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Typically, the biotech stocks dominating news headlines and Twitter feeds are those approaching FDA approval decisions. Unfortunately, as this summer's most heavily hyped stocks like Arena (NASDAQ:ARNA) and Amarin (NASDAQ:AMRN) have shown, approval has often already been priced-in by the time the attention comes. More dramatic shifts in share-price tend to occur earlier in the process, with the release of promising clinical results (recent examples include VRTX and ALNY).

With this in mind, investors looking for a speculative play with potential high-upside should be keeping an eye on Zalicus (ZLCS) over the next few weeks for the results of the company's SYNERGY Phase II trial. Zalicus is a company with a rich history of partnerships with Big Pharma, and an intriguing potential entrant into the $14B rheumatoid arthritis market. Despite this, ZLCS's enterprise value is well below $100M. Whether it stays that low for much longer will depend significantly on soon-to-be released clinical trial data. Zalicus' lead drug candidate, Synavive, has demonstrated anti-inflammatory effects, rapid onset of action and excellent safety profiles in clinical studies to date. The results of SYNERGY, a Phase II clinical trial of Synavive, in patients with moderate-to-severe rheumatoid arthritis are expected to be available in Q3 2012, potentially as soon as mid-August. This analysis will focus on this trial and the potential market implications of positive data.

Synavive: Version 2.0 of a leading anti-inflammatory

Zalicus' leading therapeutic candidate Synavive is a combination therapy comprised of the cardiovascular agent dipyridamole and a low dose of the corticosteroid prednisolone. Prednisolone is in a class of drugs called glucocorticoids, which are a mainstay of anti-inflammatory therapy. Prednisolone prevents the release of substances in the body that cause inflammation and is prescribed to treat a wide range of conditions including rheumatoid arthritis, allergic and respiratory disorders, and psoriasis. Though it is a popular and potent anti-inflammatory therapy, significant adverse effects have limited its therapeutic potential. Prednisolone use is associated with mild to severe side effects including psychiatric issues, insomnia, sodium retention, weight gain, increased appetite, stomach ulcers, glaucoma, cataract, elevated blood sugar, and high blood pressure. These side effects occur more frequently with high-dose or prolonged use of prednisolone.

Novel Combination Therapy. In order to increase the therapeutic potential of prednisolone, Zalicus pursued a novel multi-component therapeutic approach. In this approach, an enhancing agent (here dipyridamole) was used to sensitize immune cells specifically to the effects of low-dose prednisolone, by modulating relevant signaling pathways. This amplification of the anti-inflammatory effect does not extend to prednisolone's adverse side effects. The synergistic combination therapy of Synavive selectively amplifies the anti-inflammatory activity of low dose prednisolone in immune cells without modulating non-immune signaling pathways mediating glucocorticoid-associated toxicity. Thus, Synavive is designed to enhance or amplify the efficacy of prednisolone without incurring the adverse side effects that plague high-dose prednisolone therapy, a potentially game-changing development in the field of arthritis treatment.

Market competitive landscape
In the SYNERGY clinical trial, Synavive was tested for the indication of Rheumatoid arthritis (RA), which is a chronic, inflammatory disease that causes pain, swelling, and loss of functions primarily in the joints. It affects 1% of the world's population across all ages, although onset occurs most often between 40 and 50. In the US, it is estimated that 1.3 million people, or roughly 0.6% of the US population, suffer from RA. In 2010, the total worldwide pharmaceutical market for RA drugs was in excess of $14B. In addition, previous Synavive clinical trials also targeted hand and knee osteoarthritis (OA), which affects an even larger population of nearly 27 million Americans. With an estimated 28 million Americans affected with either OA or RA, the potential market size for a broadly efficacious Synavive would be substantial.

Two Types of RA Treatment. The treatment of RA is built on two categories of drugs: (i) disease-modifying antirheumatic drugs (DMARDs) which reduce bone/cartilage damage, and (ii) anti-inflammatory/analgesic agents which treat the symptoms of RA. Corticosteroids including Synavive belong to the latter category. While DMARDs remain a necessity for the long-term treatment of moderate-to-severe arthritis patients, corticosteroids used in low doses complement DMARDs by reducing inflammation as well as acting as "bridge therapy" when starting DMARDs until those DMARDs become effective. Although corticosteroid cannot substitute for DMARDs, effective corticosteroid treatment can postpone the usage of DMARDs, which cost $2,000 to $25,000 a year. In the SYNERGY trial, all patients are receiving Synavive in addition to simultaneous DMARD therapy. However, if the trial is successful, we anticipate Synavive will be an attractive candidate for treatment designed to postpone DMARD-therapy initiation given Synavive's excellent side-effect profile. The significant costs of DMARDs may prove an important incentive for insurance providers to support Synavive prescription.

