Zalicus (NASDAQ: ZLCS) was my pick for the InvestorPlace contest for the best stock of 2011, and it has been doing well, running from $2.30 in mid-April to over $3 by the end of the month. As so often happens in small-cap and biotech investing, life threw them a curve in the March quarter, and the stock is back to $2.30. But I don’t think it will stay there for long.
Zalicus is the top performer of the 10 stocks on the InvestorPlace.com list, with 43% returns year-to-date in 2011. (Check out the complete list of 10 stocks)
Although Zalicus is a development-stage biotech company focused on alleviating pain, they do have an approved drug. That prescription drug is Exalgo, which is marketed by Mallinkrodt, a subsidiary of Covidien (NYSE: COV). Exalgo is a timed-release version of Dilaudid (hydromorphone), a well-understood pain drug, and is the only long-acting form of hydromorphone approved in the U.S. It is not a hard sale to convince a doctor to prescribe a once-a-day version of this popular drug, as it increases patient compliance and, in an institutional setting, reduces costs.
Exalgo was approved on March 1, 2010, and following the usual practice, Covidien shipped a large amount of the drug to build up pharmacy inventories in the June quarter, generating a $1.1 million royalty payment to Zalicus. Covidien then began marketing the drug, and as prescriptions grew, pharmacies filled them from inventory. This also is typical practice – prescriptions grow much faster than shipments of the drug at first, and the royalty payment to Zalicus fell to $100,000 in the September quarter and increased only slightly to $400,000 in the December quarter.
In the March quarter I was expecting $1 million in royalties, and sales of the drug probably were strong enough to justify that. In Covidien’s conference call Richard Meelia, Covidien’s CEO, said: “Exalgo’s right on plan, doing very well, and there’s a lot of expectation that it may exceed our original forecast, so that’s good.” They were very pleased with the uptake of the drug.
But in the Zalicus conference call nine trading days later, we learned that Covidien had made numerous deals with their customers promising rebates and inventory adjustments, and that when these were deducted from the actual sales, the resulting royalty to Zalicus was only $350,000. The stock sank back, giving you an excellent second chance to start or add to positions.
Exalgo is selling more and more each quarter, on a trajectory to reach Covidien’s target of $200 million to $300 million in sales. I think the royalty payment to ZLCS will hit $1 million or more this quarter if the Covidien rebate programs are over, and climb from there. That is the first reason to buy or add to ZLCS now.