San Diego's Biotech Boom

http://video.cnbc.com/gallery/?play=1&video=3000160449

Major Revenue Losses From Patent Expirations Forces Big Pharma Companies to Look to the Biotech Industry for Replacements

Recent analyst upgrades and articles like this have provided a boost for Arena Pharmaceutical shares.

http://finance.yahoo.com/news/major-revenue-losses-patent-expirations-132000024.html

See disclaimers in the side bar.  This is not an endorsement for any company, or investment in any company.

Disclosure:  the author and family members are long shares of ARNA.  The author has no position in VVUS.

Thestreet.com reiterates Sell recommendation--Which is a contrarian signal to Buy

Adam Feuerstein is the biotech analyst at Jim Cramer's Thestreet.com.  He had a Sell recommendation on Dendreon ("DNDN"), before it subsequently soared from $3 to $58 after its prostate cancer drug Provenge was approved by the FDA on April 29, 2010.  (Editor's note:  shares of DNDN have subsequently plummeted back to $5.28 as of today due to commercial uptake issues).

Feuerstein has also had multiple Sell recommendations on another battleground biotech company, Arena Pharmaceuticals ("ARNA").  Shares of arena have also soared from its 52-week low of $1.23 to its 52-week high of $13.50 upon FDA approval of its anti-obesity drug Belviq ("Lorcaserin").  Today, Thestreet.com reiterated a Sell recommendation on ARNA, with the shares trading around $8.72.

http://www.thestreet.com/story/11800338/1/arena-pharmaceuticals-inc-stock-sell-recommendation-reiterated-arna.html

With the benefit of hindsight, any investors listening to Thestreet.com's recommendations would have lost money--or worse, missed out on spectacular returns of more than 1000%.

Meanwhile, Thestreet.com settled Federal civil charges of accounting fraud.  In typical Wall Street fashion,

TheStreet Inc. and the three executives neither admitted nor denied the allegations but agreed to refrain from future violations of the securities laws.

This outcome occurred despite these shenanigans by the company's executives:

The company filed false financial reports throughout 2008 which reported revenue from sham transactions at the subsidiary, which it acquired in 2007, the SEC said. The subsidiary conducts promotions such as sweepstakes on the Internet.

The agency said Alwine and Barnett made the phony transactions and also fabricated and backdated documents to enable the fraud.

Here is a link to the story:  http://finance.yahoo.com/news/thestreet-com-company-3-executives-182033815.html;_ylt=A2KJjb3ILNtQwGgApCSTmYlQ

Meanwhile, shareholder value of Thestreet.com has plummeted over the years.  Here is a price chart of TheStreet ("TST") shares from 1999 to December, 2012:

http://finance.yahoo.com/echarts?s=TST+Interactive#symbol=tst;range=my;compare=;indicator=volume;charttype=area;crosshair=on;ohlcvalues=0;logscale=off;source=undefined;

Shares have plummeted from $45 to $1.61.  How this firm has been accused of and prosecuted for accounting fraud, and has consistently put out wrong directional investing recommendations, and is now trading as a penny stock--but can still stay in the business of stock-picking is beyond me.  But wait--we have our answer:  Jim Cramer, the clownish host on CNBC's Mad Money show is Thestreet.com's co-founder.

In hindsight, TheStreet.com should have put a Sell recommendation on itself 13 years ago.  As for Thestreet.com's reiteration of a Sell recommendation for ARNA, you be the judge.

Cowen is bullish on Arena Pharmaceuticals

Phil Nadeau, biotech analyst for Cowen & Co., is bullish on ARNA. He sees what I've been saying for over a year: a deeply undervalued company with a short-term catalyst in potential FDA approval for Lorcaserin (anti-obesity drug) and long-term viability (deep drug pipeline, valuable intellectual property, and experienced management team).

Unlike some of his peers, Nadeau has a scientific background with a Ph.D. in neurobiology from Harvard University and an B.S./M.S. in electrical engineering and computer science from MIT. Hence, I give his opinion more weight than a captured journalism hack with a degree in political science, whose only function in life is to bash solid biotech companies with promising therapeutics. Adam, are you listening?

http://www.businessweek.com/news/2010-07-01/eisai-will-sell-arena-s-weight-loss-drug-in-the-u-s-.html

The deal was seen as favorable to Arena by Phil Nadeau, an analyst for Cowen & Co. in New York, because “they preserve for Arena a good amount of lorcaserin’s expected profits, without requiring Arena to shoulder any of the marketing costs.” Nadeau expects the company to outperform the Nadsdaq by 15 percent to 20 percent over the next 12 months, he said in a note today to investors.

