Cubist Pharmaceuticals Inc (NASDAQ:CBST) surged 10% on July 31, after the company acquired two antibiotic makers, Optimer Pharmaceuticals, Inc. (NASDAQ:OPTR) and Trius Therapeutics, Inc. (NASDAQ:TSRX), to strengthen its drug pipeline. After that big rally, shares of Cubist Pharmaceuticals Inc (NASDAQ:CBST) now trade at 45 times trailing earnings, and are up nearly 45% over the past six months. Should investors sell into the stock’s bullish strength, or load up on more shares in anticipation for more robust growth in the future?
A closer look at Cubist
Last quarter, Cubist Pharmaceuticals Inc (NASDAQ:CBST)’s earnings declined 25% year-on-year to $0.54 per share, missing the consensus estimate of $0.42. The company attributed the top-line miss to a 52.3% surge in total operating expenses, primarily from higher R&D costs from growing its pipeline. Revenue rose 12.2% to $258.8 million, thanks to strong sales of Cubicin across the world. Sales of Cubicin rose 13.4% to $227.1 million in the United States, and 31.6% to $15 million in international markets. Combined Cubicin sales comprised 93.5% of the company’s top-line.
Sales of Entereg rose 27.6% to $12.4 million, while Dificid service revenues came in at $3.7 million. Therefore, with neither Entereg or Dificid making a significant contribution to Cubist Pharmaceuticals Inc (NASDAQ:CBST)’s top-line growth, the company needs new avenues of revenue growth. Cubist’s high R&D expenses were primarily used to diversify its product line with three important Phase III candidates: ceftolozane/tazobactam — for urinary tract and abdominal infections, Surotomycin — an oral antibiotic for “fatal diarrhea,” and Bevenopran — an opioid-induced constipation treatment.
Taking out the antibiotic market in one fell swoop
Cubicin’s patent protection lasts until September 2019, which could mean the end of the line for the company if it fails to bring more approved treatments to the market. In addition, generic medication maker Teva Pharmaceuticals, which already has a licensing agreement with Cubist to produce Cubicin, will only be one of many eager generic companies looking to manufacture the company’s best-selling antibiotic.
That pressure is the reason investors cheered the company’s decision to acquire Optimer Pharmaceuticals, Inc. (NASDAQ:OPTR) and Trius Therapeutics, Inc. (NASDAQ:TSRX) for $535 million and $707 million in cash, respectively. However, adding in the “contingent right value” (determined by drug sales milestones) of the two companies, the total deal could reach $1.62 billion.
Yet in that one fell swoop, Cubist has taken the lion’s share of the antibiotic market, and the combined company’s portfolio could provide up to four of the ten new antibiotics that the Infectious Diseases Society of America believes the world will need by 2020, according to CEO Michael Bonney.
What new treatments does Cubist gain?
By acquiring Optimer Pharmaceuticals, Inc. (NASDAQ:OPTR), Cubist will own Dificid, rather than merely receiving service revenues from sales. Yet Dificid’s lackluster sales of $16.8 million last quarter, which came in below the consensus estimate for $20 million, show that it can only be considered a secondary revenue stream like Entereg, rather than a top product like Cubicin. Optimer Pharmaceuticals, Inc. (NASDAQ:OPTR) has been researching alternative applications for Dificid as well.
By acquiring Trius Therapeutics, Inc. (NASDAQ:TSRX), Cubist gains the antibiotic tedizolid phosphate, a treatment for Gram-positive staph infections currently in Phase IV treatment. Trius Therapeutics, Inc. (NASDAQ:TSRX) co-developed tedizolid phosphate with Bayer for overseas markets. Trius Therapeutics, Inc. (NASDAQ:TSRX) is also working on GyrB/ParE, a treatment for Gram-negative infections (which are more resistant to antibiotics), which is currently in the discovery/pre-clinical phase.
The Foolish Bottom Line
Investors should recognize Cubist’s primary motivations for acquiring Optimer Pharmaceuticals, Inc. (NASDAQ:OPTR) and Trius Therapeutics, Inc. (NASDAQ:TSRX) – diversification and domination. By diversifying its pipeline, it can avoid being classified as a one-trick pony completely dependent on its best-selling antibiotic, Cubicin. It can also expand horizontally and add more antibiotics to its pipeline, expanding its reach into other Gram-positive and Gram-negative treatments. Most importantly, the acquisition could double Cubist’s annual revenue to $2 billion by 2017 and clear the road for future growth after Cubicin’s patent expiration.
Investors shouldn’t be in a big hurry to invest in Cubist, however. The stock’s 5-year PEG ratio of 2.09 suggests sluggish earnings growth ahead, and its forward P/E of 36.3 is considered a premium to its industry peers. Lastly, the company only reported $1 billion in cash last quarter, but is shouldering $408.2 million in debt. This means Cubist will have to take on even more debt to finance its acquisition of Optimer and Trius.
For now, biotech investors should still keep a close eye on how the Cubist deal plays out, since it could alter the market for antibiotics significantly, but it would be prudent to wait to see if these two costly investments pay off first.
The article Will This Biotech Company’s Big Bet Pay Off? originally appeared on Fool.com and is written by Leo Sun.
Leo Sun has no position in any stocks mentioned. The Motley Fool recommends Cubist Pharmaceuticals. Leo is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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