by Michael Murphy | May 23, 2011 9:21 am
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.
Zalicus has a second important project that they partnered with Fovea, which was bought by Sanofi-Aventis primary for this program. It is Prednisporin for ophthalmic indications, beginning with allergic conjunctivitis. Sanofi has completed a large Phase II study, and we are waiting for them to announce the results. I expect the data to be very positive, and then Sanofi will spell out its plans to advance to Phase III trials. This is the second reason to buy ZLCS now.
Their third and fourth partnered programs are drug discovery collaborations with Novartis, which exercised an option to continue for a second year, and an early program with Amgen. Zalicus owns a high-throughput drug discovery technology focused on testing combinations of existing approved drugs, and any new combination drugs that come out of these relationships will earn royalties for Zalicus. The Novartis relationship alone calls for $4 million upfront, up to three years of research funding, and up to $58 million in milestone payments per combination drug.
On their own nickel, Zalicus has developed Synavive for immuno-inflammatory diseases, where they have completed multiple Phase II studies. It is essentially a patented, low-dose steroid that avoids the usual side effects, but with an amplified anti-inflammatory effect. The first application is rheumatoid arthritis, where patients eventually advance from oral drugs to expensive injected biologics. Synavive can delay the need to put a patient on a $2,000 a month injectable, with a once-a-day oral drug (much preferred by patients) that has lower toxicity that common steroids.
Synavive has been through many Phase II studies and shown high and sustained efficacy without a single adverse event. The company has planned a Phase IIb study of 250 patients, each dosed for 12 weeks at one of 60 treatment centers around the world. It won’t take long to get the efficacy data, and the company will follow with the one-year safety study that eventually will be required for approval. Zalicus is waiting for FDA feedback on their Phase IIb study design any day, and expects to begin enrolling patients in June. This is a third reason to buy ZLCS today.
The focus of the company today is on ion channel blockers, both calcium and sodium channels, to control pain, a $14 billion market. Z160 is an N-type ion channel blocker for chronic pain that Merck developed under a 2006 license, including Phase I and Phase II trials. Merck discontinued the program and gave the drug back to Zalicus. Zalicus scientists reformulated the drug to dramatically increase bioavailability, and it will be in human clinical trials again by year-end.
Z944 is a T-Type ion channel blocker for chronic and acute pain now in animal toxicology studies, which should be in a Phase I human trial by year-end. The company has numerous other T-type and sodium channel blocker candidates for chronic pain in development.
Zalicus has a very experienced management team. The CEO and EVP-R&D have their names on 14 approved drugs between them. Most biotech managements are lucky to be able to name one drug they developed that made it to market. The company raised $19.2 million in March and April, and had $52.8 million in cash at the end of March, plus $4.1 million raised in April, plus a $20.0 million secured credit facility. They burn about $9 million in cash each quarter, but they think they can fund their operations from cash, royalties and milestone payments into 2014.
I am still confident that between the quarterly announcements of the Exalgo royalty payments, the Sanofi data and Phase III plans for Prednisporin, the Synavive Phase IIb trial commencement, the early clinical trials for their ion channel pain medications, and additional partner announcements for their drug discovery platform that ZLCS will be at $7 a share by the end of 2011.
Check out the other FREE stock picks that make up InvestorPlace.com’s Top 10 Stocks for 2011.
Michael Murphy is the editor of New World Investor. He is currently recommending Zalicus and Antares stock in his newsletter. Read more about Michael and his strategy at NewWorldInvestor.com.
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