Wall Street Is Seriously Discounting This Biotech Micro Cap

The biotechnology sector might best be described as a grass-covered field with hidden pots of gold and mines that explode. No, I didn't purposely make that rhyme, but it's a perfect analogy for the hit-and-miss nature of investing in biotech stocks. For every winner, there always seems to be at least twice as many losers.

But every once in a while I come across a company that just might end up being a winner and, often, it winds up being a micro-cap or small-cap company that's been completely ignored by Wall Street. Today, I want to take a closer look at biodefense drug company PharmAthene (AMEX: PIP  ) , and I'll show you why it has me enthused about its long-term prospects.

Sharing is caring
Rarely does a lawsuit have such a lasting impact on the value of a company, but in this case, it's PharmAthene's saving grace. Back in 2006, PharmAthene sued SIGA Technologies (Nasdaq: SIGA  ) claiming that it had the exclusive rights to develop and market SIGA's smallpox antiviral pill ST-246, which is used to treat smallpox when the disease is treated too late for the standard treatment to be effective. The two companies had previously been in line to merge with one another, but when that fell through, and the companies failed to work out an amicable agreement, PharmAthene sought the help of the courts.

Well, it took five long years, but in September of 2011, a Delaware court sided with PharmAthene and awarded the company half of ST-246's net profits for 10 years after SIGA collects the first $40 million in net income.

Normally, this would have been a cheery event, but shareholders would have had to sit back and wait for SIGA to find a buyer for ST-246. In this case, they didn't have to wait at all. In May, SIGA signed a five-year, $433 million deal with the Department of Health and Human Services to supply the U.S. government with 1.7 million doses of ST-246 at a cost of $255 per dose beginning in 2013. Once SIGA clears its $40 million in net profit -- and I can't assume the cost to produce the drug is high at all, which should yield gross margins well above 80% -- PharmAthene will be ready to share the wealth.

By my best guestimate, I'd say that that PharmAthene could be in line for around $20 million in added sales in 2013, and closer to $35 million to $40 million each year in 2014 through 2017. This is fantastic news because PharmAthene has more to its pipeline than just ST-246, and this added cash flow should allow it to advance its growing pipeline of drugs.

Don't forget the rest of the pipeline
Aside from ST-246, SparVax, the company's prospective drug for protection against inhalation anthrax, and Valortim hold the most promise.

SparVax is backed by $213 million in government funding and is going head-to-head with Emergent BioSolutions (NYSE: EBS  ) , which just signed a multiyear agreement with the Centers for Disease Control and Prevention to supply its product BioThrax, the current standard treatment for inhalation anthrax. So far one phase 1 and two phase 2 clinical trials have been completed.

As for Valortim, it is being co-developed with Bristol-Myers Squibb (NYSE: BMY  ) and is also a potential treatment for inhalation anthrax but works as a different pathway than SparVax. The government has awarded $27 million toward researching and developing Valortim, which is currently in the middle of phase 1 clinical trials. It has also been granted FDA fast-track and orphan drug status.

Foolish roundup
What I haven't mentioned is that PharmAthene's reduced expenses in 2011 likely mean it will be able to turn a profit once the added revenue from SIGA kicks in. I'm not going to throw out a specific figure, but assuming expenses don't shoot through the roof and based on its 2010 and 2011 operating expenses, PharmAthene could produce a profit of anywhere from $5 million to up to $25 million, or $0.10-$0.50 in annual EPS based on its current share count. Although the revenue sharing will only last for 10 years, that should give PharmAthene plenty of time to grow its pipeline. This looks like a true micro-cap gem, and I will be making a CAPScall of outperform on PharmAthene to show my conviction in the stock.

What's your take on PharmAthene? Share your wisdom in the comments section below and consider adding it to your free and personalized watchlist.

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Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.

Motley Fool newsletter services have recommended buying shares of Emergent BioSolutions. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that always takes its medicine.


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