Longer Wait, Higher Chance of Success?

"As we await the completion of the Phase 3 trial in this indication in the United States during the first quarter of 2012," Juergen Engel, PhD, President and CEO of Aeterna Zentaris (NAS: AEZS) , said at the beginning of the year.

We're two-thirds of the way through the quarter and haven't gotten the data for Aeterna Zentaris' cancer drug perifosine yet. Good sign? Bad sign?

The only sign I see is that Aeterna Zentaris and its partner, Keryx Biopharmaceuticals (NAS: KERX) , may have failed to accurately estimate the survival rates of patients with refractory advanced colorectal cancer.

The trial is scheduled to read out after 320 deaths combined from both treatment arms. There's just no way for us to know if the delay is because of an increase in survival of patients treated with perifosine, those treated with placebo, or a combination of the two.

Both groups living longer could be just as bad as the placebo group living longer than expected, because the trial is set up to measure the difference between the two groups. A difference of 5.5 months versus 7.5 months might be statistically significant, and would be an improvement on Bayer and Onyx Pharmaceuticals' (NAS: ONXX) regorafenib, which increased survival by just 1.4 months. But the same increase in life expectancy pushed out a few months -- say 7.5 months versus 9.5 months -- might not hit the magic p-value of 0.05.

Clearly, if the perifosine-treated patients are living longer than expected, that's a good thing. Waiting a few extra months will mean increased sales down the road.

Handicapping the likelihood of success is difficult because there were only a small number of patients in the phase 2 trial with the same characteristics as those in the phase 3 trial. The companies enrolled a subset of the phase 2 patients who responded best in the phase 3 trial.

So the trial is going to fail?
I didn't say that. Exelixis (NAS: EXEL) misguided on the completion of its trial for cabozantinib and everything turned out just fine.

I think it's best to think of this trial like a very large phase 2 proof-of-concept trial that could be used to support a marketing application. Investors should have as much confidence as they would that any phase 2 trial will work -- that is, not much -- and not ascribe much value to the compounds.

Buy, sell, stay away?
I certainly wouldn't short either company at these levels. Keryx has a market cap under $250 million; Aeterna Zentaris weighs in at just $175 million. Shares will go down if the trial fails, but neither is completely dependent on perifosine -- they both have other drugs in their pipelines, and Aeterna Zentaris has one on the market. Whatever you would gain from the trial failing doesn't seem worth the risk if you're short and the trial succeeds.

I usually recommend investors stay away from companies where the risk profile is unclear, because otherwise it's just gambling. But there comes a point where it's worth being exposed to a small downside risk to reap huge upside potential. For instance, Human Genome Sciences (NAS: HGSI) at $0.50 per share was probably worth taking a flyer on even though history said the chance of passing a trial in lupus patients was pretty slim. It soared 6,300% from the low after Benlysta was approved.

Are Keryx and Aeterna Zentaris cheap enough to justify a bet on a successful trial? I don't know; they're certainly close. I wouldn't fault anyone for owning at this level. Just keep in mind that they're not going to soar 6,000% on an approval.

Or here's another option
If you're convinced that the trial data will be delayed beyond March 16, you could set up an option strangle, selling a call above the current price and a put below the current price. If the shares stay between those two values, both options expire worthless and you get to keep the premiums you collected when you sold the options.

Right now, you can sell a March put and a call at the strike prices above the stock price for about 14% of Keryx's share price; Aeterna Zentaris doesn't appear to have options available.

To reduce the risk on the call, it's best to buy the shares, but you'd essentially be getting them at a 14% discount.

If the data doesn't come, despite my assertions that it means nothing, a delay will almost certainly be viewed as good news and the stock might move high enough that you get your shares called away. But that would still result in a handy profit from holding for a couple of weeks.

Educated gambling
That's basically what biotech investing is. In the case of perifosine, you can study all you want, but there just isn't enough data to make an educated guess about whether the drug will succeed.

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At the time thisarticle was published Fool contributorBrian Orelliholds no position in any company mentioned.Click hereto see his holdings and a short bio. The Motley Fool owns shares of Exelixis.Motley Fool newsletter serviceshave recommended buying shares of Exelixis. Try any of our Foolish newsletter servicesfree for 30 days. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. The Motley Fool has adisclosure policy.

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