Durect's Pain-Free Deal

Sometimes it takes a big partnership deal for investors to get excited over a pharmaceutical company. A deal signed yesterday by drug developer Durect (NASDAQ:DRRX) appears to have done the trick for the small specialty pharma, since shares rose more than 25% today.

The deal Durect inked yesterday with European pharma Nycomed involves its Posidur local anesthesia injection. The drug is in multiple phase 2 trials as a treatment for post-operative pain and is slated to enter phase 3 trials in 2007. If it can achieve regulatory approval, Posidur's biggest potential benefit over other local anesthetics already on the market is its longer-lasting effect.

This deal with Nycomed provides for up to $188 million in payments to Durect if Posidur can hit certain development, regulatory, and sales milestones. Durect will also receive $14 million up front, which should equate to about another half-year's worth of cash (at its current burn rate) to supplement the $74 million already sitting on its balance sheet.

By keeping the upfront payment low and back-loading most of the cash payments, Nycomed hedges its losses in case Posidur doesn't pan out. Regardless, Durect will receive quite a high royalty rate, in the 15%-40% range, depending on the sales level Posidur achieves. Also, Durect gets to keep U.S. and Asian marketing rights for the drug.

The potential for Durect's science and technology has been validated before, when King Pharmaceuticals (NYSE:KG) signed a $400 million collaboration and marketing agreement with Pain Therapeutics (NASDAQ:PTIE), which had licensed Durect's technology for abuse-resistant pain drugs and from which Durect will receive royalties if approved.

With no possible additional drug candidate approvals and subsequent royalties or revenues anywhere close to occurring, farming out Posidur makes great business sense for Durect and will limit any share dilution from financings that may need to be done in the future. It's trading at a market capitalization of more than $330 million as of this writing, though, meaning that shares are a little richly valued for my blood, considering the length of time it will take for meaningful royalties and subsequent earnings to start coming to Durect.

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Fool contributor Brian Lawler does not own shares of any company mentioned in this article. The Fool has a disclosure policy .