The story of Anal Insulin, or how Pete lost his money (part III)
As Gluteus' share price slowly eroded, Pete tried to forget about his investment knowing that there wasn't likely to be any good news until the phase III trial was completed. Once it got down to 3, however, it seemed to stabilize for a while. From the press releases and the people on Yahoo Finance, Pete guessed it would be another six months before enrollment was completed. Now he was even closer to the explosion in stock price, and the price was only half what it was when he had bought it. If only he'd read that article a year later! But Pete had an idea. If he doubled his original investment, or say bought another seven thousand shares to make it an even ten thousand, the price would only have to go back up to 4 for him to break even. He thought about it a long time but it seemed to make perfect sense. In all likelihood the share price would rise as the phase III data release got closer, and he could even sell at a profit and not have to take a chance on some screw up in the trial. Pete sold off some more mutual funds and bought another seven thousand shares of gluteus just under 3.
Pete now had ten thousand Gluteus shares at a cost basis of just about forty thousand dollars. Instead of the six months he had hoped for, the phase III trial dragged on for another ten months. During that time, the share price continued to gradually decline. On up market days it might go up two or three percent, then on some bad days it would sag by five or even ten percent. Pete perused every document he could find about the phase III trial, but there was no sign that anything was wrong except for the share price. Nothing had changed on the Yahoo Finance boards either, where the same people were still saying all was well and claimed to be buying more and more shares.
Finally, a year and a half into his investment, Pete got the news he had been waiting for. A press release in the premarket announced positive results for the phase III trial of Anal Insulin! Gluteus had closed the previous day at 1.4, but it was already up to 2.7 in the pre-market. The message boards were filled with congratulatory posts and seemed to have a whole bunch of new participants as well. Fortunately he wasn't working that day so he was able to stay at his computer and wait for the markets to open. It seemed like an eternity before 9:30 came. In the meantime, Pete tried to guess how high the shares would go that day. The consensus on the message boards seemed to be about 7 or 8.
When the markets finally opened and Pete saw the first Gluteus quote, he was a little confused. He had seen 2.7 in the pre-market, and now the last trade was saying 2.4. He refreshed the screen a few times, and the price continued to drop. An hour into the session Gluteus was trading at 2, and an hour after that 1.8. Pete was frozen at his screen. He read and reread the press release about the trial results, and the data sounded great. Anal Insulin seemed to work just as well as the injectable kind. Pete didn't leave his house all day, and barely got up from the computer. By the time the markets closed, Gluteus was down to 1.18, much lower than it had closed the previous day. Pete was stunned. He'd waited all this time for this to happen? The tone on the message boards had also changed, from congratulating and crowing to infuriated missives against stock manipulation and the weak company management that permitted it to happen. It didn't seem like anyone had managed to sell out for a gain. A brief note on the events from CNBC mentioned that despite the positive phase III trial, the stock was down for the day on "profit-taking". Pete wondered who the hell had profited when the stock was reaching new all-time lows.
The next day, two events seemed to shed some light on the situation. First came a more in-depth article from a biotech analyst on a stock website, which was critical of the statistical analysis Gluteus had used to generate their data. The analyst claimed that if they had used a more conventional analysis, the results actually weren't statistically significant. Furthermore, Gluteus hadn't followed the hemoglobin A1C, which is the best measure of long-term glucose control. Without that, the analyst claimed, efficacy compared to injectable insulin couldn't really be established. Next came a downgrade from a prominent brokerage firm. The comment from the brokerage analyst was that even if the phase III trial results were solid, people couldn't be rationally expected to start shoving insulin into their anuses. Pete was flabbergasted. How come none of this came out during the year that the trial was in progress? It almost seemed like the cranks on the message board were right, that there was a hedge fund conspiracy to drive down the price.
Within a week, the share price was below a dollar. The company management seemed to ignore all the commentary and their plunging share price, describing their results in glowing terms in their next quarterly statement and conference call. An NDA submission was planned. Pete wished he'd never heard of Gluteus, but he didn't give up hope completely. If the Gluteus submitted the NDA then Anal Insulin had a chance to be approved. No one's opinion would matter at that point except for the FDA. However, a new problem became apparent. The company had been burning more than ten million dollars each quarter during the phase III trial, and now only had fifteen million left in cash and investments. One day the company released a statement about something called a shelf financing. They were going to create and sell an additional ten million shares to raise money to keep them going until the NDA submission. Pete didn't even know a company could do that, but he had enough sense not to be surprised when the share price dipped yet again on the announcement.
Pete is still waiting for the NDA to be submitted, eight months after the phase III results. There haven't been any more magazine articles about Gluteus Pharmaceuticals or Anal Insulin. At last glance, the share price was 0.41. But Gluteus doesn't seem to be worried. In fact, in their last quarterly statement, they proudly described their newest project shortly to enter clinical trials. Apparently the anal tissues are a rich source of valuable stem cells which can be harvested by a special technique they have developed.
If there's one critical lesson to learn before investing in small cap biotech stocks, it's how to avoid being a Pete. The obvious answer is that you invest in a company, not a story. If Pete had researched Gluteus a little more vigorously, he probably would have found a twenty year history of failed projects, plunging prices, and creative financings. But Pete wanted to believe, wanted his Porsche, and closed his eyes and ears to everything else. On my next post, I'll try and identify some features of small biotech companies that have made their shareholders money, and those that have made their shareholders broke.