A nicotinic fit

Born out of a cigarette maker’s R&D, Targacept is zeroing in on a new treatment for depression that has sent its stock price soaring.
By Ken Otterbourg

The downward spiral started, coincidentally, on Sept. 15, 2008, the day Lehman Brothers filed for bankruptcy protection and the U.S. economy started slipping on the sloppy mess left by risk without responsibility. For Targacept Inc., the problem had nothing to do with credit-default swaps or subprime loans. It was with a molecule known as AZD3480, a pinpoint on a pinpoint that seemed to hold exceptional promise for treating cognitive disorders and the Winston-Salem biotech company’s best chance for cutting a lucrative deal with a major pharmaceutical company.

The results were in on a test of its effectiveness treating Alzheimer’s disease. After the market closed that afternoon, with Wall Street’s swagger melting into the summer swelter, CEO Don deBethizy had to issue a press release that contained a phrase he hated: results inconclusive. Even with a flood of other bad news, investors took note. Targacept stock fell from $8.46 to $5.88 the next day. And it kept dropping, bottoming out at $1.40 Nov. 25. Less than two weeks later, the company reported that AZD-3480 had failed to meet performance criteria as a treatment for schizophrenia. A whiff of panic wafted through the air.

Chief Financial Officer Alan Musso, normally almost annoyingly upbeat, pulled no punches: He told deBethizy the company needed to get serious about conserving cash. To bring down expenses, it didn’t renew contracts of 30 temporary workers and slowed the flow of its drug-development pipeline. Then it waited. There was little choice. Targacept likes to call its approach to drug development a “shots on goal” strategy, and it had only two shots left.

Through the first half of 2009, its shares never got above $5, despite a positive result from a trial for treating attention-deficit and hyperactivity disorders. Then on July 15, it scored a hat trick when its treatment for depression delivered exceptional results in a large trial. It signed a development deal with London-based AstraZeneca PLC worth as much as $1.24 billion if the drug reaches the market, plus royalties on sales. The first payment — $200 million is already in the bank — eased the cash pinch. And its stock soared, hitting $20 in September and reaching $25 in May. By the end of June, its market cap had increased 800% in 12 months, the most among the state’s largest corporations (“Top 75 Public Companies,” August).

Luck played a part in the turnaround. But at its center were three key drivers: the dismantling of Big Pharma as it offloads drug development to smaller, nimbler companies, the need to find new ways to treat depression and Targacept’s risky decision to push through expensive clinical trials on its own dime.

In the past, Winston-Salem’s business successes have been built as much on marketing as on merchandise. Think of R.J. Reynolds Tobacco Co. and the camel. Or Hanes Corp. and its Beautymist pantyhose and Joe Namath. Even Krispy Kreme Doughnuts Inc., before the glaze melted away. Targacept is a different kind of company for a place where commercial innovation traditionally has come through the factory and the cubicle rather than the lab. To understand what Targacept does, it helps to understand the science. And to understand the science, it’s useful to go back to the beginning.

During the early 20th century, some scientists experimented by dabbing a nicotine solution on the exposed muscles of animals and noting the reactions. In 1905, British physiologist John Langley reported his observations on exposing the leg muscle of a chicken to nicotine and started developing the theory behind the body’s neuronal receptors, which regulate the chemicals called neurotransmitters that help control the central nervous system. Not all receptors responded to the nicotine, but those that did were called nicotinic, and that labeling has stuck to this day. Neurons can misfire, receiving too much or too little of the chemicals. Alzheimer’s, for example, is linked to a drop in the production of acetylcholine, a neurotransmitter at the heart of many cognitive functions.

What would eventually become Targacept started in 1982, when Reynolds began a rigorous program to study nicotine. It assembled more than a dozen scientists, and they set to work analyzing how this chemical interacts with the brain. They wrote papers. They applied for patents on molecules they created, and they swapped information with the larger scientific community, which also was beginning to explore the workings and possibilities of nicotinic receptors as a treatment gateway. But RJR wasn’t just doing research for its own sake. Its scientists also helped develop Premier, the company’s ill-fated “smokeless cigarette,” and its successor, Eclipse.

During the ’80s, an emerging body of research suggested that smokers were less likely to develop Alzheimer’s and Parkinson’s diseases. Nicotine appeared to help the cognitive receptors in the brain keep acetylcholine flowing. Problem is, nicotine isn’t very selective. When a smoker inhales, nicotine will bind with nicotinic receptors everywhere — not just in the brain — increasing blood pressure, breathing and heart rate. The idea was that compounds could be developed that targeted specific receptors so that healthy brain activity could be restored. Think of it as a lock and a key. Each of the receptors is a tiny lock, and there’s a potential to develop a molecule that is the key for that lock — and only that lock.

