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2012: The year Zalicus makes it big?
2011's almost history, and it's time to start placing bets for next year's winners. Or at least, that's what investment banker McNicoll, Lewis & Vlak seems to think. Last week, while most of America was busy with last-minute shopping and last-second wrapping, McNicoll instead issued a last-days-of-2011 stock recommendation ... for Zalicus (Nasdaq: ZLCS ) .
For those unfamiliar with the company, Zalicus is a biotech start-up focusing on drugs to treat pain and inflammation. After the well-publicized troubles with Pfizer's (NYSE: PFE ) Celebrex and Merck's (NYSE: MRK ) Vioxx, pain treatment is practically moaning for new products, and in partnership with Covidien (NYSE: COV ) , Zalicus has already brought one such drug to market -- Exalgo. It has several more drugs in the pipeline, including partnered efforts with Sanofi (NYSE: SNY ) and Novartis (NYSE: NVS ) , as well as several drugs it's working on solo.
McNicoll thinks this pipeline justifies a $4 share price on the stock; other analysts who have looked at it think even that's conservative, and $5 is the proper price. Are they right?
Let's go to the tape
It's hard to say. McNicoll doesn't report its ratings through Briefing.com, so we don't have an independent accounting of its past picks to examine, no unbiased third-party judge to show us whether this analyst is as smart as it thinks it is. Fortunately, what we do have is Zalicus itself, and a recent example of a Zalicus competitor to consider.
Beginning with Zalicus itself, I see at least one argument in the company's favor. Unlike so many other profitless biotech start-ups, Zalicus at least has a product on the market, generating revenues. That's a big help because, with no profits to its name, and "free" cash flow that runs to negative $31 million annually, we don't have a whole lot else to value Zalicus on but its revenues.
Problem is, it's still hard to justify Zalicus' $131 million market capitalization based on the company's still-meager $7 million annual revenue stream. On a price-to-sales basis, this works out to a lofty 19 multiple -- a valuation at least seven times more expensive than any of the other drug companies named above.
I'd also point out that when Teva (Nasdaq: TEVA ) bought Zalicus competitor Cephalon earlier this year, the valuation there more resembled what investors are paying for Pfizer, Merck, et al. than it did what speculators are bidding for Zalicus today. Teva anted up $6.8 billion for Cephalon, including the value of assumed debt. That worked out to about a 2.4 sales multiple to Cephalon's 2010 sales. Again, a far cry from 19 times sales.
"Because he's got, hi-i-igh hopes ..."
Now granted, analysts have high hopes that Zalicus will grow these revenues quickly. Consensus projections call for Zalicus to pull down $120 million in revenues by 2015. Is it perhaps reasonable to pay a multiple of 1.1 times these "forward sales"?
Perhaps. These are, however, very long-distance estimates. And I'm not sure how comfortable I'd be paying up for the prospect of seeing Zalicus grow its revenues 20-fold in just four years' time. (Talk about your high hopes!) Yes, Zalicus has more drugs in its pipeline after Exalgo. Of the six candidates I'm aware of, though, none is yet in phase 3 trials, and only two are in phase 2. Even if all these drugs ultimately receive FDA approval and come to market, it could be years before they begin generating appreciable levels of revenue for the company.
Meanwhile, the sand is fast draining from Zalicus' hourglass -- and the cash from its bank account. As I mentioned, Zalicus burned through more than $30 million over the past year. With $47 million in its bank account (less, if you factor in net debt), the company could be out of cash within 18 months -- at which point Zalicus would face a choice between shutting its doors, taking on even more debt, or issuing new stock, thus diluting its current shareholders.
So could McNicoll be right that Zalicus will hit $4 within a year? Sure it could -- anything's possible in biotech. But would I bet on it? Not a chance.
Zalicus' prospects look iffy, but not all small caps are created equal. We'll tell you about two small companies with more potential to profit in our new, completely free report "Too Small to Fail: Two Small Caps the Government Won't Let Go Broke."