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When a major source of funding for a biotech declines to invite the company to submit a full proposal for continued funding, it's understandable that investors might be a little worried.
But dive a little deeper into Cleveland BioLabs' (Nasdaq: CBLI ) situation with CBLB502, and it looks like cutting nearly a quarter of the company's value yesterday seems a little extreme.
The first step for procuring funding through the Biomedical Advanced Research and Development Authority often involves submitting a white paper, which serves as a way to engage BARDA to try and figure out exactly what the agency wants in the technical proposal.
BARDA rejected Cleveland's white paper for continued development of CBLB502 to treat patients that have been exposed to high levels of radiation. The agency isn't convinced that Cleveland is running the right studies to prove CBLB502 works. Considering the indication, demonstrating efficacy isn't as cut-and-dried as it is with other indications. It's not like you can expose patients to radiation to prove the drug works -- animal studies need to be convincing enough to give confidence that the drug will work on humans, and then human studies need to be run in volunteers to show the drug is safe.
But BARDA isn't the government agency that will ultimately decide the appropriateness of animal or human safety studies. That task lies with the Food and Drug Administration, which is in charge of approving the drug just like it does for drugs with less-theoretical applications.
Cleveland has two FDA meetings -- one on the animal model and a second on the human safety trial -- scheduled with the FDA this month. And BARDA representatives are expected to be at the FDA meeting. It seems likely the white paper rejection was more of a "We don't know what experiments are right; let's wait for the FDA," than a "We think you're doing the wrong experiments."
So Cleveland's plan is to wait 30 days for the FDA to send minutes from the meeting and then use those to write up its technical proposal to seek funding from BARDA. The review should be done later this year or in early 2013, which shouldn't be a major problem for the company that has cash expected to last into 2013. And it has a backup plan to seek funding from the Department of Defense.
Investing in companies expecting government support adds risk since renewed funding isn't guaranteed. And even when a drug is developed, it might only result in a one-off sale. Human Genome Sciences (Nasdaq: HGSI ) , for instance, was in the black in 2009 thanks to sales of its anthrax treatment, but hasn't registered an annual positive income since. Sometimes the sales can go on, though. Last October, the government decided to purchase more of Emergent Biosolutions' (NYSE: EBS ) anthrax vaccine BioThrax, causing shares to pop.
Assuming Cleveland's characterization of the situation is accurate and this really is just a procedural issue, it sure seems like investors are overreacting here. It looks like a good entry point, so I've opened a CAPScall predicting Cleveland will be able to beat the S&P500.
Fool analysts have found two other companies with solid deals with the government and the potential to deliver multi-bagger returns. You can read about them in our free report: "Too Small to Fail: Two Small Caps the Government Won't Let Go Broke."