ALZA: A DRUGMAKER HEADING FOR A 'MAJOR BREAKOUT'?

Edited by Douglas Harbrecht

In recent years, research into sex-specific diseases and conditions such as premenstrual syndrome and impotence has created a growing niche for drugmakers. One condition getting particular attention is male hypogonadism -- or testosterone deficiency. At least 1 million American men are believed to suffer symptoms related to insufficient testosterone, which can include depression, decreased energy, and lower sex drive.

The antidote in many cases is fairly simple: Increase testosterone levels. But until recently, injections were the only option. And they tended to produce discomfort from anxiety and aggression immediately after an injection. That gave way to exhaustion and letdown as testosterone levels dropped before the next treatment. Controlled-release testosterone patches have alleviated some of the problems, but they have drawbacks, too: Of the two currently on the market, one has to be applied directly to the scrotum, and the other can cause significant skin irritation. The upshot is that only about 10% to 15% of men with the condition receive treatment today.

In early March, however, Alza Corp. in Palo Alto, Calif., began shipping a new product that releases testosterone through a thin, clear patch that can be placed on more comfortable spots such as the arm or back, can be removed and reapplied for swimming or showering, and doesn't cause significant skin irritation. That's good news for hypogonadism patients, and analysts believe it could significantly expand the $30 million patch market. It's also a milestone for Alza, whose Testoderm TTS, as it's called, is the first of a new product lineup that Alza has developed as part of a strategy to market drugs under its own name.

That's a major switch for the 30-year-old company, which until now has primarily worked with pharmaceutical giants to put their drugs into novel release systems and collect a royalty for its efforts. Last year, Alza had operating earnings of $164.8 million on revenues of $464.4 million (although nonrecurring charges resulted in a net loss of $261 million). With its push to become a much bigger and more profitable company by selling its own products, "Alza has finally transformed itself from being an R&D shop to being more like a regular drug company," says Hambrecht & Quist analyst Alex Zisson. Indeed, after years of trading at mediocre multiples compared with its drug and biotech brethren, its shares have jumped in recent months to just under 38, the stock's highest level since 1992.

Testosterone deficiency is a perfect example of the kind of problem that launched Alza. Drug-industry visionary Alejandro Zaffaroni started the company in 1968 on the premise that by paying more attention to the delivery of drug compounds, companies could improve a medicine's performance, create new markets, and add value to drugs that were going off patent or hobbled by side effects. That's because both pills and injections typically flood the body with excess levels of a drug initially. Then, the body absorbs or metabolizes the drug to the point where it's nearly gone before the next dose. That roller coaster can create side effects and limit a drug's effectiveness. Alza developed a line of delivery vehicles, including skin patches, tiny pumps inside tablets, and other controlled-release systems, that made drugs work better by maintaining an ideal dosage for a longer period of time.

Over the years, Alza has created special-delivery products for some of the biggest names in the industry: Pfizer, Merck, Novartis, and G.D. Searle. It came up with innovative systems to deliver a wide variety of medications, from pain drugs and antihypertensives to nicotine for easing smoking withdrawal. But there were two problems: The partners always called the shots, and Alza earned only a modest royalty of 10% or so of product sales. "In the past, Alza has put all the risk and most of the profit in the hands of the client," notes Chief Executive Ernest Mario, the former CEO of Glaxo whom Zaffaroni recruited to run Alza in 1993.

When Mario arrived, Alza was still reeling from the wild ride it took on the back of the short-lived explosion in nicotine patches, one of which Alza developed for Marion Merrell Dow. Alza's market capitalization zoomed as high as $4 billion at the beginning of that fad, then its stock collapsed in 1992, when follow-on orders fell off and proposed Clinton health-care reforms frightened many companies into pulling back on "luxury" projects such as improved drug delivery.

Mario soon made strategic changes, including setting up Alza's own research and development spin-off to begin developing products under the Alza brand name. He added a sales force that is now more than 100-strong and also began licensing products in areas where he hoped Alza would soon have its own line, such as urology and oncology. Previously, Alza had done some limited drug development and marketing (the scrotal testosterone patch was developed and sold by the company). But Mario made it clear that developing its own products would be Alza's growth engine for the future.

He concedes that the transition caused culture shock and has taken longer than he had hoped. In fact, the company lost some experienced scientists during the changeover, and Alza's stock remained in the doldrums as increased R&D spending cut into the bottom line. Now, though, several drugs are on the runway, and margins are growing. "Everything's been going right, and it's setting the company up for a major breakout," believes Jami Rubin, a drug-industry analyst with Schroder & Co.

One thing Wall Street is beginning to appreciate, analysts say, is that this strategy is not nearly as risky or expensive as the challenge biotechnology companies face in developing drugs from scratch: Biotech drug-development efforts can consume a dozen years before it's clear that something doesn't work. Alza's primary approach, by contrast, is to obtain rights to existing drugs or generics, then use its value-added drug-delivery technology to deliver a reformulated product -- such as the new, "user-friendly" testosterone patch. That means the drugs Alza is developing are usually already understood and unlikely to produce the kind of nasty surprises that have driven some biotech companies out of the game.

Indeed, Alza is "seeing the fruits of our investment in our portfolio," says Mario, who has spent about $750 million on R&D since he arrived. The company has a number of promising products in the works, including the incontinence drug Ditropan XL, for which it sought Food & Drug Administration approval in December. It's also working on an implantable form of a prostate-cancer drug and a new formulation of the attention-deficit-disorder drug methylphenidate, both of which are in the mid-to-late stages of testing. Mario predicts that sales of Alza-brand products, including Testoderm TTS and others that it has licensed, will increase threefold, to about $150 million this year, and should reach $300 million in 1999. Best of all, Alza's gross margins are rising -- from 35% in the third quarter of 1997, to an anticipated 40% this year.

Mario has caught flak for taking the industry's drug-delivery pioneer down a suddenly conventional path even as some two dozen companies are moving into Alza's original stomping ground -- experimenting with exotic technologies for novel compounds. "There are lots of opportunities in drug delivery that are still enormous," says the chief executive of a rival delivery company. "I just think Ernie is more comfortable in a more traditional drug company."

Mario makes no apologies for that -- and for creating more value for shareholders. "A product developed and marketed by Alza with $50 million in annual sales can have the same impact on earnings as a $500 million product sold by a client company paying us a royalty on net sales," he told shareholders in last year's annual report. With a handful of such products almost ready to roll, Mario may be ready to deliver some pretty good numbers along with those high-powered drugs.

By Joan O'C. Hamilton in Palo Alto, Calif.