Biodel and the Bottle Imp
Investment strategies sometimes come from unusual places. I developed one perspective on baby biotech speculation from a 19th century story by Robert Louis Stevenson called “The Bottle Imp”. If you aren’t familiar with the story, it’s a beautiful classic from one of our literary masters. The gist of the tale is that at the turn of the century (19th to 20th), a poor Hawaiian laborer buys a bottle that contains a magical imp who can grant any heart’s desire. There are several conditions involved in owning the bottle. The first is that if you die in possession of the bottle, your soul will burn in Hell for eternity (for those of you lacking religious education, that’s bad). The second is that the bottle must be sold for less money than it was bought for, and in coin currency only. The third is that the prospective recipient of the bottle must be told the exact and full terms of ownership prior to the sale. The final catch is that the bottle cannot be discarded or destroyed. If any of these covenants are violated the bottle will return to the previous owner.
Through a series of unusual and dramatic events, the laborer comes into possession of the bottle at several times in the story, and of course each time it becomes more difficult to part with. As the bottle becomes cheaper and cheaper, the buyer must balance the enormous benefits of ownership against the unimaginable penalty should he fail to find a more desperate person to purchase the bottle. And eventually of course, the bottle will be bought for the smallest coin value possible and possession can no longer be transferred.
Contemplation of this conflict leads one to the “Bottle Imp Paradox”. Assuming that no one would consider the granting of all earthly desires to be worth the price of eternal torment, no one would ever buy the bottle for the lowest coin value possible. For the sake of argument, call that value a cent. But in that case, no one should ever buy the bottle for two cents as they would know that they would never find someone to sell it to. By the same argument, no one should buy the bottle for three cents or any higher monetary value ad infinitum. However, intuition tells us that if someone were offered the chance to buy such a bottle for a hundred dollars in coins, they would jump at the opportunity. So what would be the lowest safe price to buy the bottle and feel confident you could pass it on before your death?
The story reminds me of a specific situation that occurs in small cap biotech stocks from time to time, although in somewhat of an inverted manner. In this situation, a major binary event will occur at some point in the future where the time is reasonably well known. Good examples are a PDUFA date or a release of data from a pivotal phase III trial. At the present time, the share price is substantially depressed due to information which has impacted negatively on the prospects of a positive outcome of the binary catalyst. In many of these cases, as time passes the share price will begin a strong upward trend. It seems as though the possibility of a huge payoff from a positive outcome continuously becomes more attractive as the binary event approaches. Of course, in most of these cases the outcome is negative and the share price drops off a cliff. It seems like the positive outcome happens just frequently enough to perpetuate this interesting phenomenon. I call this a Bottle Imp effect, although in this situation one must continuously sell one’s shares at a higher price rather than a lower one, and there is no obligation to tell the buyer of your shares that he is an idiot. But the crux of the paradox remains the same. Why would someone buy shares of a biotech for 7 one month before a PDUFA when they could have bought them for 3 six months before the PDUFA, with exactly the same probability of FDA approval?
There are several questions to ask oneself when one takes note of the conditions necessary for such a pattern to take place. One is, will there be a Bottle Imp effect? If so, when will it begin and at what level of price depression? How long will it continue and how high will the price go? Can I be sure of the timing of the catalyst so I don’t hold shares through it and end up burning in bagholder Hellfire for eternity?
Good examples of recent Bottle Imps are Poniard, Mannkind, and Dendreon. In April 2009 Poniard was trading in the 2’s in advance of results of the phase III SPEAR trial of picoplatin in lung cancer. For reasons I won’t get into here but are detailed in my old Poniard red thumb, I strongly expected negative results from SPEAR. However I watched from the sidelines in amazement as over the course of 2009, Poniard’s share price steadily increased and my negative score climbed without any apparent change in the probability of SPEAR success. Of course, negative data was eventually released in November and the share price plunged back down below 2 (can you hear the shrieks of the damned)? In late 2008 and early 2009, Mannkind hovered in the 3’s even after the NDA for their potentially revolutionary inhaled insulin Afresa had been submitted. The share price had been depressed for a year on concerns related to poor commercialization and cancer risks from Afresa’s inhaled insulin predecessor Exubera. Yet in April 2009 the share price began a strong upward climb even before the NDA was accepted in May. This Bottle Imp effect capped once at 11.45 in September, fell back on concerns about lack of partnership, and then resurfaced leading to a peak of 10.5 in January before falling to the current 6.5 after an FDA Complete Response. But Afresa in September 2009 was exactly the same drug with the same prospects as Afresa in April 2009, except for the three-fold difference in share price. Dendreon is a good example of the kind of outcome that perpetuates the Bottle Imp effect. By March 2009, a combination of pessimism about the IMPACT phase III trial of Provenge in prostate cancer and generalized market malaise drove the share price to multi-year lows in the mid 2’s. Over the next month the share price rose steeply to 7 before jumping more than 100% again with positive results for IMPACT.
I recently profited from a Bottle Imp effect that I foresaw in Alkermes. I was lucky enough to time the bottom, and predicted a double prior to the weekly exenatide PDUFA in 3/10. Sure enough, the share price steadily rose and peaked at 14 at about the time of the Complete Response or delayed approval, depending on how you look at it. Success with one diabetes drug led me to think about another, Biodel’s ultra-rapid acting injectable insulin Viaject. In 9/08 the share price fell off a steep cliff after the company revealed that “positive” data for a phase III trial of Viaject in type I diabetes hinged on post facto exclusion of data from India that seemed inconsistent. In other words, the company decided to manipulate the data after the fact to convert a lack of significance into a statistically significant benefit. Since then, the share price has bopped between 3 and 5 after previously reaching highs near 20. Biodel went ahead and submitted their NDA for Viaject with the Indian data excluded, and the FDA accepted the NDA with a PDUFA of 10/30/10. Now, it seems likely that the FDA will look poorly upon Biodel’s interpretation of the phase III data, which is likely the reason Biodel’s share price has remained stuck in the 4 range. But between now and the end of October, I believe the Bottle Imp will exert its magical force on the share price and elevate it much higher prior to the PDUFA. After all, the FDA has done stranger things than approve Viaject (check out Vanda). As of yet I haven’t invested any real money – I want to see the share price back below 4 and possibly below 3.5 as it was just two months ago. On the other hand, I submitted Biodel as my entry in floridabuilder2’s Chimp Contest (I requested a 4.16 price, 100M cap limit order but he went ahead and entered it at a recent high of 4.4). Biodel certainly doesn’t represent my idea of the best possible baby biotech investment, but it is my strongest candidate for winning a contest of a hundred picks. Obviously, the winner of this contest will have to at least double and more likely triple in the next 6 to 8 months. For this contest, it makes more sense to pick a stock with a 1% chance of tripling and 99% chance of going bankrupt than a stock with a 99% chance of increasing by 50%. In real life, of course, the opposite would be true. And of course the timing of the Viaject NDA seems perfect for FB’s estimate of the duration of the contest. So we’ll see – perhaps I’ll end up coming from 70th or 80th to first on the last day of the contest if the FDA approves Viaject. Should be interesting.