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There were several biotech investing dangers I wanted to discuss in greater depth since I wrote the first piece. Two things in particular I wanted to warn potential biotech investors about are the threat of class action lawsuits on behalf of their fellow shareholders and pharma vs pharma suits as well as short pressure.
Shareholder vs Biotech
According to a lawyer friend there are literally hundreds of firms that troll through the financial pages for companies that understate, misstate, or overstate something material to the company's performance. They have interns and paralegals whose sole job is to find these opportunities. Biotechs are particularly vulnerable because of their volatile trading patterns.
Human Genome Sciences (NASDAQ: HGSI) is a good example of what can happen. In November 2010 the FDA released a report about its concern that Benlysta, the company's breakthrough treatment for lupus, had a serious risk profile of increased suicide among patients. The stock dropped 10% and continued to slide. Over a year later attorneys jumped in to recompense shareholders who lost money in that stock slide. More than five firms from all over the country were vying to be lead plaintiff because that's where the gravy is.
Investors new to biotech or even investors new to these kinds of suits see headlines, one after the other, So and So Suing Esquire seeks shareholders whose rights were breached. I have gotten several of these shareholder rights invitations to sue after an action has been filed in all kinds of stocks. These suits do not necessarily mean there is something wrong with the company but from December 2011 to the GlaxoSmithKline takeover bid in April, Human Genome Sciences slid down from $10 to below $7. Investors see day after day another pool of legal talent looking to sue and don't realize only one firm will represent the class, that it will take years to settle and that any responsible corporate entity has to be prepared for suits. And finally, they are settled for pennies on the dollar. It's just the cost of doing business. The only people that see any real money are the attorneys.
There are shareholder activist lawsuits. Again, Human Genome Sciences is being sued by a shareholder in hopes of a temporary restraining order being issued against Human Genome Science's poison pill provision blocking a GlaxoSmithKline takeover. After hours Friday rumors about Celgene coming in as a ‘white knight’ bidder drove the stock up 5%.
Biotech vs Biotech
One example was the long drawn out legal battle between Siga Technologies Inc (NASDAQ: SIGA) and PharmAthene Inc. (NYSEMKT: PIP)This battle still has all the earmarks of a Jarnyce v Jarndyce “Bleak House” scenario. Normally a Fool article wouldn’t mention players with such small stock prices both under $5 currently but this is an object lesson in the foolishness (not the good kind of Motley Foolishness) of investing based on the hoped for outcome of a trial. In late May the Delaware Chancery Commission decided to award PharmAthene half the profits of ST-246 after Siga earns an initial $40 million in sales. The US government had already awarded a supply contract on the smallpox drug to Siga in 2011. Siga is appealing the decision. PharmAthene popped on the decision, but any favorable appeal for SIga could send it down again. Expect much more legal wrangling in the future.
Shorts vs Biotech
Shorts are always nipping at the heels of the small to mid cap biotechs. Dark conspiracy rumors abound of paid bashers and rumormongers (great word) for hire. Maybe paid bashers exist, certainly bashers and rumormongers of the unpaid stripe do, especially so before big news in a stock that has had a lot of momentum. Just remember all the stock volatility in Dendreon (NASDAQ: DNDN) before it received final FDA approval of Provenge. An unfounded rumor hit the wires the day of the expected approval that the FDA was going to deny approval entirely and the stock dropped from $21 to $11 and then was halted until the next day. As volatile as Dendreon has been over the last few years few will ever forget that day and long, long night.
Shorts can manifest as bad press. A news site will state right up front they are shorting the stock they cover and regardless of any refutation by the company the stock will dive, dive, dive. This happened to Questcor Pharmaceuticals Inc (NASDAQ: QCOR) in mid-January and the stock plummeted 13% on huge volume. It had been trading around $45.00 and in the following weeks traded down to the low $30’s. Several weeks later the same site said they had taken off their short position, but the damage was done. The article questioned whether the company’s main product, H.P. Achthar gel an improved version of a product bought out by Questcor and used for adult multiple sclerosis, some types of nephrotic syndrome and for infantile spasms, was just a recycled pharmaceutical formula and did not justify its current share price.
Even with a positive pre-announcement before last earnings release it wasn’t enough to heal the share price and Questcor has only recently returned to the $50’s where it was trading last fall. Questcor is getting a lot of positive commentary and press before its July 23 earnings release and while trading at a 34 P/E the hope is great that earnings will reduce that P/E. Obviously the best time to buy was when the shareholders were fearful but such are the vagaries of biotech. On July 9 the stock jumped 10% on good news about June sales figures for Achthar.
What’s An Investor To DO?
All these cases above are just a few object lessons of the dangers of biotechs. The reason it’s like the Wild West in this sector is because there is so much money to be made, long and short, on a cure or treatment of a dreadful disease.
Do your due diligence just like the attorneys are doing. Know the stock’s story before you plunge in because sooner or later all pharma stocks get some kind of bad news. You have to know in your heart of hearts whether this is just a short attack, a cost of doing business lawsuit; is this a minor setback or whether something has significantly and fundamentally changed.
That said, try to stay unemotional about your biotech investment. Be skeptical of both short bashing and long gushing. You need all your wits about you in the final frontier of biotech investing.
Note: Questcor was again hit with a piece by reported short seller Citron Research and the stock dived over 20%. As Questcor is in a quiet period before earnings it will likely not rebut the charges that it has more competition to Achthar than it thinks. Just another example of the damage these raids can do.
leglamp has no positions in the stocks mentioned above. The Motley Fool owns shares of Dendreon. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.