Creating Targacept (which takes its name from “targeted” and “receptors”) as a wholly owned subsidiary in 1997, Reynolds spun it off in August 2000, keeping a 43% stake. An initial public offering scheduled for 2005 was scuttled at the last moment because the price was too low. A year later, it went public at $9 a share. The tobacco giant owned 5.8% of the stock, but its holdings now fall below threshold reporting requirements of 5%.

DeBethizy, 59, came to Reynolds in 1985 from Rohm and Haas Co., now part of Dow Chemical Co. He was a toxicologist who grew up around Washington, D.C., and whose doctoral dissertation at Utah State University focused on dietary fiber and colon cancer. All he wanted was to be a good bench scientist, but his role kept expanding as his bosses realized he was good at explaining science in ways average people could understand. He became, in his words, a “soldier in the tobacco wars,” defending Big Tobacco and its nicotine programs to a skeptical public. Now, he says, “I didn’t realize what an emotional burden and toll being at a tobacco company was.”

No longer in the lab, he still considers himself a researcher, someone who asks hard questions and can cut through the details of technical answers. His job — which earned him $796,026 last year, up 59% from 2008 (page 64) — requires him to move back and forth between the precision of science and his more open-ended mission of communicating with the public and motivating his employees. A convert to the organizational research of Donald Clifton, co-author of Now, Discover Your Strengths, he keeps handy a list of the strengths of each of his 120 employees, based on the formal assessments Targacept uses to determine how to staff project teams. His own strengths: inclusiveness and winning others over, known by the acronym WOO. Weakness: time management.

The path from lab to the pharmacist’s shelf is a brutal obstacle course. After scientists hit on a treatment theory, it must be tested in increasingly larger, more complex and more expensive trials. None ensure commercial success. And since Targacept was selling a new treatment mechanism, it couldn’t piggyback on another company’s work. DeBethizy keeps a hockey stick in his office — not out of a love of the game but as a symbol of this process. During presentations, he would describe the company’s struggles as it tried to make the jump from research to commercialization, where the real money starts flowing in. The imagery kept returning to a hockey stick. The blade, parallel to the ground, represents all the work and risk drug development requires, and the handle, rising sharply, is the potential for reward. “We were down in the blade for a long time,” he now says. “And then we kept getting into the heel, but the fricking market kept running away from us.”

Since going public, Targacept has had only one profitable year: 2006. And that came because it was allowed to recognize a huge research payment as revenue in December rather than January, when it was deposited. It lost $39.4 million in 2009. In recent years, most of its revenue has come from industry research grants and milestone payments made when drugs reach key points on the road to regulatory approval. AstraZeneca has paid Targacept $82 million as part of a research and licensing agreement for AZD3480 that began in 2005. GlaxoSmithKline has paid $45 million since July 2007.

These payments, and the covenants and agreements they represent, are part of the intricate dance that is remaking the research end of the pharmaceutical industry, where the cost of bringing a new drug — including the price of failures — to market averages $1.3 billion. “New-product development is expensive and ties up resources and makes it harder to fund later stage development,” says Kenneth Kaitin, director of the Tufts University Center for the Study of Drug Development in Medford, Mass. “More and more companies are looking at the parts of the process that others should do.”

And like most business deals, it’s all about who takes the risk and who gets the reward. Small companies, such as Targacept, have the research and energy. They have focus and ideas. What they often lack is the cash needed to move an idea from the lab to the market, particularly through the expensive later-stage clinical trials. Enter AstraZeneca or Pfizer or Merck. They’re willing to invest in promising ideas, but it comes at a price. The earlier they enter, the more generous terms they can extract. Conversely, if startups can hold on and present a drug as a surer investment, their reward increases. “There’s a give and take,” Kaitin says. “Big Pharma doesn’t want to lose access to an asset. And in most cases, small companies, which can be undercapitalized, say, ‘The sooner we can unload this asset the better.’”

The selling of AZD3480 illustrates how Targacept played the game. The compound is a molecule that regulates a nicotinic receptor called Alpha 4 Beta 2. It was first thought to hold great promise for treating Alzheimer’s and schizophrenia. As part of its 2005 agreement with AstraZeneca, Targacept received $10 million the next year, then $20 million more in 2007. It was considered the company’s star product until 2008, when it turned in the poor results on key clinical trials in the two treatment areas that sent the stock price tumbling. Work in those areas with this molecule is under further review.

But Targacept had hedged its bets. Noticing that the compound seemed to help adults with ADHD, it paid $500,000 for its own small trial, done at a clinic affiliated with the University of Vermont. The results were positive, and AstraZeneca agreed to pay the company $10 million, with the potential for more than $100 million in milestone payments, plus royalties, if the drug makes it to market. A larger, equally important, clinical trial for the compound is about to begin.

