Take a punt on this biotech tearaway

"Bengt, I've been reading your blogs. You say you're holding cash, ferreting away corporate bonds and all that defensive stuff. But where are all the top-tips?"

"What do you mean? The stuff I write about is what I do"

"Aah, but what about the more speculative punts the stuff that really makes the money?"

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That was part of a conversation I had on Tuesday when I met up with an old mate from the City.

He knows me well. Though I think now is a time for defensive investing, he's right I dabble in the odd speculative stock too. Today I want to show you something I've been watching. It's a stock that could be very interesting.

Don't read this if you're not prepared for a punt', because that's what it is. I wouldn't allocate more than 1% to a stock like this.

But I dothink this is a great opportunity. Here's why.

This biotech burnout is primed for a takeover

In August I wrote that we could be looking forward to a wave of biotech buyouts.

A close friend who's the chief financial officer of a small pharma company had been telling me why he was sure that there'd be consolidation in the industry.

So I went away and had a good hard look at the sector. And then someone I was talking to suggested one to look at. This is a company with no debt, and a market value that barely accounted for its cash holdings. A company whose CEO has a history of doing deals with large pharma. And a company that could have some rather attractive products in the pipeline.

So why didn't I let you know about this stock? Because hot tips have a nasty habit of turning out badly. And this is one did exactly that.

Over the last few months the price of Vernalis (LSE:VER)has halved from about 40p to under 20p.

But if you look at the five-year chart it's much, much worse...

The horrible collapse of Vernalis

Source: Digitalook

This stock has been an unmitigated disaster. During the last few years it's fallen from over £11 to 20p. The business is now valued at less than £19m. And yet the latest results (end of June 2011) record that the business had £27.1m in the bank.

Its balance sheet tells a rather sorry tale retained losses £640m! That's how much they've spent on drug research on the search for a wonder drug that could make shareholders millions.

That's pretty horrific for shareholders, but those tax losses could be useful in the future.

Although Vernalis is a drugs development company, it has a drug on the market too. Frovatriptan brought in about £4m for the six months ending June. Brokers forecast Vernalis will generate £12m of income for the year to the end of December.

But more importantly they've got eight drugs in the pipeline at various stages of testing.

The market has written off what could be a very decent pipeline

Now I'm certainly no expert when it comes to assessing the chances of Vernalis getting their drugs approved. Frankly, I'm yet to find someone that is. And neither do I know what sort of potential there is for the drugs should they get through.

But the accounts tell me there's reason for hope here. They tell me there's good reason to consider a small punt on this one. They've got two drugs at pre-clinical stage, three at phase I and three at phase two. (There are three phases to drugs trials).

The market isn't really attributing any value to the pipeline. I suppose the market thinks the business will burn through the cash it's got left and then come cap in hand to shareholders for more. Or worse, it could just go bust. And you can't rule that out.

The company tells us they've got enough cash to see them through to the end of 2013. That gives them two years.

That's plenty of time for this bet to pay off. Whether it's through a clinical breakthrough or the company getting taken over doesn't matter.

The former will probably be better approval for just one of their drugs could land them with revenues of tens of millions of pounds. But even a takeover could see the share price at multiples of where it is today.

Definitely don't put down more than you can afford to lose on speculative stocks like this. But if you're looking for a punt, I think this looks like it could be a nice opportunity.

Ticker: VER:LSE

Price: 20.875p

52 Week High/Low: 50/20.88

Market Cap: £18.921m

Five year performance: 2006 +2.46% | 2007 -89.94% | 2008 -48.33% | 2009 +62.88% | 2010 -52.86% | 2011 (to 29 November) -48.48%

This article is taken from the free investment email The Right side. Sign up to The Right Side here.

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