The FDA: Small-Cap Catalyst or Small-Cap Killer?

This particular bureaucracy neither gives nor takes. Data do. If a drug works, the company that develops it will do well. If a drug doesn’t work, the company that develops it had better have a diversified pipeline.

Many of the 4,000 or so drugs in the Food and Drug Administration’s (FDA) approval system are there because of the work of intrepid scientists employed by small-cap companies.

Some are so unique they gain special status. Some generate positive clinical trial results. Some generate negative clinical trial results.

It can be a long, cumbersome, and expensive gauntlet. But “efficacy” can be an elusive target when it comes to complex chemical interactions.

FDA decisions are, ultimately, driven by data, not by some nefarious desire to stymie innovators’ and entrepreneurs’ desire to save lives.

Here’s how it works.

Phase 1 trials are about safety. They typically involve 20–80 patient volunteers, with testing designed to identify a candidate drug’s most frequent side effects and how it’s metabolized and excreted.

Phase 2 emphasizes effectiveness, with a patient volunteer pool numbering in the hundreds and the trial often placebo-controlled. The goal is to gather sufficient data to determine whether the drug actually works for its intended purpose. Safety and short-term side effects are also evaluated.

Phase 3 trials typically involve thousands of patient-volunteers. Here, more data are gathered about safety and effectiveness, while testing is fine-tuned to assess impact on different populations at varying dosages and in combination with other drugs.

Many of the 4,000 or so drugs in the Food and Drug Administration’s (FDA) approval system are there because of the work of intrepid scientists employed by small-cap companies.

The FDA’s New Drug Application (NDA) review involves a meeting with a drug’s sponsor, a formal submission of the drug, a formal review of all research on safety and effectiveness, an evaluation of drug labeling for appropriate information, and an inspection of the facility where the drug will be manufactured.

Following all that, the FDA will either approve the application or issue a response letter. The former is, obviously, positive. The latter is not.

Even after a drug is approved, the FDA continues to monitor it, as “it’s not possible to predict all of a drug’s effects during clinical trials.” During the Phase 4 post-marketing monitoring stage, a drug sponsor submits periodic safety updates.

“Fast Track Designation” is an alternative FDA process designed to facilitate faster approval of drugs developed for serious diseases that “address an unmet medical need.”

“Breakthrough Therapy Designation” speeds the development and review of drugs meant for a serious condition where “preliminary clinical evidence indicates that the drug may demonstrate substantial improvement over available therapy on a clinically significant endpoint(s).”

“Accelerated Approval” regulations allow FDA to base approval of drugs “for serious conditions that fill an unmet medical need on whether the drug has an effect on a surrogate or an intermediate clinical endpoint.”

“Priority Review” is granted in cases where a drug, if approved, represents “a significant improvement in safety or effectiveness in the treatment of a serious condition.”

Meanwhile, “Orphan Drug Designation” provides clinical trial tax credits, user fee waivers, and exclusivity to incentivize development of drugs for rare diseases.

Phase 3 is perhaps the most important catalyst. Results here “are very important for biotech companies, as they offer insight into the real effectiveness of a drug in human patients and drives [sic] the ultimate market valuation.”

At all points along the way, there are opportunities to make profits and suffer losses, based on positive or negative decisions and results.

Analysis by Thomas J. Hwang, formerly a researcher at Harvard Medical School and an associate in healthcare investment with Bain Capital Ventures, supports the conclusion that trial data matter for stock prices of publicly traded companies:

The release of clinical trial results is an economically significant event and has meaningful effects on market value for large biopharmaceutical companies. Stock return underperformance due to negative events is greater in magnitude and persists longer than abnormal returns due to positive events, suggesting asymmetric market reactions.

Although his study was limited to “large biopharmaceutical companies,” including Amgen Inc. (AMGN), Bristol-Myers Squibb Co. (BMY), Eli Lilly and Co. (LLY), Merck & Co. Inc. (MRK), and Pfizer Inc. (PFE), Hwang notes, “These findings confirm and extend previous scholarship on the significant market reactions to clinical trial results for biotechnology companies with few compounds in development.”

At all points along the way, there are opportunities to make profits and suffer losses, based on positive or negative decisions and results.

FDA catalysts affect large- as well as small-cap drug developers. At the same time, research suggests small caps will react more violently in terms of changes in market capitalization than large caps.

Indeed, we have ample supporting evidence developed just in the first two weeks of December.

Take, for instance, Achaogen Inc. (AKAO), now a $377 million company.

Achaogen announced on December 12 that its Phase 3 trial of plazomicin, for patients with complicated urinary tract infections and acute pyelonephritis, “met the FDA objective of noninferiority compared with meropenem and achieved superiority for the European Medicines Agency (EMA) primary efficacy endpoints.”

The stock closed at $5.25 on December 9, closed at $13.03 on December 12, traded as high as $16.20 on the day after the announcement, and is now priced at $14.00. That’s a gain of 166%.

Vericel Corp. (VCEL), now valued at $140 million, received FDA approval for its Maci (autologous cultured chondrocytes on porcine collagen membrane) therapy “for the repair of symptomatic, full-thickness cartilage defects of the knee in adult patients” on December 13.

