Onyx Pharmaceuticals Chooses the Long Run

Onyx Pharmaceuticals (ONXX) disappointed biotechnology investors with short time horizons when management announced that most of this year's potential profits from cancer drug Nexavar will be reinvested in research and development.

Nexavar (Sorafenib) has been approved by the FDA as a therapy for liver cancer (aka HCC) and kidney cancer (aka RCC). It is marketed through a partnership with Bayer. Under this arrangement Bayer sells the drug and tracks expenses for marketing and research and development costs. The net proceeds after costs are split, with Onyx receiving 50%. Until this year the revenues from Nexavar did not cover the costs, so Onyx received nothing. In addition Onyx had costs of its own, so it reported net losses.

However, global Nexavar sales for Q2 were $168.5 million, more than doubling Q2 2007 sales of $81.3 million. Mostly this reflects Nexavar being approved for use with liver cancer, in addition to its prior approval for kidney cancer. On a global scale most major nations now allow Nexavar for kidney cancer, but it is still being rolled out for liver cancer. All indications are that sales will continue to grow rapidly well into 2009.

Onyx received $30.2 million from Bayer, down from Q1 despite increased sales because of increased joint expenses. GAAP net income was reported as $4.5 million, because Onyx racked up $28.4 million in operating expenses outside the Bayer partnership. It also had some interest and investment income.

Today Onyx, with a stock price of $39.55, has a market capitalization of about $2.2 billion. That is a lot of market capitalization for $4.5 million net income in a quarter. If anything goes wrong (like serious, previously undetected adverse reactions), a lot of that value could disappear.

But Nexavar could also become a blockbuster. It is the first drug to show good results against HCC. It attacks cancer metabolic pathways at multiple points. Chances are good (but not certain) that it will have some effectiveness against a variety of cancers beyond liver and renal. Under FDA rules clinical tests have to be done for approval for each cancer type.

Of course Nexavar could fail with other cancers, either overall or by not doing as well as other therapies. So investing in R&D presents a risk, the possibility that profits from already-approved indications will mostly be drained away for further research.

On the other hand, a good result in a common form of cancer, say one of the common types of breast cancer, would propel the value of Nexavar through the stratosphere.

So I own some Onyx stock, but I realize it is a risky deal. All the more reason to keep a portfolio within the pharmaceutical or biotechnologies segments diversified.

It may be 2010 or later before Nexavar is approved for more cancer types. In the meantime the ramp for liver cancer should result in improved financial numbers. HCC is rare in the United States, where most liver cancer actually started as a different type of cancer. But it is one of the most common types of cancer in China and some other Asian nations. Approval to market Nexavar in China was recently granted.