Welcome back to the Biotech-Stock Mailbag. This week, I'll tackle questions on Viropharma ( VPHM), Indevus Pharmaceuticals ( IDEV), ArQule ( ARQL) and (briefly) Northfield Laboratories ( NFLD).

James "Jimmy" T. writes: "Can you please give your perspective on Viropharma and Nastech Pharmaceuticals ( NSTK)? Of the two, it looks like Viropharma is way undervalued and in the case of Nastech, it is way overpriced compared to sales."

I'm going to focus on Viropharma and leave Nastech for another Mailbag, mainly because Viropharma was dealt a big blow to its drug pipeline Friday.

Dosing of the company's hepatitis C drug HCV-796 was stopped after patients in an ongoing phase II study developed liver toxicity. Viropharma and its partner Wyeth ( WYE) have not permanently shelved the HCV-796 yet, but a drug that causes liver toxicity, especially in hepatitis C patients, is an extremely serious problem.

It's unfortunate because HCV-796 appears to have a strong antiviral effect against the hepatitis C virus, but I have a hard time envisioning a scenario where HCV-796 survives this setback.

When Jimmy emailed me his question, HCV-796 was still a viable and promising drug in Viropharma's pipeline. In fact, I wrote this column on Thursday, so I had to revise it when the HCV-796 news hit Friday.

I can understand how Jimmy viewed Viropharma as undervalued prior to this recent setback. Second-quarter earnings easily topped Wall Street estimates and the company raised 2007 sales guidance for Vancocin, its treatment for gastrointestinal tract infections.

At Thursday's closing price of $10.22, Viropharma was trading at a price-to-earnings ratio of just 12 times estimated 2008 earnings, or 4 times estimated 2008 sales.

Cheap, right? Well, not exactly. The reason that investors were discounting Viropharma's valuation is because of worries that Vancocin would face generic competition next year. Vancocin gross margins are in the 90%-plus range and because of that the drug generates a good amount of cash flow for Viropharma.

That's great, but if a cheaper generic version of Vancocin is launched, Viropharma's operating business takes a big hit. You can see that playing out in the current analyst estimates: They have Viropharma earning $1.17 per share this year but only 86 cents per share in 2008.

Viropharma is fighting efforts by Akorn ( AKRX) to launch a generic Vancocin by late this year/early next year. At this point, it's not clear who will win, but even if Viropharma can delay a generic launch, competition for Vancocin is coming eventually. This explains, partially, why the stock seemed undervalued.

It also explains why Viropharma's ability to advance its drug pipeline is so important to the investment thesis. HCV-796 was a linchpin in that effort, but now it's probably gone. At the very least, whatever value ascribed to the drug by investors will be all but erased.

That leaves Camvia as the most important drug in Viropharma's pipeline. The antiviral drug is being developed to protect stem cell transplant and liver transplant patients from infection with cytomegalovirus - a common virus but one that can cause serious health problems for people with weakened immune systems.

Two phase III studies of Camvia are currently enrolling, with data from the first, in stem call transplant patients, due in the second half of 2008.

As I write this Friday morning, Viropharma is down $2.42, or 24%, to $7.80 per share. Unfortunately, generic Vancocin concerns plus the blow-up of HCV-796 are likely to outweigh any enthusiasm for Camvia in the near term.

Clarence P. asks about Indevus Pharmaceuticals: "Why hasn't Indevus taken a leap forward with the early approval of Sanctura XR? In fact, the stock has dropped a bit."

On Monday, Indevus announced the Food and Drug Administration approval of Sanctura XR, its long-acting drug for overactive bladder. Good news, but the stock actually fell a bit. As of this writing, Indevus shares are trading around $7 per share, basically flat since Monday.

Are we in such a bear market for biotech stocks that even an FDA drug approval isn't viewed by investors as positive? Not exactly. In Indevus' case, Sanctura XR's approval was expected. Management had been telling institutional investors for weeks that approval was a layup, so there was no surprise when the good news was released.

Sanctura XR is a very good drug. In fact, it might be the best drug for overactive bladder on the market. The problem is that Indevus assigned the responsibility of marketing the drug to Esprit Pharma, a small, privately held drug company.

Esprit has a big challenge in front of it. It must market Sanctura against competing drugs sold by some of the largest pharmaceutical companies in the world: GlaxoSmithKline ( GSK) and Pfizer ( PFE), which sell Vesicare and Detrol LA, respectively.

Anyone who watches evening network news shows has seen dozens of ads for Detrol LA and Vesicare. Big pharma spends millions to market its overactive bladder drugs, so needless to say, Wall Street is a bit skeptical that tiny Indevus and Esprit Pharma are going to be able to compete.

That said, I spoke with a trusted hedge fund manager who likes and owns Indevus. He believes the stock is relatively cheap because expectations for Sanctura XR's commercial sales are low. If Esprit manages to perform well, or if the company signs a Sanctura XR marketing deal with a larger drug company, Indevus shares should go higher.

But forget about Sanctura XR. A better reason to own Indevus, according to this hedge fund analyst, is the company's fairly deep pipeline of urology and endocrinology drugs. One highlight is Nebido, a long-acting injectable testosterone that should be a best-in-class treatment for male hypogonadism, a condition where a man's testes fail to produce adequate amounts of testosterone.

Nebido will be filed with the FDA later this quarter and could be on the market in 2008. The drug can be given once every three months, which makes it a much better alternative than current treatments, which are topical gels or two- and four-week injections.

Male hypogonadism is a $500 million market opportunity with room for future growth. If Nebido can capture 30% to 40% of that market, it will have a markedly positive effect on Indevus' market valuation, currently just north of $500 million.

"What your thoughts on ArQule after its recent earnings and conference call?" asks Saurai. "It appears to be reacting well and recovering from the pummeling it took after the secondary offering."

I've discussed ArQule in the past as one of the more promising early-stage cancer companies. On its recent conference call, the company said it will start the phase II program for its drug ARQ-197 in October, which is a slight delay from expectations, but nothing to worry about too much.

As for the stock's performance, trading follows a fairly typical pattern. ArQule traded up into the big ASCO cancer conference in June, then sold off into the summer, when biotechs are historically weak. During this period, the company strengthened its balance sheet with a $54 million stock offering.

ArQule's drugs are still in the early stages of development, so it's hard to make a definitive prediction about their ultimate success, but ArQule has a place in any biotech investor's diversified portfolio.

Last, a brief question and response to Nicole V. regarding Northfield Laboratories and its blood substitute Polyheme.

"What are the chances for Northfield to rebound?" she wonders.

Very small, I say.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Nastech Pharmaceuticals, ArQule and Northfield Laboratories to be small-cap stocks. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.

Adam Feuerstein writes regularly for RealMoney.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet.com. He also doesn't invest in hedge funds or other private investment partnerships. Feuerstein appreciates your feedback; click here to send him an email.

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