DRRX – Initiating Coverage of DURECT Corp. (DRRX) (PFE)

We are initiating coverage of DURECT Corp. (DRRX) with a ‘Buy’ rating. We believe the story is vastly undervalued. We have stripped the company down into its individual product components through a “sum-of-parts” analysis. We arrive at a price target of $2.50 per share.

Abuse of OxyContin is a major healthcare concern, and recent FDA advisory panels and CDC workshops have the problem on the top of the “get it fixed” list. We think Remoxy is a meaningful step forward in the fight to reduce the OxyContin abuse epidemic.

DURECT is entitled to receive a tiered royalty on global sales of Remoxy at Pfizer. There are no expenses associated with the ongoing royalty stream. In fact, DURECT and Pfizer recently signed a long-term supply agreement whereby DURECT will supply some of the excipients included in the Remoxy formulation at a cost-plus transfer price. We see the royalties from Remoxy, heavily discounted, worth $1.75 per share.

Investors may be questioning DURECT strategy to file for approval of Posidur based on the failure of the phase 3 BESST trial earlier in the year. Our model assumes the company receives a complete response letter (CRL) and that the FDA requires DURECT to re-conduct another phase 3 program. We think BESST was outside the core capabilities of the product – surgical pain. We think odds favor success in a second phase 3 trial with a more narrow focus for Posidur. We see only a 20% chance of approval on the first NDA. Nevertheless, even with the expected CRL and the delay and costs necessary to conduct another phase 3 trial, we think Posidur, with peak sales around $250 million, is worth $0.40 per share.

Below is our sum-of-parts analysis. We include only modest contributions from the rest of the pipeline, including Eladur, TRANSDUR-sufentanil, Relday, and early-stage ORADUR candidates. We also include projected operating expenses over the next several years at around $30 to $35 million in combined R&D and SG&A, a net operating loss (NOL) carryforward of approximately $228 million at year end 2011, and a projected cash balance of $17.5 million at year end 2012. We see cash sufficient to fund operations into 2014.

We would be buyers of DURECT stock at today’s price. We see upside over the next 12 to 18 months of nearly 150%. We see several catalysts on the horizon, including the Posidur and Remoxy NDA filings and potential partnerships on Eladur and ORADUR-ADHD as bringing investor attention back to the name.

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