It is biotech stocks like Cubist Pharmaceuticals (Nasdaq:CBST) that keep investors coming back into a sector that is arguably more famous for spectacular failures than reliable success. While Cubist stock has not reclaimed the highs of the 2000-2001 era, the company has nevertheless ridden the success of its antibiotic Cubicin to become a near 10-bagger from the lows of late 2002. The question for investors now, though, is whether the company can find another Cubicin and keep the investor enthusiasm healthy.
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A Solid, But Not Special, Second Quarter
Cubist reported sales growth of 5% for the second quarter, fueled by 9% growth from the company's core drug, Cubicin. Although Cubicin sales were a bit stronger than analysts were generally expecting, overall revenue was basically in line with expectations. Margin performance was likewise unspectacular in either direction - the company saw some gross margin erosion (due in part to larger sales discounts), but adjusted operating income growth tracked revenue.

The Need to Go Beyond Cubicin
At the time of its introduction in 2003, Cubicin was a big deal - one of the first really new antibiotics to hit the market in years, and one with a very different mechanism of action than the standard therapies. It was also something of an improbable success - the drug was originally discovered and developed by Eli Lilly (NYSE:LLY) but ultimately abandoned and sold to Cubist.

Cubicin has made a niche for itself as a second-line (and, in some cases, first-line) therapy for serious infections like MRSA (Methicillin-resistant Staphylococcus aureus). That said, Cubicin still competes with cheaper alternatives like generic vancomycin and branded drugs like Forest Labs' (NYSE:FRX) Teflaro and Pfizer's (NYSE:PFE) Zyvox.

While Cubist got a significant win for itself when it negotiated a settlement with Teva (Nasdaq:TEVA) that will keep Cubicin generics off the market until 2017 or 2018, the clock is still ticking.

The Pipeline
One of the leading concerns with Cubist is the relatively thin pipeline of two drugs. CXA-201 is going to head into phase three studies for urinary tract infections and complicated intraabdominal infections, and it could be a valuable gram-negative antibiotic, but it may be worth only about one-third of Cubicin in terms of market value for the stock. Even if CXA-201 shows strong efficacy in certain lung infections, the value would not rise to that of a replacement for Cubicin.

Cubist is also waiting to make a go/no-go decision on a phase three trial for CB,315 in C.diff - another serious infection with increasing issues of resistance to available drugs. Phase two results were encouraging, but do not suggest category-killer potential. Complicating matters is that clinical results for 315 seem fairly similar to those of Optimer's (Nasdaq:OPTR) Dificid - a drug that Cubist recently agreed to co-promote.

Worries About Competition and Acquisition
On one hand, Cubist benefits from the fact that antibiotics just are not a very popular area of research for large pharmaceutical companies. True, companies like AstraZeneca (NYSE:AZN) and Sanofi (NYSE:SNY) are working on some compounds, as well as smaller biotechs like Achaogen. The problem, though, is that antibiotics are difficult to develop (compounds that are good at killing living things like bacteria tend to have side effects) and the markets are not that large - antibiotic resistance is a problem, but many infections can still be handled by cheap generics, and that limits market and pricing potential.

Some shareholders also seem to be troubled by the possibility that Cubist will pursue acquisitions to fill out its pipeline and/or give its salesforce more product to sell. This concern largely comes down to one of horizon - investors who want to hold Cubist for a while should be encouraged by pipeline-filling deals (assuming reasonable valuations), while investors holding in the hopes that Cubist itself gets bought out will likely view these deals as unnecessarily risky and disruptive to deal prospects.

The Bottom Line
Cubicin is a good drug, but Cubist looks fairly priced today. An acquisition could certainly change the company's pipeline value, but it is hard to see many near-term events that would fuel a major rise in the stock price apart from an outright sale of the company to a larger drug company. (In a volatile market, domestic investing can be risky. Many investors choose to look overseas for diversification - but that strategy comes with its own risks. To learn more, see The Risks Of Investing In Emerging Markets.)

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