One of the newest small cap biotechs that I’ve added to the Small Cap Gems portfolio is Conatus Pharmaceuticals (Nasdaq: CNAT). This company is a biotechnology company focused on the development and commercialization of novel medicines to treat liver disease.

The stock has an approximately $120 million market capitalization and goes for just over $7.50 a share. The shares touched over $14.00 earlier this year before the sharp biotech sell-off in early March, put in a bottom around $6.00 a share, and are starting to rally a bit of late. Conatus came public in late July of 2013 and the stock has traded in a wide range of $5 to $15.50 a share since then.

One of themes and focus areas around biotech this year has been diseases of the liver. Gilead Sciences (Nasdaq: GILD) released Sovaldi earlier in the year to treat Hepatitis C, a potentially fatal disease that affects 3.5 million people just in the United States. This drug has racked up more than $8.5 billion in sales just in the first three quarters of roll out and will go down as the most successful drug launch in history based on first year’s revenues. It’s on pace to finish up at $11 billion.

There are many diseases that attack the liver such as Hepatitis B, a much more prevalent but much less lethal version of that disease as well cirrhosis, cancer other forms of afflictions. Viral infection, alcohol, obesity and autoimmune diseases all increase caspase activity leading to liver damage.  The amount of people affected in the United State and other major Western economies with various liver afflictions is quite large and represents a lucrative opportunity.

The liver is the largest internal organ in the human body and its proper function is indispensable for many critical metabolic functions, including the regulation of lipid and sugar metabolism, the production of important proteins, including those involved in blood clotting, and purification of blood. There are over 100 described diseases of the liver, and because of its many functions, these can be highly debilitating and life-threatening unless effectively treated. 

Given the prevalence and cost of treating various ailments of the liver, it is a prime candidate of interest for myriad drug and biotech firms along as for investors. The stock of Achillion Pharmaceuticals (Nasdaq: ACHN) soared in early summer when it announced its Hepatitis C product used in conjunction with Sovaldi cured 12 out of 12 patients in an early stage trials.

Sovaldi by itself already has 98% cure rate and its recently approved combo drug to treat the disease eliminated almost all of the side effects with the previous combo that usually used Olysio by Johnson & Johnson (NYSE: JNJ), so the 80% jump in Achillion’s shares seems like a bit of an overreaction to early trial results but demonstrates how any good news in this space can sharply rally the underlying stock.

The lead and only product of note for Conatus is Emricasan.  This compound is a first-in-class, orally active pan-caspase protease inhibitor designed to reduce the activity of all ten human caspases, which are enzymes that mediate inflammation and cell death, or apoptosis, for the treatment of patients with chronic liver disease and acute exacerbations of chronic liver disease. Conatus believes that by reducing the activity of these enzymes, Emricasan has the potential to interrupt the progression of liver disease and potentially provide treatment options in multiple areas of liver disease.

Emricasan has achieved scientifically significant results in several Phase I trials and is now being tested in five Phase II trials for the treatment of a variety of diseases that impact the liver. Investors can expect numerous studies to be completed over the next three to nine months which will make this stock a volatile one as these trial results should cause big swings in the equity, hopefully for the positive in the vast majority of cases.

Conatus is a bit different than our other picks in that those companies were developing a stable of different products. Conatus is almost entirely focused on Emricasan, which it is testing for a variety of diseases.

Emricasan has a colorful history. Over a decade ago, Emricasan was a pre-clinical stage drug candidate owned by a small, privately-owned biotechnology company named Idun Pharmaceuticals. The CEO of that company was a man named Dr. Steven Mento, the current CEO of Conatus.

The drug showed exciting promise as it seemed capable of both activating cytokines and preventing physiological cell death. The potential for treating a wide spectrum of liver disease manifestations with a similar mechanism garnered a considerable amount of attention and in 2005 Idun Pharmaceuticals was purchased by Pfizer (NYSE: PFE) for that potential.

Three years after the acquisition Pfizer abandoned its Emricasan program, following multiple failures to address safety issues which concerned the FDA. Two years later, Conatus acquired Emricasan back from Pfizer. Dr. Mento and his team that originally developed Emricasan believed they could address the FDA concerns and still thought the compound had great potential.

In 2013 Conatus successfully addressed the concerns of the FDA and the agency lifted the clinical hold on the drug candidate. The company then began the process of bringing Emricasan to market once again. Which brings us to where we are today on Emricasan.

It’s clear the management team believes strongly in the potential of this compound to treat a variety of liver diseases. They hold a major stake in the firm and have not sold a share since the month of the IPO over a year ago even when the stock spiked earlier in the year.

The company has over $45 million in net cash on its balance sheet which represents over a third of the stock’s market capitalization at current levels. This is should alleviate the need for any dilutive capital raise for the foreseeable future.

The five analysts that cover the stock have price targets ranging from $13 to $19 a share on the stock of Conatus. Two five-star rated analysts (according to TipRanks based on performance of previous calls against the overall community of analysts) from Roth Capital and Stifel Nicolaus have both issued Buy ratings on Conatus over the prior three months.

Conatus is a binary play. If Emericasan succeeds in trials to treat one or more of its targeted liver diseases, the stock is going to soar given the potential market and the company will become an instant buyout target. Either of which could make the stock of Conatus a multi-bagger. If trials completely fail, the future of the firm as an ongoing entity is in doubt. In short, this stock is the consummate high risk/high reward play which I am optimistic about and hold within my own portfolio.

Given the unusual nature of potential and diverse return trajectories for Conatus, we do not have a price target on the stock as I do not want to leave a potentially huge amount of money on the table. As a risk mitigation strategy, I do advise that if the stock spikes to $15 a share on any trial results or buyout rumor that you consider taking your  double and sell half of your stake. The rest of the stake will now be played with the house’s money and we will monitor progress closely and advise if and when to take further profits.