The 10Q Detective: Losing Sleep Over Cephalon

Shares of Cephalon are down on fears that growth of its sleep disorder drug Provigil is slowing and could be hurt by the early rollout of generics

By David Phillips

David Phillips

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Even as the broader stock market and much of the pharmaceutical sector have clawed their way back from early-year lows, shares of drugmaker Cephalon (CEPH) have dropped around 25% since January. Wall Street jitters are likely due to evidence of slowing growth for Cephalon's flagship product, the sleep disorder drug Provigil. Also, pending litigation could result in the introduction of cheaper, generic copies of the top-selling medicine before its patent expires in 2012.

Of course, big stock-price drops like Cephalon's can awaken value players looking for an opportunity in a beaten-down pharma with an attractive product. But the 10Q Detective thinks investors may wish to hide under the covers on this one. The longer-term value of the company's sleep disorder franchise could come under pressure from efforts by government and businesses to hold down costs of pricey branded drugs. And, it's not certain that Cephalon can beat back the looming generic challenge by successfully switching patients to its next-generation narcoleptic treatment Nuvigil.

The company is also seeking Food & Drug Administration (FDA) approval to promote Nuvigil for new treatments to broaden its commercial appeal beyond narcolepsy. Value investors should note, however, that FDA delays, combined with sooner-than expected generic intrusion, could undermine the company's balance sheet. The 10Q Detective has unearthed a few eye-openers contained deep in recent filings: millions in potential asset writedowns and insufficient cash flow from operations to repay $750 million of convertible notes—if presented for conversion—and other cash obligations coming due in the next 12-18 months.

Price Hikes Boosted Revenue

In the event that a significant conversion of convertible debt did occur, management has stated in its second-quarter regulatory filing that the company could obtain the necessary funds through a combination of existing cash ($1.2 billion), a $200 million credit facility, or raising money in the capital markets.

Comparable U.S. revenue from the sale of Provigil tablets (active ingredient, modafinil), indicated for the treatment of sleep disorders such as narcolepsy and sleep apnea, increased 13%, to $485 million, for the six months ended June 30. That's not as impressive as it seems when considering the source of the increase: a price hike of 10% in early 2009 offset a 3% decline in total prescription growth. The same held true for 2008, when domestic price increases totaling 16% masked a 2% decline in total prescriptions written for Provigil. That's even more alarming when one realizes that Provigil accounted for 54% of total U.S. sales in the first half of 2009.

Prescription growth for Provigil started to slide last year after the company reached a $425 million settlement with the U.S. Justice Dept. to stop promoting its pill for non-approved uses, such as general fatigue.

An Atypical Stimulant

In a nation of 24-hour shoppers and sleep-deprived coffee gulpers, perhaps it should come as no surprise that Provigil, which was launched in February 1999, witnessed explosive growth in the last decade. U.S. sales jumped from just $28.7 million in 2000 to almost $925 million in 2008, making Provigil a true blockbuster. Provigil, an atypical stimulant that is not as addictive as other drugs, found wide acceptance among stay-awake types like college students and truck drivers. It is also frequently written for non-approved uses like attention deficit hyperactivity disorder, weight loss, and depression.

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