FDA Decision on Heron's Non-Opioid Pain Med Imminent

We think Heron (HRTX) has a very good chance of approval by the FDA by the April 30, 2019 due date for its non-opioid pain med HTX-011. This would be good for society in our fight against the opioid crisis. Furthermore, it could be rewarding for investors too, since this derisking event if the FDA approves HTX-011 should increase the value of HRTX. Just how rewarding, might depend on the exact label language approved by the FDA if the FDA approves HTX-011.

HTX-011 is a long-acting, extended-release formulation of the local anesthetic bupivacaine in a fixed-dose combination with the anti-inflammatory agent meloxicam for the management of postoperative pain. Safety and efficacy data have looked very good in 7 Phase 2 or Phase 3 clinical trials, which is probably one reason the FDA did not convene an Advisory Committee meeting in advance of this PDUFA date, in addition to the fact that HTX-011 is a combination of approved drugs in an improved formulation using a better pH and its extended release Biochronomer technology (see here). HTX-011 along with over-the-counter pain meds like Tylenol and Ibuprofen, have the ability to eliminate the need for opioids for most patients at least in some post-surgical settings (see here). Therefore, this possible approval would be good for society in our battle with the opioid addiction epidemic, a fact that is important to the FDA too. Indeed based on its impressive clinical data, HTX-011 has received breakthrough therapy designation and Priority Review from the FDA (see here).

Of course, there is always the chance for a PDUFA rejection (complete response letter "CRL") by the FDA even with good clinical data, based on, for example, a manufacturing or quality control testing issue, which can be difficult for investors to see in advance. And in the current situation, there is a chance that the FDA requires more clarity/training material related to application of HTX-011, which uses a special applicator rather than injections, which are more familiar to the medical community. The downside for HRTX would be large if they get a CRL instead of approval. However, in our view this CRL downside is very unlikely. The bigger issue that will affect HRTX stock price in our view is the market's perception of the precise wording of the label that is approved by the FDA. It will likely have the typical heart-attack, stroke warning of NSAID's since one of the ingredients, Meloxicam, is an NSAID (See warning on Meloxicam label, which is not that different than warnings on over-the-counter NSAIDs in our reading), which hopefully won't spook the market. Will the label mention the ability of HTX-011 to eliminate the need for opioids in many post-surgical patients when combined with over-the-counter pain medicines? Will it cover all post-surgical indications or just some/all of those where HRTX has clinical data - hernia repair, abdominoplasty, bunionectomy, total knee arthroplasty and breast augmentation? These details will be important to investors.

HTX-011 will face both branded and generic competition in the post-surgical, non-opioid pain market. Generic bupivacaine and ropivacaine are commercially available for example. Furthermore, there are pumps now available that deliver local anesthetics on demand for up to 3-5 days post surgery (See Avanos On-Q). Possibly HTX-011's biggest competition will come from Exparel (liposomal bupivacaine) (Exparel web site), manufactured by Pacira Pharmaceuticals (PCRX). Indeed, PCRX is a possible investor counter-play to HRTX for those who disagree with our bullish position on this HTX-011 PDUFA approval event. Although HTX-011 and Exparel have never been tested side-by-side in the same trial as far as we are aware, the data for HTX-011 has been much more consistent with respect to better efficacy over generic Bupivacaine in the post-surgical pain setting (e.g. compare HTX-011 phase 2 data available here with Naviasky et al., "Bupivacaine Liposomal Versus Bupivacaine: Comparative Review" Hosp Pharm (2014) 49(6):539–543 at 540-542 "EFFICACY VERSUS ACTIVE CONTROL"), especially between 24 and 72 hours post-surgery. In fact, the statistical and clinical superiority of Exparel vs. generic Bupivacaine has been questioned. Id. Furthermore, HRTX's opioid sparing pain studies with over-the-counter pain medicine have been impressive (e.g. see here). Thus, it appears that HTX-011 has better data to support its efficacy than Exparel.

The current value of HRTX is difficult to calculate with much certainty, as expected for a biopharma company whose major commercial asset has not yet been commercialized. At its current market cap of about $2B (4/28/19) and enterprise value of around $1.7B, HRTX is valued at less than 1/2 of its peak valuation last year, despite several positive HTX-011 readouts with over-the-counter pain medicines in opioid sparing studies since then. PCRX achieved Exparel revenue of $331M in 2018 and guide to at least $400M Exparel revenue in 2019, in the U.S. market only. However, Exparel has both a broad post-surgical pain indication and a nerve block indication (See INDICATIONS AD USAGE in Exparel label), which according to HRTX is about 15% of procedures (See HRTX March 2019 corporate presentation slide 55). Exparel appears to have less than 10% of the current market extrapolating from HRTX's data showing that Exparel had 4% of the local anesthetic market in 2016 with $276M total Exparel revenue. Thus, there is probably at least a $1B plus commercial opportunity for HTX-011. By our rough revenue multiple models, depending on commercial success, HRTX value sits between $2B and $4B currently, and with a regulatory approval with a favorable label, both regulatory and commercial risk decrease and HRTX's value range should increase.

One consideration for biopharma investors is cash and cash burn because companies like HRTX that are currently losing money as they develop drugs, need to periodically raise money from investors to fund ongoing operations. This dilutes the share count and decreases the stock price. Heron ended 2018 with well over 2 yrs of cash ($332M) at the 2018 net cash loss rate of about $150M, by our calculations (see HRTX 2018 financial highlights here). This is a good amount of cash, but HRTX still might decide to raise more cash if the stock price recovers with possible FDA approval including a favorable label. Therefore, an approval might bring a stock price increase, but the stock price might give back some of that increase after a financing round as HRTX may want to increase its cash as it gets ready to launch HRTX.

Our position in HRTX is a mix of stock ownership and stock options. We have traded bullish call positions from time to time since mid-March, buying May-expiring calls with strike prices at $22 or $23 and selling calls with strike prices in the $25-$30 range. We find that a mix of stock ownership and options can provide an effective risk/reward diversification going into a biopharma catalyst event.

Overall, we remain bullish on HRTX going into this FDA decision and are excited for patients and society at the possibility of a step forward in reducing the opioid epidemic. Although the magnitude of the downside risk of an FDA rejection (i..e. CRL) on HRTX stock price is probably greater than the magnitude of the short-term upside based on approval, we think HTX-011 is highly likely to get approved. Furthermore, we think the label language will be favorable enough that the market will see this as a positive event for HRTX's valuation not only because it eliminates the regulatory risk, but because is increases the chance of commercialization success as well.

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