Low-Risk Biotech Could Double

03/17/2011 11:18 am EST

Focus: STOCKS

Michael Murphy

Former Editor, New World Investor

Development-stage biotech Zalicus, which already has one painkiller selling well, could play its niche—combining two drugs that have FDA approval, thus avoiding the risky gambles associated with testing an all-new drug—into an easy double or triple by the end of the year, writes Michael Murphy of New World Investor.

Zalicus (ZLCS)—my top pick for a biotechnology stock breakout in 2011—is proving its worth, based on fourth-quarter results.

The company burned $2.1 million in cash during the quarter, and ended the period with $46.5 million in cash and equivalents. As is usual with development-stage biotech companies, aside from cash levels and cash burn, the accounting numbers were less important than management’s program update.

Zalicus has one product on the market: Exalgo, for chronic pain, marketed by a subsidiary of Covidien (COV).

When Covidien reported their results, they mentioned “good sales of our new Exalgo” product. I had forecast $400,000 in Exalgo royalties to Zalicus in the December quarter, so I was pleased to learn that they hit that right on the button.

With the initial distributor inventory back in balance, from here on Exalgo royalties should track prescription growth.

This year, I expect Covidien to target 12,000 frequent prescribers and sell about $50 million in Exalgo, yielding around $4 million to Zalicus at my 8% royalty estimate. Sales should increase to $100 million in 2012, $200 million in 2013 and level off at around $300 million in 2014.

The associated royalties of at least $8 million, $16 million and $24 million will help fund research and clinical trial expenses, with no stock dilution. Zalicus says the royalty rate is “tiered,” so my 8% estimate is conservative.

The Pipeline Is Filled with Projects
There are many reasons to bank on Zalicus moving higher in the months ahead.

Zalicus has an extensive patent portfolio in ion-channel blockers. These are drugs that control pain by blocking proteins that transmit electrochemical signals between cells.

The company’s business model is to get most drugs through dosing trials with some efficacy data, and then partner them for further development on someone else’s nickel. The pain medication market is huge—more than $14 billion—and current drugs often have gastrointestinal and cardiovascular side effects, or are highly addictive.

The company’s other drug discovery platform takes two approved drugs, combines them, and screens for a better drug for the original condition, or an all-new use. Because the side-effect and clinical profiles of the two approved drugs are known, they can have some confidence that the safety trials will go well, and focus on efficacy.

The lead drug candidate here is Synavive, a once-a-day pill that has completed multiple Phase II studies, and is about to start another one, for rheumatoid arthritis. In addition to rheumatoid arthritis, Synavive may be useful in osteoarthritis and Crohn’s disease, as it amplifies and reduces the need for steroid therapy.

The company also has a discovery collaboration with Novartis (NVS), using the same screening platform for oncology research, which Novartis just extended to May 2012. Zalicus just began a second funded research phase of another oncology pilot program with Amgen (AMGN). Sanofi-Aventis (SNY) is another partner.

Although Zalicus is up nicely from my original recommendation, it still has a total market capitalization of less than $190 million. Against that, it has $46.5 million in cash, no debt, a $254.6 million net operating loss carryforward to be applied against future taxes, and a drug on the market that will show accelerating royalties.

Exalgo alone is worth $1.50 a share. I still think Zalicus will end 2011 between $4 and $7 a share, roughly a double or triple from current prices, and be one of the top-performing stocks of the year. [Shares rose 3%, topping $2 a share Thursday—Editor.]

This remains what some call an oxymoron: A low-risk, development-stage biotech.

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