The Targacept Secret That Wall Street Doesn't Want You to Know About

WINSTON SALEM, NC ( TheStreet) -- Why is mutual fund giant Fidelity and a well-known healthcare hedge fund buying more Targacept ( TRGT) despite the company's miserable drug development track record? Yet another of Targacept's clinical trials ended in failure Monday.

The answer: Alzheimer's disease. More specifically, there's a drug sitting in Targacept's pipeline that could one day treat Alzheimer's and maybe schizophrenia, too. Billion-dollar plus markets, both.

Targacept shares trade at $4.31 even though the company has $205 million in cash on hand, worth roughly $6 per share. At that steep discount to cash value, Targacept shareholders get the Alzheimer's/schizophrenia drug, known as TC-5619, essentially for free.

Fidelity Investments owns 5 million shares of Targacept, including 1.2 million shares acquired in the second quarter, according to CapitalIQ. BVF Partners, run by hedge fund manager Mark Lampert, disclosed a 3.6 million-share ownership stake in Targacept on Sept. 10. Since May, Lampert has doubled the size of his position in Targacept, according to regulatory filings.

At this point, you're shaking your head, or laughing out loud. Alzheimer's drugs, no matter how promising, all fail in the end. Pfizer ( PFE), Elan ( ELN), Eli Lilly ( LLY) and Johnson & Johnson ( JNJ) have taught us that lesson well. And Targacept? The company whose depression drug blew up because it ran clinical trials in India, sending shares plummeting 80% in 2011 and another 23% this year? C'mon. . .

All true, but here's the interesting bit about TC-5619: The drug's mechanism by which it's supposed to improve cognition is shared by another drug owned by privately held EnVivo Pharmaceuticals. Better yet, the EnVivo drug, EVP-6124, has already posted positive data in both Alzheimer's and schizophrenia.

Most recently In July, EnVivo announced positive results from a six-month, double blind, phase IIb study that evaluated EVP-6124 in patients with mild to moderate Alzheimer's. Treatment with EVP-6124 resulted in statistically significant improvements in cognition and clinical function -- hitting on both of the study's co-primary endpoints. Slides summarizing the EVP-6124 Alzheimer's data can be downloaded here.

And who is the sole investor backing EnVivo Pharmaceuticals? Fidelity Biosciences, the healthcare venture capital arm of Fidelity Investments.

It could be coincidence that Fidelity and its VC arm both happen to be investing heavily in two separate drugs targeting Alzheimer's that work in similar ways.

Or, Fidelity is bankrolling EnVivo and buying shares of Targacept for a reason.

Those EVP-6124 data turned heads at the recent Alzheimer's Association International Conference, and now EnVivo is advancing the drug into a phase III study. It didn't take long for that buzz to reach Wall Street. Since Fidelity has EnVivo walled off, institutional investors looking for a similar drug found Targacept and TC-5619.

Targacept shares are trading below cash, so obviously, the confidence level in TC-5619 is not high. Nor should it be. On Monday, the drug failed a mid-stage study in adults with attention deficit/hyperactivity disorder.

But Targacept is conducting another phase II study of TC-5619 in schizophrenia patients. Results are expected in the middle of 2013. If positive, Targacept shares aren't likely to be trading below cash any longer, especially if investors connect the dots and start drawing parallels between TC-5619 and EVP-6124.

--Written by Adam Feuerstein in Boston.

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Adam Feuerstein writes regularly for TheStreet. In keeping with company editorial policy, he doesn't own or short individual stocks, although he owns stock in TheStreet. 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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