Corticosteroid Competition. The major potential direct competitors of Synavive are generic corticosteroids and Horizon Pharma's recently approved time-release corticosteroid, Rayos. With Rayos not currently available, the systemic corticosteroid market has been limited by significant side-effects and price competition from cheap generics. Despite this, systemic corticosteroid sales exceed $500M/year in the United States. Rayos and, if-approved, Synavive, appear poised to increase these revenues substantially for two reasons. First, Synavive and Rayos differentiate themselves from generic corticosteroids with decreased incidence of adverse side-effects, a major concern for the frequent and long-term users of corticosteroids. The negative side effects of corticosteroids increase with duration of exposure and dose, prompting physicians to delay or shorten corticosteroid prescription when feasible. We anticipate prednisolone-containing compounds like Rayos and Synavive will increase the number of patients receiving corticosteroids with increased duration of use. Secondly, we expect that Rayos and Synavive, which do not face competition from identical generics, will likely be able to charge more than the off-patent drugs that currently dominate the market segment. Given the adverse affects experienced by many corticosteroid users, we anticipate that many patients will pay a significant price premium to switch to safer alternatives.

While Horizon Pharma is likely to be a direct competitor, Rayos's recent FDA decision is a positive sign for the approval chances of the similarly prednisolone-modulating Synavive. Rayos sales over the next year will be an indication of physician interest in safer alternatives to generic prednisolone. Investors will be watching these sales numbers as a guide to Synavive's potential market penetration. Additionally, these investors will be analyzing the results of the SYNERGY trial for indications of Synavive/Rayos advantages. Zalicus has reported in preclinical studies that Synavive's combination therapy results in greater efficacy than currently available corticosteroids with diminished side-effects. If confirmed, this efficacy boost would offer Synavive a competitive edge over Rayos (Rayos was compared only to placebo and was not shown to outperform other corticosteroid therapies in its Phase III trial). Furthermore, although SYNERGY covers only RA, the previous clinical trial application of Synavive on OA implies a possible application in another market (30x larger) not occupied by Rayos. Of course, this assumes the new Synavive formulation will prove more efficacious than the one that failed its initial Phase II trial (see below for further discussion of this study).

SYNERGY trial results coming soon: What to look for

The most important indicator of Synavive's potential to reach the market will be the SYNERGY (SYNavivE for Reducing signs and sYmptoms of rheumatoid arthritis) Phase IIb trial, the results of which are expected in the 3Q 2012. The SYNERGY trial is a double-blind study of 292 patients with moderate-to-severe rheumatoid arthritis (arthritis severity is determined by number of joints affected) comparing Synavive to placebo/alternate therapies with regard to both efficacy and safety.

Efficacy. The Synergy trial is particularly useful in evaluating the market potential of Synavive because it compares the drug not only to a placebo, but also to 3 active competitors. Two of those competitors are the individual components of Synavive taken alone (prednisolone 2.7mg and dipyridamole 360mg); the third is a higher dose of prednisolone (5mg). Well-established clinical research has previously shown that prednisolone is a powerful anti-inflammatory agent; consequently, we consider it highly likely that the prednisolone-containing Synavive will outperform placebo and the dipyridamole-alone conditions. The more interesting data will be in the comparison of Synavive with the two concentrations of prednisolone-alone (dipyridamole is an adjuvant that has shown only modest anti-inflammatory potential when taken alone). Zalicus has significant preclinical data demonstrating an increase in the efficacy of low-dose prednisolone when combined with dipyridamole, but the clinical data has been more mixed. In smaller studies, Synavive has outperformed the placebo (there was no comparison to prednisolone-only treatment) in both RA and osteoarthritis trials.

However, a 279-person Phase II trial (COMET-1) in 2008, which compared Synavive to 2.7mg prednisolone and placebo in osteoarthritis patients, failed to meet statistical significance in its primary outcome measurement- reduction in pain while walking following 12 weeks of treatment. Synavive did show encouraging, though not statistically significant, trends of dose-dependent improvement with regard to joint pain, stiffness, and function. Furthermore high-dose Synavive outperformed both placebo and prednisolone in all of these measurements. The failure of these Synavive-dependent effects to achieve statistical significance was due in large part to unexpectedly positive responses in placebo and prednisolone-only patients. Subsequent analysis revealed that ~10% of patients were simultaneously taking additional unapproved anti-inflammatory drugs (such as an NSAID or COX-2 inhibitor) in violation of the experimental protocol. These protocol violations were disproportionately represented in the placebo and prednisolone-only treatment arms contributing to the unexpectedly high response rate in these groups.

