A company in the small cap biotech space worth a quick look is Santarus (SNTS). Santarus is a special situations play with several near-to-medium term catalysts. As a background, the company currently markets(1) two products, Zegerid and Glumetza, and has several product candidates in Phase III. The company’s financial position is currently stable with positive net income, net cash per share of $1.45 (versus a recent share price of $2.45) and access to a $25 million revolving line of credit.(2) Why the depressed share price?
In April 2010, the company’s shares plunged by over 30% on a (very) unfavorable court ruling regarding the company’s patents for Zegerid.(3) The case dated back to 2007 to challenge Par Pharmaceutical’s (PRX) ANDA filing for a generic form of Zegerid. This ruling coupled with Par’s ANDA application basically put SNTS’ core product and source of 75% of total revenues at substantial risk. In June the company implemented a comprehensive internal restructuring and a strategy to introduce their own generic version of Zegerid to offset the damage from the loss of product sales.
Despite the discussed issue, given the current stable financial position of the company, SNTS makes an interesting speculative play with favorable risk/reward characteristics driven by several future catalysts:
- Court Ruling: The company filed an appeal to the court decision in May. A positive outcome will, without a doubt, cause a significant share rise back to the pre-court ruling value of around $7. Make no mistake, however, the timing (and potential positive outcome) of this catalyst is uncertain but likely more than six months.
- Cycloset: Cycloset is an FDA-approved drug for the treatment of type 2 diabetes. SNTS recently announced a distribution and license agreement with VeroScience and S2 Therapeutics regarding this drug – the news of this deal briefly caused the shares to rocket-up 21%. Commercial launch is expected in November 2010. Santarus will record all sales of Cycloset and pay a product royalty of 35% of the gross margin to S2 Therapeutics and VeroScience.(4) In my opinion, SNTS should be positioned to provide some update on the P&L contribution of Cycloset by 1Q’11. Any positive data should help to begin to shift focus away Zegerid and support the share price.
- Phase III top-line data: Santarus has three Phase III product candidates including Budesonide MMX for ulcerative colitis, Rifamycin SVMMX for travelers’ diarrhea and Rhucin for hereditaryangioedema. Regarding Budensonide, the company is expected to announce top-line data for two Phase III studies in September. If eventually approved, SNTS estimates product revenues of $150 to $250 million per year. SNTS is currently enrolling patients in Phase III study for Rifamycin. The company estimates potential product revenues of $50 to $150 million. Finally, Rhucin was granted Orphan Drug and Fast Track Status in the U.S. for treatment of acute attacks of HAE with estimated sales of up to $200 million.(4)
Here is the structure I am using to trade this situation (amounts are for example; only the ratio matters):
Sell 10 NOV 2.50 Put @ 0.35 ( = (10) * 0.35 * 100 = $(350) Credit)
Sell 20 FEB 2.50 Put @ 0.75 ( = (20) * 0.75 * 100 = $(1,500) Credit)
Buy 50 NOV 2.50 Call @ 0.35 ( = 50 * 0.35 * 100 = $1,750 Debit)
Initial Position P&L = (100) Credit
This position is basically a ratioed synthetic stock position that I am getting paid to initiate (this trade was done for a Credit). If Phase III data is positive in September, the Call position should generate solid gains. In my opinion, the Calls are currently quite cheap and do not reflect potential upside (especially given the November expiration!). In a negative scenario, the stock will likely drop – I do not believe the drop will be that large in absolute terms as the stock should be supported by a high cash per share value ($1.45), access to additional liquidity and the large number of other impending price catalysts/revenue generating opportunities. In the negative situation, the November expiration (beyond the September data catalyst) may also provide additional opportunities for the stock to rally and to thus “double dip” on the same Calls. If the shares fail to rally above $2.50 by expiration, I will be assigned the shares and thus maintain the option to hold, sell the shares, or sell Calls against the shares. Over the term of the trade, I will continue to hold the sold FEB '11 2.50 strike Puts and benefit from time decay (supported by longer term catalysts mentioned herein).
(1) Promotion revenues for Glumetza with Depomed.
(2) Santarus recently extended the maturity of its $25 million revolver to July 2013 which I view as bullish for the company’s prospects – despite tight covenants, main street commercial banks tend to be risk averse; an extension of the maturity communicates that the bank is comfortable with the risk.
(4) Source: Company Presentation, September 15, 2010.
Disclosure: Long Calls, Short Puts