Durect at Attractive Entry Point

We highlight Durect Corp. (DRRX - Analyst Report), Endo Pharmaceuticals (ENDP - Snapshot Report) and King Pharmaceuticals, Inc. (KG - Analyst Report).

Durect Corp. (DRRX - Analyst Report) has had a rocky past few months. The stock was hit harder than we expected in December 2008 when the FDA rejected the application on Remoxy. From our standpoint, the rejection of the NDA was not a surprise, but the reaction on Durect stock was.

Nevertheless, we think the FDA’s issues, most likely around the labeling, the abuse ability, and the risk management program, should only delay final approval by a year. We think that Remoxy will be on the market and generating royalties for Durect by the middle of 2010.

The second big sell-off in the stock came in early March 2009 when Durect announced that Transdur development partner, Endo Pharmaceuticals (ENDP - Snapshot Report), was returning U.S. and Canadian rights to the product to Durect. The news came as a big shock to us, considering the duo just recently met with the FDA for an “end-of-phase II” meeting and outlined a path to approval with a phase III program.

We are clearly disappointed with the news, but we feel comfortable saying that Endo walking away from Transdur has more to do with Endo refocusing its efforts around the Indevus acquisition than it does anything negative about Transdur or the FDA meeting.

In the long-run, this may work to benefit Durect because they: 1) get to keep the $10 million upfront payment, 2) got someone to help fund the bulk of the phase II development, and 3) can now re-partner the drug with significantly better terms than they did before. Plus, management is also looking to partner Transdur in the EU and Japan, so the bidding process can now include larger organizations that are interested in worldwide rights.

It may be difficult to believe -- it is always darkest before the dawn -- but management can use this as a fantastic opportunity to improve its position.

The immediate concern of biotech investors when they see a sub-$2 stock is the cash position. Any stock trading below $2 must have significant cash burn concerns, right? Well, like Lee Corso says, “Not so fast my friend!” Durect exited the first quarter with $47.0 million in cash on hand and virtually no debt. Burn for the first quarter was only $5.7 million, and we expect that to decline in the coming quarters based on the March 2009 headcount reductions.

Plus, we see several potential non-dilutive cash raising opportunities in 2009 and 2010. Firstly, once Remoxy is finally approved management will begin receiving payments from King Pharmaceuticals (KG - Analyst Report). This will help reduce burn. However, management can sell the rights to these royalties for upfront cash if they choose.

Second, management is going to re-partner Transdur at some point in 2009 or 2010. Partnership opportunities for Transdur include the U.S., the EU, Japan, or any combination of the three. In a conversation we had with management recently, they noted that previous discussion they held with larger organizations that were only interested in worldwide rights to the drug are now back on the table. In the end, we think Endo walking-away from Transdur may prove to be a significant benefit to Durect.

The other big partnership opportunity for management in 2009 is for Posidur. Opportunity exists to partner the drug in the U.S. and Japan (Nycomed already acquired EU rights in late 2006). The current cash balance of $47.0 million will be enough to fund operations into 2011.

Despite the recent setback and future challenges, we like Durect’s position and think the stock is worth $5. Better times are ahead -- investors just need to be patient, because we think the pipeline will eventually pay off.