The Deipnosophist

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Location: Summerlin, Nevada, United States

A private investor for 20+ years, I manage private portfolios and write about investing. You can read my market musings on three different sites: 1) The Deipnosophist, dedicated to teaching the market's processes and mechanics; 2) Investment Poetry, a subscription site dedicated to real time investment recommendations; and 3) Seeking Alpha, a combination of the other two sites with a mix of reprints from this site and all-original content. See you here, there, or the other site!

22 February 2006

Discovery Labs/DSCO

I have an acquaintence who is smart as a whip; she crackles with intelligence on a bevy of subjects. She specializes in matters medical, and prefers to invest in bio-technology stocks. Her name is Ilene Carrie. The comments that follow are her insights re...

Discovery Labs/DSCO is a long-time favorite biotech of mine and the maker of Surfaxin, one of the most exciting biotechnology products set to enter the neonatal care market. Last October, Laboratorios del Dr. Esteve, a family-run business group, and one of the largest pharmaceutical-chemical corporations in Southern Europe, bought 650,000 shares of DSCO at $6.88 dollars, almost $4.5 M worth of DSCO stock. Esteve is partnered with DSCO in the development and marketing of Surfaxin, which is anticipated to get FDA approval this April. Esteve has the rights to market the drug in Southern Europe and it is no stretch to consider Esteve a prominent and knowledgeable insider.

DSCO's market cap is a little over $400M, but their surfactant-based products have the potential to address multi-billion dollar market opportunities for many lung diseases where there are few or no adequate therapies. Surfactants in the lungs are essential for keeping the air sacs in the lungs open, allowing for breathing. DSCO's pipeline is based on their precision-engineered surfactant, designed to mimic the human lung surfactant-system. DSCO's lead product, Surfaxin, is awaiting approval for treating Respiratory Distress Syndrome (RDS) and is also being studied for other respiratory diseases, Chronic Lung Disease (CLD) in infants and Acute Respiratory Distress Syndrome (ARDS). Surfaxin will soon become the Gold Standard in neonatology, the greatest breakthrough in reducing infant mortality from RDS.

DSCO's vision is to become the global leader in pulmonary critical care. In addition to RDS in infants, many serious lung conditions, for the first time, may be treatable using DSCO's Surfactant Replacement Technology products (SRT). SRT products are likely to be useful in treating a long list of diseases which are associated degradation of lung surfactant. DSCO's pipeline of products can revolutionize treatment in the pulmonary disease arena.

The current standard of care in infant RDS is animal-derived surfactants, but these are problematic and not approved for other conditions because animal surfactants are too immunogenic to be used safely, except in premature infants whose immune systems are not well-developed. Animal surfactants are also difficult to produce, costly, have significant lot-to-lot inconsistencies, and carry a risk for transmitting diseases. DSCO's products, Surfaxin and Aerosurf (an aerosolized version), can be produced readily in sufficient quantities for other pulmonary conditions in which normal surfactant has been degraged.

Beyond Surfaxin, the next revolution in the neonatal and adult arena is DSCO's aerosolize surfactant product, Aerosurf, with a delivery system capable of painting the lungs with surfactant. Aerosurf is planned to enter phase 2 trials for a number of indications this year. If the high-quality humanized surfactant can get delivered inside the lung, it may effectively treat a host of serious lung diseases which are associated with impaired surfactant. Getting the surfactant into the lungs of a baby without mechanical ventilation very well could be considered the "Holy Grail of neonatal medicine."

As revealed recently, DSCO has formed a strategic alliance with Chrysalis Technologies, a division of Philip Morris, to develop and commercialize aerosolized SRTs that can address numerous respiratory conditions. DSCO will provide the therapeutic surfactant technology and Chrysalis will contribute their aerosolization device for delivering the surfactant deep into the lungs, avoiding the need for harmful and expensive mechanical ventilation. The companies will focus their work on new treatments for conditions including acute lung injury, neonatal respiratory failure, chronic obstructive pulmonary disorder, asthma and cystic fibrosis. These serious respiratory conditions represent multibillion dollar opportunities. (See below.)

DSCO is a compelling investment opportunity for 2006, as many milestones will be reached and the company should be well on its way towards commercializing a revolutionary product for pulmonary medicine.

Milestone 2006 Summary:

Q1: Data for Phase 2 study of Surfaxin in ARDS. ARDS may be caused by a variety of insults to the lungs, with a common denominator of degradation of lung surfactant. The standard of care is mechanical ventilation and the mortality is high, 30%-40%.

April: Anticipated FDA approval of Surfaxin for RDS in premature babies. Surfaxin will displace animal-derived products, being more consistent, cheaper to produce, less immunogenic, and with no risk of transmitting diseases.

Q2: Launch of Surfaxin, entry into a $150-200 million neonatal care market. Surfaxin approval anticipated in Europe.

Q3: Results of Phase 2 study for Surfaxin in infant bronchopulmonary dysplasia (BPD), also called chronic lung disease (CLD).

2006: Initiate Phase 2 trials for Aerosurf, a potential breakthrough in respiratory medicine, with a $1 billion opportunity in neonatal ICU and a multibillion opportunity in pulmonary critical care.

Potential Market for Surfactant-Based Therapies:

Neonatal Market: RDS (approvable letter, awaiting final approval)
Chronic Lung Disease (Phase 2 testing)
Others (e.g., Respiratory failure, Pneumonia)
Combined Potential Revenue $0.5-1.0 Billion
Respiratory Distress: Acute RDS (Phase 2 testing)
Acute Lung Injury
Potential Revenue >$3 Billion
Obstructive Disease: Asthma (pilot study completed)
Chronic Obstructive Pulmonary disease (COPD),
Potential Revenue >$1.5 billion
Infection: Pneumonia
Respiratory Syncitial Virus (RSV) Potential Revenue >$1 Billion
Lung Fibrosis: Potential Revenue >$0.5 Billion
Upper Airway Diseases: Potential Revenue ~$1 Billion

That's over $7B worth of market opportunity and potential in months and years ahead. DSCO is currently being valued by the market near $400M, a disconnect to it's potential going forward that the insiders recognize as a compelling opportunity.

I think their ARDS trial results are likely to confuse the market because I doubt the results will be straight-forward fantastic. Therefore, it wouldn't surprise me if the stock sold off somewhat, while people were trying to figure out what the results mean.

If they do not get full FDA approval in April as anticipated, the stock will also temporarily get hit. They will ultimately get approval, but the FDA could come up with more pre-requisites. I would be cautious in the entry price. I do have a lot of it, but at lower prices, and I would buy more if there was bad news, but I might also lighten up before the results come out. Make sense? I suggest waiting to buy a full position until the ARDS results come out, which could be a great buying opportunity.

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