The story of TC-5214 — Targacept’s big hit — is more complicated. It is one of two enantiomers in the drug mecamylamine hydrochloride, which is sold under the brand name Inversine. Enantiomers are molecules that are mirror images of each other. They have the same chemical composition but can have different biological properties. Though approved as a hypertension medication, Inversine was most often prescribed for Tourette’s syndrome, autism and bipolar disorder. As a defensive move, Targacept had acquired the rights to sell the drug in 2002, and in early testing, it saw that TC-5214 had more anti-depressant activity than Inversine.

That was potentially important, but it took a back seat to the other molecules Targacept was testing. “Investors only pay attention to your lead asset,” deBethizy says. So while the company was signing research deals for other compounds, TC-5214 stayed unattached. In July 2008, Targacept began a clinical trial of 579 patients. A test of this size, known as a Phase 2B or proof-of-concept trial, can run upward of $10 million. To bring the price below $4 million, Targacept did what many drug companies now do, conducting the lion’s share of the trials in the developing world. It used 20 sites in India and three in the U.S.

While that was under way in the summer and fall of 2008, the bottom fell out. Concerned about Targacept’s future, deBethizy, considered cutting a deal to license TC-5214 at a discount, ahead of the results. “We recognized that if we had a failure, in ADHD and 5214, we would have to restructure the company, and there was no way I was going to do that. I was focused on survival and not focused on the upside.” But the board of directors stepped in. (Unlike the chief executives at most public companies, deBethizy isn’t chairman — that job belongs to Mark Skaletsky, chairman and CEO of Newton, Mass.-based Fenway Pharmaceuticals Inc.) “There’s been a bit of a roller coaster here in the past two years,” says board member Charles Blixt, a former Reynolds general counsel who has worked with deBethizy more than 20 years. “But nobody’s confidence in the underlying concept of nicotinic receptors has ever flagged.” That confidence pushed directors to discourage deBethizy and his management team from pursuing a deal. “We said we’re not going to just go out and give this asset away. Let’s see where we are.”

“What the board did,” deBethizy says, “was go, ‘Don, you’re doing that assessment on an assumption of what the comparables are. Remember, depression has had nothing new in it in 20 years. If you really hit this Phase 2B, those comparables probably really aren’t accurate. What we would rather do is roll the dice.’”

“If you take something that’s preclinical or Phase 1 and license it at that stage, the economics you get aren’t very interesting,” Musso says. “You don’t have enough downstream to reward you for what you’ve discovered. But if you are able to preserve it through Phase 2, then you are able to get terms that are appropriate for that level of derisking and for that clinical proof of concept.” The gamble paid off handsomely. Targacept netted $10.6 million in the first half of 2010 and has $285 million in the bank. DeBethizy says it can bargain harder with partners over the terms of deals and shepherd more molecules through proof-of-concept tests without signing deals on terms it doesn’t like.

The jackpot that Targacept hit with TC-5214 can in one sense be traced back to a report by the National Institute of Mental Health released in 2006. Called Sequenced Treatment Alternatives to Relieve Depression, it was the largest clinical trial on the ailment, covering nearly 3,000 patients. The results were profound. Only about a third responded to their initial course of treatment, known as first-line medication. And even after changing medication or adding other drugs, only about half described themselves as symptom-free. Clearly, there was a need for something better.

The depression market is enormous, including nearly 15 million Americans. Most existing treatments are in a class known as selective serotonin reuptake inhibitors, and they work by regulating the neurotransmitter serotonin. The list includes Prozac, Zoloft and Celexa. They are among the most widely prescribed medications, but they are also off-patent, meaning that generic drug makers have entered the market and prices and profits have fallen. “Cheap and cheerful” is how deBethizy describes them. In the next three years, three other depression blockbusters — Effexor, Seroquel and Lexapro — will lose patent protection, and they represent more than $10 billion in annual global sales.

Targacept wants TC-5214 to fill that gap, both medically and financially. DeBethizy won’t make estimates, but he says analysts have told him sales could reach $1 billion a year once it gains acceptance. TC-5214, he says, fits squarely in the company’s game plan of targeting “large, unmet needs.” Targacept officials are confident that it will perform well in its Phase 3 trials and lead to a new drug application before the Food and Drug Administration by the end of 2012, but the truth is that it could still stumble. One possible glitch: Some researchers worry that clinical trials in the developing world lead to underreporting of side effects because patients don’t want to lose access to medicine.

Harry Tracy, a pharmaceutical consultant who publishes the industry newsletter Neuroinvestment, named deBethizy its executive of the year, for his vision and perseverance. “Nicotinics have established themselves as the place to be,” he says. “Targacept does a great job of knowing the chemistry. They’ve done their homework. They do nothing else. It’s as promising as any treatments that exist right now.” That said, he thinks Targacept and AstraZeneca will face some hurdles from insurers, who — at least initially — won’t be eager to exchange off-patent depression treatments for the more expensive alternative of an off-patent plus a high-end adjunct. “Patients are going to be started on SSRIs, and then they have to fail. I’m not sure you want to be first on the list of new treatments when the current medication is so cheap.”

