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Is ImClone Out of the Woods?

By Frank DiLorenzo, CFA With an FDA decision on anticancer drug Erbitux anticipated by Feb. 13, biotech outfit ImClone Systems is in the news again. Standard & Poor's Equity Research expects ImClone (IMCL

; recent price, $43) and its partner, Bristol-Myers Squibb (BMY

; S&P ranking 3 STARS, or hold; $30), to get the green light to begin commercializing the drug in the U.S. We're also assuming approval in the European Union by mid-2004. Erbitux was initially approved in Switzerland in December, 2003.

The success of ImClone, whose shares are highly volatile, largely hinges on Erbitux, in our opinion. ImClone carries S&P's highest investment recommendation of 5 STARS, or buy.

Erbitux is expected to be used initially to treat patients with advanced colorectal cancer. However, we expect it to prove effective at earlier stages as well. Other areas that may hold promise include head and neck cancer and non-small-cell lung cancer. If Erbitux is approved, we expect investors to focus on the subsequent sales ramp-up for it and upcoming clinical trial results.

BUYOUT TARGET? Another important investment consideration is ImClone's manufacturing capabilities. Capacity at the current facility, where Erbitux is already in inventory, should enable ImClone to meet demand over the next two years, in our view. If ImClone is successful in its plans to expand manufacturing operations, it may be able to leverage this asset by licensing additional compounds from other drugmakers in the second half of the decade. The potential risks involve delays in the expansion or greater-than-expected demand that could potentially lead to production shortfalls.

While purely speculative on our part, we think ImClone would make for an interesting buyout candidate, for three reasons. One, we believe Erbitux has the potential to be a highly successful oncology therapy. Two, the terms of ImClone's collaborative agreement with Bristol-Myers are extremely favorable to ImClone, in our opinion. Lastly, with strong financial backing (something that ImClone now lacks), we think ImClone has a number of potential anticancer compounds in its R&D stable that could reach Phase II testing within three years.

We expect strong sales of Erbitux in the U.S. and the EU over the next several years. We believe that ImClone's two solid partners -- Bristol-Myers and German pharmaceuticals outfit Merck KGaA -- should help it boost sales. While we think the vast majority of ImClone's value is based on Erbitux' approvability and commercial potential, we also believe ImClone has some compelling drug targets in its pipeline.

OF MICE AND MEN. Erbitux (cetuximab) is a chimeric monoclonal antibody (MAb) -- the structure of which features an approximate one-third mouse protein sequence and two-thirds human protein sequence -- that binds to epidermal growth factor receptor (EGFR). Overexpression of EGFR is common in a number of solid-tumor cancers, and Erbitux may block epidermal growth factor and transforming growth factor-alpha (TGF-alpha) from binding to this receptor, thereby potentially slowing tumor growth.

ImClone has estimated that over 70% of advanced-stage colorectal cancer cases express EGFR. In addition to colorectal cancer cells, other solid tumors with high EGFR expression include non-small-cell lung cancer, head and neck cancer, and pancreatic cancer.

In contrast to a chimeric MAb, a fully human MAb is based on an entire human protein sequence. Theoretically, one of the main advantages of a fully human design is a decreased propensity for immunogenicity, or a negative immune response to the treatment. Abgenix (ABGX

; 3 STARS; $15) is collaborating with Amgen (AMGN

; 4 STARS, or accumulate; $64) on ABX-EGF, a fully human MAb that blocks EGFR. If successfully developed, we think this compound could reach the market in 2006. However, patents held by ImClone could lead to potential lawsuits and a delay in ABX-EGF commercialization.

COMBO OPTIONS. If approved by the FDA, the initial use for Erbitux would be to treat irinotecan-refractory colorectal cancer patients -- those who haven't responded well to chemotherapy. The FDA rejected a biologics license application (BLA) for Erbitux in December, 2001, but ImClone subsequently worked with Bristol-Myers and Merck KGaA on a new BLA that was submitted in August, 2003.

While certain clinical trials have tested or are testing Erbitux as a single-agent treatment, we believe the drug will primarily be used in combination with chemotherapy. A prior trial by Merck KGaA showed Erbitux to be more effective when used with irinotecan in patients having irinotecan-refractory colorectal cancer. Data from this clinical trial was included in the recent BLA submission.

In addition to a Phase II refractory colorectal cancer clinical trial (350 patients) that's testing Erbitux as a single agent, two Phase III trials (1,300 and 1,100 patients) of Erbitux in combination with chemotherapy for the treatment of second-line colorectal cancer are ongoing, as is a Phase III trial (2,200 patients) in combination with chemotherapy for first-line colorectal cancer. Our long-term projections assume Erbitux sales in the treatment of colorectal cancer as well as other solid-tumor cancers.

PARTNER PAYMENTS. ImClone and Bristol-Myers entered into a commercialization agreement for Erbitux in September, 2001. In March, 2002, slight changes were made to the deal, largely regarding lower potential milestone payments to ImClone and a lower royalty payment from Merck KGaA. However, terms for payment on U.S. sales were largely unchanged, and ImClone is entitled to a $250 million cash payment from Bristol-Myers upon initial FDA approval. Subsequent FDA approval in an additional indication would yield ImClone one more $250 million payout.

