The Short Case for Zalicus: Not Worth Its Market Cap

The fair value of Zalicus (ZLCS) shares is about $0.50 to $1.00. Our fund is short Zalicus.

Calculating the fair value of Zalicus is relatively straightforward. There are two main assets, Exalgo and Synavive.

Exalgo is a pain drug sold by Covidien (COV). The royalties due to Zalicus are run-rating at approximately $1.5 million annually. The drug seems to have peaked in sales. Even assuming it doubles and then peaks, the Exalgo royalties ($3m X 8x sales for a cost-free royalty) are worth $24 million, or $0.25 per share. Exalgo isn't quite the flop a Nuedexta or Bidil is, but for it to be a meaningful drug for Zalicus' meager royalty share, it will have to do a lot more in revenue to move the needle for this minority owner.

Synavive is a maligned drug. In 2008, the Synavive "COMET-1" study for osteoarthritis failed. How soon the market forgets. This combination of two generic drugs did not do any better (amazingly, it did worse!) than its component drugs. Why should we expect a different outcome from the SYNERGY study? The biological rationale for this drug (formerly known as CRX-102) is flawed, and that was proven in COMET-1. I think Zalicus management is taking this study on because they have nothing better to do. With "SYNERGY", management gets to continue the farce that the company's market cap of $250 million resembles those of other "promising phase 2 companies".

Synavive is the combination of prednisolone and dipyridamole. The company claims they have a composition of matter patent on the combination of two extremely old drugs. Someone should inform management that to win a composition of matter patent, they should probably invent the compound in question first. Synavive won't work in SYNERGY. This asset is worthless. It's worse than worthless--it will eat up $10 to $20 million in cash as the SYNERGY study reads out in the next year.

I value the rest of the pipeline, including the interesting Nav ion channel drugs, with a modest $0.25 value until they enter the clinic.

With 90% downside, ZLCS is a great short. I think the average investor forgets there is no difference between a $2 stock and a $20 stock and a $200 stock and your expected return. A smaller stock price is actually inversely correlated with performance.

Yesterday's stock move in Zalicus is noteworthy. The 3 research analysts covering the stock, JMP Securities, Wedbush and Oppenheimer, have no interest in helping you make money. They exist to support their "business model" of writing new secondary deals for overvalued stocks like Zalicus. Zalicus' CEO made $2.5 million in 2010 according to Bloomberg ($446,000 in salary). Zalicus claims no serious institutional shareholders. Don't subsidize this CEO and this forgettable asset for the illusion of a "cheap" stock. Think in market cap - not stock price. Is this company worth $250 million? Is it worth $500 million or $100 million? If you can't follow this exercise, the market isn't for you. Consider a job selling research at an investment bank.

Disclosure: My hedge fund and I are short ZLCS. We may change our positions at anytime without updating Seeking Alpha.