Summary
Cubist Pharmaceuticals (CBST) is a biopharmaceutical company focused on developing products for the antiinfective market. Cubist was incorporated in 1992 and was listed on the NASDAQ in 1996. Cubist currently has one product on the market, Cubicin, and one product, HepeX-B, in clinical development. Cubicin received FDA approval in September 2003 for complicated skin and skin structure infections (cSSSI) and is currently in phase III studies for bacteremia. Cubist is developing HepeX-B for the prevention of HBV re-infection in patients with liver transplants and has already received Orphan Drug Status in the U.S. and in the European Union.

Cubist’s future value rests in Cubicin’s ability to penetrate into the cSSSI and Bacteremia markets. We project total probability adjusted 5 and 10-year revenues from Cubist to be $450.1 million and $629.3 million, respectively, and value Cubist’s 5 and 10-year pipeline at $26.11/share and $21.69/share respectively. As of Cubist’s May 5, 2005 closing price of $9.48/share, we find the company significantly undervalued. One cause for this discrepancy may be Cubist is being valued using a shorter outlook of one or two years, when the company first becomes profitable.

Given Cubist’s lack of a pipeline, its future catalysts are somewhat limited. The primary one will be trial data and a follow-on NDA for Cubicin in Bacteremia. Cubist has indicated it expects to release top-line data from its ongoing Phase III trial in mid-2005.

A secondary catalyst will be Cubist’s ability to move along HepeX-B’s clinical development. This process will most likely be slow, with a very low number of liver transplants each year. Cubist plans on reporting data from a second Phase II study in second half of 2005.

DRUG PIPELINE

Cubicin (Daptomycin)
Cubicin is the first in a new class of antibiotics called cyclic lipopeptides. Cubicin exhibits rapid, concentration-dependent bactericidal activity against a broad range of Gram-positive bacteria, including organisms that are resistant to oxacillin, Zyvox (linezolid), methicillin and vancomycin. Cubicin has a unique mechanism of action to other antimicrobials – it causes bacterial membrane depolarization that disrupts membrane function causing bacterial cell death. In vitro studies have shown Cubicin to possess potent activity against a range of aerobic and anaerobic Gram-positive bacteria including drug-resistant strains.

Cubicin received FDA approval in September 2003 for complicated skin and skin structure infections (cSSSI) and is currently in phase III studies for bacteremia.

Cubicin for skin and skin structure infections
Skin and skin structure infections (SSSIs) are among the most frequent sites of human bacterial infection. They represent one of the most common indications for antibiotic therapy and account for 10% of hospital admissions in the USA. A wide variety of SSSI exist ranging from simple infections (uncomplicated) to complicated SSSI which can be fatal when it extends beyond the skin to other organs. Each year, there are nearly 2.5 million cases of cSSSI in the United States and approximately 400,000 patients with cSSSI who require hospitalization.

Complicated SSSI typically involve gram-positive pathogens such as Staphylococcus aureus. In the U.S., S. aureus is the most common cause of skin and skin structure infections, as well as of invasive infections acquired in hospitals. Treatment of serious S. aureus infections has become challenging due to the emergence of drug resistance, particularly methicillin-resistant strains. For the life-threatening infections caused by MRSA, the only viable treatment is Vancomycin (Vancocin; Eli Lilly), a glycopeptide antibiotic that has been available since the 1950s. However, Vancomycin, the so called “antibiotic of last resort”, is no longer invincible with the development of resistant strains including Vancomycin-intermediate and Vancomycin-resistant S. aureus.

Cubicin received FDA approval in September 2003 for complicated skin and skin structure infections (cSSSI). Approval was based on results from 2 large phase III studies, DAP-SST-98-01 and DAP-SST-99-01, that enrolled 1092 patients. The first study (98-01) was conducted in the U.S. and South Africa while the second study was conducted in Europe, South Africa, Israel, and Australia. The study protocols were identical and compared Cubicin, given for 7-14 days, to either penicillins PRP (cloxacillin, nafcillin, oxacillin, or flucloxacillin) or Vancomycin. Both studies demonstrated that Cubicin exhibited comparable efficacy to PRPs or Vancomycin in treating cSSSI.

With its comparable effectiveness at treating cSSSI and its efficacy at eradicating drug-resistant strains, Cubicin has already achieved a sizeable uptake in the cSSSI market. However, with physicians unlikely to prescribe Cubicin except for serious or life-threatening cases to prevent bacteria from developing resistance to this unique drug, Cubicin is unlikely to be used off-label for uncomplicated SSSI or simple infections.

