Value.able: Acrux

PORTFOLIO POINT: Acrux has strong prospects in the US and Europe and, even after its shares have rallied their intrinsic price is higher.

The pharmaceutical sector in Australia is not easy territory for investors. The R&D required, combined with the clinical trial process and hurdles of legislation, make life exceedingly difficult for any investors proposing to dedicate a portion of their portfolio to it.

Inevitably for many companies whose discovery gets close to commercialisation, a cashed-up foreign suitor – perhaps facing expiry of its own patents – turns up to buy the results, leaving tired and weary Australian investors responsible for having largely funded the risk only to have the spoils taken away from them at the last minute.

To see an Australian company that has successfully and profitably launched a drug or drug delivery technology, or partnered with another to do the same, is thus an exception rather than the rule. One such company that has not only jumped many if not all the hurdles needed to label its achievements a “success” is Acrux (ACR).

Just eight months ago Acrux announced that the US Food and Drug Administration – the body responsible for giving biotech companies access to 300 million potential patients – granted approval for Acrux’s male testosterone replacement product called Axiron.

Eli Lilly, the first company to mass-produce penicillin and the world's largest manufacturer and distributor of psychiatric medications, has an exclusive licence to sell Axiron worldwide. The FDA approval resulted in an $US87 million milestone payment to Acrux. In March this year, Eli Lilly launched the product – the first to be approved for administration transdermally via the armpit.

More payments are likely to emerge. In fact, Acrux is entitled to receive almost $US200 million in milestone payments (in addition to those already received) as well as royalties from sales. Other milestones include sales hurdles, marketing applications outside the US and the securing of additional patents (more on the latter in a moment).

With Acrux’s market cap at just $675 million, one wonders whether it might just be cheaper for Eli Lilly to buy the whole company?

The target market for testosterone replacement therapies is over $1 billion and it has been growing at 15–20% per annum for more than five years because fewer than 15% of men with below-normal levels of testosterone are currently receiving treatment.

At March 31, Acrux had $135 million cash in its accounts thanks to an earlier upfront payment of $US50 million from Eli Lilly and the first milestone payment of $US87 million. It spends about $1 million a quarter on salaries, $600,000–800,000 a quarter on R&D and $3.3 million in the last quarter for licence fees presumably to suppliers.

So basically, with an operating cash burn of just over $13 million a year, the business is now in a position where it is highly profitable, provided Eli Lilly does its job capturing market share.

If one assumes the company receives, say 20% of sales as a royalty – reflecting the fact that the deal with Eli Lilly was struck late in the development cycle and its product was well developed – then an annual royalty of $50–100 million per annum is possible.

Once again, why wouldn’t Eli Lilly just buy the company?

The answer may be dependent on the outcome of an application to extend the armpit delivery patent to 2026. This would provide certainty and, quite frankly, incentivise Eli Lilly to grab as much market share as possible.

Some analysts suggest a 30% market share is conservative but these analysts are not practitioners in the field and in most cases have already had their fill of testosterone. But on a more serious note, in its first 11 weeks after launch, the product has captured 29% of scripts written by urologists and endocrinologists and 13% of scripts written by GPs who are new to the brand.

According to research conducted by IMS Health and cited by one analyst, market share as measured by prescriptions written plateaus at 30% above the share achieved in the 14th week. On this basis the treatment may just reach market share of 40%.

All of the above would be enough to get many investors excited about the kind of company that would normally slip by them unnoticed. But there’s more.

In May, Acrux received its first European drug approval with Sweden’s Medical Products Agency granting the company marketing approval for its spray for treating menopause symptoms. This is an important milestone because under Mutual Recognition procedures, approvals in other European countries will be easier to obtain.

The oestrogen therapy market in Europe is estimated to be about $US360 million a year; therapy and transdermal technologies account for half. Marketing applications are also being reviewed in Switzerland, South Korea and South Africa.

Acrux is an A1 company on the Montgomery Quality Rating scale, with no debt and substantial returns on equity. The parimutuel system that is the stockmarket is working perfectly and with the risky part of the development process behind it, the share price has rallied substantially.

But don’t despair. The intrinsic value is higher and I estimate Acrux is worth $3.09 this year (which is well below today's close of $4.05) and $4.58 next year. On top of that, Eli Lilly may yet bid for the company if patents extending to 2026 are granted.

The biopharmaceutical industry is fraught with risk and failure. Acrux is however a shining example of the profitable leveraging of Australian ingenuity and it appears to be still reasonably priced.

Roger Montgomery is an analyst at Montgomery Investment Management and author of Value.able, available exclusively at rogermontgomery.com.