It could be lights out for Cramer's thestreet.com

Biotech investors have had a hate/hate relationship with thestreet.com's biotech "analyst" Adam Feuerstein, as he has bashed promising companies, probably as an accomplice in bear raids against microcap biotech companies, orchestrated by shorts and hedge funds. Well, Jim Cramer's thestreet.com is about to get de-listed in an ironic comeuppance. Perhaps Cramer should have hired an analyst with a biotech background, instead of a political science hack.

http://www.zerohedge.com/article/taking-it-streetcom

He failed as a hedge fund manager before becoming a cheerleader on CNBC. And now he has failed as the CEO of an investment company. Mr. Cramer better keep his daytime job at CNBC. Booyah!

Two "misses"

BDSI's cancer pain drug Onsolis did gain FDA approval as expected, but the prices have declined since its approval, which is unexpected. I'm sitting on a slight loss on the shares, so will probably hold until their next pivotal event in September/October--or until the market realizes the commercialization potential of Onsolis, its unique breakthough drug delivery technology, and solid pipeline up for FDA approval.

I also contemplated taking a stab at Human Genome Sciences (HGSI) last week, waiting for today's announcement for its Lupus drug, Benylsta. Results were positive, and shares rocketed overnight over 200%, despite the market's prior skepticism. Even though we missed on it, I don't feel that bad, because I didn't perform enough due diligence to be comfortable enough to pull the trigger. The main beneficiary is the biotech sector, as these big winners will attract more retail and institutional investors. Clinical stage biotech stocks require capital to fund their development work, so the positive news gives them more options for financing.

Biotechs and the FDA

In a letter I wrote to a friend and fellow investor:

Dick,

I like your synopsis on the disconnect between pivotal event-driven biotech stocks and the overall market (which is driven by consumer demand to the tune of 70% of our economy).

One thing I would add on the 20% success rate of FDA approval--I believe that is for drugs that enter into clinical trials--all 3 phases. I believe once a drug reaches Phase III clinical stage, the probability of approval is between 50-80%, depending on who you talk to. So if we stick with Phase III drugs, our chances of approval greatly increase, because at that stage, they are toying with dosages, and hopefully, most of the safety and efficacy issues are already ironed out.

We know the cycles for biotechs are sometimes greater than 10 years. In semiconductors, product cycle times are in the months, so investing in Phase III biotechs is necessary for the impatient (which we all are). It's been said that scientists have to discover 360 molecule compounds for every approved drug, due to the high failure rate. This ratio takes into account research and development, multiple phases of clinical trials, new drug or biologic application, FDA approval and commercial launch. Each step carries potential attrition risk.

There's another reason why I like ARNA--their patent portfolio is strong so that if other pharma companies want to target a particular malady relating to the central nervous system, metabolic systems, cardiovascular, and inflammatory diseases, chances are they will need to license one of ARNA's compounds. Dr. Behan has found a way to selectively target G Protein-Coupled Receptor's (GPCR) for their desired effect. The selectivity is what makes ARNA so valuable, as it doesn't stimulate other receptors, and therefore adverse side effects are minimized. This sounds trivial, but it's the difference between a few billion dollars in annual revenue and $21 billion of lawsuit claims that Wyeth had to pay out, due to cardiac valvulopathy from the failed phen-fen 12 years ago. It's also why I think ARNA will win out over VVUS and OREX, even if their offerings are approved also.

I really want multiple partnership deals, and not an outright buyout from a big pharma. The pps will soar if ARNA remains independent.

Greg

Is the biotech sector cheap?

According to Dr. Steve Sjuggerud, biotech stocks are currently cheap, based on the price/sales ratio. At the tech boom peak, the P/S ratio was over 20. Today, due to last year's massive market decline and subsequent difficult financing environment, the P/S ratio lies at 3, near it's bottom during the late 1990's.

The media and public have also become enamored with green technology and the massive government boondoggle of tax-and-spend. My personal opinion is that clean technologies like solar and wind power won't gain meaningful traction for years, if not decades, and will only exist as long as government subsidies support their money-losing business models.

