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Implications for Trius Shareholders

Cubist Pharmaceuticals (CBST) and Trius Therapeutics, Inc. (TSRX) announced that they have signed a definitive agreement under which Cubist will acquire all outstanding shares of Trius for $13.50 per share in cash. In addition, Trius shareholders will receive a Contingent Value Right that entitles Trius shareholders to receive up to $2.00 for each share owned depending on the achievement of certain sales milestones for tedizolid.

I project that tedizolid will be approved and launched commercially in the U.S. in 2H, 2014 and Europe in mid-2015. I have projected a launch that produces U.S. sales of $39 million in 2015 (the first full year of marketing), $137 million in 2016 and $625 million in 2020 respectively. International sales potential could be of the same magnitude. While the milestones needed to achieve the full payment on the CVR haven't been delineated, I would be reasonably confident that if my estimates are reached, Trius shareholders will receive the full $2.00, probably in the 2018 to 2020 period. The CVR is worth about $1.00 to $1.25 if it is discounted at a 10% rate and milestones are reached in 2018 to 2020.

My research focuses on small emerging biotechnology stocks in which there is high risk and high reward. I sometimes get it wrong, but in the case of Trius I got it right and I just thought I would take a victory lap. I first recommended Trius on May 30, 2012 in a report entitled Trius Therapeutics' Tedizolid has Blockbuster Potential for MRSA Infections (TSRX, $5.05) and have consistently recommended purchase over the past year in reports on Seeking Alpha and my website. The takeover price represents a 270% return in one year based on the $13.50 and nearly a triple if you believe my analysis of the CVR.

This is a perfect example of my asymmetric investing approach which is based on the assumption that when the analysis is correct on small biotechnology stocks, the reward is so substantial that one winner can offset multiple losers. Let's assume that we decided to put equal amounts of money into Trius and two other stocks a year ago and that the two other stocks declined 50%. In this scenario, the investor would still have realized a one year return of 33%. Hopefully, the success ratio will be a little better than this, but the key is to diversify the portfolio among several stocks that have asymmetric upside potential.

This Is a Great Acquisition for Cubist

I have not written on Cubist, but I see this as a wonderful acquisition for the Company. Cubicin (daptomycin) cannot be used in pneumonia because it is degraded by surfactants in the lungs. There are three major types of infections in the hospital market: skin and soft tissue, lung and bacteremia. Tedizolid allows Cubist to compete in the lung market. Also, the oral formulation of tedizolid will allow Cubist to compete more effectively in the treatment of long-term infections like osteomyelitis that require weeks or months of treatment.

There is still another subtle but important component of this acquisition. On May 30, 2013, I wrote a report entitled Trius Therapeutics: Newly Allowed Patent Provides Important New Dimension to Investment Outlook. At the time I wrote:

"Trius announced an important new development today that bolsters my investment case for Trius and I continue with my Buy on the stock." In a recent report, I explained why I thought that Trius could potentially reach $40 per share in 2020. This bolsters the potential for achieving that lofty price target.

I want to make it immediately clear that the patent application that is the subject of this report is based on non-clinical studies that have yet not been confirmed in human studies. However, non-clinical data for antibiotics have considerable predictive importance for human studies. It is a well-established principle that the in-vitro activity of antibiotics is a surrogate for the activity in the human body if in-vitro concentration of the drug matches that of in-vivo. There have been comparable examples in the development of hepatitis C virus drugs in which non-clinical data were important harbingers of human activity and I think that this could be the case here.

Trius has discovered that a low dose formulation of tedizolid when combined with Cubist's blockbuster antibiotic Cubicin (daptomycin) can significantly reduce the emergence of bacteria resistant to daptomycin. Daptomycin plays a major role in treating bacteremia (systemic infections including those of the blood and heart) and the emergence of resistance is a serious clinical concern. This discovery led to a recently allowed patent application; tedizolid seems to be much more effective than any other available antibiotic in this regard.

As will be discussed later in this report, this discovery could provide a valuable pathway forward for tedizolid that can shorten the potential time of approval in bacteremia from 2018 to 2016. The recent passage of the GAIN Act, which is intended to allow the FDA to move more quickly to advance important new antibiotics, also works in tedizolid's favor.

Bacteremia is a very large commercial opportunity and moving the approval timeline forward substantially increases net present value of the Company.

An interesting angle in this unfolding situation is how this discovery affects Cubicin and how Cubist might react from a business development standpoint. The combination could address the concern that growing bacterial resistance to daptomycin, particularly in bacteremia, could negatively impact the usage of Cubicin in bacteremia. Bacteremia accounts for approximately one-third of Cubicin sales in the U.S. and is a strategic growth area for Cubist. Cubist is also faced with even more troubling commercial issue on U.S. sales of Cubicin which account for about 95% of current corporate revenues. Cubist agreed to a patent settlement which allows Teva (NYSE:TEVA) to introduce a generic daptomycin in 2018, which will cause a very sharp erosion of sales.

The discovery by Trius that a tedizolid-daptomycin combination largely eliminates the key weakness in bacteremia treatment could be the answer to two major problems facing Cubist. It could address the problem with emergent resistant bacteria and it could also blunt the generic risk in 2018. I think that if (and when) Cubist concludes that the combination of tedizolid and daptomycin has such value; it should be highly incented to offer Trius a lucrative partnering deal or perhaps just to acquire Trius outright. Trius currently has a market value of $359 million and Cubicin has a market value of $3.1 billion. Cubicin currently has cash and short-term investments of $850 million."

Disclosure: I am long TSRX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.