ImClone is entitled to a distribution fee approximating 39% of U.S. and Canadian Erbitux sales from partner Bristol-Myers. ImClone will supply Bristol-Myers with Erbitux at a 10% markup above cost of goods sold. Bristol-Myers is largely responsible for development, sales, and promotion of the product. However, ImClone also plans to field its own small, specialized sales force.

Merck KGaA is responsible for EU sales of Erbitux, with ImClone entitled to a royalty. We estimate this payment at 7.5%. While ImClone will initially supply Merck KGaA with Erbitux, Merck may eventually build its own manufacturing facility. We believe Merck KGaA will eventually produce its own supply once construction is completed.

OTHER TARGETS. We think ImClone has enough current manufacturing capacity (30,000 liters) at its facilities, as well as inventory buildup of Erbitux, to cover demand through 2005. We think additional production capacity could be available by 2006. We would expect ImClone to attempt to gain additional capacity from a third-party manufacturer by 2005 if the initial Erbitux launches in the U.S. and EU proceed stronger than expected into next year.

We believe it would be a mistake not to procure a manufacturing promise from a second source if sales are building very strongly. Additionally, we believe Merck KGaA manufacturing its own supply by 2006 or 2007 would help to prevent potential capacity shortfalls.

ImClone is also working on a number of other oncology targets that we view as promising. It has been prudent, in our opinion, not to accelerate these programs as it concentrates on Erbitux approval and conserving cash until it potentially receives a $250 million milestone payment from Bristol-Myers.

In addition to collaborating on Erbitux, ImClone and Merck KGaA are working on a cancer vaccine called BEC2. It's being tested in a long-term, Phase III clinical trial in patients with limited disease small-cell lung carcinoma. We think BEC2 could potentially be approved by 2006, at the earliest, assuming a positive patient-survival outcome.

CANCER OPPORTUNITIES. ImClone is also conducting research into antibodies that block vascular endothelial growth factor (VEGF) receptor. Its most advanced agent in this area is designed to block VEGF receptor 2 (known as KDR). We believe a Phase I trial with a fully human MAb is possible by yearend. In 2005, we think ImClone could move into the clinic with a fully human MAb against VEGF receptor 1 (known as Flt-1).

ImClone is also conducting research into type 1 insulin-like growth factor receptor (IGF-1R). It has been hypothesized that blocking the binding of insulin-like growth factor may lead to apoptosis (cell death). A compound that disrupts this binding process may have utility in treating certain solid-tumor cancers. We think it's possible that ImClone can potentially move a MAb against this receptor into Phase I trials in 2005.

According to the National Cancer Institute, an estimated 147,700 new colorectal cancer cases were reported in the U.S. in 2003, with about 57,100 deaths. Potential opportunities in other cancers, contingent upon clinical trial results, could lead to off-label use and expanded approvals. We're assuming a cost of $15,000 to $20,000 for a full course of Erbitux therapy. As a result, we think there could be a substantial commercial opportunity if Erbitux is highly adopted in the oncology community.

PROFITS IN '05. We're projecting $138 million in U.S. Erbitux sales for 2004 and $279 million in 2005. Our peak annual sales estimate in the U.S. reaches $1.5 billion in 2012. We forecast $37 million in EU sales for 2004 and $102 million in 2005, with peak annual EU sales of $600 million by 2012.

EU sales are much less significant to ImClone due to the terms of its collaborative arrangements. While we estimate losses per share of $1.58 in 2003 and 32 cents in 2004, respectively, we expect ImClone to turn profitable in 2005 with earnings per share of 45 cents, followed by $1.30 in 2006. Based on our net present value analysis of Erbitux and the rest of ImClone's pipeline, our 12-month target price is $50. We believe that over 85% of ImClone's value is embedded in Erbitux' potential success.

On an S&P Core Earnings basis, we see a per-share loss of $2.08 in 2003 and a per-share loss of 75 cents in 2004. The difference between our S&P Core EPS and operating-earnings estimates largely reflects stock-option expense. While we expect rapid EPS growth into the second half of the decade, option issuance could significantly increase the number of shares outstanding. We have reflected this in our valuation. Without heavy option issuance, we think ImClone would be more valuable than our current analysis suggests.

RIVALS OR PARTNERS? Two significant risks exist, in our view. One is the possibility that Erbitux isn't approved. If this occurs, ImClone shares would likely decline. The second noticeable risk are dwindling cash reserves. ImClone clearly needs the approval to occur by February so it can receive the $250 million infusion from Bristol-Myers. Additionally, approval and a strong launch could lead to a possible financing deal, in our view.

In addition to ABX-EGF, some other high-profile anticancer medications may compete directly against Erbitux or even possibly be used in combination with it. Merck KGaA is developing EMD 72000, a humanized MAb that binds to EGFR. Although it doesn't use the same mechanism of action as Erbitux, Genentech's Avastin will also likely be a major player in the treatment of colorectal cancer, and possibly other solid-tumor cancers.

All of the products mentioned above are injectable biologics. However, a number of small molecules approved or under development are designed to disrupt the intracellular signaling of cancer cells. AstraZeneca's (AZN

; 3 STARS; $47) Iressa is approved for non-small-cell lung cancer, and OSI Pharmaceuticals (OSIP

; not ranked; $32) is developing Tarceva for the treatment of non-small-cell lung cancer and pancreatic cancer. Analyst DiLorenzo follows biotechnology stocks for Standard & Poor's Equity Research

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