Cubicin for bacteremia
Cubicin is currently in phase III studies for endocarditis and bacteremia caused by S. aureus infections. Enrollment was completed in late 2004 and in February 2005, Cubist announced that the treatment phase of the study has been completed and the study is now in the follow-up stage with results expected in mid 2005.

Early phase II data released in 2000 showed that Cubicin treatment resulted in a clinical cure in all (100%) of clinically evaluable patients and a 93% eradication rate in the microbiologically evaluable patient group. Based on these positive data and and given the need for newer antimicrobials that are effective against drug-resistant strains, we believe that Cubicin will gain FDA approval for bacteremia by the end of 2006.

Cubicin licensing
Cubicin was originally developed by Eli Lilly in the early 1980s but clinical development was suspended due to concerns about skeletal muscle toxicity. In 1997, Cubist acquired exclusive worldwide rights to develop, manufacture and market Cubicin. Cubist paid an upfront license fee in cash and agreed to pay milestone payments by issuing shares of common stock to Eli Lilly. In addition, Cubist also pays royalties to Eli Lilly on worldwide sales of Cubicin. On March 03, 2005, Cubist announced it agreed to purchase from Eli Lilly a 2% reduction in the royalties on net sales of Cubicin.

On October 2003, Cubist signed a License Agreement and a Manufacturing and Supply Agreement with Chiron for the development and commercialization of Cubicin in Western and Eastern Europe, Australia, New Zealand, India and certain Central American, South American and Middle Eastern countries. Chiron paid Cubist an up-front licensing fee of $8.0 million. Cubist is entitled to receive milestone cash payments from Chiron of up to $32.0 million. Chiron will also pay Cubist royalty payments based on Chiron's sales of Cubicin.

HepeX-B
According to the world health organization (WHO), 400 million people are chronically infected with hepatitis B accounting for 1 million deaths each year worldwide. In the U.S. alone, the Center for Disease Control (CDC) estimates that 1.25 million people have chronic hepatitis B, and despite an effective vaccine that can prevent infection being available since 1982, 100,000 new cases were reported in 2004.

Hepatitis B is the commonly caused by the hepatitis B virus (HBV), which attacks cells of the liver leading to cirrhosis (liver scarring), cancer of the liver or liver failure. Liver transplantation is the last resort for patients with life-threatening liver damage induced by hepatitis B, however, with the virus still present in patient’s blood and organs, liver transplantations carry the risk of fatal HBV reinfection or the grafted liver. Thus patients are often not eligible for a liver transplant unless adequate suppression of HBV infection can be achieved.

Cubist is developing HepeX-B for the prevention of HBV re-infection in patients with liver transplants and has already received Orphan Drug Status in the U.S. and in the European Union. HepeX-B is a combination of two human monoclonal antibodies, Libivirumab and Exbivirumab, directed at different epitopes on the surface antigen of the hepatitis B virus (HBV). In early phase II studies in patients with chronic hepatitis B, HepeX-B was comparable to Epivir (Lamivudine; GlaxoSmithKline) at maintaining serum HBV levels. Epivir is the current standard treatment for suppressing HBV in liver transplant patients. HepeX-B is currently being studied in an international phase IIB study in HBV patients undergoing liver transplantation.

HepeX-B licensing
In June 2004, Cubist entered into a license agreement with XTLbio for the worldwide development and commercialization of HepeX-B. Cubist paid XTLbio an up-front fee of $1.0 million and will pay collaboration support of $2.0 million over a two-year period. Cubist may also pay an additional $3.0 million in milestone payments. Cubist will be required to pay royalties to XTLbio on any sales of HepeX-B. Cubist will fund the development costs of HepeX-B and will be solely responsible for registration and commercialization of the product worldwide.

REVENUE POTENTIAL

Cubist for cSSSI
After being approved in late 2003, Cubicin has shown nice growth reaching $58.6 million in sales in 2004. We project Cubicin for cSSSI to achieve slightly less penetration than Zyvox, at 22.5% in 2007 and 2008. As such, we project Cubist in cSSSI to achieve U.S. revenues of $212.3 million and $233.0 million, with worldwide revenues of $288.4 million and $363.1 million in 2007 and 2008, respectively.