Biotechs have also participated in the huge rally since March 6, up over 30%. My cohorts and I have profited immensely as a result, a product of due diligence, prescient market timing, and frankly, instincts and luck. Fear ruled the market in early March, and it just smelled overdone. The due diligence on pivotal events catalyzed the outsized gains.

To summarize, Dr. Sjuggerud likes biotech for the following reasons: they're cheap, unloved, and in an uptrend. I'm just glad my buddies and I picked up on this trend a few months ago.

The disconnect between the market rally and the jobless economy

I've always posited this recent strong rally, while good for account values, was a bear market rally--a sucker's rally, if you will. While a 40% rally is legitimate by any measure, it's within a secular bear market. Why? Any recovery will be tepid, as industrial output is plummeting, cash- and credit-strapped consumers aren't spending, banks aren't lending, and the private sector isn't hiring. Barron's has a good article on the true measure of the state of the economy, tax revenue:

http://online.barrons.com/article/SB124579469824143923.html#mod=BOL_hpp_dc

I don't know when the market will wake up and realize how dire the prospects for worldwide economic growth are. But as long as central banks continue to print currency in an attempt to stimulate their respective economies, I suppose asset values can continue to rise. Aside from pivotal event-driven biotech stocks, and a few precious metal plays, I am on the sidelines, even if it means I miss the next 10 or 20%. It's never wrong to take profits.

It's been a good ride, but I am not going to fall in love with this market. I don't want my heart to be broken.

Market Correction

The pullback I anticipated is finally occurring and accelerated in the last few days. The only strategy that is working are my puts on the SP500, a cruise liner and for-profit educator. I completely sold out of my oil trade, and lightened up on my gold and silver trade last week (although, in hindsight, I should have sold completely out of it). It's never bad to take profits.

What is hurting me is hanging on to pivotal-event driven biotech plays, although any of these stocks can pop up upon an FDA approval, successful clinical trial, or big commercial order. I expect continued weakness into the summer months, so hopefully these binary events are positive, and occur soon.

Biotech update

All our biotech plays are green, including obesity, swine flu, renal, and various oncological drug companies. This is a relief, but it always concerns me when stocks gap up. I've taken some profits, leaving most shares on the table in case they gap up due to pivotal events. While I am bearish short-term, this bear market rally has some juice behind it as the Fed continues to pump the system with a flood of dollars.

Nominally, investors should do well, but returns will lag in real terms once inflation kicks in. More on that later...

Money management

Money management to me is positioning your assets so they are poised to appreciate, but having enough liquidity to pounce when opportunities arise. You need bullets in your rifle to hunt your prey.

When markets rise and my asset values do accordingly, I get increasingly nervous. I am nervous by nature when it comes to finances, and I also have a bargain-shopping mentality. Perhaps that's why I don't mind it when markets drop--they represent buying opportunities. That's just my personality make-up.

The current rally in equities and commodities is a head fake to me, but strong enough to appreciate 40% so far from March lows, and irrational enough to extend another 20% potentially. So even though I believe this is a short-covering rally wrapped inside a secular bear market, I won't be shorting it--I won't get in the way and will let it run its course.

Instead, I pulled some profits off the table, leaving the majority in play for more profits--in case I am wrong on an impending correction. The higher the market goes, the more I'll pull off the table. Just like I will average in (buy) while the market tumbles, I will average out (sell) when it rises. I'll never be 100% invested, and I'll never be 0% invested. You don't want to get caught 100% long when the market tanks, but you don't want to completely miss a huge rally either. Meanwhile, I also am writing covered calls to generate income while I stay in the market. This will limit my upside if called away, but I'd still be up triple digits on my entry points and I keep the options premiums no matter what. Not bad. If the market corrects as I expect it to, I have some dry powder to go bottom-fishing.

In a raging bull market, your best returns result from being fully invested. But in a declining market, being 100% long leaves you no recourse but to sell into that declining market. Liquidity is king in those instances. So I will never be fully invested, no matter how bullish I am. And I am certainly not bullish today--at least not on equities.

