Last Updated: 2007-03-29 16:00:16 -0400 (Reuters Health)

By Toni Clarke

BOSTON (Reuters) - Cephalon Inc. is expected to win approval for a tweaked version of its sleep disorder drug Provigil on Friday, but the risk of a negative surprise may be higher than some expect.

Analysts expect the U.S. Food and Drug Administration to approve the drug, Nuvigil, though probably with a warning that it could cause a serious skin rash.

The reaction of Cephalon shares, which have risen 8 percent to $71.44 over the last 10 days, will depend on the severity of the warning, which is expected to also be added to the label for Provigil, since the two drugs share the same active ingredient: modafinil.

If the FDA requires a broad "black box" warning, the most serious, or if the drug is rejected outright, Cephalon's stock will likely plunge, since Provigil is the company's biggest selling product, with annual sales of nearly $730 million.

Despite the recent gains in Cephalon shares, activity in the options market suggests more pessimism about the outcome than those gains imply.

"There is a lot of money out there betting both ways," said William Lefkowitz, options strategist at brokerage firm vFinance Investments in New York. "However, there appears to somewhat of a negative bias because the puts are more expensive than the calls."

The FDA has focused a particularly harsh spotlight on Nuvigil, which is almost identical to Provigil. Both drugs are designed to treat excessive sleepiness, sleep apnea and shift-work sleep disorder.

Provigil has been on the market for nearly a decade and has a relatively clean safety record. However, the FDA has delayed approval of Nuvigil -- which Cephalon hopes will take over from Provigil once Provigil's patent expires in 2012 -- to probe any potential link to a severe skin rash.

Last year the FDA rejected a drug called Sparlon that Cephalon had hoped to get approved for attention deficit hyperactivity disorder. The agency cited a suspected case of Stevens Johnson Syndrome, a potentially disfiguring skin rash that has been associated with numerous drugs.

Sparlon was little more than a higher-dose version of Provigil, and the suspected case of Stevens Johnson Syndrome was never confirmed. But the FDA, which made its Sparlon decision amid an intense political debate over drug safety following the withdrawal of the painkiller Vioxx, has focused on the suspected case with an intensity some consider irrational.

"Compared to many drugs out there, the safety of Provigil is extraordinary," said Dr. F. Xavier Castellanos, professor of child and adolescent psychiatry at New York University School of Medicine, who has no ties to Cephalon. "It's hard to even kill a rat with it."

Analysts are betting that the FDA will approve Nuvigil, and that a warning, as long as it is not too severe, will not substantially hurt sales.

"We view the most likely scenario as Nuvigil approval and warning language in both labels that could have a modest negative impact on share growth," Gregg Gilbert, an analyst at Merrill Lynch, said in a recent report.

"That said, we believe that there could be significant downside if the labels include black box warnings that prevent growth or if Nuvigil is not approvable."

(Additional reporting by Doris Frankel in Chicago)