One Biotech Stock Ready to Rebound?

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Irish-based drugmaker Elan (Nasdaq: ELN  ) recently reported a second-quarter loss of around $213 million after the company set aside around $206 million to settle a U.S. government investigation into Elan's marketing of the epilepsy drug Zonegran. Elan is one of the industry leaders in Alzheimer's research. Motley Fool Associate Advisor Charly Travers is bullish on the company despite the stock's recent poor performance. I recently asked him about the future of Elan.

Mac Greer: Charly, the stock has lost ground over the past one, three and five years, and yet I know that you are a fan of Elan. Why the attraction to this stock?

Charly Travers: Well before I get into the attraction, I will say the recent problems are perpetually recent problems stretching back over most of the last decade. I think you have to point to management at some point. This is a company that at one point had huge debt problems and then they had the Tysabri problems, which were pretty well-known. But that drug has come back, and right now they have been rumbling about spinning off their drug delivery segment. It's just one thing after another with this company over the years, and I think they have a credibility problem. But that said, they have some really attractive R&D, and with the stock where it is at, if you are interested in biotech, this is a company to look at right now.

Greer: And going forward, what do you see as their greatest opportunity and what is the greatest threat?

Travers: I would say the greatest opportunity is their world-class Alzheimer's research. So the likelihood of a person getting Alzheimer's disease goes up dramatically as you age, and by the time somebody is 85 years old, you have got about a 50-50 chance of having Alzheimer's. With people living longer and the baby boomers aging, this is going to be one of the big medical markets. It is already huge. It is going to get even bigger. So most of the current treatments are basically stopgap measures that don't really hit at the mechanism of the disease. They just basically slow down the decline, and so you want a company doing cutting-edge research in this area, and that would be Elan.

They have one of the top Alzheimer's pipelines in the industry. I think that tends to get a little overlooked with some of the missteps the company has made, but if you look deep in the early stage pipeline, they have several really interesting compounds.

Greer: And they have partnered with Johnson & Johnson (NYSE: JNJ  ) on some of these?

Travers: Yes. It is a three-way partnership with Johnson & Johnson and originally with Wyeth, which was recently acquired by Pfizer (NYSE: PFE  ) . Elan has about a 25% interest in the immunotherapy-based Alzheimer's drugs, which you would see in the popular media as an Alzheimer's vaccine-kind of situation where the dangerous proteins in the brain will be cleared up by your immune system.

Greer: What is the biggest challenge for Elan?

Travers: Typically, I would say just the drug development risk in general. Alzheimer's disease is notoriously hard to attack. For a long time, the mechanisms of how the disease worked weren't really understood, and to create a drug against something you don't understand is nearly impossible, but the science has come a long way in the last decade.  But to get a drug into the brain and have an effect is incredibly difficult. So while they do have a number of interesting products, this is a high failure rate research area.

Greer: And does Elan need to have success with these Alzheimer's treatments in order to be successful, or are they diversified enough outside of that?

Travers: They are diversified enough outside of that. They do have the multiple sclerosis drug Tysabri, which is partnered essentially 50-50 with Biogen Idec (Nasdaq: BIIB  ) . Elan is going to do over a billion in revenue this year, and they have been cash flow positive through the first half of this year.  If you think about biotechs just incinerating money and always having to issue shares to raise more money, Elan is not quite in that boat because of their Tysabri stake and their drug delivery business that is bringing in substantial revenue. They are in pretty good shape to ride these Alzheimer's products out to the goal that they hopefully hit.

Greer: Let's talk risk. On a scale of 1 to 10, with 1 being low risk like a Johnson & Johnson, and 10 being very high risk, where do you see Elan?

Travers: Ten is like a software company in some guy's basement.

Greer: Exactly.

Travers: I would put them at a 7. For one reason, the stock is already beaten up. It's at a five-year low. Biotech stocks have been pretty beaten up this year, and Elan has been crushed. So if you are going to look at [Elan], look at it when it is at a five-year low. That cuts some of your risk. And compared to other biotechs, which I would consider higher risk and grade a 9 or a 10, the fact that Elan already has an approved blockbuster drug and a lot of revenue brings its risk down.

Greer: And what one or two numbers will you look at to gauge Elan's success?

Travers: I think people underestimate the importance of a strong balance sheet for a biotech company. Drug development is incredibly expensive, and Elan has made a lot of progress shoring up the balance sheet to have nearly $900 million in cash. And since they are cash flow positive, that is a pretty substantial war chest, so I would look for them to keep those strong.

Greer: Three years from now, is Elan still a stand-alone public company or has it been acquired?

Travers: Yeah, I think [acquisition] is inevitable. If you're a shareholder, you want them to hold out as long as possible and get people thinking that one of these Alzheimer's drugs is going to be a $4 [billion] or $5 billion compound, which a truly successful Alzheimer's drug could hit those kinds of sales, really ramp up that share price and then get taken out for a nice premium. And then you go take your wife out to a nice dinner.

Neither Mac nor Charly owns any stock of any companies mentioned in this article.

Elan is a Motley Fool Rule Breakers recommendation. The newsletter is always on the hunt for hot drug stocks and other cutting-edge picks. Click here to see all of our latest discoveries with a free 30-day trial subscription. 

Pfizer is an Inside Value selection. Johnson & Johnson is an Income Investor pick, and Motley Fool Options has recommended buying calls on its stock.The Fool has a disclosure policy.

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