3 Things You Need to Know About XOMA Corp.

Source: Food and Drug Administration, Facebook.

When it comes to investing, there are few sectors that offer as much reward, and risk, as biotechnology.

Sure, the biotech sector has a handful of established, almost household drug developers which have carved out sustainable profits from their existing product portfolios and are sitting on gold mine pipelines. But, when push comes to shove, most biotech stocks are losing money, and many are still trying to get their first drugs approved by the Food and Drug Administration. The reward, however, for discovering a clinical-stage company with the next potential blockbuster drug can be enormous.

One of those high risk, high reward potential biotech stocks is XOMA . But before investing in XOMA, though, there are three things that investors should know about the company.

1. It's highly leveraged to one drug XOMA's product pipeline consists of human and humanized monoclonal antibodies designed to treat metabolic, inflammatory, and cardiovascular diseases. Its lead therapy is gevokizumab, which it owns the commercial rights to in the U.S. market and Japan, with co-development partner Servier holding rest-of-world development rights. Under the initial deal, signed in early 2011, XOMA received $35 million in upfront payments, and was eligible for approximately $470 million in future regulatory and development milestone payments.

Source: National Institutes of Health, Facebook.

Gevokizumab (previously known as XOMA-052) is a monoclonal antibody designed to bind with interleukin-1 beta, a pro-inflammatory cytokine. Or, in other words, XOMA and Servier's drug seeks out the cause of inflammation for a number of inflammatory diseases and attempts to stop it in its tracks.

Gevokizumab comprises nearly all of XOMA's ongoing research, though, to be fair, the drug does involve a number of indications. Gevokizumab is currently being studied as a treatment for non-infectious uveitis and Bechet's disease uveitis, as well as for patients with moderate-to-severe acne and those with autoimmune inner ear disease.Among these indications, the clear moneymaker here for gevokizumab is the drug's potential in treating ophthalmic disorders.

Beyond gevokizumab, the only other clinical-stage therapy being analyzed is XOMA-358, a drug designed to help remove excess insulin from a person's body so they don't wind up with hypoglycemia (low blood sugar). While phase 1 data presented at the Endocrine Society annual meeting earlier this month demonstrated successful down-regulation of insulin receptors, XOMA is still very much a single-story stock that revolves around gevokizumab.

2. Gevokizumab could be wildly profitable, but it isn't perfectDespite placing its chips on the table largely behind just one drug, gevokizumab has the potential to be wildly profitable if it's successful in clinical studies. Wall Street estimates, though a bit sparse, suggest the drug could hit peak global sales of between $1 billion and $3 billion per year. With XOMA valued at less than half a billion dollars, it's quite possible current shareholders could be nabbing quite the bargain here.

Source: National Institutes of Health, Facebook.

A lot will be riding on its EYEGUARD trials. EYEGUARD A & C are testing gevokizumab as a treatment for non-infectious uveitis, or NIU, a disease affecting approximately 150,000 people in the U.S. that causes eye pain, redness, and swelling. EYEGUARD B is examining gevokizumab for Behcet's disease uveitis, which is rarer (affecting an estimated 7,500 people in the U.S.), but it can be more serious and eventually lead to blindness.

But investors should understand that gevokizumab isn't infallible. In March 2014 XOMA provided an update from two midstage studies involving gevokizumab that showed it did not meet its statistically significant endpoint in treating erosive osteoarthritis of the hand, or EOA. This proof-of-concept study stopped XOMA in its tracks -- at least when it came to developing its drug to treat EOA. While XOMA could be successful in its EYEGUARD studies, investors should not expect gevokizumab to deliver statistically significant results in every indication it's being tested for.

3. XOMA is probably going to need more fundingLastly, even with a co-development partner and the potential for milestone revenue, it looks as if XOMA will need additional funding to really build out and mature its pipeline.

Source: Flickr user Myfuture.com.

In XOMA's recently released fourth-quarter report it announced that it ended the year with $78.4 million in cash and cash equivalents. What's more, this figure includes a registered direct offering of nearly 8.1 million shares, with an accompanying warrant to purchase nearly 8.1 million shares of common stock at $7.90 per share. The share/warrant offering generated $37.7 million in net proceeds for XOMA. The company also obtained a $20 million secured loan during the quarter.

However, XOMA's guidance calls for the company to burn through $60 million to $65 million in cash from ongoing operating activities in 2015. This figure includes revenue it expects to receive from licensing and contracts throughout the year. In other words, by this time next year XOMA could be running out of cash unless it does something. That something is likely another share offering.

It's worth keeping in mind that while share offerings sustain XOMA's research by providing cash, they also dilute existing shareholders. This is a cycle that could repeat for the next couple of years as XOMA looks to spend heavily on late-stage pipeline development.

Your smartest moveXOMA clearly has potential on the heels of gevokizumab, and perhaps even XOMA-358 down the road. There's an in-demand market for ophthalmic products, and that alone could lead to substantial profits and margins if its EYEGUARD studies find their mark.

But until that point, these are costly and drawn-out studies that are likely to necessitate additional financing. Furthermore, XOMA's vast reliance on a single drug, even though it has indications across a number of therapeutic indications, leaves it open to wild swings if the data isn't as good as expected.

I believe the smartest thing investors can do here is to wait out XOMA's EYEGUARD studies on the sidelines and use its phase 3 data to determine whether an investment is suitable. You may miss out on an initial pop if it meets its primary endpoint, but I suspect there will be ample room for sales growth to add to your gains over time. If you are on the sidelines and gevokizumab disappoints, you'll be pretty thankful.

The article 3 Things You Need to Know About XOMA Corp. originally appeared on Fool.com.

Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.