Stuck in a trading range for about five years, Cubist Pharmaceuticals (CBST) has had a pretty good year in 2011. The company resolved a patent dispute with Teva Pharmaceuticals (TEVA) on reasonably good terms, got some patent extensions that should further boost its profit potential on Cubicin, and struck marketing deals with Optimer (OPTR) and AstraZeneca (AZN) to make better use of its own sales force. But that's not all that's working in Cubist's favor recently. The company's pipeline has also come along nicely, as the Calixa deal has delivered two promising compounds, one of which is now in late-stage studies.
That said, it has not been all sweetness and light for Cubist. Investors have been troubled by this company's heavy reliance on Cubicin and the inevitable declines that are coming in operating income, to say nothing of the inefficiencies of operating a salesforce with few compounds to sell. Investors have been waiting for Cubist to do a deal or two and now management has done just that – giving the company an additional product to sell and also adding some clinical compounds outside of its core anti-infective space.
The Deal For Adolor
Cubist announced Monday morning that it has reached an agreement to acquire micro-cap biotech Adolor (ADLR) for $4.25 in cash or $190 million. In addition to the upfront purchase price, Cubist is adding a sweetener for Adolor shareholders – a contingent payment right (CPR) worth up to $4.50 tied to the future of Adolor's experimental compound ADL5945.
With that CPR attached, this is an interesting deal for both parties. I expect some, if not many, Adolor shareholders will be disappointed in the $4.25 buyout price, even though the stock closed below $2 on Friday. It was not so long (August, to be precise) that William Blair initiated coverage with a $6.25 target price. What's more, even with potential competition coming from companies like Nektar (NKTR), AstraZeneca and Progenics (PGNX), Salix Pharmaceuticals (SLXP), it is not hard to be optimistic about the revenue potential from Adolor's opioid-induced constipation drug candidate ADL5945 – to say nothing of its other OIC and pain drug candidates and its approved drug Eneterg.
To be sure, Cubist is not paying a huge price for Adolor – even if the initial market reaction in Cubist stock was not so positive. That said, plenty of companies have had time to kick the tires on Adolor and consider a deal. Given that many big-cap pharmaceutical companies need products to sell and promising candidates to add to their portfolio, it is perhaps unreasonable to think that Adolor was going to get a substantially better deal.
Does This Answer Cubist's Needs?
Cubist certainly had other choices. Savient (SVNT) would almost certainly like to sell itself and even a company like Nektar (NKTR) or Targacept (TRGT) would conceivably have been digestible for Cubist. Said differently, there are more than a couple micro-cap and small-cap drug companies with approved products and/or late-stage candidates.
So what makes Adolor a good mix for Cubist?
For starters, the addition of Enterg gives Cubist a good drug that is basically unique in its category – a drug that blocks the GI-side effects of opioids following gastrointestinal surgery. It's not a huge market (this is not another Lipitor, for instance), but it's a good specialty drug that should find a solid market with a focused sales effort. Along those same lines, this allows the company to leverage its sales infrastructure a little further – there may not be the sort of direct synergies between selling Entereg and the company's other pain drugs that some investors may have wanted, but it should still be incrementally positive.
Filling The Pipeline
The Adolor deal also loads up and diversifies Cubist's pipeline. This has arguably been the biggest bear argument with the stock – after Cubicin, what does Cubist have? Adolor's ADL5945 looks to be a viable contender in the OIC space and programs in pain and Parkinson's are high-risk/high-payoff opportunities. Perhaps just as much to the point, the presumed revenue and cash flow from Entereg and ADL5945 should throw even more cash into Cubist's coffers and give it means to do further deals down the road.
The Bottom Line
Cubist isn't trading at a huge discount to its fair value (even including Adolor), but it is undervalued. Moreover, if Cubicin sales continue to outperform, if the Calixa compounds make it through the FDA process, and if Adolor's pipeline develops, it will seem significantly undervalued by 2014 or 2015. Certainly that is a lot of “if's,” but that is the nature of biotech. Investors who want the closest things to sure things have to pay Alexion-like (ALXN) prices to get them. In the meantime, Cubist is a pretty respectable balance of risk and reward.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.