In honor of Thanksgiving, I’ve decided to write about my biggest turkey, Aurora Foods. Aurora Foods was born of private equity cobbling together a bunch of orphan brands from major food manufacturers and loading them up with debt. Brands you probably have in your pantry: Duncan Hines, Lenders Bagels, Van De Kamp, Mrs. Paul’s, Celeste Pizza, Aunt Jemima Frozen Breakfasts, and several others. I first bought it when it was trading at a reasonable P/E and had shown good numbers.

My timing was impeccable. The very next day, the stock was halted and it was announced that earnings would be delayed. When the stock next traded, it was down 70%. So I bought more. It soon came out that management had committed a massive accounting fraud and they later went to prison. I kept holding though, and even buying more as it dropped further, believing that new management could revive these once-proud brands. I even got more shares and cash as part of a class-action settlement. I still have the worthless stock certificate I received as a reminder of my foolishness.

New management was indeed able to get the company back to profitability for one quarter. It was enough to get them their bonuses that year, and I was able to sell a little at a profit thanks to the runup. The company would never report a profit again and soon thereafter entered bankruptcy and my investment disappeared with it. The prepackaged bankruptcy merged Aurora into some castoff brands from Campbell to form Pinnacle Food Corporation.

I learned several valuable lessons. Big companies rarely sell brands that can easily be “fixed” unless forced to because of antitrust concerns. If Procter & Gamble’s marketing whizzes and ample capital can’t fix it, Joe’s Overleveraged House Of Dead Brands probably can’t either. If an IPO is happening and somebody other than the company is getting the bulk of the proceeds, stockholders will more than likely be left holding the bag. And what goes down doesn’t always go back up.

What was your biggest turkey? What did you learn from it?

I previously wrote about BJ’S Wholesale(BJ) in September when the stock was at $26. Since then, the stock has slowly crept up prior today’s leap which has had it trading as high as $32. Today’s jump comes after the company announced that CEO Mike Wedge would be retiring. Reading the press release further gives additional color to the circumstances of Wedge’s departure:

In a joint statement, Messrs. Wedge and Zarkin stated, “While the Company has made great strides in its efforts to improve general merchandise sales and customer traffic, overall progress has not come as quickly as we had hoped and expected. We agree that the Company’s leadership team will benefit from a fresh perspective at this time.”

Mr. Wedge was replaced as CEO by 68 year old Chairman of the Board Herb Zarkin, who will serve in an interim role as replacement is found. Based on the positive move upwards, the market appears to think that longstanding rumors that BJ’s will be acquired will come to pass. The company looks like an attractive target for private equity as it has no long term debt and owns substantial real estate.

On the other hand, Mr. Wedge’s departure raises troubling questions about the company’s performance. Same store sales have been lackluster of late, but last week’s earnings announcement was ahead of expectations and management expressed optimism regarding Q4.

I have a sinking feeling that another shoe may drop before a buyer comes along. Given the 25% runup in the past 2 months, now looks like a good time to follow Mr. Wedge out the door and say goodbye to BJ’s

Disclosure: I have a position in BJ

US Air(LCC) announced this morning that it plans to buy Delta(DALRQ). My friend at Flight Wisdom has a fine post summarizing the details, but the stock movements are a bit mystifying to me.

US Air is up 12.5% now, down a bit from its high of the day, but still a substantial jump. Clearly investors applaud the idea of an US Air-Delta combination. But there are many hurdles to such a deal. First, neither Delta nor the creditors have agreed to anything, Second, there are rumors that other buyers have expressed interest. Third, bankruptcy is a complicated process and there are no assurances that anything will happen. US Air has soared on vapor, and is likely to pull back as investors have a chance to reflect.

Delta’s movement is even more strange. Delta stock is also up over 10%, driven up by buyers excited at the prospect of an acquisition. Yet, there is almost no chance that Delta stock will have any value post bankruptcy. The creditors own the company. Game over for the stockholders. Period.

It’s strange to see this new era of speculation in airlines. Warren Buffett said in his 1992 letter to shareholders:

Investors have regularly poured money into the domestic airline business to finance profitless (or worse) growth. For these investors, it would have been far better if Orville had failed to get off the ground at Kitty Hawk: The more the industry has grown, the worse the disaster for owners.

Buffett later fomusly quipped that had he been there, he would have shot Orville down as a public service. Of course it’s possible to make money in airlines. But extreme caution would be prudent.

