Like many biotechs that have been around since the last century, Ariad Pharmaceuticals (NASDAQ:ARIA) has shifted its research focus. Having once worked primarily on treatments for osteoporosis and arthritis, the company now has a promising drug in the pipeline that could help fight advanced sarcomas.

That drug, called deforolimus, recently attracted Merck's (NYSE:MRK) attention. On July 12, Ariad announced that it had signed a deal with the pharma heavy hitter to develop the drug. Ariad gets $75 million up front and could be eligible for further payments that might catapult the entire value of the deal to more than $1 billion.

This was good news for Ariad. Not only does Merck's interest validate Ariad's research, but a $75 million cash infusion is also a big bump for a company that had only $39 million in cash on hand at the end of its first quarter. And Merck itself, of course, has an impressive record of discovering new drugs.

Deforolimus is an inhibitor of mTOR -- which stands for "mammalian target of rapamycin" -- and is a kinase enzyme responsible for regulating a range of functions in the cell. Kinases, like proteases in the 1980s, are a hot topic in drug discovery recently.

At last year's American Society of Clinical Oncology meeting, Ariad presented results of a phase 2 study on deforolimus against advanced sarcomas. Of 193 patients evaluated, 28% had a "clinically beneficial response," meaning the tumor being targeted shrank or at least stopped growing. A phase 3 trial is expected to begin this quarter. Meanwhile, deforolimus is also in phase 2 testing for treating other types of cancer, including hormone refractory prostate cancer, endometrial cancer, and leukemias and lymphomas. 

While the Merck deal sounds impressive, it's important to remember that future cash payments are dependent on Ariad's meeting certain goals -- so the payments are not at all guaranteed.

Mr. Market hasn't seemed too impressed at this point. On the day of the announcement, Ariad stock hit a high of $6.40 before closing at $5.56 on 20 times normal volume. The stock has since drifted further down to the mid-$4 range.

I don't think the sell-off is rational. Ariad has a good bit of upside potential, since its market cap is a paltry $290 million. What's more, a positive result from any of its four clinical trials would be a significant catalyst. And with the infusion of money from Merck, there's no need to secure financing for at least a year or two.

No, the stock isn't likely to experience dramatic short-term growth -- though it may, once the market realizes that the Merck deal was indeed good news -- but I do think its prospects are good for the next year or so.

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Merck is a former Income Investor recommendation.

Fool contributor Andrew Vaino has no position in any company mentioned in this article. Send your comments to The Fool has a disclosure policy.

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