There’s a drama unfolding in the health care field that is as dramatic as the daytime soap operas. Lots of “he said, she said” has been tossed around, and just to add a little spice, a “bete noire” has also appeared on the scene to cause trouble. If this drama plays out a certain way, then shareholders of one or two of the companies involved may see a big windfall.

The drama began back in 2006 when little-known Pharmathene (NYSE: PIP) sued Siga Technologies (Nasdaq: SIGA) for damages stemming from a broken business deal. Pharmathene had loaned Siga money to fund research into a vaccination against smallpox. The loan was presumed to be an interim step before the two firms eventually merged. At a minimum, Pharmathene hoped to at least be granted rights to Siga’s drug, known as ST-246. The two firms had even drawn up documents that appear to imply a merger discussion was the eventual expected result.

Siga appeared to eventually lose interest in any deal, figuring that it no longer needed Pharmathene’s stronger balance sheet to help fund the development of ST-246. In October 2010, this dispute suddenly became a very big deal. The U.S. Department of Health and Human Services (HHS) awarded Siga a $500 million contract for ST-246, with an option to take it up to $2.8 billion. (Stay tuned, as these numbers really imply the wide range of potential benefits that these firms are fighting over.)

Two months later, in January 2011, the long-awaited trial finally got under way. Predictably, both companies hold very different views on what took place five years ago. Pharmathene’s President, Eric Richman, told the court “we weren’t loaning another company money unless we merged or got the product,” according to Bloomberg news. Siga only recalls making oral commitments to merge or license ST-246, and insists it was within its rights to ultimately walk away from the talks. During the course of a week’s testimony, Pharmathene’s lawyers provided ample evidence that advanced talks took place, but failed to actually produce any sort of signed final agreement. Investors have since been left to wonder if “an agreement to agree” is a legally binding action.

In coming weeks (or perhaps in a month or two), the court is finally expected to decide. Parsing the judge’s comments, it does appear some sort of beneficial outcome will result for Pharmathene. It could be as modest as $10 million or $20 million to compensate Pharmathene for minor damages and legal expenses or it could be a truly Solomonic solution, where both parties equally benefit from the HHS contract award.

Although investor message boards are filled with partisan rhetoric on both sides, predicting an outright victory for one stock or the other, it’s quite possible that both stocks will rally on a verdict if a worst-case scenario for either party is avoided. This is not a zero-sum game.

But that HHS contract award may look better than it actually is. Investors are fixated on a potential $2.8 billion payday, but Uncle Sam has only committed to a $500 million deal. In light of the current budget woes in Washington, it’s prudent to assume that a $500 million smallpox vaccine will have to suffice for now. That’s not peanuts, but probably not enough to enable each of these stocks to post 100% to 200% gains the most bullish investors are expecting. Instead, upside closer to 50% for each or both parties may be the best for which they can hope.

The plot thickens…
Just as this drama appeared to almost be at an end, another twist has emerged. Privately-held Chimerix has protested the HHS contract award, citing the fact that Siga does not possess the required “small business” designation that is stipulated as part of the contract award. Siga is backed by MacAndrews & Forbes, the large hedge fund run by Ron Perelman. And that affiliation implies Siga has ample access to capital, unlike a true small business.

Congressman Darrell Issa (R-CA) supports Chimerix’s protest. The Congressman has a stated mission of halting and investigating virtually any contract award doled out under the Obama administration. So it’s easy to dismiss his support for Chimerix as merely partisan politics. It doesn’t help that Chimerix’s law firm has been a financial backer for Issa, making his motives even murkier. Chimerix’s challenge will need to be addressed by August 2010, and the company appears to have little chance of succeeding. But it was enough to spook investors in Siga Technologies and Pharmathene. Both stocks have plunged in recent days and weeks.

Action to Take –> That plunge actually opens a nice opportunity for investors not yet in these stocks. Shares of Pharmathene had been up near the $4 range in anticipation of a beneficial verdict that would take shares to $5, $6 or beyond. Shares are now below $3. Siga’s shares have fallen from $14.50 to $11 in the last few weeks on those same Chimerix-related concerns. This sets up a potential double, if Siga’s most ardent backers are correct in their analysis.

The gains for both of these stocks may prove to be more modest if investors stop fixating on a $2.8 billion contract and instead think about a $500 million contract. Nonetheless, an imminent legal ruling and closure with the Chimerix challenge could help to give one or both of these stocks a nice quick gain later this summer.

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