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Expert Financial Analysis and Reporting

SmithOnStocks Opines on Stocks May 19, Edition

One Approach for Investing in Emerging Biotechnology Stocks

I write on biotechnology and pharmaceutical companies of all sizes, but I have spent much of the last year focusing on small biotechnology companies ranging in size from as low as $50 million in market about $400 million. There is much less analyst and investor attention on these stocks which can lead to pricing inefficiencies. There is also considerable risk as the investment thesis for the stocks often hinges on the outcome of a single clinical trial. While I don't have precise statistics, my impression is that more than half of late stage trials fail. These investment opportunities fit my asymmetric investing approach.

What do I mean by asymmetric investing? Some hedge funds have made enormous returns by looking for asymmetric investment opportunities. These stem from finding upcoming events that are not well understood and which have the potential to cause dramatic stock movements in the case of a positive outcome. The chance for such a positive outcome may be modest, but if it does occur the potential reward dramatically offsets the risk of being wrong. Perhaps the upside opportunity is a fivefold or more increase in the stock price and the downside is losing much or all of one's money. These characteristics are similar to an option, but have the advantage that there is not the time element. One can be right on thinking that leads to an option investment and still lose all or much of your money if the option expires prior to an anticipated event. This is asymmetric investing and emerging biotechnology lends itself very much to this approach.

For an asymmetric opportunity there has to be lack of awareness or extreme skepticism that a positive outcome can occur. Small biotechnology companies fit this approach because most Wall Street analyst coverage in biotechnology is focused on larger biotechnology names (more symmetric investing). In addition, the large number of trial failures in small biotechnology has produced a pervasive skepticism that any clinical trials will succeed. Asymmetric investing does not mean that an investor is smart enough to predict with certainty clinical trial outcomes. The premise is that the event has a reasonable chance of occurring, is unexpected and if it does occur the upside potential dramatically offsets the risk of losing much or all of the investment if the outcome is negative.

When I write my articles I always think that my idea will be successful, but I know that some will fail. At least, that has how it has worked in the past. It has been my experience that one winner will significantly offset the loss of one or several losers and I aspire to be right more than half of the time. I tend to take small positions in many companies so that I am not overly exposed to any one stock and in the aggregate, biotech is about 15% of my portfolio which contains much of my personal wealth. However, no one position is so large that if the stock blows up that it will have a major impact on my portfolio.

I want to emphasize that if you are looking to trade the biotech stocks that I am involved with, my articles are probably not for you. I am generally locked in on an event or series of events that will prove me right or wrong and these can sometimes take a year or longer to unfold. Along the way, unavoidably there will be many uncertainties and surprises that lead to sharp up and down movements in stock price and periods when a stock is just plain boring. I tend to ignore these and as long as the reasons that I bought the stock remain in place, I just shrug my shoulders and hang in there. I know that some people try to trade swings in the market and stocks, in an attempt to enhance their total return. I have actually tried on occasion to do this as I suspect everyone else has. However, it just found it didn't work well for me.

While trading is neither my goal nor my forte, it does not mean that I am uninterested in short term stock movements. There are times when I emphasize my buy recommendations because I anticipate an event that may cause near term strength in the stock. Other times, when I think that the stock might be ahead of itself on a short term basis, I usually go quiet. As a rule try, I don't to trade in and out of stocks in an attempt to catch a short term move as long as I believe that my long term thesis is intact.


Current Thoughts on Stocks in My Universe

This section highlights companies that I have recently written about and/or events that were meaningful to companies in my coverage universe. It is not necessarily comprehensive.


Neuralstem (CUR) is the most intriguing near term situation. The lead investigator will give an important update on the ALS phase I trial on Friday, May 17. This should have meaningful efficacy data on eight patients and safety data on fourteen. I believe that the paper will be positive and potentially quite positive, which could result in a good near term move. See my report


A.P. Pharma (APPA.OB) common has done well since the management change and of course, it was recovering from the 50% drop following the disappointing Complete Response Letter received on March 28, 2013. It is up more than 50% from its lows which has been spurred on by a management change. I think that the stock could retrace to $0.60 to $.70 if the NDA is refiled and a PDUFA date is established. My asymmetric upside target is $3.00 to $4.00 in 2015. See my recent report.


