Profit from this banned drug

The pros and cons of illegal drugs continue to be debated as the ‘war on drugs’ rages. But one drug in particular – cannabis – is becoming increasingly useful as a legitimate medicine. Matthew Partridge picks the best way for investors to cash in.

The debate over the war on drugs' is becoming increasingly heated.

On the one hand are those who argue that current prohibition policies have failed, and merely hand control of a lucrative trade over to criminals. Others argue that the potential social costs in terms of rising addiction are too high simply to legalise drugs outright.

It's not clear which side is winning. In the US, Colorado has become the first US state to fully legalise marijuana. But at the same time, The Netherlands is moving in the opposite direction, cracking down on its notorious coffee shops that sell the drug.

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However, there is a way for smart investors to profit from America's increased willingness to discuss medical uses for otherwise illegal drugs such as cannabis.

It's all about one very specific British company

The risks of experimenting on illegal drugs

However, the legal status of cannabis has meant that getting approval for proper research has been hard. Governments don't want any crops produced to fall into the wrong hands. They are also wary of being seen to be giving ground to those who want to legalise it more generally.

On their part, companies have been unwilling to invest in trials without cast-iron promises that they won't be shut down or landed in jail. They also worry about the potential implication of a relaxation in drug laws. There's not much point in spending a fortune on research and development only to see sales collapse as patients get the green light to grow their own supply.

Because of this, the only drug to get approval up until recently Marinol, created by Solvay in the 1980s was based on synthetic versions of the chemicals found in marijuana. While it remains on the market, it is only approved for a narrow range of conditions, such as eating disorders caused by AIDS.

The lack of success made both companies and the authorities, especially in the US, even less willing to allow future experiments.

How GW Pharmaceuticals turned marijuana into medicine

And in the end, GW came up trumps. Its cannabis-based drug, Sativex, is able to reduce pain for cancer patients and help with some of the symptoms of multiple sclerosis (MS) in a way that both conventional drugs and illegal cannabis are unable to. Better yet, it has relatively few side effects.

Three years ago, Sativex gained approval for use in the UK for MS. It is currently being sold in six other countries: Spain, Germany, Denmark, Canada, Israel and Norway.

But Sativex could have a lot more to give. It is in late-stage (phase 3) clinical trials for use in the much larger cancer pain market. Results are expected in 2015.

On the strength of these trials so far, GW has negotiated licensing deals with Bayer, Otuska and Novartis. That means that if successful these pharma giants will throw their distribution and marketing might behind Sativex. GW will retain a large chunk of sales via royalty payments.

Meanwhile, the Holy Grail' of drug trials approval in the giant US market may be only a few years away. Late stage US trials begin next year.

Looking further ahead, GW also has a very interesting drug pipeline. Later this year, trials of a compound aimed at treating diabetes will begin their second stage. There are also drugs for colitis, schizophrenia, epilepsy and glioma (brain tumours) being developed.

Risky, but worth a punt

Like most small-cap drug companies GW Pharma (LSE: GWP) (NASDAQ: GWPH) is far from being a risk-free investment. Of course there is a chance that even these late-stage trials could fail. And funding all of these trials and further research is not cheap. As a result, GW is projected to make a loss for the next two years.

However, by small drug company standards, the downside risk looks relatively low. Given that Sativex has been approved in a wide range of countries so far, you would expect it to have a good chance of achieving approval in the States too.

The company also recently launched a secondary listing in the US. The money raised from this should help it fund trials and research without any further need to dilute shareholders.

Michael Aitkenhead of Edison Research reckons GW should be turning a significant profit by 2016, while revenue should nearly double. Even putting a conservative valuation on future revenue streams suggests that from today's price, the shares could eventually double.

This article is taken from the free investment email Money Morning. Sign up to Money Morning here.

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Dr Matthew Partridge

Matthew graduated from the University of Durham in 2004; he then gained an MSc, followed by a PhD at the London School of Economics.

He has previously written for a wide range of publications, including the Guardian and the Economist, and also helped to run a newsletter on terrorism. He has spent time at Lehman Brothers, Citigroup and the consultancy Lombard Street Research.

Matthew is the author of Superinvestors: Lessons from the greatest investors in history, published by Harriman House, which has been translated into several languages. His second book, Investing Explained: The Accessible Guide to Building an Investment Portfolio, is published by Kogan Page.

As senior writer, he writes the shares and politics & economics pages, as well as weekly Blowing It and Great Frauds in History columns He also writes a fortnightly reviews page and trading tips, as well as regular cover stories and multi-page investment focus features.

Follow Matthew on Twitter: @DrMatthewPartri