Disclosure: I hold no position in LCC or DARLQ

In 1947, Bing Crosby, unhappy with the necessity of performing his radio broadcasts live, invested in a small company developing recording technology of sufficient quality to allow him to prerecord his show. It would prove a shrewd investment as not only was Crosby able to record his show ahead of time, but Ampex(AMPX) grew to dominate recording for the broadcast industry, not just for audio but for video as well.

Like many American icons, Ampex faded as new technologies supplanted its core products, and attempts to move in new directions were unsuccessful. By late 2003, Ampex’s stock was below $1 and it was delisted from the American Stock Exchange.

Then came Act II. Ampex began asserting some of the many patents it owned covering various aspects of digital photography and struck several licensing deals including one with Sony that paid it $40 million. The stock zoomed upward, topping $50 in 2005. It has since dropped back to its November 13th close of $14.15, still far above its 2003 lows.

Despite early success with patent licensing, questions linger. A patent responsible for much of the licensing revenue expired in April 2006, and the company lost a key patent case to Kodak. The company has begun to derive revenue from additional patents, and still sells high-end data storage systems, but with its heavy debt load and pension obligations it has been unable to regularly report a profit. Although it did report a profit in its most recent quarter, this was only because of a large one-time gain relating to a deal involving another company once controlled by its CEO.

It’s difficult for me to assess the value here. While the company still has a large array of active patents, they are not easily valued. At least one large shareholder feels there is significant value though. After the close on November 13, ValueVest High Concentration Master Fund filed a 13D disclosing an 8.3% stake in Ampex. In addition, ValueVest disclosed that in February it had hired an intellectual property firm to help it evaluate Ampex’s IP. As a result of the evaluation, ValueVest contacted and met with management several times beginning in May, and offered to acquire additional equity through a strategic investment.

On September 15, ValueVest upped the ante:

the Investment Manager once again confirmed the Master Fund’s interest in acquiring or making a further equity investment in the Issuer. In that letter, the Investment Manager also indicated that it would like to discuss an alternative transaction in which the Master Fund would acquire the Issuer’s Data Systems business and all of its intangible assets other than those patents which the Issuer was currently licensing or litigating and their related patent families. The Investment Manager indicated that it believed that this alternate asset transaction, which would not be subject to any financing contingency or condition, could be implemented relatively quickly and would give the Issuer the opportunity to realize immediate value for its shareholders and to generate further shareholder value through its ongoing patent licensing and litigation efforts.

On September 15, the company responded that the matter would be discussed at Ampex’s next board meeting in early November. ValueVest filed its 13D having still not received a response from the company. During this time, ValueVest has continued to purchase shares, over 130,000 since the beginning of November.

If the company’s patents can be successfully licensed, it stands to bring in a great deal of money. The company owns patents which may cover digital still and digital video cameras, cell phone cameras, DVD recorders, DVRs, and other similar devices. In the shorter term, ValueVest’s agitiation could raise the stock price, but I’d be cautious given the runup over the last week as ValueVest has acquired shares.

List of Ampex patents

Disclosure: I hold no position in AMPX

As I am a bit of a curmudgeon, one of the highlights of my weekend is picking Barron’s up off my front steps and reading the column by master curmudgeon Alan Abelson. Mr. Ableson’s prolonged absence earlier this year had me quite concerned and since his return, I have read with a new appreciation. Also, and this is a completely superfluous bit of name-dropping, Mr. Abelson and I went to the same high school. Of course, being a half century apart, I never met him, though I suppose we’d belong to the same alumini association if I ever bothered to pay my dues. Not only that, but at my graduation, they picked the other long-time columnist alumnus with the same initials to speak.
I was particularly pleased to see another investor referred to as “inelegant” in Abelson’s column this week. Abelson quotes from the latest quarterly letter from famed investor Jeremy Grantham. Grantham is the founder of GMO and his commentary is available at gmo.com after free registration.

In his most recent letter, Grantham has a wonderful piece continuing a previous discussion on the shortcomings of volatility as a measure of risk. In his previous piece, he described how

In the long term, volatility seriously overstates the risk of equity ownership because it ignores the strongly mean-reverting tendencies of both economic fundamentals and the stock market. That is to say, bad times fairly reliably follow very good times, and vice versa. Conversely, in the short term, volatility, at least as typically used, tends to understate risk by underestimating both the extreme nature of short-term outliers in real life and the occurrences of extreme events not hitherto experienced.

