A Free Call Option on a Drug

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If Myriad Genetics (Nasdaq: MYGN) won the award for the best deal of 2008 when it got H. Lundbeck A/S to agree to pay most of the development costs of its Alzheimer's disease drug before it crashed and burned, then BioMarin Pharmaceutical (Nasdaq: BMRN) might have already wrapped up the 2009 award.

On Tuesday, the orphan-drug specialist announced that it licensed Riquent, La Jolla Pharmaceutical's phase 3 lupus nephritis treatment. The drug has a checkered past -- the Food and Drug Administration gave it an approvable letter in 2004 -- and La Jolla is kind of on the ropes -- it got caught up in the auction rate securities mess -- so BioMarin probably had the upper hand in the negotiations.

BioMarin basically back-ended the licensing payments so that the majority of payments are only made if the drug works. Its upfront payment is a measly $15 million broken into $7.5 million in cash and $7.5 million for purchasing preferred shares at the equivalent of a common stock purchase price of just under $0.74 a share. With the news causing La Jolla's shares to jump to around $1.50, BioMarin's equity stake in La Jolla is now worth around $15 million.

That's right, Fools: The Rule Breakers pick essentially has a free call option on Riquent. Of course, if the drug fails in phase 3 trials, those shares will be near worthless and BioMarin will be out the $7.5 million in cash, but it's a neat trick for now, don't you think?

Lupus is a debilitating disease, and a new drug specifically for treating it hasn't been developed in more than 45 years. But that doesn't mean that BioMarin and La Jolla will be without competition. Many companies, including Novartis (NYSE: NVS), Genentech (NYSE: DNA), Bristol-Myers Squibb (NYSE: BMY), GlaxoSmithKline (NYSE: GSK), and AstraZeneca (NYSE: AZN), are testing drugs in lupus patients, either with lupus nephritis or an earlier stage disease called SLE. Riquent may have some advantage because it keeps the lupus flare-ups from happening rather than just treating the flare-ups and doesn't have a widespread suppression of the immune system. But the drug has to be approved first before competition is an issue.

And that's the big question now. Fortunately, BioMarin investors should know by the end of the year if Riquent works. And the company hasn't bet the farm if it doesn't.

More Foolishness on options (for stocks):

• Get protection with puts.
• Get puts for free using a collar.
• Buy stocks on a layaway plan using calls.