With the ever increasing incidence of MRSA infections, Cubist should continue to grow revenues, even after its share of patients reaches its peak. We currently project peak U.S. revenue of $347.5 million in 2015, with peak worldwide revenue of $789.2 million the same year.

Cubist records the revenues from Cubicin and then pays a royalty to Lilly through its cost of goods sold. We estimate this royalty to be approximately 15%. In Europe we estimate Cubists will receive 35% of revenues, while Chiron and Lilly will receive 50% and 15%, respectively. We project total 5 and 10-year revenues received by Cubist for Cubicin in cSSSI to be $308.3 million and $423.9 million, respectively.

Please see our recent indication report and revenue models for more information on the cSSSI market.

Cubist for Bacteremia
Bacteremia represents another large opportunity for Cubicin. This is partly due to the increased dosage necessary in this setting. We currently project peak U.S. revenue for Cubicin in Bacteremia to reach $205.5 million in 2014, with peak worldwide revenue of $535.1 million the same year. We project 5 and 10-year U.S. revenue of $140.8 million and $187.8 million and 5 and 10-year worldwide revenue of $306.7 million and $503.6 million, respectively.

We project total Cubicin in Bacteremia revenues received by Cubist to be $169.2 million and $250.2 million of revenue in 2010 and 2015, respectively.

HepeX-B
Cubist estimates there are between 200-300 liver transplants due to HBV infection each year in the U.S. and that the total worldwide market for HepeX-B is $100 million. We predict HepeX-B will capture 75% of the market and the drug will be priced in-line with other orphan drugs at $150,000 per year. We estimate Cubist will receive 85% of revenues from HepeX-B, resulting in peak U.S. revenue of $99 million in 2015. We project 5 and 10-year worldwide revenue of $78.3 million and $99 million, respectively.

Company Valuation
Cubist’s future value rests in Cubicin’s ability to penetrate into the cSSSI and Bacteremia markets. We have chosen to value Cubicin only on the basis of cSSSI and Bacteremia. Cubicin will most likely receive some slight usage in other infectionous settings, however we feel it will be used primarily when all else fails. Our model predicts Cubist will achieve 22.5% penetration in cSSSI and 15% penetration in Bactermia. Taking out royalty payments to Lilly, we project total probability adjusted 5 and 10-year revenues from Cubist to be $450.1 million and $629.3 million, respectively. We value Cubist’s 5 and 10-year pipeline at $26.11/share and $21.69/share respectively. As of Cubist’s May 5, 2005 closing price of $9.48/share, we find the company significantly undervalued. One cause for this discrepancy may be Cubist is being valued using a shorter outlook of one or two years, when the company first becomes profitable. Please see our company valuation for more detail.

Upcoming Catalysts and Valuation
Given Cubist’s lack of a pipeline, its future catalysts are somewhat limited. The primary one will be trial data and a follow-on NDA for Cubicin in Bacteremia. Cubist has indicated it expects to release top-line data from its ongoing Phase III trial in mid-2005. Assuming positive data, we then expect Cubist to file an sNDA by the end of October. Should Cubicin for Bactermia move into the NDA stage and remain 5% above average LOA, we would value its 5 and 10-year pipeline at $29.08/share and $22.92/share, respectively.

A secondary catalyst will be Cubist’s ability to move along HepeX-B’s clinical development. This process will most likely be slow, with a very low number of liver transplants each year. Cubist plans on reporting data from a second Phase II study in second half of 2005. Should Cubist be successful in moving HepeX-B into Phase III and Bacteremia to NDA, we would value Cubist’s 5 and 10-year pipeline at $31.98/share and $23.96/share, respectively.

Cubist Convertible Debt
In October of 2001, Cubist issued $165 million in convertible subordinated notes. The notes pay 5.5% semi-annually and mature on November 1st, 2008, with a conversion price per share of $47.20. This was issued at a 10% premium at the time. The bond had two provisional soft call features that were never triggered, needing the stock to maintain a market price above $70.80 for 20 out of 30 business days. The next hard call period is scheduled to begin November 1st, 2005 with a call price of 102.357% of par. There are two other hard call periods that begin on the same day in 2006 and 2007 at 101.571% and 100.786% of par.

Given that these notes are trading significantly out of the money with Cubist’s 52-week share price range of $7.71 - $13.00, it is fair to say that they will not convert into common stock nor be called back by the company. As a result, even with Cubist reaching profitability in 2006, it is our estimation that the company will need to raise additional capital to have sufficient funds to continue operations and pay back the $165 million in principal.