In his latest missive, Grantham provides data which demonstrates that low beta stocks have consistently outperformed high beta stocks. He then explains what might be the cause of this counterintuitive conclusion. Grantham posits that growth stocks have lower “career risk” and illustrates what he means with an anecdote:

In our earlier years at Batterymarch, the investment firm that Dick Mayo and I co-founded with Dean LeBaron, we lost 50% in the 1973-74 decline (almost identical to the losses of the big banks with their Nifty Fifty stocks). But we lost far more business and nearly failed because, as one client brilliantly put it, we lost our 50% ‘inelegantly.’ Great Lakes Dock and Dredge, Hartford Steam Boiler, and Twin Disc Clutch made clients feel much worse, apparently, than losing the same money in Avon, IBM, and Johnson & Johnson. It is my opinion that this is one of the central truths of the investment business. Stocks and assets that make investors feel uncomfortable even if they are less risky will always have to return more than appealing, currently successful, and exciting companies. Owning the latter, and explaining why you do, is simply a better business proposition.

Fortunately for me, I have no clients to please, but the temptation of “exciting” stocks still takes work to avoid. Inelegant investing isn’t always easy, but I’ll continue to prefer higher long term returns to short term thrills.

Analyzing a stock is reading a tale of two companies and deciding whether it’s the spring of hope or the winter of despair. Blair Corporation(BL) initially caught my attention because it has no debt and trades close to its book value. Blair has a market cap of only $120 million, and its 3.8% yield looked quite attractive. Further investigation yielded the other story, the tale that explains the modest valuation.
Blair began in 1910 as a direct marketer of raincoats. The company has expanded and is a direct marketer of women’s clothing, men’s clothing and home fashions. Blair began the decade with big hopes. John Zawacki was promoted from head of women’s wear to CEO at the end of 1999, and announced ambitious plans to grow the company from its 1999 sales level of $522 million to over $1 billion by the end of the decade. In 2000, Zawacki described the company’s problem to Multichannel Merchant:

The Blair customer file has been aging for some time,” says John Zawacki, Blair’s president/CEO, who took over for Murray McComas in January. “In 1965, the average age of the Blair customer was 47; today it’s 65. We realized we had to find a way to bring that younger demographic into the fold.

To try to grow the business and move into a younger demographic, Zawacki launched the Crossing Pointe catalog, signing Jane Seymour to brand a clothing line. Crossing Pointe never gained real traction and was shut down by the company in 2005. Other attempts at starting new product lines such as a wholesale outerwear business called Allegheny Trail failed as well and were shut down.

By 2003, Zawacki had managed to grow revenues only 10%, and they would peak there at $582 million. Since then, they have fallen precipitously to only $456 million in 2005 and only $307 million in the first nine months of 2006. One thing that the company had going for it through the first half of the decade was consistent profitability. This derived largely from the company’s profitable financing division. In 2005, under pressure from activist investors, the company sold its financing arm and used the proceeds to buyback more than half of its outstanding shares at $42 per share. Since the completion of the tender offer, the stock has fallen to the low 30s as Blair has been unable to show a profit.

As the company’s revenue has plunged, it has not been able to cut costs fast enough to keep up. While it has done an excellent job of improving sourcing as cost of sales has dropped from 47.4% of total sales in 2003 to 45.4% in 2006, both advertising and G&A have surged as a percentage of net sales. Advertising has gone from 26.9% of total sales in 2003 to 30% in the first 9 months of 2006, and G&A from 23.4% to 29.1%.
Fortunately, the company’s losses aren’t too great. An improvement of a few percent on any of these items would swing the company to a profit, and in fact it showed a modest one in the Q2 2006. Unfortunately, there’s no reason to think that current management is capable of this.

Ultimately, this company needs to fix its fundamental problem. Its current business is declining as customers age, no new business is taking its place, and its fixed costs remain high. I believe that this will eventually combine in some fashion with other catalog/internet retailers so that its exisiting infrastructure could be used more fully. As far as I can tell, the company has never completed an acquistion. My bet is that the company is acquired either by a strategic buyer(IACI could be a good fit) or private equity. I might consider buying some if it fell back near its low of $23.73, but at yesterday’s close of $31.50, it’s too rich for me.
Disclosure: I own none of the stocks mentioned

… in which the Inelegant Investor tries his hand with Google’s new custom search engine feature.

