The Short Case for Zalicus: Not Worth Its Market Cap

https://seekingalpha.com/article/278121-the-short-case-for-zalicus-not-worth-its-market-cap

The fair value of Zalicus (ZLCS) shares is about $0.50 to $1.00. Our fund is short Zalicus.
What is fair value?
Theoretically?
Practically?
Why does it matter?
How is it calculated?
Notice that the FV given above is a range as opposed to an exact number.
How does this impact how you structure a trade, if it does?

Calculating the fair value of Zalicus is relatively straightforward. There are two main assets,
Exalgo and Synavive.
There seems to be a trend in pharma/biotech when it comes to the ease of calculating FV.
Here, the fact that the company only has two assets seems to be significant wrt
calculating FV/ease of calculating FV.
What other factors influence calculation of FV?

Exalgo is a pain drug sold by Covidien (COV).

[?] What does it mean for a company's drug to be sold by another drug?
Is this some kind of royalty agreement?
Which of the filings detail the royalty agreements a company has agreed to?
What does each drug do ie what indication does it treat?
This is important and you should know it and incorporate it into your models.

The royalties due to Zalicus are run-rating at approximately $1.5 million annually.
[?] What does `run-rating` mean?
MEANING: if you extrapolate roylaties TO predict annual royalties, you get $1.5 million.

The drug seems to have peaked in sales.

How can one tell?
Where do you get the data for this?
How can one make sure?
This seems super important wrt to evaluation.

Even assuming it doubles and then peaks, the Exalgo royalties ($3m X 8x sales for a cost-free
royalty) are worth $24 million, or $0.25 per share.
What does `8x sales for a cost-free royalty` mean?
What is a cost-free royalty?
How can the Exalgo royalties be worth only $24 million if this calculation is for peak royalties?
Obvious but note that he calculates FV per share.

Exalgo isn't quite the flop a Nuedexta or Bidil is, but for it to be a meaningful drug for Zalicus'
meager royalty share, it will have to do a lot more in revenue to move the needle for this
minority owner.
How do we know Zalicus has a meager royalty share?
How can we (technically) discern that Zalicus is the minority owner.

==============================

Synavive is a maligned drug. In 2008, the Synavive "COMET-1" study for osteoarthritis failed.
How soon the market forgets.
GENERAL POINT: how to tell if a study has failed?
Before the results come out.
After the results come out.
You need to read this COMET-1 study.

This combination of two generic drugs did not do any better (amazingly, it did worse!) than its
component drugs.
KEY PRINCIPLE: you need to absolutely know, scientifically, what the drug is?
Biologic?
Small molecule?
Combination of small molecules?
etc
Scientifically speaking, why might a combination do worse than its component drugs?
Why did this one in particular do worse?

Why should we expect a different outcome from the SYNERGY study?

Rhetorical question.

The biological rationale for this drug (formerly known as CRX-102) is flawed, and that was
proven in COMET-1.
NOTE: he mentions another name for the drug. This is absolutely key when it comes to doing
research. See the AXON tutorial.
NOTE: another key principle; which one of those is this? (A Ray Dalio principle)
Is there any way to tell if the `biological rationale` for a drug is flawed BEFORE doing an
experiment?
Any way to guess this by combining prior literature SANS doing the experiment?
Technical question: were the indications the same in COMET-1 and SYNERGY?
I would guess that they were.
Where can we even find the biological rationale for a drug?

I think Zalicus management is taking this study on because they have nothing better to do.
With "SYNERGY", management gets to continue the farce that the company's market cap of
$250 million resembles those of other "promising phase 2 companies".
What incentives could be motivating management to continue with studies that are doomed to
fail?
This question is worth careful consideration in just about every single investment.

Synavive is the combination of prednisolone and dipyridamole.

What IS the drug you are studying? >> Very important general principle.
Technical question: is it worth it to do a very detailed study of the component drugs?
My guess: Probably ... but how?

The company claims they have a composition of matter patent on the combination of two
extremely old drugs.
A scenario to keep in mind if it comes up again.
What is a composition of matter patent?
Examples where the patent was justified.
Examples where the patent was NOT justified.

Someone should inform management that to win a composition of matter patent, they should
probably invent the compound in question first.
What other criteria decide if a composition of matter patent is defensible?

Synavive won't work in SYNERGY. This asset is worthless. It's worse than worthless--it will eat
up $10 to $20 million in cash as the SYNERGY study reads out in the next year.
Important cost figure.
Know these cost figures for every phase of a trial. See appropriate references.
Important general principle: When will study results come out?

I value the rest of the pipeline, including the interesting Nav ion channel drugs, with a modest
$0.25 value until they enter the clinic.
This seems super arbitrary.
Technical question: How can we value assets that have not entered the clinic?
Ask Martin, see appropriate references, as a professor.
When he says `until they enter clinic` ... does this mean no sooner than they start preclinical
studies?
What does it mean to `enter clinic`?

With 90% downside, ZLCS is a great short. I think the average investor forgets there is no
difference between a $2 stock and a $20 stock and a $200 stock and your expected return. A
smaller stock price is actually inversely correlated with performance.
What does he mean when he says there is no difference though?
Seems like a false statement on multiple levels.
WRT second sentence: meaning that cheapter stocks tend to do better?
You should check this out to verify/dismiss it.

Yesterday's stock move in Zalicus is noteworthy. The 3 research analysts covering the stock,
JMP Securities, Wedbush and Oppenheimer, have no interest in helping you make money.
What may have prompted the move?
Really worth asking Martin this.
General Principle: know who is covering the stock.
Can be found on a company's website.

They exist to support their "business model" of writing new secondary deals for overvalued
stocks like Zalicus.
Another KEY instance of knowing the incentives at play.
Two examples of this so far in this paper. Worthy careful study as you are basically
fighting against these incentives when you do your valuation.
What is a `secondary deal`?

Zalicus' CEO made $2.5 million in 2010 according to Bloomberg ($446,000 in salary).
You do not know enough about judging compensation for company employees.
Is it good that the CEO in this instance made most of his earnings from nonsalary comp?
Is it bad?
Zalicus claims no serious institutional shareholders.
This seems very important ...
What does it mean?
How can you figure out who the institutional investors are?

Don't subsidize this CEO and this forgettable asset for the illusion of a "cheap" stock.
Why is he chastizing the CEO?
Is there more to the CEO story?
Worth asking Martin.
Is he using the word `subsidize` in the right context here?
Does he mean `support`?
NOTE: price of a stock == price of the ENTIRE company. ALWAYS and FOREVER.
NOT the per share price.

Think in market cap - not stock price. Is this company worth $250 million? Is it worth $500
million or $100 million? If you can't follow this exercise, the market isn't for you. Consider a
job selling research at an investment bank.