Commodities--that's another story. With the dollar continuing to be flogged in the FOREX, the energy sector, metals, and soft commodities have all soared. This plays right into my thesis of the Fed reflating the economy with dollars in order to stave off another Great Depression. I think Bernanke will be successful by his criteria, but looking around the corner, this monetary explosion will result in inflation--the commodities markets are telling us that--all we have to do is listen to them. By the way, an exploding money supply is also why I believe equities may have more room to run north, but structurally, our economy is so broken I can't see a sustainable rally in equities.

I will stay mostly long my core inflation holdings: gold and silver mining shares, oil companies, natural gas drillers and pipelines, and commodities. The only equities I'm long on are specialized biotech companies which fluctuate somewhat independently of economic cycles, as they are pivotal event-driven, based on FDA approval. I use the qualifier "somewhat independently" because the financing environment is still very difficult, and markets have a low tolerance for risk. Unless the road to FDA approval is paved with certainty, microcap biotech companies have to be resourceful in order to fund their clinical trials. So far, the biotech companies I have invested in have shown promise, and some have even paid off financially already. A year from now, hopefully all of them will be in the green.

Until then, I stand firmly grounded in my thesis that paper money is becoming increasingly cheap, and owning hard assets will be the best hedge against debased currencies worldwide, including the US Dollar.

Is the swine flu scare over?

Apparently not, as the World Health Organization (WHO) is contemplating raising the pandemic alert from phase 5 to phase 6, the highest level. The Influenza A(H1N1) virus is rapidly spreading throughout multiple countries, and is now mutating to the point where there is human-to-human transmission. Roche's Tamiflu and GSK's Relenza are stockpiled in the US, but Tamiflu is potentially ineffective against new mutations, and Relenza may only be marginally effective in combating the virus.

Hence, I invested in another clinical company which has developed a vaccine which has been proven effective in Phase III and Phase II trials in Japan and the US, respectively. They already have existing contracts with government agencies, and negotiations are underway to roll out doses for hospital use and for stockpiling. Unfortunately, this swine flu pandemic is not going away any time soon.

Biotechs getting some run

With health conference season in full swing, biotechs are showing green on a daily basis. In between rubber chicken luncheons, CEO's are pitching their companies on the next game-changing treatment for various human ills through endless PowerPoint presentations. Many will fail to live up to their promise, but a few will actually make it through the FDA approval--estimates are 1 in 5 succeed.

The DNDN effect is providing even biotech penny stocks new life, as no one wants to miss out on the next blockbuster. Some companies have also had impressive price appreciation, including VNDA, who received a surprise FDA approval, despite a rejection last year. Partnership and buyout rumors are floating around these conferences, with big pharmas looking to replenish their drug portfolios, as their pipelines dry up due to patent expiration. This effect is driving up premiums for clinical-stage, microcap biotech companies, whose share prices were decimated by the credit crunch and financial crisis last year.

Let's hope the overall market doesn't take away the punch bowl.

Taking profits

And in these skittish markets, I'm not ashamed. Took some profits on TBT, up 50% due to rising 30-year T-bond rates (TBT is a double short ETF betting on rising bond yields and declining bond prices). It gapped up today and could break out, so I kept some on the table. But with a 50% profit, I had to take some off the table. If the Fed goes through with quantitative easing and monetizes that debt, they could temporarily drive bond prices up and yields down. Long-term, I'm still bearish Treasury bonds, so I will wait for another good entry point to buy TBT. But with volatile markets, you take your winners and cut your losers. Buy and hold won't work going forward (it didn't work in the last decade either).

Also, I cashed out partial positions in a uranium stock (up 25%), and of course DNDN this morning for a better than 300% pop. Notice I said "partial", as I am merely taking some profits, but letting the house money ride. Most professional traders average in their buys, and average out their sells, because no one can buy at the absolute bottom or sell at the absolute top. Don't blow your wad with one initial big trade. And don't get discouraged if the price drops a little as soon as you buy, or goes up a little when you sell. Knowing when to sell is as important as knowing when to buy.

The reflation play is still intact, and I will be looking to buy into dips on hard assets (commodities, precious metals, energy). We are in the throes of a bear market rally, but I certainly don't want to stand in the way of stampeding longs. When I hear talk of the beginning of a new bull market, I'll know this rally would have been a head fake, at which point I will buy some appropriate puts. If I miss the big decline--oh well. NOT losing money in this market is like a win.

