also strengthen Orexo’s IP situation, as any future ANDA filing(s) would have to target other patent claims.

In the rest of the world, the opioid dependence market is fragmented and Mundipharma will determine the markets in which Zubsolv registration is sought. At this stage, the timetable for Zubsolv commercialisation is unclear: Mundipharma has not disclosed its plans, or the precise economics that may potentially be due to Orexo. We highlight that the approval, reimbursement and launch timelines of pharmaceuticals products ex-US vary geographically. Finally, a partnering deal for OX51 and unveiling of the earlier-stage development pipeline could unlock further upside.

We have included the impact of the Mundipharma deal, which increases our Orexo valuation to SEK5.13bn or SEK149/share (vs SEK4.31bn or SEK125/share previously). Aside from rolling forward our model to reflect the passage of time, the main changes to our model are:

We maintain our Zubsolv forecasts in US dollar terms for 2017 and beyond; however, the SEK value of these has altered due to updating our model with the current SEK/US$ rate. Our key assumptions for the European Zubsolv opportunity are for launch in late-2018; sales of c €60m in year six, with peak sales of €100m (20% share of a conservative €500m market growing at 2% pa); and a net royalty of 10%. As the magnitude and timing of milestones from Mundipharma are undisclosed, these are not captured in Exhibit 4 or our full model; nevertheless, we would expect milestones to become due on approval/launch in key territories.

Our explicit DCF-based valuation out to 2030 assumes a WACC of 10%, a long-term tax rate of 30% after 2016 and no terminal value. We estimate a long-term gross margin of 85% on Zubsolv by 2025, with the operating margin gradually trending to 50% in the long term. We include a modest revenue contribution from global Abstral and Edluar royalties until 2020, at which point we assume for simplicity that all revenues relate to Zubsolv.

Evidence of a growth step-up following implementation of new US legalisation to increase access to treatment could lead us to positively revise our Zubsolv forecasts. Post the Mundipharma licensing deal, we include potential European royalties in our valuation, but do not capture potential milestones which are undisclosed. In addition, we do not explicitly value the RoW opportunity (ex-US, ex-Europe) until Mundipharma discloses its intention and there is more clarity on timelines; we recognise that this could provide upside to our forecasts. Securing a partnership and defining the indication for OX51 could also unlock valuation upside, as would pipeline expansion.

Orexo’s Q216 net revenues of SEK188.2m were up 49% on Q215 (SEK126.5m), reflecting growth across the product portfolio. Both periods included non-recurring revenues: SEK65.4m in relation to the €7m Mundipharma upfront in Q216, with SEK22.5m in Q215 from the Abstral fixed royalty. Exhibit 5 provides a revenue breakdown for the period and our full-year per product estimates. Decreasing COGS of SEK33.9m in Q216 vs SEK36.4m in Q215 also points to an improving Zubsolv gross margin: 70% vs 60% in the year earlier period, and 67% in Q116.

Total operating costs for Q216 were in line with Orexo guidance, although the split differed. Admin expenses of SEK62.7m (Q215: SEK33.1m) were higher, and R&D costs of SEK28.7m (Q215: SEK38.1m) were lower than expected (SEK40m). This reflects higher than anticipated costs in relation to the Zubsolv patent infringement case against Actavis (admin), and the impact of the Mundipharma licence agreement whereby costs previously incurred by Orexo for preparatory work for ex-US filings would be reimbursed (R&D). Sales expenses of SEK56.4m (Q215: SEK81.7m), however, were broadly in line with guidance.

Operating profit for Q216 was SEK12.1m, up from a loss of SEK77.3m in Q215, with PBT of SEK6.6m vs an SEK83m loss (Q215).

Management guidance for H216 is for sales expenditure in line with H116 (ie c SEK117m), and SEK80m in both R&D spend and admin costs. Nevertheless, this is caveated with Orexo’s stated intention of managing its sales investment dynamically (ie optimising sales force deployment and investment based on market conditions) particularly given the potential for increased investment in order to benefit from the impact of legislative change. In addition, the level of cost of the Actavis IP suit remains uncertain: the 30-month stay expires in November.

We have updated our model to incorporate Q216 results, new guidance and updated FX rates; a summary is provided in Exhibit 7 overleaf, with the key forecast changes shown in Exhibit 6.

Net debt at end June 2016 stood at SEK242.6m, with SEK252.9m of cash and equivalents. Orexo reported positive operating cash flow for Q116 and Q216 (SEK22.5m and SEK20m, respectively). Q316 cash flow will benefit from the inflow of c SEK75-80m of receivables from Mundipharma related to the €7m upfront payment and R&D reimbursements. Furthermore, significant Zubsolv inventory (SEK379.5m in raw material and finished product) will continue to contribute to improving future cash flow generation from operations.