Arrowhead: A Long-Term RNAi Play?

Last month, when Merck (NYSE:MRK) agreed to purchase Sirna Therapeutics (NASDAQ:RNAI) for $13 a share -- twice its market price of $6.45 -- the market considered it as a major vote of confidence for RNA interference (RNAi) therapy, since it put the field on many more investors' radars. Alynlam Pharmaceuticals (Nasdaq; ALNY) and other companies involved in RNAi, a way to "silence" the expression of harmful genes, saw their stocks lifted higher on the news.

Arrowhead Research (NASDAQ:ARWR) has not seen such a jump, but there's good reason for that. First of all, Arrowhead is a not an RNAi pure play but, as I wrote in this piece last year, more of a nanotechnology pure play along the lines of Harris & Harris (NASDAQ:TINY). Arrowhead invests in early-stage nanotech academic research and then seeks to bring the most promising of those developments to the commercial marketplace.

Among its investments, Arrowhead owns an 83% stake in Calando Pharmaceuticals. Calando is developing a proprietary technology that it hopes can deliver short interfering RNA (siRNA) to cancer cells, thereby inhibiting tumor growth by silencing the correct gene.

This ability to turn genes on or off makes RNAi so exciting to investors and researchers. As fellow fool Ralph Casale recently noted, the technology garnered the 2006 Nobel Prize in Medicine for Andrew Fire and Craig Mello, and its extraordinary promise explains Merck's willingness to pay such a healthy premium for Sirna.

So does this promise, together with Calando's involvement in RNAi, make Arrowhead a good investment? The answer depends on your penchant for risk.

Calando's RNAi technology is only in pre-clinical stages. Even if it successfully enters clinical trials, it will be years before a product finds it way to market. And, as with all clinical trials, investors must understand that the odds greatly favor failure over success.

This makes Arrowhead risky in two ways. First, because clinical trials are expensive, it's likely that investors will be called upon to fund this stage of development. The company could very well have to raise more money, and to do so, it will have to float more shares -- thereby diluting the value of the existing shares. Secondly, if the trial fails, Arrowhead's stock will take a big hit. Of course, if Calando's technology is successful, the company could very well win a Sirna-sized payday.

I believe that Calando's technology is not yet mature enough to justify the risk and that major pharmaceutical companies are unlikely to move on Calando anytime soon. Instead, they will wait until its technology has demonstrated more success in clinical trials before agreeing to a partnership (and helping fund the trials) or considering an acquisition.

I would advise investors to continue to watch the company but wait until clinical trials have advanced to a more mature stage before considering an investment. By doing so, you might miss a nice run-up if Calando's technology works as promised, but you're also very likely to avoid a significant drop on the odds that it doesn't.

Further Foolishness will not be silenced:

• Nucryst Still Licking Its Wounds
• TINY's Investment Inches Closer to Payoff
• Nanotech and the War on Cancer

Want more Foolish insights on the cutting-edge companies working on tomorrow's market-shaking technologies? Try a free 30-day subscription to Motley Fool Rule Breakers.

Fool contributor Jack Uldrich is the author of two books on nanotechnology, including Investing in Nanotechnology: Think Small, Win Big. He owns stock in Harris & Harris, a Rule Breakers pick. Merck was a former Income Investor pick. The Fool has a strict disclosure policy.