Onyx Downgraded to Underperform

We recently downgraded our recommendation on Onyx Pharmaceuticals, Inc. (ONXX) to Underperform from Neutral.

We note that Onyx Pharma’s second quarter 2011 loss of 56 cents was well below expectations, mainly due to lower revenues and higher operating expenses. Despite improved sales of the company’s only marketed drug, Nexavar (sorafenib) for cancer, which came in at $245.7 million (up 4% year-over-year) during the quarter, Onyx Pharma’s revenues experienced a 1.2% decline, amounting to $68.0 million.

Earnings were further reduced as a result of higher-than-expected operating expenses. While research and development (R&D) spend went up 16.2% to $50.3 million, selling, general and administrative (SG&A) expenses shot up 43.6% to $38.2 million.

Increased expenses for the development of carfilzomib led to higher R&D spend and an increase in employee headcount and related costs, legal expenses and pre-launch costs for carfilzomib were the primary reasons for elevated SG&A expenses.

We expect SG&A expenses to continue increasing with carfilzomib expected to be launched in the first half of 2012 and Onyx Pharma’s continued efforts to promote Nexavar outside US, particularly in certain Asia-Pacific countries. Moreover, the company currently has a number of trials ongoing for both carfilzomib and Nexavar, which will continue adding to Onyx Pharma’s R&D expenditure.

Additionally, Nexavar faces fierce competition in the kidney cancer market from some major players like Pfizer Inc.’s (PFE) Sutent, Roche Holdings Ltd.’s (RHHBY) Avastin and GlaxoSmithKline plc’s (GSK) Votrient, which might impact the drug’s sales in future. Going forward, Nexavar could face additional competition from products that are currently under development including Bristol-Myers Squibb’s (BMY) brivanib.

Nexavar, which is currently marketed worldwide for the treatment of hepatocellular carcinoma (HCC) or liver cancer and advanced renal cell carcinoma (RCC) or advanced kidney cancer, is being developed by Onyx Pharma under a collaboration agreement with Bayer AG (BAYRY). Any conflict leading to a termination of the agreement will influence the stock adversely.

We remain concerned about this partnership since a suit has already been filed by Onyx Pharma against Bayer. Bayer has been developing fluoro-sorafenib (or regorafenib) for kidney cancer. However, the ownership of this compound is under dispute with Onyx Pharma filing a lawsuit in May 2009.

Onyx Pharma is seeking a declaration that fluoro-sorafenib (a variant of sorafenib having the same chemical structure as Nexavar except that a single fluorine atom has been substituted for a hydrogen atom) should be treated as a compound under the collaboration agreement while Bayer claims its sole rights.

Moreover, in early October 2010, Onyx Pharma announced a delay in the filing of its New Drug Application (NDA) for carfilzomib, being evaluated for the treatment of relapsed and refractory multiple myeloma. The filing, which was originally expected to occur by year-end 2010, was finally initiated in February 2011, with the company commencing the submission of a rolling NDA for gaining accelerated approval of carfilzomib.

Onyx Pharma expects to complete the submission by the end of September 2011, with potential approval in the first half of 2012. The timely filing of the application could have resulted in carfilzomib’s approval by mid-2011.

Thus, keeping all the aforementioned issues in mind, we have downgraded Onyx Pharma to Underperform.

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