DISCLOSURE: Readers should assume that all stocks mentioned in this column are owned by the author and/or his firm unless otherwise noted.

Shares of Discovery Labs (NASDAQ: DSCO), a biotech firm, hold only a fraction of the value they did just over a year ago, when they traded in the area of $8. But down-and-out DSCO looks a good bet to recover from its recent travails.

As CPA Insider™ readers may not know, since March 1, eight insiders have signaled a new-found bullishness. They purchased 164,500 shares of DSCO for between $1.95 and $2.12 each. All but one of these insiders increased their holdings in the firm significantly with their latest purchases. Several have also traded this or other stocks well in the past.

The last noticeable cluster of buying at DSCO came in March 2005, when four execs purchased 62,000 shares at an average price of $5.38. Those purchases were profitable for most of the year after they were made. DSCO even traded up to $9 six months after the buys. But the company lost its way going into the final phases of trying to get its first drug to market, which explains why the stock plummeted all the way down to $1.16 last summer.

Such is the all-or-nothing sort of risk/reward profile that development-stage biotechs often offer investors. But I think insiders have bottom-ticked their shares well in this case.

What I find most interesting about Discovery is that the clinical promise of its drug, Surfaxin, is not the primary issue dragging down its shares. Analysts (and the FDA) seem to agree that Surfaxin should be of great benefit to premature infants suffering from respiratory distress syndrome. Discovery also is developing an aerosol version of the drug (called Aerosurf). Together, the drugs have great promise to target a demand in the neonatal market that is estimated to be between $500 million and $1 billion.

So “clinical risk” (which is the main bogey man for most development-stage biotechs) isn’t Discovery’s problem. The problem involves manufacturing the drugs in suitable quality and quantity to get its non-disclosure agreement (NDA) approved.

The manufacturing concerns came as a surprise to management and investors alike last summer, since the company had managed to manufacture previous batches without much trouble. Addressing the sudden problem, Discovery has taken over full control of the manufacturing process from its old partner. The company has also hired more experienced manufacturing and regulatory personnel to make sure more surprises are less likely.

A meeting with the FDA last December went as well as can be expected, and Surfaxin now looks promising to hit the market by the end of 2008. That does not seem too far away in biotech years to start betting on the outcome — particularly when the clinical aspects of the product have been proven, and the company’s shares have been punished as much as DSCO has.

As recently as a month ago, liquidity was the more acute risk for Discovery. But the private placement of over 14 million shares at the beginning of April relieved that concern by putting nearly $30 million in the company’s bank account.

Also important, however, was that DSCO traded well through the dilutive PIPE (private investment in a public equity) offering. Although the stock predictably weakened as much as eight percent between its highs on April 2nd and lows on April 3rd in the wake of the announced offering, DSCO recovered well, and actually finished up for the week following the PIPE. That’s impressive considering that Discovery’s shares outstanding increased 9.7 percent, to 70.5 million, as a result of the offering, with shares sold at a price more than 12 percent below where they closed a few days after the event.

With liquidity concerns addressed, and the trading risk of the dilutive PIPE offering behind it, Discovery looks in good shape to address the manufacturing problems relating to Surfaxin, and start generating meaningful revenues in 2008.

Jonathan Moreland is the Director of Research at New York-based Insider Insights.com. View a FREE trial issue of the firm's weekly newsletter Insider Insights.