Closing comments on A.P. Pharma:

During my last post I covered a majority of the information I wanted to cover on A.P. Pharma’s anti-emetic drug, APF-530. Now I would like to conclude my analysis and present my thesis for investing in APPA.

Here are the key reasons for investing in APPA:

1.) The active compound in APF-530 (granesitron) has a long, favorable safety and efficacy profile for treating CINV of more than 15 years.

2.) The market potential for APF-530 is relatively large (extremely large for a company the size of AP Pharma) and easy to calculate based on current sales of Aloxi and the total market potential of more than $1-1.5 billion for this class of drugs. If approved, APF-530 would be the only drug on the market for treating highly emetogenic patients in delayed onset CINV, therefore differentiating itself from Aloxi.

3.) A.P. Pharma has designed a simple phase-3 trial going head-to-head with the best-in-class market leader Aloxi. This helps to remove any doubt as to its superiority in treating delayed onset CINV in highly emetogenic patients. A trial design of any type other than this one would lower my confidence in a final FDA approval as well as the company’s ability to capture market share from Aloxi.

Investment conclusion:

I consider the risk-reward profile of investing in APPA  to be very favorable at its current valuation. The company’s market cap is a mere $45 million with enough cash on hand to complete their phase-3 trial and file an NDA with the FDA.  The company’s management does very little to market or to get the word out about their product. I understand that some investors are uncomfortable with the appearance of management’s lack of confidence in their product, but I’m of a different opinion. Having attended countless investor conferences, presentations, and personal meetings with management, I’ve concluded that the majority of managers are great at giving investors the positive ”spin” on their products’ market potential. I’m o.k. with a subdued approach that management takes with investors as long as the company is conducting a properly designed trial with meaningful and achievable end-points. I’ve personally spoken with both the CFO and the VP of R&D about various questions I had.

To give you an example of what kind of value we are looking at with A.P. Pharma’s anti-emetic product, we can use Aloxi as an example since MGI Pharma was sold to Japanese drug maker, Eisai, less than 10 months ago for $3.9 billion in cash.

Considering that MGI Pharma reported total sales of $343 million in 2006 and of this total, $270 million was derived from sales of Aloxi, we can roughly determine what Eisai thought Aloxi alone was worth. Conservatively speaking, Aloxi appears to have been worth about 75% of what Eisai paid for MGI Pharma. Without getting too far into growth rates or market potential of the individual products of MGI’s pipeline, we can estimate that of the $3.9 billion Eisai paid to acquire MGI Pharma, approximately $2.9 billion was attributed to revenue derived from Aloxi.

Once you break these figures down, you can begin to see that something doesn’t make much sense here in terms of AP Pharma’s current stock price. Assuming that APF-530 truly has the potential to capture a large portion of sales from Aloxi, we have a situation that seems to suggest several possibilities. Either Eisai paid a huge premium for Aloxi in their purchase of MGI Pharma or that AP Pharma is being completely overlooked by investors. Another possibility is that investors are aware of APF-530 but don’t have much faith in the ability of this drug to steal market share from Aloxi.

Once again, AP Pharma’s market cap is currently $45 million. Lets stay with conservative figures and discount almost $1 billion off our calculated figure of what Eisai paid for Aloxi. Now we’re somewhere in the $2 billion range. Lets also assume that APF-530 only captures 50% of market share as only oncologists administering aggressive, highly emetogenic regimens would prescribe this drug for their patients. Now we’re somewhere in the $1billion range as a valuation for APF-530. In light of these assumptions, AP Pharma’s stock could be worth more than a factor of 20 today. Seems ridiculous, I know, but it wouldn’t be the first time I’ve seen a price anomaly like this.

Of course time will tell how this plays out. I like the odds of betting on this product and willing to risk a specific amount of my capital for the probability to win big. The magnitude of the return on this investment is what I’m most interested in. There’s also a high probability that AP Pharma would be an immediate take over candidate upon FDA approval. Who knows, maybe Eisai would be interested in APF-530 in order to dominate the entire anti-emetic market or to hedge any potential loss of revenue on Aloxi.