I also want to get liquid and keep my powder dry, as another biotech opportunity is presenting itself. This may not be another DNDN blockbuster, but FDA approval seems imminent. Stay tuned.

The FDA drug approval process

Clarity and purpose are very important to me: it is tough to make money in manipulated markets, and I try my best to teach people how money works.

That's why I divorce myself from politics: what the government is doing is more important to me than what our elected officials claim they are doing.

A stock like Dendreon was trading at $3 for a reason--market makers, hedge funds, analysts, and even big pharma companies manipulate the share price down via short selling--one would think they would want a higher price per share. For reasons I've gone to at length, they use the media to rig the markets into suppressing the share price. One analyst--the night before Phase III clinical trial results announcement, reiterated a $1 price target, when it had closed at $7.30 the day before. The next morning, in pre-market trading, it spiked up to $26. The shorts got wiped out and are scrambling to cover in a short squeeze.

A buy out offer just got that much more expensive for any big pharma suitors. In fact, the company is going to go at it alone, manufacturing and marketing the drug themselves in the US, and partnering with another company to penetrate Europe. Valuations from analysts now range between $40 to $300, as this immunotherapy for prostate cancer could potentially extend to cancers of the breast, kidney, colecteral, lung, head and neck, etc. Chemotheraphy companies had a stake in suppressing this technology as well, as they will be wiped out when this treatment gains traction. Couple that with a corrupt FDA with members on the advisory panel with admittedly conflicting interests, and it is no wonder 80% of drugs are rejected by the FDA.

Once in a while, a blockbuster drug comes along. In other words, just because a stock is $3 doesn't mean it stays there, despite darker forces at work. The key is to uncover value when you see it, against a sea of skepticism. Most of the time, the skepticism is warranted. But when it's not, it's a gold mine. I researched DNDN in February, before pulling the trigger just days before their pivotal announcement last week. No textbook or classroom is going to teach me that. The Street (Wall Street and Main Street) is still mulling over an imminent GM bankruptcy, toxic bank assets, bailouts, stimulus bills, yada yada yada. These were discounted into the markets 9 months ago. The funny part is just as the market is getting complacent about real estate foreclosures, a 2nd wave is about to hit more neighborhoods. In order to succeed in investing, look ahead and anticipate what the markets will do. Don't invest based on current events alone--that is looking in the rearview mirror.

Short Squeeze

It looks like the short squeeze is on for shares of the biotech firm I invested in. The price gapped up over 15% within the first hour of trading and is holding, despite the overall market being down (the Dow Jones was down over 100 points). Rumor has it they will announce results of a Phase III clinical trial Monday or Tuesday, and the longs are being joined by the shorts looking to cover their short bets.

Short interest is high, which could potentially intensify the short squeeze next week if results are positive. Call option volume is also high, indicating available shares are scarce, so shorts are turning to calls to hedge their short bets. Other factors that attracted me to this stock was high institutional ownership, relatively few floatable shares, and NONEXISTENT INSIDER SALES. In other words, executives believe in their products and their own company, instead of cashing out early for personal gain. Their interests are aligned with shareholders like myself. They are looking to build large enterprise value, instead of looking to cash out for their own immediate financial gain.

If results are negative, the shorties will overwhelm the longs, driving the price down by more than 75%. If results are positive, we could have a triple from here. Longer-term, with forthcoming Phase III trials also positive, a new drug application, an announcement of a co-marketing partner, and finally FDA approval, this company may attract a bidding war among big pharma companies to buy out the company. Big Pharma has been on an acquisition binge lately, as they aim to replenish their drug pipelines, as many of their drugs are about to go off-patent, destroying their profit margins in the process to generic manufacturers. Good for consumers, bad for Big Pharma. In any case, this tiny biotech company is on the radar of several potential acquirers, as they have shown promising results for a class of drugs that the Big Pharmas have failed to get FDA-approved.

If the company can secure enough capital to address cash flow concerns until FDA approval, the return to shareholders will be even larger, as the market potential for this drug is huge. Based on its risk/reward profile, this speculative play worth it, in my humble opinion.

Increasing shareholder value is contingent on execution by company executives and employees. But the absolutely essential ingredient is the golden goose. The drug needs to be effective and safe--everything else is noise. We should find out soon enough whether we have a mega-blockbuster on our hands, or a dud.