Markets & Finance

A Drug R&D Firm Worth Discovering


By Herman Saftlas Standard & Poor's Focus Stock of the Week is Pharmaceutical Product Development Corp. (PPDI), which carries S&P's highest investment ranking of 5

STARS (buy).

Ranking as the third largest company in the $6 billion global contract research organization (CRO) industry, PPDI operates through three subsidiaries--PPD Development, PPD Discovery, and PPD Virtual--which provide specialized contract and consulting discovery R&D services for pharmaceutical and biotechnology companies.

Representing its core CRO business, PPD Development offers comprehensive analytical laboratory and clinical development services, including designing and monitoring clinical trials for experimental compounds, analyzing the results, and submitting finished new drug applications to regulatory agencies.

GENOME POTENTIAL. While growing conventional CRO businesses currently provide for the bulk of sales and profits, more significant potential is seen for the company's earlier stage, genomics-based drug discovery operations. Besides regular CRO development fees, discovery deals also provide for patent access payments, R&D funding, milestones and royalties on commercial products.

PPD Discovery utilizes a proprietary functional genomics technology referred to as the GSX System to indentify, validate and analyze novel molecular targets. GSX is used to map functional protein domains; select cells with specific gene inhibition properties such as resistence to a virus or destroying cancer cells; and discover new drug targets through combinatorial chemistry and high throughput screening. Using these tools, GSX streamlines and compresses the overall drug discovery process, offering savings in both time and money.

This technology has been validated through corporate alliances with Aventis and Pfizer's Agouron biotechnology subsidiary. PPDI is working on new drug targets in the areas of oncology, inflammation, cardiology, inflammation and central nervous system with Aventis; and in HIV and oncology treatments with Agouron. Drug discovery revenues expanded 5.4-fold to $14.8 million last year.

PPD Virtual provides virtual drug development consulting and management for companies seeking ways to reduce fixed costs while accelerating product development. Using state-of-the-art product assessment techniques, PPD Virtual critically evaluates drug candidates early the development process before clients invest heavily in what may turn out to be dry holes.

PPDI is also a major factor in clinical testing services in the exciting field of pharmacogenomics, the science of using an individual's genetic information to predict the safety and efficacy of specific diagnostic and therapeutic products. R&D in this area is expected to lead to "designer"-made pharmaceuticals tailored to a person's or group's genetic composition; such drugs could offer important advantages in improving efficacy and eliminating unwanted side effects.

STRATEGIC PARTNERS. A key element of PPDI's future growth strategy involves technology sharing partnerships with other firms capitalizing on cutting-edge genomics and biopharmaceutical technologies, as well as the formation of collaborative agreements with CRO clients and others to develop new compounds that provide for sharing in the profits of new drugs.

PPDI recently signed new technology sharing deals with Affymetrix for access to their GeneChip arrays and related instrumentation to monitor gene expression for use in genomics R&D; and with InforMax for use of its informatics system to manage and analyze massive quantities of genomic data.

One especially promising compound which PPDI licensed two years ago from Eli Lilly is dapoxetine. A selective serotonin reuptake inhibitor (SSRI), dapoxetine has the potential to become the first oral drug for the treatment of premature ejaculation, a sexual dysfunction that affects up to 30% of the men in the U.S.

The drug, which has been licensed to ALZA Corp. (being acquired by Johnson & Johnson), has demonstrated statistically significant efficacy in recent Phase II studies. While it still has a long road ahead of it, dapoxetine has the potential of ultimately developing into a several hundred million dollar product, with PPDI receiving royalties on the sales.

BULLISH SIGNS. The company has significantly outpaced the overall CRO industry in recent years. While the industry has been impacted by contract cancellations due to recent mergers in the global pharmaceutical arena, PPDI's CRO business continues strong, growing at a 15%-20% annual clip. This reflects PPDI's relatively large client base (the largest client accounts for only about 7% of revenues) and client appreciation of the company's high quality service record. PPDI's year-end backlog of orders totaled $498 million, up 41% from the year before. A bullish indicator for 2001 is the fact that new orders in the fourth quarter increased 40%, significantly surpassing the 18% advance in revenues during the quarter.

Demand for CRO services such as those offered by PPDI should experience robust growth over the coming years, as pharmaceutical and biotechnology companies scramble to develop new genomics based drugs and improve R&D productivity. We project outsourcing's share of total global pharmaceutical development spending to rise to over 20% by mid-decade, up from an indicated 15% last year.

Reflecting brisk demand for its services and anticipated contributions from new contracts (including one to service Oracle's pharmaceutical applications division), revenues this year are expected to climb 20%, to $420 million. Margins should widen on the better volume and an improved product mix. EPS are expected to rise to 34%, to $1.71, with a further step-up to $1.95 seen for 2002. Factoring in anticipated contributions from new drug partnering deals, robust EPS growth should continue in the ensuing years as well.

The company also has a strong balance sheet, with cash of $76 million, minimal long-term debt and a healthy current ratio of 2.0. Return on equity has nearly doubled over the past three years, to 15.2%.

ATTRACTIVELY VALUED. At the current price of $43, PPDI trades at a multiple of 25 times our 2001 estimate, roughly in line with the multiples of conventional CRO companies. However, besides its core PPD Development CRO business, PPDI also has more significant profit potentials from genomics research, pharmacogenomics, and new drugs such as dapoxetine that we believe are not fully appreciated by the Street.

The stock also trades at one of the most attractive valuations based on P/E to growth (PEG). Its PEG based on projected three year forward EPS growth is presently 0.7, versus a PEG of 1.2 for the overall specialty pharmaceutical sector. We would expect to see some expansion in the present multiple, reflecting greater investor recognition of PPDI's expanding genomics business and positive dapoxetine news.

Our 12 month price target, based on our 2002 estimate of $1.95 and a multiple of 27, is $53, implying a 23% upside potential from the current level. Saftlas is a pharmaceutical industry analyst for Standard & Poor's


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