Interpretation of trial data was hampered too by an unexpectedly high percentage of patients who did not complete the trial (~10% not including those later found to have committed protocol violations). This failure to complete was no more common in the Synavive-arm than the placebo, but the lower patient number reduced the statistical power of the study. Re-analysis of the trial data modified to exclude all patients taking unapproved drugs did show a statistically significant improvement in high-dose Synavive over placebo in all efficacy measurements. Also, in this re-analysis, the high-dose Synavive showed improvement over prednisolone-alone in these same measurements (though the difference was not statistically significant in all cases).

Since this trial, Zalicus has reformulated Synavive to result in extended-release of the active components, a change they claim increases anti-inflammatory efficacy and decreases headaches, the most common adverse effect and one contributor to the higher-than-expected trial drop-out rates. If the new formulation of Synavive can support Zalicus's preclinical data and outperform prednisolone-alone (particularly the 5mg prednisolone dose), the market potential for the drug would be far greater. Prednisolone at 5 - 60 mg/day is a standard treatment for moderate rheumatoid arthritis and is available as a generic at a very low price. With a prednisolone level of <5mg, Synavive has demonstrated a safety profile without many of the severe adverse effects that plague current, higher-dose prednisolone therapy regimens (see below for further discussion).

Unfortunately, this improved safety profile will mean little without significant, complementary efficacy data. However positive its safety data, we consider it unlikely that physicians will make significant use of Synavive without clear evidence that the new drug will deliver anti-inflammatory efficacy at least equal to the lower dose end of standard therapy, i.e. 5mg prednisolone. In short, though eventual FDA approval may require only that Synavive outperforms the placebo, market viability will be dependent on clinical data indicating Synavive's superiority to its inexpensive, generic competitor.

Efficacy Outcome Measurements: Digging Deeper. The primary outcome measurement of the trial will be DAS28 CRP, a score which incorporates both a subjective level of joint tenderness and an objective measurement of C-reactive protein (a factor which increases in blood as a result of inflammation). To justify a Phase 3 trial, Synavive will need to outperform placebo in this scoring system, and DAS28 scores are likely to lead any announcements of top-line results. Savvy investors, however, will also be looking at one of the trial's secondary outcome measurements, ACR20, to judge future market potential. ACR20, like DAS28, integrates both subjective and objective measures of joint discomfort and inflammation. An ACR20 score indicates the number of patients who experience a 20% reduction in a given number of ACR component tests.

Importantly, ACR20 is also the only outcome measurement shared by both the SYNERGY study and the recent Phase III study that led to the approval of likely Synavive-competitor, Rayos. Horizon Pharma's Rayos outperformed placebo 49% to 29% by ACR20 score in a patient population similar to that of the SYNERGY trial in its Phase 3 trial. By comparison the previous formulation of Synavive outperformed placebo 60% to 30% in a 2007 Phase 2a trial. Comparison by ARC20 of the new formulation of Synavive's performance in the SYNERGY trial to Rayos' historical data in its Phase III (CAPRA-2 trial) will be the only opportunity investors and physicians are likely to have to compare the efficacy of these two competing therapies for a long time.

As such, it is an important data point in assessing the competitive landscape of corticosteroids, should Synavive be approved. If Synavive's new formulation continues to outperform placebo to a greater degree than Rayos by ARC20 measurement, the results will be reflected in valuations of both Zalicus and Horizon Pharma.

Safety. While previous clinical trials have left the efficacy of Synavive in doubt, the superior safety profile of the drug in these trials has been consistently encouraging. In the previous Phase II trial for osteoarthritis, patients taking the 2.7mg prednisolone alone or the prednisolone-containing Synavive reported no incidents of serious adverse effects. Given that high-dose prednisolone is associated with a host of severe adverse side effects including weight gain, psychiatric issues, insomnia, ulcers, glaucoma, and cataract, this is a promising finding. In addition to this, there were even indications that Synavive's combination therapy actually decreased less severe side-effects relative to prednisolone-only therapy. Patients receiving prednisolone alone suffered increases to both systolic blood pressure and serum triglyceride levels (both have been previously reported prednisolone side-effects); those receiving Synavive, like those on the placebo, did not experience increases in either of those factors.

