Two Calculated Risks Possibly Worth Taking

Includes: CYPB, LDK
by: David White

Many people are thinking there will be an Obama rally in January, in part due to his popularity and in part due to the stimulus package that he and the Congress are proposing. Then too there are the recent actions of the Fed – both lowering interest rates and declaring that they will apply every means they can to bring the economy out of its downward spiral. There is the rescue of the Big 3, which seems likely to need more money. However, it also seems likely that those 3 will get it if they make a very strong effort toward profitability in the near future. This should actually be a very positive process, since the automakers should emerge from it much stronger than they were going in. Oil prices are down, which is terrifically good for the US economy. I could go on.

If you believe in the likelihood of this January rally, how best can you profit? I have noticed two stocks which seem to present excellent opportunities: LDK Solar (NYSE:LDK) and Cypress Bioscience (CYPB). Why these two? They are both excellent short squeeze candidates. LDK has 11.3M shares shorted with a float of 32.8M (Mr. Peng still owns most of the shares, which actually speaks well of his faith in the company).

LDK is a solar maker. Since Obama is a noted “green” and alternate energy proponent, virtually all solar stocks should benefit as he is inaugurated. Further there is likely to be some stimulus for the solar industry built into the approx. $1 trillion stimulus package. This should benefit all solars, even foreign solars such as LDK. LDK has extensive long term contracts. LDK has already sold all of their 2009 production for fixed prices. If the recession worsens (as many expect), it is unlikely that LDK will have to sell any of their production for reduced prices. Rather, the price of raw polysilicon has been falling, so it is likely that LDK will be able to increase its margins as the year goes on.

Further LDK will have its own polysilicon plants coming online in 2009. The first stage of the big one is supposed to be functioning by the spring. This too should allow LDK to raise their margins. If you add LDK’s already fantastic numbers to this, you get a really pretty picture. LDK has a PE of 4.28, an FPE of 3.10, and a PEG of 0.09 (Yahoo finance). If the market starts to take off to the upside, LDK, with a Beta of 1.3, is sure to follow. When this happens, the short squeeze will kick in. The short sellers will have to cover their positions; LDK’s fundamentals are just too good not to. The short interest is about 35% of the float. It is supposed to take about 5 days to cover it. That should provide for quite a rally. Further the short interest has decreased about 10% in the last month without a substantial rally. This bodes well for LDK’s direction in the case of a good January Obama rally. Oil is also positioned to rally. An oil rally could be further spurred on by the infrastructure spending the Obama stimulus plan is now proposing. If this happens, it will add further fuel to the LDK rally.

CYPB is a new biotech company which has recently submitted a fibromyalgia drug, milnacipran, to the FDA for approval. CYPB submitted based on two phase 3 studies. Since that time, they have completed a 3rd phase 3 study, which lends further credence to their claims for the drug. CYPB is currently at $6.65 (Friday’s close). The analysts say that CYPB could go to $15 if the drug is approved. Analysts also say CYPB could go to $1 if the drug is denied approval. The current average analyst rating on this stock is 1.5 (a strong buy). Piper Jaffray recently initiated a Buy rating on the stock. Zacks recently recommended it highly. Generally people think that it is no longer a question of whether the drug will be approved, but when. The FDA is a little backed up at the moment. Plus they could ask for more proof.

However, the most likely data they would ask for would be the data supplied by the 3rd phase 3 study, which was very positive. It also seems unlikely the CYPB will go to $1. CYPB has considerable money on its balance sheet (about $168M in net tangible assets) in cash and short term investments. This equates to about $4.4/share. It has no debt.

In addition there are many years of positive data on milnacipran from outside the US. The actual timing of the approval of this drug seems somewhat up in the air. However, it could come in the relatively near future. A January rally should push this stock price up considerably. If this happens, most of the short sellers are likely to liquidate their positions because the technical data on the new drug is very good. If the approval comes during this rally, the stock could overshoot the analysts' target price of about $15. There are currently 4.9M shares shorted with a float of 37.6M. Since this is a lightly traded stock, it would take 10 days for the shorts to cover.

This would provide a huge boost to the stock price. This looks like a great buy at least until after the huge boost it gets from the drug approval. At that time you would have to reevaluate the stock based on its new price and its future prospects. The upside gain potential is about $15 - $6.65 = $8.35. The longer term possible (but not probable) downside move is likely limited by CYPB’s net tangible assets value of $4.4/share. The downside potential is thus $6.65 - $4.4 = $2.35. This makes the risk/reward ratio on this stock $2.35/$8.35 = 0.28.

In other words, to get a likely profit of $8.35 you are only risking $2.35. If you make enough of this kind of investment, you are extremely likely to come out a big winner.

Disclosure: Author holds a long position in LDK and CYPB