Biotech stocks have raced ahead in 2012, up 40 percent on average. We look for more gains in 2013, thanks to new products and more mergers and acquisitions.

We especially like Santarus (NSDQ: SNTS), a small drug company with a biotech component. Santarus stock has been relatively flat since 2008 (hovering at around $4 a share). But it has more than doubled in 2012, on a tripling in profits and a slew of good news about its products.

First, a little background. San Diego-based Santarus was founded in 2004 to launch a heartburn medication called Zegerid. This is basically a generic version of top-selling Prisolec, whose patent had expired, combined with baking soda to allow for faster absorption. By 2009, Zegerid was bringing in $119 million a year, about 70 percent of revenue.

But Santarus’ patents on Zegerid were struck down in 2010, and Par Pharma started selling a generic version. Santarus appealed, and earlier this year two of the Zegerid patents were affirmed by a federal appeals court through 2016. More importantly, Par Pharma stopped distributing the generic competitor.

Samurai Santarus

Patent fights are a large part of Santarus’ skillset, as is fast response. During the Zegerid ordeal, Santarus executives, lead by CEO Gerald Proehl, cut the sales force in half and diversified into other products. They have proven they can spot a promising niche drug, protect the patent and increase sales (most of Santorus’ employees are sales reps).

Santarus has so far specialized in drugs for gastrointestinal (GI) disorders, such as heartburn, ulcers, and type 2 diabetes. It buys licenses to develop and/or market the drugs from the creators, usually smaller companies whose products don’t interest the industry giants because of relatively low sales potential, limited patent protection or some other reason.

Most of Santarus’ drugs are improvements to existing compounds that have gone off patent. They improve how the basic medication is released into, or absorbed by, the body—and so they are patentable. Below is a closer look at Santarus’ drug lineup.

In the Market

Cycloset. This is the first FDA-approved drug for patients with type 2 diabetes that targets dopamine, a chemical messenger between neurons in the central nervous system. The result is greater glycemic control. And Cycloset does this without increasing the risk for heart problems, the Journal of the American Heart Association recently reported.

Cycloset, a quick-release form of a bromocriptine, was licensed from VeroScience and S2 Therapeutics for $5 million plus royalties of 35 percent to 40 percent. The patent expires by early 2015, so Santarus can get several more years of strong revenue growth here.

In third-quarter 2012, prescriptions for Cycloset shot up 74 percent vs. the year-earlier period.

Glumentza. This is another treatment for type 2 diabetes, licensed for the US market from California-based Depomed, with royalties of 27 percent to 35 percent. 

Glumentza, whose patent expires in 2016, has the potential to be Santarus’ biggest- selling drug the next several years. It is an extended-release version of the existing diabetes drug metformin, allowing patients to take it just once a day to maintain a beneficial level. However, Santarus is in a legal battle with Wyatt Pharmaceuticals over a generic version of Glumentza. A settlement could lead to the generic hitting the market in 2015, still several years out.

Currenty, Glumetza has sales of more than $100 million a year, similar to that of competitor Fortamet. Total prescriptions for the Glumetza increased 30 percent in third-quarter 2012 vs. the year-earlier period.

Fenoglide. Licensed from Shore Therapeutics at the end of 2011, this is a cholesterol-fighting drug that’s an add-on for type 2 diabetes patients. In 2012, Santarus added some 150 sales reps (doubling its sales force) in order to promote it.

To increase the affordability of both Glumetza and Fenoglide, Santarus is introducing e-voucher programs that result in a $10 co-pay for insured patients.

Up and Coming

Santarus’ pipeline has many promising new drugs for beyond 2016, when most of its current patents will have expired:

Uceris. Licensed in 2008 from Italy’s Cosmo Pharmaceuticals, this is an extended-release version of steroid budesonide for the treatment of colitis. A New Drug Application is on file with the FDA and a response is expected January 2013.

Rifamycin SV MMX. Now in Phase III studies, this was also licensed from Italy’s Cosmo for the treatment of traveler’s diarrhea.

Ruconest. For the treatment of the rare disease “hereditary angioedema” (swelling of various parts of the body, including the larynx), this compound was licensed from Dutch company Pharming Group. Phase III FDA studies were completed November 2012, with an application for approval to be filed in the first half of 2013.

SAN-300. A monoclonal antibody to treat inflammatory diseases (rheumatoid arthritis, psoriasis, etc.), currently in FDA Phase I studies.

Winning Outlook

For the first nine months of 2012, Santarus’ revenue more than doubled—up 110 percent, to $148 million. Earnings more than tripled—up 367 percent, to $13 million or $0.19 per share, vs. the year-earlier period.

For 2013, Santarus is expected to earn $0.76 per share and $1.27 in 2014. Currently trading at just over $10 per share, we think the stock can gain another 50 percent in 2013.

Note well: Santarus is not for the faint of heart. Moves of 30 percent are not uncommon. Take a relatively small position and be prepared for ups and downs.

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Greg Pugh, an income-investing expert, publishes a newsletter called Investing for Monthly Income.