Synavive's most common side-effect was a headache; ~50% of patients reported experiencing them and 4% dropped out of the trial citing this as a reason. Zalicus has reported that the reformulated Synavive with time-delayed release of prednisolone and dipyridamole (which has been associated with headaches in other studies) decreases the incidence of headache. Confirming a decrease in headache frequency as well as maintaining an edge over prednisolone-only in blood-pressure and triglyceride measurements may be important to Synavive's eventual sales strategy. Zalicus has good IP protection for the combination of the drugs prednisolone and dipyridamole but not the individual components which are available as generics.

As the company discussed in its financial filings, there exists the possibility that physicians might prescribe the two components separately to decrease treatment costs, potentially limiting the price Zalicus can charge while maintaining adequate market share. Any evidence that the combination of prednisolone with dipyridamole, particularly the extended-release dipyridamole that Synavive uses, leads to fewer adverse events is particularly crucial in this regard. We consider it very unlikely that physicians will regularly prescribe the drugs separately if there is clinical evidence that separating the two drugs not only decreases efficacy but could lead to additional safety concerns (e.g. elevated blood pressure and triglycerides).

One element of the study that bears additional scrutiny is the comparison of Synavive and the higher dose 5mg prednisolone. Prednisolone-associated side-effects are dose-dependent. If the new formulation maintains the excellent safety profile demonstrated in the previous Phase II trial, the contrast to prednisolone-alone is likely to be even greater with 5mg prednisolone than 2.7mg. The side-effects associated with 2.7mg prednisolone are minor, so the safety benefit offered by the combination therapy is similarly slight. If Synavive efficacy meets or exceeds that of 5mg prednisolone, Synavive may be a replacement for prednisolone regimens associated with far more serious adverse effects (like those listed above). In these cases, Synavive's decreased side-effects, if confirmed, would provide ample reason for physicians to prescribe the Synavive over generic prednisolone, counterbalancing what is likely to be a significant increase in cost.

Zalicus: Prepared for Success:

Should the SYNERGY trial prove successful, there is good evidence that Zalicus is well-prepared to take full advantage of that development. First, Zalicus appears to have a strong IP position with regard to Synavive. Though both components - prednisolone and dipyridamole - are available as generics, Zalicus has both method-of-use (US patent 7,253,155) and composition-of-matter patents (US patent 7,915,265) covering their combination. With those patents granted in 2007 and 2011 respectively, the window of IP protection is substantial.

Additionally, Zalicus has experience partnering profitably with Big Pharma players to develop its technologies and drug candidates. In 2006, Neuromed (which later merged with CombinatoRX to create Zalicus) partnered with Merck (NYSE:MRK) to develop a drug candidate in a deal estimated at the time to be worth >$450M. Currently, Zalicus and Novartis (NYSE:NOV) have partnered to further develop Zalicus' combination high-throughput screening (cHTS) technology that helped design the composition of Synavive. Due in part to that cHTS technology, Zalicus has an intriguing pipeline of drug candidates, though none are as clinically advanced as Synavive (Zalicus's pain-relief pipeline is the subject of in-depth analysis elsewhere on Seeking Alpha).

Finally, despite its low market cap, Zalicus is in a strong position financially with the capital on hand to take a new product into the next stage of development without having to resort to stock dilution or borrowing. The company's financial reports show that Zalicus had approximately $44.1 million in cash and short term investments in Q2 2012; operations are expected to be funded sufficiently into the middle of 2013. The current cash burn rate is higher than ideal at ~40M/year ( ~30% market cap). It is worth noting that this burn rate reflects the cost of continuing the SYNERGY trial which is now complete; we anticipate the burn rate will decrease closer to a pre-SYNERGY level of $4.5M/year (~13% market cap).

Even if the burn rate does not appreciably decrease, the current cash reserves do appear sufficient to last Zalicus well past the release of SYNERGY data and a post-Phase II meeting with the FDA. Should SYNERGY succeed, the positive Phase II data will be reflected in increased share price before any additional financing is necessary.

Recommendation:

In all cases, predicting the results of clinical trials is extremely difficult and comes with a very high level of risk. That an earlier formulation of Synavive has previously failed in another Phase II trial of osteoarthritis patients makes Synavive an even riskier call than most. We believe that the SYNERGY trial has a significant chance of failure. However, we also believe that the science behind Synavive is promising and that, if successful, Synavive has the capability to substantially grow within a Rheumatoid arthritis market that is worth $14B/year.

Given this large market size and Synavive's potential, we believe Zalicus could realize tremendous gains in share-price with positive Phase II data. This massive upside is not reflected in the stock's current pricing. With an enterprise value of ~$100M, ZLCS is significantly undervalued in our opinion. As a potentially high-upside, speculative investment, we believe ZLCS is an appealing opportunity to watch for in 3Q 2012.

Source: Zalicus: Preparing For A Q3 Catalyst