We have added Panacos Pharmaceuticals to our evaluated company list and created a Panacos 5 and 10-year pipeline valuation model.

Panacos is a biotechnology company that is developing novel small compounds for infectious diseases. The company’s primary focus is on developing small molecules for the treatment of human immunodeficiency virus (HIV), with a particular focus on a new class of HIV drugs called maturation inhibitors. The company has one maturation inhibitor, PA-457, in phase II clinical trials and is also researching a next generation HIV maturation inhibitor (IND expected this year) and an oral fusion inhibitor (IND expected in 2007). Given the need for new HIV agents due to viral mutations that lead to drug resistance, particularly for those with novel mechanisms of action, we feel that Panacos’ focus on novel HIV drugs is attractive, although the market is highly competitive.

DRUG PIPELINE

PA-457

The company’s lead compound, PA-457, is a first-in-class maturation inhibitor. PA-457 inhibits the correct processing of the HIV capsid protein, resulting in immature virus particles that lack infectivity. PA-457 was granted Fast Track designation by the FDA in early 2005. PA-457 is currently in early phase II studies.

In a phase I/II standard dose-finding 10-day monotherapy trial, PA-457 was tested at 50, 100 and 200 mg given orally once-a-day. The study showed that PA-457 dose-dependently reduced viral load with the highest dose reducing median viral load by 1.03 log10 (with 1.6 log10 being the highest individual reduction seen). The dose-response curve and the greater than 1 log10 viral load reduction are encouraging and suggest that PA-457 has significant anti-viral activity.

PA-457 appears to be well tolerated with minimal adverse events which include headache, nausea and diarrhea. No liver or kidney toxicity signals (these are common with HIV drugs) arose from this study although one case of stroke (lacunar cerebrovascular accident) was seen in a patient with a history of poorly-controlled hypertension. This stroke may have been related to PA-457 use, though this has yet to be established. Since the stroke only occurred in one patient and the patient had a predisposing condition for stroke, we believe that it is unlikely that PA-457 played a strong causal role in this adverse event. Overall, the safety profile of PA-457 is encouraging.

The company has also performed drug interaction studies to evaluate whether PA-457 can be given with other HIV agents. This is important since novel HIV drugs are likely to be given in addition to an optimized background triple-drug therapy (termed highly active anti- retroviral therapy or HAART). These interaction studies determined the effects of PA-457 on the protease inhibitors Reyataz (Bristol Myers Squibb) and Norvir (Abbott) and found that PA- 457 does not interfere with these drugs. This suggests that PA-457 can be safely added to a PI-based HAART regimen, the regimen most likely to be used in treatment-experienced patients.

While the reduction in viral load with PA-457 treatment is significant and clinically meaningful, as outlined in our HIV indication update report, these results do not appear to be as good as those seen with HIV integrase inhibitors. The HIV integrase inhibitors are also a novel drug class and two drugs in development in this class, MK-0518 (Merck) and GS 9137 (Gilead), have reduced viral load by more than 2 log10. In PA-457’s defense, the optimal dose for PA-457 may not have yet been reached and a higher dose may result in more potent viral load reductions. Indeed, the company is initiating a phase IIb study this quarter which will test higher doses of PA-457.

The phase IIb study comprises a dose-finding study to evaluate higher doses of PA-457 (400, 500, and 600 mg). Once the optimal dose has been established, the study will expand enrollment to evaluate the safety and efficacy of this dose. The company plans to initiate this phase IIb study once bioequivalence has been confirmed in an ongoing study evaluating the new tablet form of PA-457 (PA-457 was previously given in liquid form).

The company has indicated that they plan to initiate phase III studies in 2007 with an NDA submitted in 2008. The company is likely to pursue PA-457 for treatment-experienced patients first since that is undoubtedly the quickest path to FDA approval. However, the company has indicated that they will also pursue PA-457 for treatment-naïve patients.

Overall, we are encouraged by PA-457’s efficacy and tolerability. Given the results to date, we see the drug being used primarily by treatment-experienced patients with inadequate virologic control as an add-on drug to optimized background therapy (perhaps a PI-based regimen). We also see a small uptake in first and second line patients who are infected with drug resistant HIV strains. PA-457 has the potential to be used in treatment-naïve patients and since the drug can be given as a once-a-day pill, it has the potential to be combined with existing regimens such as Truvada (Gilead) or the new Sustiva/Truvada coformulation (Gilead and Bristol Myers Squibb). However, we see this to be unlikely since the combination of Sustiva and Truvada or Combivir (GlaxoSmithKline) is already highly efficacious in these patients. Moreover, there is reluctance to move all novel treatments into the front-line setting (so as not to encourage the emergence of new drug resistance strains). We believe that novel drugs are more likely to be reserved for patients who have failed existing therapies so as to prevent the development of new resistant HIV strains.