Earlier this week, Google(GOOG) announced the availability of a new feature which allows users to build custom search engines. While this isn’t likely to have any immediate material impact on the business, it fits perfectly into Google’s paradigm of providing free tools to others on a rev-share basis. Google doesn’t care what you do with these tools, but they know that users will develop content and then go out and market it and acquire traffic, leaving Google to sit back and develop more tools. One particularly nice part of this model is that it generates low-cost capital. Since most users never get anywhere near the $100 minimum AdSense payout, Google gets to sit on the cash, which by my reading of their most recent report is about $307 million and growing at around $12 million per month. Small change for a company with quarterly profits above $700 million, but a nice little no-interest credit line nonetheless.

But I digress.

The fundamental problem with search is that users expect an oracle. Unfortunately, search engines are deterministic machines, and their input is insufficient to allow them so see inside of the mind of their users. Some attempts at personalization have been made, but even the same person will expect different results at different times. So, while when I search for “java”, I’m more likely to be looking for information on programming, sometimes, I might really be interested in coffee.

One solution to this is breaking search from a monolithic experience into multiple targeted engines, and forcing you to select the one most likely to have your results. To some extent Google and other engines have done this; readers will be familiar with separate tabs for image search or news search. The key here, described succintly by the motto of the Delphic Oracle is: “Searcher, know thyself!”

What this new product does is allow experts in every niche to create focused catalogs designed to return optimal results in those niches. As an example, I have created a quick and dirty catalog to search for stock information which can be accessed through the search box on this page or at www.stockaroo.com. While by no means comprehensive, even with a number of refinements, I find it already gives me a reasonable response to my queries. Please provide feedback on queries that return bad results or sites that ought to be added either in the comments, or by emailing investor@inelegantinvestor.com.

While Google has made it quite simple to set up Custom Search Engines, one thing that could be improved is the collaboration feature. Though there is the ability to allow others to help customize your engine, the interface allows no way that I could find to see what changes they’ve made and modify them. So you’d better entirely trust your collaborators, because they have the power to completely subvert your results. Of course you can remove them and all their modifications, but without being able to see what they’ve done, that’s a rather blunt management tool.

Almost 6 years after filing for bankruptcy under the weight of mounting asbestos liability lawsuits, Armstrong World Industries(AWI) emerged from bankrupty last week and was largely ignored. The manufacturer of flooring, cabinets and other building products averaged volume of only 60,000 shares per day in its first 3 days of trading, and very little has been written about the company’s rebirth.

The company has not released many figures yet, though it will release Q3 numbers and give guidance at the end of October. In addition reports issued during bankruptcy are available and can provide some indication of the company’s state.

The restructuring plan called for the issuance of 56.4 million shares, with two thirds of them going to a trust to pay out remaining asbestos liability claims. The remaining third went to unsecured creditors. In addition, the company received $1.1 billion in financing much of which went to the creditors. At Friday, October 20th’s close of $39.45, I believe the company has a market capitalization of $2.225 billion. Note that all of these numbers are based on my understanding of various company filings and have not been confirmed.

For the first 6 months of 2006, Armstrong reported $68.2 million in net earnings, showing substantial growth form $17.7 million in the first 6 months of 2005.

Q3 should show a benefit from lower oil prices. On the other hand, the slowing housing market should negatively impact revenues and earnings. I haven’t had the time to put together an adequate model, and no analysts have yet put anything together, so for the purposes of simplicity, I’ll treat the first 6 months of year as the current run rate, and say that the company has earnings power of $136.4 million this year. Admittedly this is a poor measure, but we’ll have better numbers next week, and it’ll at least give us an idea of how the company is valued. This number gives Armstrong a P/E of 16.3, substantially higher than competitors like Mohawk(MHK) and Masco(MAS) which both have P/E ratios between 13 and 14.

On the surface, this doesn’t look like a particularly compelling valuation, but companies coming out of bankruptcy can sometimes show strong earnings leverage, so I’ll be watching next week’s earnings carefully.

As an aside, I should mention what first attracted my notice here. Armstrong Holdings(ACKHQ) was the former owner of AWI, but had all of its ownership cancelled on AWI’s emergence from Chapter 11. Though Armstrong Holdings has no other assets, it does have a series of claims against AWI. These include tax refunds and various intercompany charges and credits.

