We recently downgraded our rating on Enzon Pharmaceuticals Inc. (ENZN) from Neutral to Underperform with a target price of $9.50.

In mid-May 2011, Enzon announced plans to halt the development of its lead pipeline compound PEG-SN38 (EZN-2208), a PEGylated version of the active metabolite of the cancer drug, irinotecan, for the treatment of metastatic colorectal cancer (mCRC). Enzon decided to halt development as the company intends to focus its resources on other areas with nearer-term commercial potential. The discontinuation of development of PEG-SN38 for mCRC is a disappointment, leaving the company with just one clinical program in mid-stage development (PEG-SN38 for metastatic breast cancer) and all others in early stages of development.

The company’s pipeline candidates include PEG-SN38, hypoxia-inducible factor1 (HIF-1) alpha, survivin antagonists and multiple messenger RNA (mRNA) antagonists based on the locked nucleic acid (LNA) technology for cancer indications; all in early or middle stages of development. We are thus concerned about the early stage status of the compounds. These candidates are several years away from approval and commercialization. We believe Enzon must deliver new products in order to offset the slowing royalty revenue.

Following the sale of the specialty pharmaceutical business in 2010, Enzon has no marketed product and its revenues consist primarily of royalties. Enzon earns royalties from several products manufactured using its proprietary PEGylation technology. These are PegIntron, marketed by Merck (MRK - Analyst Report), Macugen marketed by Astellas Pharma/Pfizer (PFE - Analyst Report) and Cimzia marketed by UCB Pharma (UCBJF).

However, royalty revenues, the majority of which come from Merck’s PegIntron sales, declined approximately 9% in the first quarter of 2011 due to reduced sales of the drug. Declining sales of PegIntron could impact the company’s top-line further. Novel agents like Vertex Pharmaceuticals (VRTX - Snapshot Report)/Johnson & Johnson’s (JNJ - Analyst Report) Incivek (Telaprevir) and Merck’s Victrelis (boceprevir) recently received approval for the treatment of HCV. These candidates will pose strong competition to PegIntron, which in turn would affect royalties from PegIntron sales. These pressing factors have led us to downgrade Enzon from Neutral to Underperform.