Investors sure do like Merck's (NYS: MRK) deal with Endocyte (NAS: ECYT) . The biotech doubled today on word that Merck had licensed its lead oncology product, vintafolide.

Interestingly, they still don't seem to be ascribing much value to vintafolide or the rest of Endocyte's pipeline. The biotech had $128 million at the end of the year and got another $120 million from Merck in the licensing deal. It's certainly spent some in the first part of the year but should still have around $230 million pro forma, and the company has a market cap of only $275 million.

Sure, Endocye is going to spend much of that $230 million before it's cash flow-positive from sales and royalties; the phase 3 ovarian cancer trial for vintafolide, which Endocyte is still primarily responsible for, is expected to cost $40 million. Endocyte will also need to spend money setting up a commercial infrastructure in Europe, if it's approved there, since Endocyte retained the rights to sell the companion diagnostic for vintafolide. And then there's the pipeline of early stage drugs, which will suck resources for years to come.


But there's potential for more cash to come in from Merck. The deal calls for up to another $880 million in development, regulatory, and commercialization milestones. Unfortunately for investors, the company didn't break it out further, so there's no way to know when the cash might come in.

The choice of Merck is an interesting one, since the pharma isn't really an oncology powerhouse. None of the top-selling drugs it breaks out sales for on its earnings releases is a cancer drug. In Merck's pipeline, there's ARIAD Pharmaceuticals' (NAS: ARIA) ridaforolimus, which doesn't look likely to be approved, and no phase 3 drugs. The pharma giant does have four cancer drugs in phase 2 trials, so maybe it's building in the hot area.

Ron Ellis, Endocyte's president and CEO, said there were "a lot of companies" interested in licensing vintafolide, so maybe it's just a case where the money was too good to turn down. Partnering with Eli Lilly (NYS: LLY) or Pfizer (NYS: PFE) , each of which has more experience with cancer drugs, would be nice, but if Merck is going to put up potentially $1 billion to get its hands on vintafolide, it's probably going to spend a lot marketing it as well.

Overall, the deal looks good and should help prevent shareholder dilution for the foreseeable future. I'm inclined to say Endocyte is undervalued even after the jump, but that's a long-term call; don't be surprised to see some weakness in the short term, as often happens with biotechs with no near-term catalysts.

While you're waiting for the vintafolide data, take a look at what Fool analysts believe is the next rule-breaking multibagger. Get the free report.

At the time this article was published Fool contributor Brian Orelli holds no position in any company mentioned. Check out his holdings and a short bio. Motley Fool newsletter services have recommended buying shares of Pfizer. The Motley Fool has a disclosure policy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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