Trius (TSRX) has had a fairly steady stock rise since the equity offering in January and last week it was boosted by the unanticipated news of an allowed patent for the combination of tedizolid and Cubicin (daptomycin) to treat bacteria resistant to daptomycin. This added a new dimension to the Trius investment thesis and the possibility that this could incent Cubist to enter into a lucrative partnering deal or even acquire Trius outright. See my recent report.


Antares (ATRS) has been pretty much flat for the last half year perhaps due to the settlement that delayed the launch of Teva's (TEVA) potential AB rated generic to EpiPen and a stock offering. Also, the market capitalization is over $500 million while reasonable for the unusually strong pipeline, it is not as undervalued or ignored as most of the companies that I focus on. The stock may have gotten ahead of itself last year.

With the approaching of the PDUFA for Otrexup and the potential for exciting pipeline developments throughout the balance of the year, I think the stock could trade up over the remainder of the year. My focus for the stock is on the 2015 period and beyond when I think that the Company will enter a period of explosive growth. I have a price target of $11 for 2015. This is based principally on the launches of Otrexup, Vibex QTS and the AB equivalent to Epipen. See my recent report.


Discovery Laboratories (DSCO) has just completed (still another) public offering of 9.5 million shares with no warrants at a stock price of $1.50. This brings the share count to 53.2 million. There are a large number of outstanding warrants, but only about 4.9 million issued in the Deerfield transaction are likely to be exercised below $10.00. There are also about 2.0 million options. This brings the fully diluted share count to about 60 million shares. At the current price of $1.50, this results in a market capitalization of $90 million.

DSCO ended 1Q, 2013 with $26 million of cash and I estimate that the Company will burn about $10 million per quarter through the balance of 2013. With no equity offering or an infusion of cash from any other source, DSCO would have had cash of $6 million of less at about the time of the probable new launch date for Surfaxin in 4Q 2013. However, DSCO will receive $20 million from Deerfield upon the first dollar of commercial sales of Surfaxin which should occur in 4Q, 2013. This factor along with the $13.5 million raised in this deal could bring the year end cash position to $30 million. I also believe that a patterning deal on Aerosurf could bring in an additional $15 million of cash in 1H, 2014. Assuming a $10 million quarterly burn, which is may be too high, the Company would have $25 to $30 million of cash in mid-2014. I don't foresee the need for an equity offering in the next year.

The stock has been an extreme disappointment over the last decade as it has received six complete response letters for Surfaxin- I beleive that this is a world's record. This has led to innumerable equity offerings over the last decade that has diluted the share price tenfold. No one who has bought the stock over the last decade and held it has made money. The stock has become a pariah and many seasoned investors would not go near the stock at any price.

Sometimes investors have to forget the past and look at where the Company is now. The PDUFA data for Surfaxin is probably sometime in early October and it now has enough cash to launch Surfaxin and end the year with $30 million of cash. Surfaxin is a relatively limited opportunity with peak sales potential of perhaps $75 million, but the pipeline potential provides the potential for an asymmetric upside. I have never wavered in my enthusiasm for its pipeline product Aerosurf which I consider one of the most exciting new products in biotechnology. It will be entering phase II in 4Q, 2013 and we could see meaningful proof of principal data in 2014. I also anticipate a partnering deal for Aerosurf, probably for foreign rights, in 1H, 2014. I would urge investors to erase their memory banks and buy the stock. I am adding to my position. See my recent report.


Transcept (TSPT): Will Purdue Return Rights to Intermezzo?

In an 8-K filed after the close on May 13, Transcept announced that Purdue will eliminate the 90 contract sales reps detailing Intermezzo and will continue to promote only with its 525 pain specialist reps. There were initially 275 contract reps hired when Intermezzo was launched in April 2012. This reflects the disappointment with the Intermezzo launch. I would not be surprised to see Purdue transfer rights for Intermezzo back to the Company.

The initial Intermezzo launch has failed. The CEO of Transcept, Glenn Oclassen, has significant experience in building small pharmaceutical companies. I will be watching to see what he decides to do with Intermezzo if rights are returned and how he will deploy the $81 million of cash on TSPT's balance sheet. The cash per share is $4.31 which is more than the current stock price of $3.59. By this time next year, TSPT will be a very different company and I will be monitoring the situation, but I have no opinion on the stock at this time. I may have thrown in the towel on the initial launch of Intermezzo, but I haven't thrown in the towel on Mr. Oclassen. See my recent report.

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