Wow! This Biotech IPO Doubled on Day One

Source: Axovant Sciences, Ltd.

Shares in Axovant Sciences Ltd soared on their first day of trading, nearly doubling from their IPO price. There are, however, a lot of question marks associated with this instant biotech darling that investors should consider before jumping in and picking up shares.

First, a bit of backgroundBermuda-based Axovant Sciences didn't exist until late last year when it was created by the upstart private biotech firm Roivant Sciences, to shepherd along RVT-101, an Alzheimer's disease drug formerly under development by GlaxoSmithKline as the drug SB742457. In December, GlaxoSmithKline agreed to sell Roivant rights to SB742457 in exchange for $5 million up front, 12.5% royalties on future sales, and milestone payments that total in the tens of millions of dollars, depending on Axovant Sciences' success in developing and commercializing the newly-named RVT-101.

The deal would seem to be a steal based on investors reaction to Axovant Sciences' IPO -- which was the biggest in biotech history. Exiting day one, investors had bid up Axovant Sciences' market cap to nearly $2.8 billion.

Why so much excitement?Drug developers have had limited success in developing drugs that successfully address the myriad symptoms associated with Alzheimber's disease, but those drug that have made their way to market have been top-sellers. One of the most widely-prescribed of these Alzheimer's disease drugs is Aricept, a cholinesterase inhibitor that slows the breakdown of key enzymes tied to cognition. Actavis' Namenda is another widely-prescribed drug that boosts the activity of enzymes associated with memory and learning.

Those two drugs have been big commercial successes. Prior to losing patent exclusivity, sales of Aricept were roughly $2 billion per year, and in the first quarter, sales of the original version and the long-lasting formulation of Namenda totaled a combined $396 million.Clearly, Aricept and Namenda indicate that there's significant market potential for Alzheimer's therapies.

That may even prove to be an understatement given projections for growth in the number of people diagnosed with the disease. An estimated 5 million people suffered from Alzheimer's disease in the U.S. in 2014, and that number is expected to climb to 13.8 million by 2050.

Causes for concernThere's little debate that there's a major unmet need for new and increasingly effective Alzheimer's disease treatments; however, investors ought to exercise some caution when considering buying shares in this company. GlaxoSmithKline decided not to pursue internal development of RVT-101 following its phase 2b trial. Conceivably, if GlaxoSmithKline believed that this drug was a de facto blockbuster, they would have ponied up the funding for phase 3, or ostensibly asked for a higher upfront payment when they sold it to Roivant.

Investors may also be correct to wonder why other deep-pocketed suitors didn't line up to buy this compound from GlaxoSmithKline, and if they did, why weren't any of them willing to offer GlaxoSmithKline more generous terms? Investors should also remember that Alzheimer's disease drugs are notorious for struggling during clinical trials, and that historically, between 30% and 40% of all phase 3 trials end up failing.

Additionally, investors should remember that large, late-stage trials are incredibly expensive. Despite this IPO providing the company with funding that it estimates will carry it through phase 3 trials, which should wrap up in time to provide an opportunity for a potential filing in 2017, there's no guarantee that costs won't end up eclipsing their estimates, resulting in additional and dilutive capital raises down the road.

Looking aheadThe risks facing Axovant Sciences' investors are real, but to Axovant Sciences' credit, it has established a deep bench of talent with a proven track record. Among the employees responsible for developing RVT-101 will be Lawrence Friedhoff, who led the development team responsible for Aricept, Lawrence Olanoff, the developer behind Namenda, and Atul Pande, the person who led GlaxoSmithKline's efforts on this drug before it was sold.

Investors should also have some confidence in Axovant Sciences' CEO, Vivek Ramaswamy. Ramaswamy is a former hedge-fund star with the multibillion hedge fund firm QVT, so he knows his way around the business end of biotech.

All in all, RVT-101 is intriguing for being a potential new weapon that could be used alongside Aricept to boost cognition, but I'm not fully convinced that Axovant Sciences is worth the $2.8 billion market cap that investors awarded it on its IPO. For that reason, I'll sit this one out for a bit, and see if shares dip once the IPO hype fades.

The article Wow! This Biotech IPO Doubled on Day One originally appeared on Fool.com.

Todd Campbell has no position in any stocks mentioned. Todd owns the independent equity research firm E.B. Capital Markets, LLC. E.B. Capital's clients may have positions in the companies mentioned.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.