The drugmaker continues to be a source of speculation, particularly for Credit Suisse analyst Catherine Arnold, who today issued an investor note in which she argues Wyeth “could be the top major pharma takeout candidate.” She notes that Wyeth shares have plunged 19 percent since the FDA nixed two different product approvals, which she believes spells opportunity.

“Wyeth is undervalued even in our worst case scenario…shares offer more than 40 percent upside potential in a takeout scenario,” writes Arnold, noting that patent protection on the Effexor XR antidepressant, a $3.7 billion seller last year, expires in 2011. “Pfizer, in particular, would be a fitting takeover partner.”

As she sees it, uncertainty surrounding Wyeth makes it easy to overlook a payoff. The recent problems: the FDA nixed two product approvals - one drug for depression and menopausal hot flashes, and another for schizophrenia - and upcoming litigation that may result in generic competition to its Protonix proton pump inihibor, which generated $1.8 billion in sales last year.

Among her arguments for a deal: continued strong sales of the Enbrel biologic for arthritis and the Prevnar vaccine for kids; ongoing cost-cutting, which she thinks may accelerate, and a significant research program into Alzheimer’s treatments. At the same time, she thinks Wyeth should buy back more stock and forgo further development of the schizophrenia drug.

Why Pfizer? “Pfizer is facing major challenges, both relatively near-term and longer term,” she writes. “The company could lose Lipitor exclusivity in the US as early as 2010 (and no later than 2011). Thus, Pfizer needs near-term revenues and cash flows, in addition to longer-term augmentation of its pipeline, to combat the erosion of patent expiries and insufficient current pipeline…

“Wyeth has several merits as a target for Pfizer. Perhaps Pfizer’s greatest competitive weakness is its biologics effort. Wyeth’s leading biologics platform would turn this weakness into a strength. At the same time, Wyeth’s two flagship biologics products (Enbrel and Pevnar) would buy Pfizer strong positions in therapeutic areas (autoimmune and vaccines, respectively) where it has no meaningful presence. Enbrel would form a powerful one-two punch with Celebrex in arthritis.

In addition, Wyeth’s depression franchise (Effexor, and if approved, Pristiq) would restore PFE’s prominence in this area, lost due to the genericization of Zoloft. Finally, the combination of these two primary care powerhouses would facilitate synergy opportunities.”