Cubist: Battling bacteria

Antibiotic-resistant bacteria have become an alarming problem in hospitals. Most drug companies, though, aren't interested, seeing the potential profits as limited. Today's most profitable medications are those taken chronically, while antibiotics are short-term fixes that, moreover, are usually priced very modestly.

This leaves smaller companies leading the way — in particular, Cubist (CBST). Its major drug Cubicin treats skin, blood, and heart infections wholly or partly resistant to other antibiotics.

Hospital-based bacterial infections now kill more people than diabetes. Worse, such infections are starting to appear outside of hospitals. This makes it urgent to develop new antibiotics quickly.

Cubicin sales, accounting for 80 percent of the company's profits, have soared about sevenfold over the past six years, and we expect a few more years of rapid growth. But it's still just one product with a limited life span.

It was slated to face generic competition in 2020; to help shield its sales, Cubist entered into a profit-sharing agreement with generics leader Teva that will start in 2017 in exchange for a longer period of partial exclusivity.

Given Cubist's fairly rich valuation of 21 times current earnings and 19 times estimated 2014 earnings, its pipeline is critical. Luckily, it's looking good.

A number of phase III trials are in progress for a class of drugs Cubist has developed known as CXA-201, intended to combat a wide range of antibiotic-resistant hospital infections.

Other medicines in phase III and phase II trials address various types of recalcitrant intestinal disorders. A non-opiate painkiller is in an earlier stage of testing.

The "Street" estimates the potential market for these drugs at around $1 billion, but we think it's far higher. Most estimates don't consider that the infections such drugs treat are, by their antibiotic-resistant nature, growing very rapidly and growing across the globe.

Cubist has some well-heeled marketing partners in place including Swiss drug giant Novartis. Moreover, its CXA-201-based drugs could spawn additional unique antibiotics.

CXA-201 consists of CXA-101, the most important component, along with other molecules. Cubist believes combining CXA-101 with as yet untried molecules could produce drugs with even greater potential.

Given Cubist's current market cap of $3 billion, the impact of its pipeline could be enormous. A rule of thumb is that a new and unique drug can be worth up to five times its potential sales in terms of market cap.

In total these pipeline drugs could easily have $2 billion-$3 billion potential, suggesting a target for the stock several times its current price.

The company expects to start applying for new drug approvals this year. Its success with Cubicin inspires confidence that future successes are hardly a shot in the dark.

This isn't a stock for the faint of heart, and you can expect a lot of volatility. It is, however, a company that could make a serious dent in a rapidly growing global problem while making a bundle for investors willing to take a chance on its success.