The stock closed at $2.60 on December 13, opened at $4.00 on December 14, hit $4.55 that day, and closed at $4.10. It’s now trading at $3.50, up 34% in two days.

Voyager Therapeutics Inc. (VYGR) surged as much as 33% on positive interim results for its Phase 1b trial of VY-AADC01 for advanced Parkinson’s disease, announced on December 7.

On December 8, the stock gapped up at the open to $17.50 and traded as high as $18.25. This was a short-term bounce — illustrating the fleeting momentum such early clinical results provide — as the stock is now trading at $14.69. That’s still a 7% gain since the results were announced.

Note that stocks often move days before announcements of key clinical trial results, possibly the result of insider knowledge of key clinical trial data.

Corcept Therapeutics Inc. (CORT), which develops drugs for severe metabolic, psychiatric, and oncologic disorders, bounced from $6.92 on November 1 to $10.00 on November 14.

But it didn’t announce efficacy data from its Phase 1/2 trial of its drug mifepristone in patients with metastatic or triple-negative breast cancer until December 10.

The stock has settled back a bit, closing at $8.51 yesterday.

An FDA determination of special status can also be a powerful catalyst.

On September 19, 2016, the FDA “granted” Sarepta Therapeutics Inc. (SRPT) “accelerated approval” for its Exondys 51 injection therapy – the first drug approved to treat Duchenne muscular dystrophy (DMD).

Exondys 51 enjoyed Fast Track Designation, Priority Review, and Orphan Drug Designation from the FDA.

According to the FDA, “Exondys 51 is specifically indicated for patients who have a confirmed mutation of the dystrophin gene amenable to exon 51 skipping, which affects about 13% of the population with DMD.”

In its press release announcing the approval, the FDA further explained:

Exondys 51 was approved under the accelerated approval pathway, which provides for the approval of drugs that treat serious or life-threatening diseases and generally provide a meaningful advantage over existing treatments. Approval under this pathway can be based on adequate and well-controlled studies showing the drug has an effect on a surrogate endpoint that is reasonably likely to predict clinical benefit to patients (how a patient feels or functions or whether they survive). This pathway provides earlier patient access to promising new drugs while the company conducts clinical trials to verify the predicted clinical benefit.

The approval was controversial, as many FDA insiders opposed it.

Dr. Janet Woodcock, director of the FDA’s Center for Drug Evaluation and Research, recently explained to CNBC that this surprise approval is indicative of the agency’s “broader move toward patient-focused drug development.”

Sarepta’s share price nearly doubled on September 19, opening at $28.81 and trading as high as $56.18 before closing at $48.94.

FDA catalysts affect large- as well as small-cap drug developers. At the same time, research suggests small caps will react more violently in terms of changes in market capitalization than large caps.

Stocks move on negative data, too.

Cerecor Inc. (CERC) tanked on November 30 but didn’t release its top-line clinical results from its nicotine withdrawal Phase 2 clinical trial of CERC-501, an oral, potent, and selective kappa opioid receptor antagonist, until December 5.

As Cerecor noted in its announcement:

The trial did not meet its primary objective in nicotine withdrawal. CERC-501 was well tolerated. Based on this favorable side-effect profile, and as previously planned, Cerecor intends to move forward with development of CERC-501 in its primary indication, as an adjunctive treatment of major depressive disorder (MDD).

The stock opened at $5.12 on November 29 (against a 52-week high of $5.60) and closed at $4.72 that day. On November 30, it gapped lower at the open to $2.34, traded as low as $1.90, and closed at $2.08.

By December 5, the day the data emerged, it was trading as low as $1.10. It closed at $1.16 yesterday.

On December 12, Proteon Therapeutics Inc. (PRTO) closed at $9.90. At 8:30 a.m. ET on December 13, it released top-line Phase 3 data for its chronic kidney disease therapy, which “did not meet its primary endpoint of improved primary unassisted patency compared to placebo.”

The stock opened that day at $2.90 and is now trading at $2.05.

Ophthotech Corp. (OPHT) tanked after its own Phase 3 failure, as “no benefits were observed” from its Fovista treatment for “wet age-related macular degeneration.”

It closed at $38.77 on December 9. It opened at $6.24 on December 12 and is now trading at $4.86.

Old Things New

Farnam Street has a nice list of literary classics that “influence and inspire,” including The Great Gatsby, The Remains of the Day, The Catcher in the Rye, A Wrinkle in Time, the Foundation trilogy, and The Hitchhiker’s Guide to the Galaxy.

That three novels from Neal Stephenson make it – “the sci-fi author… comes up multiple times in the reading lists of some incredibly successful individuals” – is a sure sign I need to incorporate his works on my “to read” list.

As Shane Parrish notes:

Fiction resonates with us because it shows us truths about the human condition through great storytelling and compelling narratives. Through an engaging story we can be introduced to big ideas that just don’t resonate the same way in nonfiction: The medium allows for freedom of thought through creativity.

Smart Investing,

David Dittman
Editorial Director, Wall Street Daily

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