The Best Biotech Arbitrage Opportunity Right Now

by: James Altucher

I'm on a constant hunt for stocks with potential for 10x returns. I first started writing about Dendreon (NASDAQ:DNDN) when it was below $5, Genworth Financial (NYSE:GNW) at $1.00, and more recently Pharmathene (NYSEMKT:PIP) at $1.90 as examples. All have had significant gains. When I wrote the book, "Trade Like Warren Buffett" I learned that Buffett's primary trade when he was building his initial wealth was to find very safe arbitrage opportunities: stocks that had assets significantly greater than what their market cap was worth. Many of the situations I focus on and like to own for myself are arbitrage opportunities where you can buy a $1 bill for 50 cents. Then you know your downside is protected with the potential for significant gain.

Callisto Pharmaceuticals (OTC:CLSP) is the best and clearest arbitrage opportunity I've seen in a long time. There are two arbitrages at play here.
The basic arbitrage:
CLSP owns 48% of Synergy Pharmaceuticals (NASDAQ:SGYP). I'll describe Synergy in a second and why Synergy itself could be a strong buy at these levels. But even without that, here's the basic math: Synergy has a market cap of about $380mm. Callisto owns 48% of SGYP. That 48% this moment is worth $182mm. So CLSP has an asset worth $182mm.
CLSP's market cap is $86mm. (155mm shares outstanding fully diluted, price of 0.56). If the market was to fully value CLSP given its $182mm asset, then the stock price would be about 1.20, an immediate return of over 110% from today's price.
But wait, the story gets even better with a relative value arbitrage that exists between Synergy and Ironwood Pharmaceuticals (NASDAQ:IRWD) a $1.1bb market cap company that was the hottest biotech IPO of the year.
The real arbitrage
Synergy (whose Chairman is an ex-SIGA 13G shareholder) is in the same business as Ironwood Pharmaceuticals (IRWD). Both companies develop a drug for IBS (irritable bowel syndrome). Over 100mm people on the planet suffer from some form of IBS (primarily severe constipation). Both companies have had great clinical data. On November 2, Ironwood reported good Phase III results. On October 6, Synergy reported positive phase IIa results which had (as we'll see below) better safety results than Ironwood's drug in the same phase and similar efficacy results. Ironwood's drug and Synergy's drug are very similar. In fact, the scientistis for each company that developed their respective drugs both came out of the same laboratory in Monsanto (NYSE:MON).
There are two key differences though:
  1. Ironwood's drug has a potentially very negative side effect: diarrhea. According to a Merrill Lynch report written by their research analyst Rachel McMinn on October 6, about the Synergy drug: "The one specific detail noted is that none of the patients experienced diarrhea, a side effecte noted with [the Ironwood drug]." She also notes, "the mechanism of action of the two drugs is identical." In other words, we have a potential $20bb market with two drugs that act the same, except one drug causes "Montezuma's revenge" (Ironwood) and the other doesn't (Synergy).
  2. Ironwood has sold off 50% of its royalties in the US and Europe. Why is this significant? Ironwood's primary asset is this drug, which they've sold off 50% of their potential gains. With a $1.1bb market cap, its as if the market is valuing the value of the drug at $2.2bb. Synergy, with a $380mm market cap, owns 100% of its drug. There's an enormous arbitrage between Synergy's $380mm market cap and the $2.2bb technical value of Ironwood's drug. Both companies have the same asset, but with wildly different valuations, and with a significant side effect on the Ironwood drug.
So you could make the argument that Synergy could have a 2.2B value down the road which would be north of $22/share which would result in CLSP being worth 1.1B or nearly $7/share. I like to have as much margin of safety as possible in an investment. In this case we have two arbitrages: At current market caps, the value of Synergy suggests that CLSP should trade closer 1.20 per share, an immediate improvement of 114% over current levels. As the market begins to value Synergy's drug closer to Ironwood's drug (and research firm, Global Hunter, has already assigned a price target of $5.50 on Synergy based on catalysts they expect to happen in the next few months), CLSP can trade as high as $7 / share (although that is certainly over time). So at a current level of $0.56 share its a great immediate opportunity as an arbitrage play and a long-term deep value play eventually heading towards $7/share.

Disclosure: Long CLSP