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Small cap biotech investing in the era of underperformance

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October 10, 2008 – Comments (5) | RELATED TICKERS: ZGEN.DL , NKTR , ALXN

Now that I'm flirting with a 99 rating, I feel like I can start writing down some of my thoughts without feeling like a complete idiot. Don't get me wrong - I don't recommend that anyone buy stocks I write favorably about or use my speculations for anything except entertainment. CAPS rankings are virtually meaningless for many reasons (accuracy, red thumbing unshortable bulletin board garbage, keeping long-inactive players in the rankings, etc.). I've been getting creamed just like everyone else in the last couple of weeks, mainly because of an ill-advised decision two weeks ago to liquidate my large holdings of ultrashort ETF's and go hard long into beaten down oil and tech stocks. I was expecting a short upward burst with passage of the bailout bill in the house the first time round, and we all know how that turned out. So I ended up going to cash a couple of days ago and took a huge loss on my two week investments, but right now I'm glad I bit the bullet. At least I've got something left to buy with when this piece of crap finally hits a bottom it can live with.

So the question becomes, when the market does stabilize and you have any cash left, what small cap biotechs should you buy? First and foremost, it's a dubious question whether you should buy small cap biotechs at all. Since I started following them two years ago, probably five were down for every one that was up even before the recent round of decapitations. But if you do feel compelled to embrace the agony and the volatility, I do feel I've gained some valuable perspectives while I've helped to line the pockets of CEO's and hedge fund managers .

 The most important thing to keep in mind is that each new medication needs to overcome three major hurdles before becoming profitable. It has to be successful in clinical trials, it has to achieve FDA approval (and/or approval in other large markets), and it has to be commercially successful. The last of these is far from trivial. The majority of approved drugs from small cap biotechs in the last two years have yet to achieve significant sales. Notable flops have been Nitromed's Bidil, Zymogenetics Recothrom, Nektar's Exubera. The only major success I can think of offhand is Alexion's Soliris. So we see that the odds of success for a small cap biotech are quite small. My best estimate is that of all the small cap biotechs with market caps between 100 million and 1 billion two years ago, probably 10-15% are trading in pennies and on their way to dissolution. Most of the remaining companies are trading at significant discounts. As old companies fade away, change their names, or merge, new ones IPO to take their places (although that party may be over for a while).

On my next post I'll describe the major mistake I made when I first started investing in small cap biotech, which I think most other retail investors make as well. But I would like some idea whether anyone is actually reading these ramblings. So please leave a reply or a rec, so I'll know whether it's worthwhile continuing this thread.

5 Comments – Post Your Own

#1) On October 10, 2008 at 4:30 AM, humina (< 20) wrote:

am interested in learning more from you. I have had RXII and its former parent CYTR pitched to me. Any opinion?

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#2) On October 10, 2008 at 4:13 PM, DemonDoug (81.84) wrote:

dude i love your presence here on caps.  Biotech has been unloved during the horrendous bush administration, but if obama wins, i feel we will see a real big influx of biotech and biological agents coming online in the next 8 years.  I still like DNDN as the best odds for hitting the jackpot on the roulette wheel of biotechs.  I haven't seen many other biotechs at all looking like they will be profitable (or even surviving) for the next few years.

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#3) On October 12, 2008 at 11:00 PM, ikkyu2 (99.32) wrote:

I am a little confused by the whole Anal Insulin deal, but I am reading.

 

Full disclosure:  I am an MD and I occasionally speak on behalf of VRX, the company the makes Anal Diazepam (DiaStat).  Medical students are permitted to giggle; real professionals must maintain a straight face. 

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#4) On October 14, 2008 at 2:12 PM, zzlangerhans (99.67) wrote:

Demon, I don't see great odds for Dendreon long term. If you look at my history you'll see four red thumbs with positive scores, and I wasn't even here when the real stuff went down last year. The bottom line is that cancer vaccines just don't seem to be working, or if they do the effect is marginal. Just look what happened to Favrille, Genitope, Antigenics, and Cell Genesys. The theme of Dendreon seems to be, is it just good enough to squeak by? I'd say probably not. Sure, if it does it will be a multibagger. But there are lots of biotechs out there with better risk reward ratios. I've learned that in these stocks it's better to be the tortoise than the hare.

 Humina, I am negative on both those stocks. Rather than get into those details, ask yourself why anyone would be pitching a stock to you. Is it because they own shares they want to sell, hopefully to you at a higher price than they're worth? Good stocks don't get pitched, they take care of themselves.

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#5) On October 14, 2008 at 2:12 PM, zzlangerhans (99.67) wrote:

Demon, I don't see great odds for Dendreon long term. If you look at my history you'll see four red thumbs with positive scores, and I wasn't even here when the real stuff went down last year. The bottom line is that cancer vaccines just don't seem to be working, or if they do the effect is marginal. Just look what happened to Favrille, Genitope, Antigenics, and Cell Genesys. The theme of Dendreon seems to be, is it just good enough to squeak by? I'd say probably not. Sure, if it does it will be a multibagger. But there are lots of biotechs out there with better risk reward ratios. I've learned that in these stocks it's better to be the tortoise than the hare.

 Humina, I am negative on both those stocks. Rather than get into those details, ask yourself why anyone would be pitching a stock to you. Is it because they own shares they want to sell, hopefully to you at a higher price than they're worth? Good stocks don't get pitched, they take care of themselves.

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