Biotech Investing: The Ugly
I'll start with a company no one can defend: Atherogenics filed Chapter 11 just this month, but this was a foreseeable outcome at the end of 2004. Back then the stub traded at a healthy 26 (1.2B cap), despite the release of weak and controversial phase II data on their flagship developmental drug for atherosclerosis, AGI-1067. The company proceeded anyway with a phase III trial (ARISE). In 3/07 the share price had eroded significantly but was still at about 10. Then the ARISE results were negative and the share price was cut in half again. The company performed a post hoc subset analysis on ARISE that appeared to show a beneficial effect of AGI-1067 in diabetics, and behold a new phase III trial was born (ANDES). A surge of optimism based on initiation of ANDES took the price from 1 back to 3, then it plummeted again when late data from ARISE indicated hepatotoxicity at higher doses of AGI-1067. Final data from ANDES in 7/08 was spun positive, but was quickly dissected by the street and found to be weak and insufficient to give a shot at FDA approval. The share price continued to degrade making dilutional financing impractical. Faced with the prospects of a new phase III trial and a mountain of debt, the company decided to throw in the towel.
The stock gave investors a critical chance to escape in late 2004, when poor data only chopped the share price from 30 to 26. The lesson here in a company with no track record of success, is to get out as soon as storm clouds gather. In biotech, be fearful when others are greedy and be fearful when others are fearful. Call this Rule #1. This is far from Monday morning quarterbacking. Extensive and detailed articles were published in both the Fool and the Street at the time of the phase II data release that were unusual in their condemnation of the data and the company's prospects. What propped the share price up was the dream of a pill that could cure atherosclerosis. Once investors bought in, they couldn't let go. Company spin was given equal or greater weight to independent analysis.
Other lessons can be learned from the Atherogenics story. The last pitch for Atherogenics before they sank beneath the CAPS threshold went as follows: "At this point what do you have to lose? The stock has just about bottomed out - if it hasn't quite yet bottomed out, you're only losing .38 at the most." This was in 12/07 when the share price was 1.69 so I'm not sure where the .38 figure came from. Perhaps a loss of .38 would have brought Atherogenics down to their 101M cash value, ignoring their 287M in debt. The answer to the question, regardless, is everything. Baby biotech rule #2, cheap stocks get cheaper. It doesn't matter if you bought 1000 shares at 10, or 10000 shares at 1. When the stock goes to 0 you lost ten thousand dollars. I'm sure many investors continued to get drawn in to Atherogenics as the share price dropped and dropped, but the outcome for all of them was exactly the same.
Third and last for Atherogenics, rule #3. Don't get pulled into sucker's rallies. Atherogenics tripled in 8/07 based on nothing but the initiation of ANDES, and this was a short-lived burst as it wasn't based on any substantive results. The fundamental flaws of the company and the data hadn't changed, as would have been clear to anyone who studied the company's history for the last three years. I'd hazard a guess that some institutional ivestors and likely some insiders as well escaped at the height of that rally, at the expense of the retail guys. A similar thing happened with Corlux, another of my Ugly biotechs.
So to summarize, baby biotech rules one through three:
1. Be fearful when others are greedy, and be fearful when others are fearful
2. Cheap biotechs get cheaper
3. Don't get pulled into sucker's rallies
I'd hazard a possible fourth rule: don't disregard debt. Ultimately debt is what forced Atherogenics to quit now rather than drag out another phase III trial, although the eventual outcome would have been the same. But since I'm not a business type person and other companies seem to be functioning just fine with heavy debt loads, I'll reserve judgment on this one for now. But don't worry, there's no shortage of Ugly babies to analyze, and more rules will be forthcoming.