Vanda Pharma (NASDAQ:VNDA): "I Can't Fight This Feeling Anymore" ― Downgrading to Reduce, Lowering Price Target from $19 to $7 - Madison Williams

Madison Williams (formerly Sanders Morris Harris) is making an interesting call in Vanda Pharma (NASDAQ:VNDA) downgrading the name to a Reduce from Buy while lowering their target to $7 (prev. $19).

With a lower-than-expected base of prescriptions, underwhelming Rx growth, an overstuffed distribution channel, competition from another new product, early evidence of side effect issues, and a curiously silent marketing partner, Fanapt appears to be falling way short of their initial forecast. As a result, the firm is lowering their revenue estimates for Fanapt in 2010 from $60 million to $38 million, which includes $8 million of residual channel inventory at year-end (calculating 2010 demand sales at $30 million). They are lowering their rating on VNDA from Buy to Reduce and cutting their 12-month price target, which they derive using a blend of theirDCF model, sum-of-the-parts analysis, and discounted EPS model, from $19 to $7. Firm's valuation factors in VNDA benefitting from $27.5 million in NOLs against the Novartis $200 million payment for U.S. Fanapt rights. Firm's conversations and survey responses from psychiatrists suggest that: 1) Novartis is doing an abysmal job on Fanapt’s U.S. launch thus far; 2) side effects may be limiting the use of Fanapt; and 3) competition from newly-launched Saphris (Merck’s antipsychotic) is soaking up demand for new alternative treatments.

What is Novartis Doing? After paying $200 million to license the U.S. rights to Fanapt/Fanapt Depot, it is surprising that Novartis seems to have placed low-impact reps on the launch, and those reps have not yet visited certain key physicians. Even stranger, Novartis’s recent earnings call and slides did not even mention Fanapt as an important new product. Thus far, Novartis’s actions suggest to to the firm that it is not committed to Fanapt’s success, a key component of their downgrade of the stock.

Lack of Detailing, Side Effect Issues, and Competition is the Early Chatter with Physicians. Physicians the firm has spoken with and polled via their survey confirm that Fanapt is having a tough time commercially, indicating that the weak prescription trends are unlikely to change soon. Reasons include: more weight gain than expected, significant orthostatic hypotension side effects, a poorly designed titration pack, reimbursement issues, and the topper ― little or no sales support from Novartis. Additionally, they have heard that Merck’s Saphris is doing quite well as the new alternative treatment for schizophrenic patients who have failed first-line therapies.

Full Value is $8, Assuming VNDA Stops Spending Today. MW's sum-of-the-parts model values Fanapt royalties at $3.00/share (DCF through 2024 includes assumption for ex-U.S. sales) and cash at $5.20/share (assumes $27.5 million in NOLs are able to be used against the Novartis payment). Unfortunately, if the company continues to burn cash on operations, this lowers their present value calculation by $2.30, suggesting a $5.90 valuation. Firm notes that VNDA prescriptions could begin to perform better, and the operational spend could result in a new value driver longer term; however, they believe their $7 price target is the appropriate level for the shares until there is more information on the ramp of Fanapt and the company’s investment in its operations.

Notablecalls: These are certainly very negative comments from Madison Williams. I'm especially surprised to see comments regarding the lack of marketing support from Novartis. The feedback from physicians is almost equally concerning.

Vanda (VNDA) and its Fanapt product were all the range back in 2009, making the stock one of the top performers for the year. Remember the day when VNDA stock went from $1 to $10?

They had it all - a reasonably good product in a huge market and the backing from Novartis. A great story anyone could fall in love with.

This is also the reason why the stock has almost cult-like following, equal maybe only to Dendreon. Just take a look at what goes on at Yahoo! boards and you'll see what I'm talking about.

So, if I were David Moskowitz, the Madison Williams analyst that downgraded the stock today, I'd get my spam filters ready. There will be a whirlpool of negative comments heading your way.

I think the stock will get hit on this, possibly significantly. VNDA is scheduled to report on May 4 (next week) & I suspect people were looking for some improvement in Fanapt sales #'s. Doesn't look like it's going to happen, folks.