Neurological research has come a long way since the days of painting a nicotine solution on a chicken leg. Targacept relies on a collection of proprietary technologies and software that it calls Pentad. Developed at Reynolds, Pentad combines a library of biological data and computer algorithms that allow Targacept researchers to create molecules in a virtual lab and then synthesize only those that are most promising in their ability to react with the receptors. It saves time and money. For example, the company did a virtual screening of 11,000 compounds that might have been selective for the Alpha 7 receptor. Based on those preliminary results, it created 115 compounds in the lab, and 43 of those met other criteria for further review. That winnowing from 11,000 to 43 took just six months. One of the compounds is TC-5619, now in clinical trials for cognitive disorders in schizophrenia and also for ADHD.

Patrick Lippiello, a senior principal scientist at Targacept, likens Pentad to a board of directors. “You want lots of diversity on that board, and diversity of opinion, because no one opinion will necessarily be the right answer. It’s the consensus of all of them. And that’s how the system was designed. It’s not one algorithm. It’s batches of algorithms working together to kind of come to a consensus answer.”

Lippiello, who has been with the company since before it was spun off, thinks Targacept is just beginning to hit its stride. “That’s the beauty of the nicotinic platform. Most people are dealing with a single target, and if it doesn’t work, they’re a one-trick pony and they’re gone. The incredible diversity of indications that can be addressed with this receptor because of the subtypes and the many different things they do. That’s a luxury most companies don’t have. That’s why we‘ve been able to sustain as long as we have. We’ve had failures, but there are plenty of other opportunities for success.”

A few blocks from Targacept’s headquarters is a statue of Richard Joshua Reynolds, who arrived in Winston-Salem in 1875. His cigarettes created much of the city’s wealth, and the controversy over them led to the R&D team that was the genesis of Targacept. The tobacco company, now part of Reynolds American Inc., is in the process of closing its last cigarette factory in Winston-Salem, but its empty warehouses and old factories downtown are being recycled, and they — along with a few modern buildings — form the backbone of Piedmont Triad Research Park.

The park is part of Wake Forest University, and the goal is daunting: to create 27,000 jobs by 2035 on 230 acres sprawling along the east side of downtown and to rebrand the city as a center of the life-sciences industry. Right now, about 55 companies and 1,000 jobs (half of those through Wake Forest) are in the park. Targacept is the largest business tenant, and officials dote on the company, aware of its potential both to create jobs and to help market the place to other companies.

Park President Doug Edgeton says Targacept’s success has helped leaders here rethink strategies. “For the longest time, the thought was that you had to have an anchor tenant. That predominated the thinking. The truth of the matter is that our park is going to grow from small, smaller, midlevel companies more than likely, than relocating a huge group like a GlaxoSmithKline.”

It’s not that the research park has stopped chasing Big Pharma, but Edgeton says that research created here — whether at Targacept or at the other big draw, Wake Forest Institute of Regenerative Medicine (“Grow Your Own,” July 2005) — has the potential to create clusters and build expertise in expanding fields. “If you have something unique in the world, people will want to be near it,” Edgeton says. “And you have to provide the space. If you don’t provide it, somebody else will.”

Targacept’s relationship with the park goes back to 2000, when the company, leaving Reynolds, needed space. Edgeton had just arrived from University of Alabama at Birmingham, and he put together a business plan that resulted in Wake Forest buying Targacept’s present building and leasing the top two floors to the company. A decade later, it is about to take over the rest of the space. This is the perfect place for his company to grow, deBethizy says, adding that whatever initial concerns board members had about recruiting top-class scientists to Winston-Salem are no longer an issue.

Targacept held its annual meeting in June. It was a low-key affair, with company officials outnumbering the handful of outsiders nearly 10-1. There were muffins, juice and a Power Point display, and deBethizy outlined what’s on the horizon. Along with the depression, ADHD and schizophrenia drugs that are on the cusp of commercialization, the company is starting to tap into the promise of receptors as a way to target inflammation in such diseases as asthma, colitis and arthritis. All of these, he said, are large markets with thousands of patients who don’t respond to existing medications.

There was no hockey stick in the meeting room, but deBethizy didn’t pass up a chance to use a metaphor again, one that speaks to Targacept’s ability to move past the failures to find success. “The one thing about biotech companies, especially for first-in-class opportunities, is you have to have shots on goal, and you’ve got to have multiple opportunities because the risk of failure in any one program — as you know in drug development — is fairly significant.”

Ken Otterbourg is a Winston-Salem writer.