On Friday, Kellogg Capital Group, which owns 11.7% of Armstrong Holdings filed a 13D which included a letter Kellogg sent to management demanding information on the value and status of these claims. The text of the letter:

Gentlemen:

Kellogg Capital Group, LLC is the beneficial owner of 4,765,326 shares of common stock of Armstrong Holdings, Inc. (”AHI” or the “Company”). We purchased the shares based on our belief that they represented an attractive investment opportunity, particularly in view of claims AHI has against its former subsidiary, Armstrong World Industries (”AWI”), which is emerging from bankruptcy. Currently, little information is publicly available regarding AHI in its current state and the potential for unlocking the value of assets it has vis a vis AWI. AHI’s potential assets as we understand them are:

o An inter-company claim against AWI worth up to $12 million

o An unknown portion of a $37 million tax refund

o Substantial NOLs potentially benefiting both AHI and AWI

o Recoveries of taxes paid by the “Armstrong group of companies” in 2006

We write to you because we wish to learn more about these assets (and any potential others) and your efforts to maximize their value through negotiation with AWI and otherwise. Additionally, we are concerned by potential conflict of interest, independence and other issues at AHI based on the board’s composition. We believe these issues could impair the ultimate value of these assets if they are not resolved. A key factor in maximizing the value of the aforementioned assets will be AHI’s tenacity in negotiating with or litigating against AWI. Currently, AHI’s board has very close ties to AWI. First and foremost, Mr. Lockhart, AHI’s chairman, is also the chairman of AWI. Until AWI’s emergence from bankruptcy, AWI and AHI were integrally intertwined by virtue of AWI being AHI’s sole operating subsidiary. Additionally, AHI and AWI shared board members and executives. As a result, AHI board members M. Edward Sellers and Jerre L. Stead have long-term ties with AWI. Messrs. Sellers and Stead make up the Special Committee charged with negotiating the claims against AWI. Mr. Sellers is the Chairman and CEO of Blue Cross Blue Shield of South Carolina and The Companion Group of Companies and serves on the boards of six other corporations and endowment funds. Mr. Stead is the Chairman of IHS, Inc., a NYSE company, and serves on the boards of four other publicly traded companies. We hope these proven corporate leaders have the time necessary to aggressively pursue AHI’s claims.

Furthermore, it is unclear how the interests of the AHI directors are aligned with those of the stockholders to maximize the value of the foregoing assets. Based on AHI’s Form 10-K for fiscal 2005, as of January 24, 2006, Messrs. Lockhart, Sellers and Stead owned 100,124, 0 and 4,400 shares, respectively, of AHI common stock (not including stock options), constituting in the aggregate less than 1% of the outstanding common stock. With this nominal share ownership, what incentive does management have to maximize value for shareholders? We worry that AHI might be treated as a very small loose end to a historic and massive bankruptcy case that management will be more motivated to expeditiously resolve rather than to maximize its full value for the benefit of the shareholders. At least in perception, we think that the above issues raise legitimate conflict of interest and independence questions. There are remedies - we will offer a few ideas. The board might consider the appointment of an additional director who is a clear “outsider” to overtake or oversee the role of the Special Committee - someone who could authoritatively serve independently in a trustee capacity. We also believe the board should provide more transparency and disclosure to the shareholders it represents regarding its involvement in the AWI bankruptcy. Specifically, the Company should issue a press release or other public filing that provides clear and detailed disclosure about all of AHI’s claims, AWI’s defenses to such claims and estimates of recovery ranges for all claims as well as a timeline for such recoveries. We are particularly interested in understanding the nature of the tax assets in question as well as AHI’s and AWI’s opposing views on their usage. An open forum is all the more important right now as these negotiations will be taking place behind closed doors rather than in the light of the bankruptcy court where shareholder scrutiny is available. To our knowledge, no settlements have yet been reached with AWI on these four claims. We also have no information that would imply that AHI needs a timely resolution to any of its claims. As such, we urge you not to enter into any settlements prior to the installation of greater oversight and accountability measures at AHI either in the form of our recommended actions or otherwise. Please contact us at your earliest convenience to schedule a conference call. Thank you for your consideration.

On this news, ACKHQ was up 121% on Friday to $.35. This leaves it with a market cap of $14.2 million. Depending on the actual value of these claims, it could either be extremely cheap, or a worthless piece of paper. Good luck to the Kellogg Group and any other intrepid speculators, but I’ll be watching from the sidelines.

Disclosure: I own none of the stocks discussed

Increasingly in recent years, Warren Buffett has made a practice of meeting with groups of students and speaking to them about various aspects of his business and his thoughts on various topics. Periodically, one of these students will write a blog post or a college newspaper article about their experience, and though I have read perhaps a half dozen of these, I continue to find interesting new tidibts in each new one. I guess they’re kind of like snowflakes.

