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Biotech: Free Call Options & Special Situations


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I was wondering if anyone played in the bio-tech space. I have always been intrigued by what I call "free call options" in the space for obvious reasons.


1. Bio-tech stocks generally do not trade with the market, but rather around their events.

2. You can sometimes find companies trading below the value of their cash (which will burn with R&D) and/or the present value of existing royalty streams with a near term trial on some other drug.


I am not talking about speculating around FDA trials. I am talking about finding small companies with a downside floor (i.e. cash or NPV of royalty) and the potential to make a lot of money if a certain drug does pass a FDA trial, hence the term free option.


Here is an example of a stock that played out earlier this year and still exhbits a lot of those characteristics (FYI... I heard a pitch for this stock and started to follow it).


FURX Pharmaceuticals (FURX) - in Dec of 2012 could be purcheased for approx. $18 per share. At the time the company had a drug (Alogliptin) that was approved/marketed in Japan. The drug was marketed by a Japanese company Takeda Pharma and FURX recieved a royalty from its sales. Assuming a 5% growth rate, 15% discount rate, and 0 terminal value when the drug went generic the guy making the pitch derived a NPV for Alogliptin of $20 per share.


In late March of 2012 the stock sold off strongly when the FDA / EU rejected the drug in phase III, bc it wanted more data. Immediately following the sell-off the CEO made large open market purchases. As I already stated, the drug was being marketed in Japan and the company was recieving a royalty stream from those sales.


Investors at that time could purchase FURX at a discount to its Japanese royalty stream and get a free call option on two events.


1. Potential approval of Alogliptin by the FDA/EU once the company presented more data in 2013

2. Another drug (MuDelta) is currently in phase III (it uses opiods to induce constipation). MuDelta had a highly successfull phase II study in terms of efficacy and safety. Furthermore, the study was huge with 802 patients enrolled.


At the start of this year the FDA and EU approved alogplitin and shares jumped to a high of $42 (~100% gain) on the first free call option. Since that time the stock has sold off, but now the company has downside protection in terms of a greater Alogliptin royalty stream (EU & US in addition to Japan). The NPV of the new royalty stream is likely greater than the current stock price of $33.90 and one free call option remains. I do not own any shares, but am trying to study up.


There are plenty of other examples in the space of just interesting situations where you don't even need the free call option. Think PDLI and MAXY... these were simple value stories.


I just wanted to post and see if anyone follows the space. I am always interested in learning about these type of ideas.

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