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Cephalon Inc


Positive Review

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Stock Review

Cephalon (CEPH) specializes in bio-pharmaceuticals that target central nervous system (CNS) disorders, pain treatments, and oncology (cancer). The star product over the past few years has been Provigil, a treatment for sleep disorders, that has accounted for about half of sales. Other significant drugs in the portfolio are Fentora and Actiq (the former a replacement for the latter), which account for nearly 25% of sales. Fentora and Actiq are designed to treat cancer-related pain. The final meaningful drug is Treanda, a treatment for leukemia and lymphoma, although Cephalon also has numerous other smaller formulations that target conditions such as seizures and spasms.

Cephalon's growth will largely be tied to its newest product: Nuvigil, a replacement for Provigil which is facing imminent generic competition and loses patent protection in the next few years. Nuvigil has several advantages over the older drug, including fewer side effects and better effectiveness. Best of all for Cephalon, the drug was just launched this summer and offers over 10 years of patent protection. Nuvigil is set to be the engine of growth, particularly through expanded indications for jet lag, bipolar depression, schizophrenia, Parkinson's disease, and others. If all goes to plan, Cephalon will be able to migrate Provigil patients into Nuvigil, protecting them from competitors, and gain new patients through the expanded label. Things are going well so far: Nuvigil has already collected 19% market share in 5 months, and the FDA has fast-tracked it for jet lag approval. Some analysts believe Nuvigil has huge blockbuster potential for a company of Cephalon's size, with a potential $2 billion dollar peak market.

But there are big risks for Nuvigil, the main one being generic competition. Without going into too much technical detail, many of Cephalon's drugs are susceptible to losing generic challenges due to their formulations. Teva (TEVA), the world's largest generics maker, wasted no time, filing with the FDA to produce generic Nuvigil in October. If approved, the results would be devastating to both Cephalon's current results and future growth potential.

A similar story exists with Fentora. In addition to the primary indication, Cephalon is seeking approval to market Fentora as a back and nerve pain treatment. If approved, the growth potential is significant. But the likelihood of this is lower than for Nuvigil. Cephalon has already suffered setbacks here, as improper prescriptions led to several Fentora-related deaths, and the FDA has cracked down on expanded use of the drug. Fentora is not safe from generics either, as Watson (WPI) filed for a generic competitor last year.

The third leg of growth is recently approved Treanda, for leukemia and lymphoma. There is huge growth potential in the treatment of non-Hodgkin's lymphoma, as current care consists of chemotherapy and has a spotty success record. Treanda has a low side-effect profile, and has been proven to be quite effective, possibly leading the way to becoming the first line of treatment for this disease.

The bottom line with Cephalon is simple: if all goes to plan, growth potential is significant and the current price, at 13% of expected 2009 operating profits, is quite cheap. The risk posed by generics make it rather unlikely that everything will go to plan, though. We have to also keep in mind that generic versions of Cephalon's older Provigil and Actiq will be strong competitors to the newer drugs, due to lower prices. And if Teva is successful in getting approval for generic Nuvigil, Cephalon's profitability could be in jeopardy.

Still, generic challenges often work out a middle ground where the branded maker and generics company come to an agreement on an exclusivity period and then royalty payments are paid once the generic drug is rolled out. Such will probably be the case here, as well. In this scenario, Cephalon at the current price presents a nice bargain and is a decent buy for MFI investors, but falls short of earning a MagicDiligence Top Buy recommendation.

Steve does not own CEPH.

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