In any event, Sarah, a Harvard undergraduate, writes about her visit at lifeatharvard.com. Though I’ve heard it before, I think Buffett’s unique definition of success bears repeating:

We talked about success – real success. Buffett told a story about en elderly lady he met in Omaha, a Polish Jew who had spent years in a concentration camp during the Second World War. She told him, “Warren, I am very careful about making friends. When I meet a potential friend, I always ask myself: Would they hide me?”

“If you get to be 75, and have lots of people who would hide you, you’re a success. That’s really the test. You can’t buy it.” He talked about the importance of awareness of how you treat other people and of thinking about the reverse of your actions. “I know people whose own kids wouldn’t hide them, “Buffett said. “They’d be yelling, “He’s in the attic! He’s in the attic!”

I think this speaks to the essence of why so many people find Buffett worthy of study. It’s not merely that he has perhaps the greatest long-term track record of any investor, but that he has managed to do so without sacrificing his humanity. He has shown that success and ethical behavior are not mutually exclusive. And given the large number of recent counterexamples, our hope requires a Warren Buffett. After all, nobody aspires to be the next Jeffrey Skilling.

Santarus(SNTS) announced today that it had licensed Zegerid, a proton pump inhibitor(PPI) used for treating heartburn and related GI issues, to Schering-Plough(SGP). Schering Plough will develop and release a 20 mg version of Zegerid as an over the counter medication. Santarus will continue to promote and sell the existing prescription version in its various formulations.

Currently, Prilosec OTC is the only PPI available over the counter. The company believes that Prilosec OTC has annual sales of approximately $400 million. Unlike Prilosec, Zegerid, which contains the same active ingredient, is an immediate release formulation and provides quicker relief to patients. Santarus’ patent covering this formulation does not expire until the middle of 2016.

The deal appears to be a huge positive for Santarus. Though Zegerid sales have been climbing, they still only totaled $9.4 million in the most recently reported quarter. Sales should continue to increase as major health plans including UNH have recently added it to their list of preferred drugs. In the $13.4 billion prescription PPI market, small market share can still mean a great deal of money. Schering-Plough, which has extensive OTC experience with drugs such as Claritin, paid Santarus $15 million upfront and will pay up to an additional $65 million in regulatory and sales milestones on top of a “low double digit” royalty.

Under the terms of the agreement, Schering-Plough may not market any other OTC PPI during the life of the agreement. Schering-Plough is also responsible for all development, clinical studies, marketing and any other costs associated with the OTC product. No estimate has yet been given as to when this will hit the market, but the company will need to perform a label comprehension study and provide product stability data. It is not clear whether additional clinical data is needed, but this should become apparent once Schering-Plough meets with the FDA.

A legitimate concern is what impact Zegerid OTC will have on Zegerid RX. On its conference call, Santarus cited data from the Pepcid OTC launch which showed prescription sales continuing to grow after launch. The 40mg already accounts for over 90% of Zegerid sales and the prescription market, so even if 20mg prescription sales were to disappear, the impact would be negligible. Additionally, the patient profile for the RX versions tends to be for chronic use, versus occasional use for the OTC drugs.

The company declined to discuss Q3 performance, deferring such information to their earnings call on November 10, but we can make some reasonable guesses as to their tone. Sales growth should be strong given their increased presence in formularies and preferred status at prominent health plans. Cash position which was $54 million at the end of Q2 has probably dropped to $40-$45 million, but will jump back to $55-60 million range once the $15 million upfront is received. Over the next several quarters, Zegerid sales should move the company towards profitability. The company also has additional capital available under an equity financing agreement.

Unfortunately, there’s not currently anything behind Zegerid. The company stated that it is looking at acquiring or copromoting other GI drugs to take advantage of its existing sales force. In addition the company may license or acquire development products at the Phase I/II stage and use their experience to move those to approval. It is possible that Santarus’ proprietary technology can be applied to other PPIs as well, as a means of extending their patent protection.

Santarus’ management has proven capable of developing a drug franchise, and Zegerid’s future looks bright. Though the stock initially moved up dramtically from yesterday(10/18)’s close of $8.45 to an early high of $9.70, it has subsequently pulled back to just under $9, giving the company a market cap of $430 million. A small price to pay for a great deal of potential.

Disclosure: I own SNTS