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By Jake King

Large-cap drug company Eli-Lilly (NYSE:LLY) must have liked what it saw in April when Transition Therapeutics (NASDAQ:TTHI) reported its Phase Ib proof-of-concept results for TT-401, a novel drug candidate being developed for diabetes and obesity. The companies revealed on Monday morning that Lilly would be taking over development of the GLP-1 agonist in an amended and lucrative deal for the smaller Canadian drug developer.

We reported on this small-cap name before and after the late April trial results were released, and investors following our write-ups profited by over 65% in the stock. Monday's news, with Lilly taking over full development of TT-401, represents more good news for Transition, as Lilly could have waited until after a Phase II trial before exercising its option on the compound. Transition licensed TT-401 and a number of other pre-clinical assets from Lilly in 2010 before initiating the first clinical trial of TT-401 at the end of 2011. Now, LLY is paying Transition $7 million for the successful Phase Ib data, and will fully fund the later development and commercialization of TT-401 per an amended agreement between the two companies. In order to retain strong economics on future sales of the drug (double-digit royalties according to this morning's press release), Transition has agreed to contribute $14 million to the Phase II development of TT-401, which it will make in three separate installments based on the new agreement.

Transition reported that it had $22.9 million in cash and equivalents on March 31, and with LLY's $7 million payment to take the drug candidate fully in-house, the $14 million in future payments should be well within Transition's grasp, particularly given that LLY will now pay for all other expenses related to the drug's development. Transition's other lead asset, ELND005, is also fully funded by partner Elan Corp. (NYSE:ELN), meaning that expenses for Transition will remain remarkably low. In related news, Elan shareholders rejected the divestiture of certain assets, thus ELN will continue to own and fund the advancement of ELND005 as opposed to spinning the asset out into the Speranza vehicle as originally planned. In our view, ELND005 remaining as part of the ELN product portfolio will keep the visibility of the asset at a higher level than if it went to Speranza, an incremental positive for TTHI.

Expect shares of TTHI to trade up on Monday's news, especially given that Lilly exercising its option on TT-401 at its first opportunity validates the drug candidate, and indicates that the full Phase Ib data set is robust. Transition has yet to present the full data set from the Phase Ib, but we expect Transition or Lilly will publish in a medical journal, or present publicly, the results in the second half.

In connection with TTHI, PropThink has taken a long position.

Source: Good News For This Small-Cap Biotech: Eli Lilly Wants To Develop Its Diabetes Drug

Additional disclosure: PropThink is a team of editors, analysts, and writers. This article was written by Jake King. We did not receive compensation for this article, and we have no business relationship with any company whose stock is mentioned in this article. Use of PropThink’s research is at your own risk. You should do your own research and due diligence before making any investment decision with respect to securities covered herein. You should assume that as of the publication date of any report or letter, PropThink, LLC and persons or entities with whom it has relationships (collectively referred to as "PropThink") has a position in all stocks (and/or options of the stock) covered herein that is consistent with the position set forth in our research report. Following publication of any report or letter, PropThink intends to continue transacting in the securities covered herein, and we may be long, short, or neutral at any time hereafter regardless of our initial recommendation. To the best of our knowledge and belief, all information contained herein is accurate and reliable, and has been obtained from public sources we believe to be accurate and reliable, and not from company insiders or persons who have a relationship with company insiders. Our full disclaimer is available at www.propthink.com/disclaimer.