Why Zafgen Is Up Big After Bad News

By Brian OrelliFool.com

What: Zafgen traded up as much as 31% today after announcing that a patient in one of its clinical trials had died.

The company's statement was rather light on the details, but we do know the death occurred in a phase 3 trial testing Zafgen's lead drug beloranib in Prader-Willi Syndrome, a genetic disorder that causes people to eat uncontrollably. It isn't clear yet whether the drug caused the death; people with Prader-Willi Syndrome are morbidly obese and have all the issues that come with that like heart problems. The company doesn't even know if the patient that died was taking beloranib or if the patient was in the placebo arm.

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So what: It's not often that you see a company's shares increase after a patient died -- and certainly not 24%, which is where the stock had settled at the time of this writing.

But prices are all relative, and Zafgen had fallen 54% over the two days prior to announcing the death as investors fretted over the news it was clear Zafgen was holding. Even with the increase today, it's still trading down 42% from where it started the week.

Now what: Zafgen is only down 42% this week because we don't know what will eventually happen. If the patient died through no fault of beloranib, then it should be valued at close to where it started the week. If beloranib is contributing to patient death, it will be very hard for Zafgen to get its lead drug approved. Zafgen does have some preclinical drugs but if it pulled the plug on beloranib, it's not hard to see it trading below the approximately $8 per share in cash it has right now.

If we just take these two extremes -- admittedly there are intermediates you could imagine -- and assume that Zafgen is worth a conservative $31 (about a 10% discount to Friday's closing price) if the death turns out to be nothing and $6 (a 25% discount to cash) if beloranib's development is stopped, then at $20 per share, investors are betting there's a 44% chance that the issue is drug related.

That seems awfully high given that there's only a 66% chance that the patient was even taking beloranib -- one third of the patients were on placebo -- and the potential that the patient could have died due to their disease rather than the drug. At the current price around $20 per share, Zafgen looks undervalued with this back of the envelope calculation with the obvious warning that it's still a very speculative investment that could go down further.

The article Why Zafgen Is Up Big After Bad News originally appeared on Fool.com.

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