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Shorts often take massive positions in biotechnology companies due to the simple fact that the drug development and marketing processes are so fraught with peril. An overwhelming number of drugs in development fail to make it through clinical trials, and even those that do face a rigorous FDA approval process. Making this sector even more attractive to shorts, the marketing of drugs is extremely expensive, highly uncertain in its outcome, and pregnant with legal challenges. Nonetheless, stocks with high short volumes as a percentage of the float can, and often do, catapult to new highs on positive news (see e.g., ARNA, ACAD, DNDN, etc.), making them attractive to investors with a strong appetite for risk. After screening a number of biotech stocks with high short ratios as a percentage of float, I believe the following two companies are the ones most biotech investors are considering as short-squeeze candidates for the New Year. I discuss their suitability as short-squeeze candidates in this article.

Questcor Pharmaceuticals Inc. (QCOR) is presently trading at less than half of its 2012 highs of $58.91 a share, and the percentage of the float short stands at a gargantuan 45%. The story of Questcor's fall this year is relatively well-known within the biotech investor community, and centers around a series of negative reports by Citron Research that contain stinging criticism of Acthar Gel prescriptions, Questcor's only FDA approved drug. This short attack has been particularly adept because Questcor does not have an active pipeline developing other drug candidates, but is solely focused on pursuing additional indications to expand the use of Acthar. According to Citron Research, Questcor has overstepped the present FDA approved indications for Acthar (i.e., infantile spasms), and is aggressively marketing the drug for grandfathered indications with little to no scientific proof of its efficacy. Prime Therapeutics, a leader in pharmacy benefit management strategies, agreed with Citron's assessment and concluded that 96% of current Acthar prescriptions are in fact unnecessary. On the back of Prime Therapeutics' report, Blue Cross Blue Shield Michigan announced on December 27th that they will no longer cover Acthar Gel for any indications other than infantile spams. With a projected 5-year EPS growth rate of 33.5%, a 2013 average analyst target price of $41.86, and nearly half the float short, Questcor certainly deserves consideration as a short squeeze candidate. Unfortunately, I believe the recent Blue Cross BlueShield Michigan announcement will only be the first of many to come. As such, the projected 5-year EPS is going to drop dramatically as sales of Acthar drop from their torrid pace. In conclusion, while QCOR looks like an appealing short-squeeze play due to these factors, Citron Research appears to be dead on in its assessment. Namely, Questcor will have a number of negative catalysts coming in 2013, including a possible investigation into its marketing practices by the U.S. Justice Department. To be fair, here is an alternative view of Questcor that refutes some of Citron's claims.

Spectrum Pharmaceuticals Inc. (NASDAQ:SPPI): Short interest has been as high as 59% of the float this year, and despite concerted efforts by CEO Raj Shrotriya to reverse the trend by year's end, short float currently sits at 55%. The short thesis for SPPI centers around sales of Spectrum's Colorectal cancer drug Fusilev, which have been trending significantly downwards in recent quarters. The recent downturn in Fusilev sales is believed to be due to the launch of the generic Leucovorin Calcium by Sagent Pharmaceuticals (NASDAQ:SGNT) this past October. Because of generic competition, analysts have advised that SPPI's EPS will fall to $1.03 next year from $1.39 this year. I believe this downward estimate and the short thesis on SPPI is way off base, however. According to Sagent's estimates, the U.S. market for Leucovorin Calcium is only $14 million due to strong barriers to generic competition. Fusilev is on track to hit the $200 million dollar mark this year, so if Leucovorin did hit Sagent's maximum sales estimates, this would only represent a 7% loss in sales revenues. Analysts, by contrast, are projecting a 25% downturn in EPS. Strengthening the SPPI case as a short-squeeze candidate, Spectrum's sales of Folotyn have ramped up 45% from recent quarters, and are on track to more than make up for the loss of revenue from Fusilev due to generic competition. Topping it off, Spectrum is expected to announce critical Phase 2 results for its Belinostat, a treatment for blood-based lymphoma, on January 31st, 2013. If the results are positive, this catalyst could trigger a short squeeze that is reinforced by strong sales of both Fusilev and Folotyn in the 1st Quarter of 2013. With the stock currently trading at $11.28, I think it's highly plausible that shares of SPPI will nearly double in 2013 to approximately $22 a share. As a result, SPPI is my pick for the best 2013 biotech short-squeeze candidate.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: 2 Biotech Short-Squeeze Candidates For The New Year