Though we currently see the drug’s uptake dampened by the success of the HIV integrase inhibitors, should PA-457 show more potent virologic control in the phase IIb and III studies, PA-457’s uptake could markedly increase.

Preclinical Compounds

Panacos currently has a second and third generation HIV maturation inhibitor in preclinical testing. An IND is expected this year for the second generation inhibitor. The company is also working on an oral HIV fusion inhibitor and an IND for is expected in 2007 for this compound. There is already a fusion inhibitor on the market (Fuzeon, Trimeris), however its use is limited due to its administration: twice-daily subcutaneous injections. An oral fusion inhibitor has the potential to be more widely used in the third and subsequent line treatment setting (much like for PA-457).

PATENTS

Panacos co-owns the U.S. patent for PA-457 with the University of North Carolina (UNC). This patent expires in 2015, although pending applications may extend PA-457 patent exclusivity through 2025. According to the company’s 2005 10-K, Panacos has an exclusive worldwide license under this patent, “on terms typical of an early stage academic collaboration”, from UNC for all indications.

CATALYSTS

The main catalyst for Panacos in 2006 is the results from the phase IIb study. This study is expected to begin within the next 2 months and the dose-finding component of the study could yield results as early as the fourth quarter of 2006. Should PA-457 show a greater viral load reduction (of 2 log10 or more), then we project the drug to compete more effectively with other novel HIV agents.

REVENUE POTENTIAL

We forecast limited revenue potential for PA-457 as we feel the integrase inhibitors, which are due on the market around the same time, are superior to PA-457. Our projections for PA- 457 call for minimal market share in the 1st and 2nd line setting and a peak of 10% in subsequent lines. This equates to peak revenue of $131 million in the U.S. and $210 million worldwide in 2013.

If the higher doses of PA-457 can demonstrate an equivalent or superior efficacy to HIV integrase inhibitors in the upcoming phase IIb study, then we foresee PA-457 to be more widely adopted in the subsequent line setting. In this best case scenario, we project slightly higher market share in the 1st and 2nd line and 20% market share in subsequent lines which results in revenue peaking at $260 million in the U.S. and $418 million worldwide.

PARTNERSHIPS

As of year-end 2005, the company’s cash balance was $87.1 million. Panacos completed an $81 million common stock offering in 2005 and it recently filed a shelf registration statement with the SEC for another $100 million. In order to stay afloat until the expected launch of PA-457 in 2009, the company will either need to raise additional capital from investors and/or strike a partnership deal to generate enough cash to conduct additional clinical trials. We believe that the company, which openly acknowledges that it is exploring partnership options, will announce a partnership in the near future (possibly after positive phase IIb data which may come as early as the fourth quarter of 2006 if the dose-finding portion of the study shows potent viral load reductions). Our current model assumes the potential for up to $300 million in total milestone and licensing payments beginning in 2007. These payments are probability weighted based on our likelihood of approval for PA- 457.

COMPANY VALUATION

Panacos is a particularly binary investment as the company’s fortunes depend nearly entirely on the success of maturation inhibitors, and specifically on PA-457. Based on our revenue estimates, we project Panacos to reach profitability in 2013 and value its 5 and 10-year pipeline at $0/share and $1.17/share. This is significantly below the current market price of $6.50/share.

In a best-case scenario, in which PA-457 were to demonstrate equivalent or superior results to other novel therapies (such as the integrase inhibitors), Panacos’ 5 and 10-year pipeline would be valued at $8.88/share and $6.29/share. This valuation assumes the higher sales projections stated above ($260 million in the U.S. and $418 million worldwide) and the initiation of phase III trials.

With the current price of Panacos at $6.50/share the market is pricing in revenue close to our best-case scenario demonstrated above. While this outcome is possible, we feel it’s a risky assumption at this stage given the competitive environment and our current projection that PA-457 will be a relatively small player in that market. There is also the possibility that Panacos may be acquired, not only for PA-457, but for other compounds the company has identified from its screening platform for fusion inhibitors. While this scenario is also possible, we feel it would be the result of an acquiring company perceiving revenue potential far higher than our current estimates.